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movements may result from uninformed investor action and that maximum exposure of financial and public information is crucial to securing knowledgeable evaluation of these securities. The Commission will, therefore, recommend to the Congress that, in the case of new issues, the 40-day period be extended to 90 days or such shorter period as the Commission may prescribe by rule or order.


Much of the material submitted evidences the fundamental importance of adequate disclosure by issuers as a most vital means of investor protection. The report points out the broad range of problems and abuses in the securities markets, including improper selling practices, misleading public relations, irresponsible investment advice, and erratic "after markets” for new issues, which can be greatly mitigated by the more complete availability and dissemination of financial information. The report further demonstrates, as have prior studies, that the longstanding contrast in the disclosure-oriented protections afforded investors owning securities listed on national exchanges and investors owning securities traded in the over-the-counter market is not warranted. Issuers of over-the-counter securities, unlike their listed counterparts, are under no obligation to comply with the Commission's proxy rules or, except in certain cases, to furnish annual and periodic financial reports. Another void in investor protection in the over-the-counter market relates to insider trading. An insider of a listed company must report his transactions in the company's stock; his short-swing trading profits in the stock are recoverable by the company; and he is prohibited from selling the stock short. The policies expressed in these sections should also be applicable in the over-the-counter market. The so-called sponsorship problem, where an underwriter makes an after-market in a stock he has underwritten and at the same time is represented on the board of directors of the issuing company, has been carefully analyzed by the study. Its findings indicate that the application of the insider trading provisions will not disrupt trading markets in over-the-counter securities, except perhaps in very limited instances which could be handled through exemptions on a case-by-case basis.

Accordingly, the Commission will recommend extension of those sections of the Securities Exchange Act of 1934 which provide for the filing of annual and periodic reports, compliance with the proxy rules, and protections against insider trading to certain companies whose securities are traded in the over-the-counter market. A phased program of coverage would gradually include all those companies with 300 or more stockholders. In the case of bank stocks, which appear to account for about 20 percent of the issues of the over-the-counter market, if Congress so desires, disclosure requirements could be administered by the appropriate Federal bank regulatory authorities in order to integrate these controls with the existing patterns of bank regulation.

An analysis of the over-the-counter market will be submitted in our complete report. At this time, however, we wish to inform the Congress that we shall propose a legislative recommendation essentially directed to the wholesale quotations systems of that market.

At present the National Quotation Bureau dominates the business of over-the-counter wholesale quotations. The Bureau, a private corporation, is not regulated by any agency, Federal, State or self-regulatory. Despite the efforts of the Bureau, which has operated with a conscientious regard for the responsibility which its function and dominant position entail, this crucial segment of the over-the-counter market has had inadequate controls; numerous abuses involving quotations have been perpetrated by broker-dealers. Moreover, developments in electronic data processsing have foreshadowed the emergence of new and perhaps revolutionary quotation systems. In view of the vital significance which these systems can have to the functioning of the over-the-counter market, they should not be allowed to emerge without due regard to the welfare of the market and to the public interest.

Accordingly, the Commission will recommend to the Congress that operators of quotations systems, like the National Quotation Bureau, be required to register with the Commission and adopt and enforce rules of fair practice in the use of their systems, just as is presently the case with the self-regulatory agencies.


We have described a substantial part of the legislative measures which we shall recommend to the Congress this year. A few others will subsequently be proposed; a very important one of these might concern certain aspects of security credit regulation—which would be submitted only after full coordination with the Federal Reserve Board. Not all of the study's legislative recommendations in the chapters transmitted have been adopted by the Commission; these are the subject of our continuing study and may be proposed to the Congress at a subsequent date.

To secure the benefit of industry views on our legislative proposals, we shall immediately request leaders of the financial community to form liaison committees.

IV The Report of the Special Study is a major contribution to the understanding of the operations and problems of the securities markets. In its collection and analyses of data, it provides a thorough and responsible foundation for action. Furthermore, the enactment of Public Law 87-196 and the very existence of a Special Study have assisted in the creation of a more salutary environment and have resulted in numerous important developments. The American Stock Exchange has undergone an intensive reorganization. The New York Stock Exchange has commenced a program for improved controls over selling practices and initiated new qualification standards. The NASD has undertaken a comprehensive revision of its bylaws and Rules of Fair Practice. Broker-dealers have reviewed and altered their systems of supervision. It would go too far to assert that all of these, and other numerous changes, are the direct products of the Special Study and of the initiating legislation. Yet it would be difficult to deny that their existence has at least produced a reevaluation of existing practices and procedures by the industry, as well as the Commission, which can only be beneficial. In other words, the financial community has taken the opportunity to make its own special study, with valuable consequences.

As has been pointed out throughout this letter, the Report of the Special Study is only a prelude; it discloses many problems whose resolution will require the efforts of the Commission, the exchanges, the NASD and the industry itself. To these we will now turn our attention. Our legislative recommendations to the Congress will be an important first element, indeed a prerequisite for needed improvements. However, much of the action may be taken through the self-regulatory agencies, through exercise by the Commission of existing powers and through the influence of leaders in the securities industry to raise standards.

In concluding, the Commission wishes to express its appreciation to the members of the financial community, the self-regulatory institutions and the numerous companies that fully cooperated with the Special Study. Many gave generously of their time and manpower in assisting the study to gather information and viewpoints.

The superlative efforts of the staff of the Special Study its supervisors must be especially singled out. All worked tirelessly and with a fine understanding of the heavy responsibility they were obligated to discharge. The Commission was uniquely and most strongly served in having Milton H. Cohen as Director, Ralph S. Saul as Associate Director, Richard H. Paul as Chief Counsel, Sidney M. Robbins as Chief Economist, and Herbert C. Schick as Assistant Director. Not to be overlooked are the contributions to the study in counsel and data collection of many persons in the operating divisions and offices of the Commission. By direction of the Commission:

WILLIAM L. Cary, Chairman.



Sir: I have the honor to transmit the second segment of the Report of the Special Study of Securities Markets, containing chapters V, VI, VII, and VIII. This report is submitted pursuant to section 19(a) of the Securities Exchange Act of 1934, Public Law 87–196, which directs the Commission to make a broad study of the adequacy of investor protection in the securities markets. The first installment of this report, chapters I through IV and IX, was delivered to the Congress on April 3, 1963; the final installment should be transmitted within the next few weeks.

The chapters of the report here transmitted deal with the trading markets, the exchange markets and the over-the-counter market. As we stated in our first letter of transmittal, this report should not impair public confidence in the securities markets, but should strengthen it as suggestions for raising standards are put into practice.


There is a wide diversity among the various markets. An exchange market is concentrated in a single place and has a limited group of professional participants, as well as a selected list of traded securities. The over-the-counter market, on the other hand, has no boundaries;

it is everything outside the exchange markets. It is scattered throughout the country and represents in essence the sum of many markets. It is characterized by unlimited entry both from the viewpoint of securities traded and persons trading. It is vast, diffuse and heterogeneous. Indeed, there was no composite picture of the over-thecounter market today until this study was completed.

Because of these differences the markets have received different regulatory treatment. The report points out the more extensive, and intensive, degree of controls over trading practices in the principal exchange markets as compared with the over-the-counter market. Consequently, the problems and needs of the over-the-counter market appear greater. But in both markets there are serious inadequacies in investor protection. Certain of these shortcomings have been of continuing concern to the Commission, such as floor trading in the principal exchange markets. Others are presented in a new context, as in the case of the odd-lot dealers. In still other situations, the Special Study has amassed the technical data necessary for a thorough analysis, for example, of the specialist system or of the operation of the over-the-counter market. Finally, the study affords a unified picture of the markets which previously have been viewed only in more or less isolated fashion. Thus, we are now in a position to appreciate the effect of the New York Stock Exchange commission rate schedule on the regional exchanges and the evolution of the "third market."

The study has properly focused on problem areas. To these the Commission, the self-regulatory agencies, and the financial community must respond with promptness and thoroughness. The importance of the capital markets to our economic progress does not permit otherwise.


As we said with respect to part I of the report, we have been exceedingly fortunate to have assembled such a superior group to conduct the study. The Special Study was given freedom to analyze and point out problems as they appeared to it; in this respect, the judgments, analyses, and recommendations in the report are those of the Special Study and not the Commission.

In connection with this installment, we highlight three further points. In the first place, we emphasize that the recommendations in this part of the report, with the important exception of controls over operators of quotations bureaus, can be effected, without amending the securities acts, through the medium of the rulemaking authority of the Commission or of the self-regulatory agencies. Moreover, as the Congress is aware, the Commission has made legislative recommendations which have been embodied in S. 1642, H.R. 6789, and H.R. 6793. These recommendations are substantially based upon and supported by the first installment of the Report of the Special Study. The Committee on Banking and Currency, U.S. Senate, has reported out S. 1642, as amended. It is the Commission's opinion that these bills represent essential amendments to the securities laws and that their enactment will significantly improve investor protection. Improvement will be achieved not only through more reliable disclosure as to companies traded in the over-the-counter market, but in the market itself, through raising qualification standards for those dealing in over-thecounter securities. We further point out that, although our legislative program is a part of a general effort to raise standards in the securities markets, the program stands by itself; thus consideration of the bills can appropriately proceed independently of the discussion and resolution of the questions raised in the chapters here transmitted.

Secondly, as we have indicated, this section of the report contains recommendations designed to be carried out by the Commission under its rulemaking power or by the self-regulatory agencies. It is inappropriate, therefore, for us to speak definitively on various of the questions presented, which involve substantive changes in our rules or the rules of the self-regulatory agencies. In most cases, we cannot legally take final action until interested persons are afforded an opportunity to present their views. In other instances, a hearing and the making of a record may be necessary. In any event, we believe the responsible course of action calls for discussions with the securities industry before any final decisions are made.

Finally, as the study itself has so carefully pointed out, these problems are subtle and complex; many are just emerging, and many call for further study. Some subjects, such as automation, are long-range in nature, far-reaching in impact, and require a continuing and more elaborate analysis of a development only in its infancy in the securities industry. Many other recommendations are of a similar nature. For example, any conclusions about certain of the recommendations concerning the over-the-counter market must await further exploration and consultation with the industry. Similarly, any proposals regarding the structure of the New York Stock Exchange commission rate schedule must be premised upon a thorough understanding of the impact any change in that structure would have on other sectors of the securities markets, such as the regional exchanges.

These considerations, of course, do not preclude our endorsement of the general soundness of the report as a point of departure for discussion with the industry and for rulemaking. They do serve as a background to a more detailed response by us to the recommendations. We recognize that the Congress expects such a response, as evidenced by a letter dated April 5, 1963, from the Honorable Oren Harris, chairman, Committee on Interstate and Foreign Commerce, House of Representatives, requesting our views as to the specific recommendations contained in the first part of the report. We expect to send a letter within the next few days detailing our views on the specific recommendations in the second installment.


At the present time the Commission's efforts are heavily committed to our legislative program which is under consideration by the Congress and to the completion of the Report of the Special Study. Upon completion of these efforts, we shall concentrate upon those areas calling for exercise of our rulemaking authority or that of the self-regulatory agencies. In the meantime, the staff of the Commission is preparing proposals for presentation to the Commission and to the industry. A special Office of Program Planning has been established whose initial task will be to coordinate and assist the operating divisions and offices of the Commission in this large and very important task of carrying out recommendations of the Special Study. By direction of the Commission:

WILLIAM L. Cary, Chairman. 96-746-63—pt. 5-2

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