Report

On September 5, 1961, section 19 (d) of the Securities Exchange Act was enacted, authorizing and directing the Securities and Exchange Commission "to make a study and investigation of the adequacy, for the protection of investors, of the rules of national securities exchanges and national securities associations, including rules for the expulsion, suspension, or disciplining of a member for conduct inconsistent with just and equitable principles of trade." The Commission was called. upon to report to Congress "the results of its study and investigation, together with its recommendations, including such recommendations for legislation as it deems advisable." 1

The wording of the law and its legislative history made clear that it contemplated a very broad study of the rules, practices, and problems in the securities business and the securities markets. The existing rules of the exchanges and of the National Association of Securities Dealers, the only existing national securities association, are themselves broad in scope and varied in content. But quite apart from the existing rules, it was made clear that the study was to be concerned with any inadequacy or lack of rules relating to any aspect of the securities business and securities markets, and also with problems that might require legislation or changes in the rules promulgated by the Commission. This was expressed in the report by the House of Representatives Committee on Interstate and Foreign Commerce 2 that preceded enactment of the law:

During recent months the president of the New York Stock Exchange has issued two very firm warnings against speculation in the stock market. The country's largest brokerage firm has run a dozen newspaper ads urging investor caution, and many other brokerage houses have alerted employees to the danger of uninformed public speculation. The National Association of Securities Dealers has written to all members expressing concern over the very large total of outstanding undelivered transactions. The Chairman of the Securities and Exchange Commission has stated that there have been evidences of a substantial amount of manipulation and that they have more manipulation cases in various stages of proceedings than ever before. The Commission has initiated an investigation of the American Stock Exchange to determine whether additional rules or laws are required to insure proper operation of the exchange **

Since the market collapse which led to the enactment of the Federal securities laws, there has been a rebuilding of public confidence in the securities markets as a result of both efforts at self-regulation by the industry and the enactment

1 H.J. Res. 438, 87th Cong., 1st sess. (known as the Mack resolution, after its author, Congressman Peter F. Mack, Jr., then chairman of the Subcommittee on Commerce and Finance of the House Committee on Interstate and Foreign Commerce) became law as Public Law 87-196. The resolution provided for a reporting date of Jan. 3, 1963, and provided $750,000 to carry out the study and investigation. On July 27, 1962. H.R. 11670 became effective as Public Law 87-561, extending the reporting date to Apr. 3, 1963, and increasing the authorized appropriation by $200,000.

2 H. Rept. 882, 87th Cong., 1st sess., pp. 2, 4 (1961).

of the statutes and their administration by the Securities and Exchange Commission. The maintenance of this confidence is most essential. There has been a great growth and increased activity in the securities markets. It is important to be informed as to whether at this time in the light of changed market conditions the investing public is afforded the protection which was envisaged in the passage of the original legislation. What new statutes or rules are needed? What now unregulated areas of the securities markets need regulations? What rules need change?

In view of the comments which recently have been made as to today's market conditions and the testimony before the committee relating to market practices and to violations of statutes and rules, and in view of the nearly 25 years which have elapsed since the last overall study of the operations of securities markets, it seems to this committee that it is now highly appropriate again to review the rules governing the activities of the various securities markets to see whether they are adequate to protect investors, to determine just how they are being administered by the exchanges and the over-the-counter associations, and whether changes, modifications, or expansions of the rules or statutes are desirable now in the public interest.

Awareness of the general nature and scope of these changed conditions coincided with an absence of precise information and data about them. Although the Commission had from time to time conducted specific studies of certain aspects of securities markets, some of the very developments that had given rise to new questions and problems had so overburdened the Commission and its staff with routine administrative and enforcement work as to preclude adequate study of these changes and of the adequacy of existing regulatory institutions and procedures to deal with them. The creation of what came to be known as the "Special Study of Securities Markets" (Special Study) was thus regarded by the Congress and the Commission itself as a necessary measure to provide comprehensive and current data on both old and new phenomena in the market.

To appreciate the full scope of the new section 19 (d) and the significance of its focus on the rules of national securities exchanges and national securities associations, it is necessary to bear in mind the existing pattern of regulatory controls and the expressed purposes of Congress in directing the investigation and report.

2. RULES OF THE EXCHANGES AND SECURITIES ASSOCIATIONS IN THE REGULATORY PATTERN

The body of Federal securities law is comprised of six separate statutes, the first two of which, the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act),

In chronological order and stated briefly, the statutes are: (1) The Securities Act of 1933, 15 U.S.C., sec. 77a, et seq. (2) The Securities Exchange Act of 1934, 15 U.S.C., sec. 78. (3) The Public Utility Holding Company Act of 1935, 15 U.S.C., sec. 79. This was enacted to meet the special problems of those companies holding as subsidiaries gas and electric utilities; it requires the holding companies' registration, regulates their finances and operations, and provides for simplification and integration of the holding company structure. (4) The Trust Indenture Act of 1939, 15 U.S.C., sec. 77aaa, et seq., integrated with the Securities Act, provides that bonds and similar evidences of indebtedness shall be issued under an indenture meeting specified requirements, including an independent and financially responsible trustee, and that the indenture be duly qualified with the Commission. (5) The Investment Company Act of 1940, 15 U.S.C., sec. 80a, concerns entities whose primary business is investing in other companies; such entities must register, and provision is made for regulation of their management, voting and capital struc ture, their financial reporting, and the offering of their securities. (6) The Investment Advisers Act of 1940, 15 U.S.C., sec. 80b, requires the registration of persons whose business is advising or informing others about securities, and regulates their contracts and transactions.

The Commission is also responsible, under the Bankruptcy Act, ch. X, 11 U.S.C., sec. 608, for advising courts sitting on corporate reorganizations under that statute.

are basic to the regulatory scheme and most relevant to this study. These and the other four statutes are administered by the Commission, an independent administrative agency of the Federal Government. The Securities Act, often referred to as the "truth in securities" law, requires full disclosure in the flotation of securities (by any means of transportation or communication in interstate commerce or by the mails), and prohibits fraud in their sale. In brief, it requires issuers of securities to register them with the Commission before they are distributed and to disclose in a prospectus, of prescribed content, information important to a prospective investor's assessment of the security offered and the investment risks involved. It also prohibits fraud and misrepresentation in the sale of securities on initial distribution or thereafter. It does not, however, authorize the Commission to pass on the merits of securities or to determine which securities may be offered to the public.

The Exchange Act regulates securities markets and the business of securities brokers and dealers. It adopts two regulatory techniques. One is to impose direct requirements and prohibitions, either as statutory provisions or as rules and regulations promulgated by the Commission pursuant to the statute. The act requires, for instance, that securities exchanges register or obtain exemption from registration as a prerequisite of lawfully doing business. Similarly, it requires registration of securities, with limited exceptions, before they may be lawfully traded on an exchange. Other direct prescriptions restrict borrowing by brokers and dealers; prohibit the manipulation of prices of securities traded on exchanges and the use of manipulative or deceptive devices, as defined by the Commission, in the sale or purchase of securities; require issuers of securities listed on an exchange to file annual and other periodic reports; direct the furnishing of specified information in connection with proxy solicitations; and provide for the recapture by issuers of "short swing" profits derived from purchases and sales of securities by corporate "insiders."

The second regulatory technique of the Exchange Act is reliance on supervised self-regulation. This involves control of exchange markets by requiring or permitting national securities exchanges to adopt rules governing their practices and procedures and the business conduct of their members, and in each case imposes the responsibility for enforcement of these rules on the exchanges themselves. It requires exchanges, for instance, to adopt rules providing for the expulsion, suspension, or disciplining of a member for conduct inconsistent with just and equitable principles of trade; it expressly permits them to adopt rules on other specified subjects; and it generally authorizes them to adopt any rules not inconsistent with the act. Pursuant to these provisions, each of the major exchanges has a substantial body of rules covering operations and activities of members both inside and outside the actual marketplace. The constitution and rules of the New York Stock Exchange (NYSE), for example, filling almost 350 pages, deal extensively with such subjects as membership; commissions and service charges; dealings and settlements between members; activities of such members as specialists and floor traders; operation of member organizations, including capital requirements, the conduct of customers' accounts, financial statements, advertising, and market letters and sales literature; private wire and other connections; and the listing and delisting of securities.

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