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IRTY-EIGHTH ANNUAL REPORT OF THE

:CURITIES AND EXCHANGE COMMISSION

the Fiscal Year Ended June 30th

) sale by the Superintendent of Documents, U.S. Government Printing Office

Washington, D.C. 20402 Price $1.50 (paper cover)

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SECURITIES AND EXCHANGE COMMISSION

Headquarters Office

500 North Capitol Street

Washington. D. C. 20549

COMMISSIONERS

WILLIAM J. CASEY. Chairman'"

HUGH F. OWENS

A. SYDNEYHERLONG.JR.

PHILIP A. LOOMIS.JR.

RONALD F. HUNT. Secretary

"'On November 30, 1972. President Nixon announced the nornination of Chairman Casey as Under Secretary of State for Economic Affairs.

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COMMISSIONERS AND

PRINCIPAL STAFF OFFICERS

(As of November I, 1972)

COMMISSIONERS Term expires

June 5

WILLIAM J. CASEY of New York, Chairman 1974

HUGH F. OWENS of Oklahoma 1975

A. SIDNEY HERLONG, JR. of Florida 1976

PHILIP A. LOOMIS, JR. of California 1972

Secretary: RONALD F. HUNT

Executive Assistant to the Chairman: CHARLES S. WHITMAN, III

PRINCIPAL STAFF OFFICERS

A. JONES YORKE, Executive Director

C. KING MALLORY, III, Special Assistant

ALAN B. LEVENSON, Director, Division of Corporation Finance

THOMAS N. HOLLOWAY, Associate Director

RALPH C. HOCKER, Associate Director

RICHARD H. ROWE, Associate Director

IRVING M. POLLACK, Director, Division of Enforcement

STANLEY SPORKIN, Deputy Director

G. BRADFORD COOK, JR., Director, Division of Market Regulation

JOHN M. L1FTIN, Associate Director

LEE A. PICKARD, Associate Director

SHELDON RAPPAPORT, Associate Director

MICHAEL SAPERSTEIN, ASSOCIateDirector

v
ALLAN S. MOSTOFF, Director of Investment Company

Regulation

ANNE P. JONES, Associate Director

AARON LEVY, Director, Division of Corporate Regulation

WALTER P. NORTH, Acting General Counsel

DAVID FERBER, Solicitor

PHILIP J. KEUPER, Director, Office of Public Information

JOHN C. BURTON, Chief Accountant

A. CLARENCE SAMPSON, JR., Associate Chief Accountant

GENE L. FINN, Chief Economist, Office of Policy Research

LEONARD HELFENSTEIN, Director, Office of Opinions and Review

W. VICTOR RODIN, Associate Director

ALFRED LETZLER, Associate Director

WARREN E. BLAIR, Chief Administrative Law Judge

WILLIAM E. BECKER, Chief Management Analyst

FRANK J. DONATY, Comptroller

ERNEST L. DESSECKER. Records and Service Officer

HARRY POLLACK, Director of Personnel

RALPH L. BELl, EDP Manager

vi
REGIONAL AND BRANCH OFFICES

REGIONAL OFFICES AND ADMINISTRATORS

Region 1. New York, New Jersey.- Kevin T. Duffy, 26

Federal Plaza, New York, New York 10007.

Region 2. Massachusetts, Connecticut, Rhode Island, Vermont,

New Hampshire, Maine.-Floyd H. Gilbert, Suite 2203, John

F. Kennedy Federal Bldg., Government Center, Boston, Mass.

02203.

Region 3. Tennessee, Virgin Islands, Puerto Rico, North

Carolina, South Carolina, Georgia, Alabama, Mississlppl,

Florida, part of Louisiana.-Jufe B. Greene, Suite 138,

1371 Peachtree Street, N. E., Atlanta, Georgia 30309.

Region 4. Illinois, Indiana, Iowa, Kansas City (Kansas),

Kentucky, Michigan, Minnesota, Missouri, Ohio, Wisconsin.-

John I. Mayer, Room 1708, Everett McKinley Dirksen Bldg.,

219 South Dearborn Street, Chicago, Illlnots 60604.

Region 5. Oklahoma, Arkansas, Texas, part of Louisiana,

Kansas (except Kansas City).-Robert F. Watson, 503

U.S. Court House, 10th & Lamar Streets, Fort Worth,

Texas 76102.

Region 6. Wyoming, Colorado, New Mexico, Nebraska, North

Dakota, South Dakota, Utah.-Donald J. Stocking, 7224

Federal Bldg., 1961 Stout Street, Denver, Colorado 80202.

Region 7. California, Nevada, Arizona, Hawaii, Guam.-

Gerald E. Boltz, Room 1043, U.S. Court House, 312 North

Spring Street, Los Angeles, California 90012.

vii
Region 8. Washington, Oregon, Idaho, Montana, Alaska.-

James E. Newton, 900 Hoge Bldg., Seattle, Washington 98104.

Region 9. Pennsylvania, Maryland, Virginia, West Virginia,

Delaware, District of Columbia.-William Schief, Room 300,

Ballston Center Tower #3, 4015 Wilson Boulevard, Arlington,

Va. 22203.

BRANCH OFFICES

Cleveland, Ohio 44199.-Room 899, Federal Office Bldg.,

1240 E. 9th at Lakeside.

Detroit, Michigan 48226.-1044 Federal Bldg.

Houston, Texas 77022.-Room 2606 Federal Office & Courts

Bldg., 515 Rusk Ave.

Miami, Florida 33131.-Suite 701 DuPont Plaza Center,

300 Biscayne Boulevardway.

Philadelphia, Pa. 19106.-Room 108, U.S. Customs Bldg.,

2nd and Chestnut Street

St. LOUis,Missouri 63101.-Room 1452, 210 North Twelfth Street.

Salt Lake City, Utah 84l1l.-Room 6004, Federal Reserve Bank

Bldg., 120 South State Street.

San Francisco, California 94102.--450

Golden Gate Avenue, Box 36042.

viii
COMMISSIONERS

WILLIAM J. CASEY, Chairman

Chairman Casey was born in Elmhurst, New York, on March

13, 1913. He received a B.A. degree from Fordham University in

1934 and an LL.B. degree from St. John's University in 1937. At

the time of his appointment to the Commission, he was a partner

in the New York law firm of Hall, Casey, Dickler & Howley and

the Washington law firm of Scribner, Hall, Casey, Thornburg &

Thompson. Mr. Casey has authored and edited a broad spectrum

of publications on legal, tax, financial and economic subjects, and

has served as Chairman of the Board of Editors of the Research

Institute of America and Chairman of the Board of Editors of the

Institute for Business Planning, a subsidiary of Prentice-Hall.

During World War II, he served as Chief of the Secretariat at the

European headquarters of the Office of Strategic Services and,

subsequently, Chief of O.S.S. intelligence operations In the European Theatre. In 1948, he served on the legal staff of the European headquarters of the Marshall Plan. Subsequently, he served

as special tax counsel for the Senate Small Business Committee.

He has served as a member of the General Advisory Committee on

Arms Control and as a member of the Presidential Task Force

on International Development. He has also been President of the

International Rescue Committee and of the Long Island Association. He has served as Trustee of Fordham University, of Good

Counsel College and of Catholic Charities in the Long Island

Diocese. Mr. Casey was sworn in as Chairman of the Securities

and ExchangeCommission on April 14, 1971.

ix
HUGH F. OWENS

Commissioner Owens was born in Muskogee, Oklahoma, on

October 15, 1909, and moved to Oklahoma City in 1918. He

graduated from Georgetown Preparatory School, Washington,

D.C., in 1927, and received his A.B. degree from the University of

Illinois in 1931. In 1934, he received his LL.B. degree from the

University of Oklahoma College of Law, and became associated

with a Chicago law firm specializing in securities law. He reo

turned to Oklahoma City in January 1936, to become associated

with the firm of Rainey, Flynn, Green and Anderson. From 1940

to 1941, he was vice president of the United States Junior Chamber of Commerce. During World War II he attained the rank of

Lieutenant Commander, U.S.N.R., and served as Executive Officer

of a Pacific Fleet destroyer. In 1948, he became a partner in the

firm of Hervey, May and Owens. From 1951 to 1953, he served

as counsel for the Superior Oil Company in Midland, Texas, and

thereafter returned to Oklahoma City, where he engaged in the

general practice of law under his own name. He also served as a

part-time faculty member of the School of Law of Oklahoma City

University. In October 1959, he was appointed Administrator of

the then newly enacted Oklahoma Securities Act and was active

in the work of the North American Securities Administrators,

serving as vice president and a member of the executive committee of that Association. He took office as a member of the

Securities and ExchangeCommission on March 23, 1964, for the

term expiring June 5, 1965, and was reappointed for the terms

expiring June 5, 1970 and 1975. Since June 1964, he has served

on the executive committee of the National Association of Regula.

tory Utility Commissioners.

A. SYDNEY HERLONG, JR.

Commissioner Herlong was born in Manistee, Alabama, on

February 14, 1909, and in 1912 moved to Sumter County, Florida,

and later to Lake County, Florida, where he attended public

schools. He received an LL.B. degree from the University of

Florida, Gainesville, Florida, in 1930, and commenced practicing

law in his home town of Leesburg, Florida. Commissioner Herlong

continued practicing law until 1937 when he was elected County

Judge of Lake County, Florida. He continued serving as County

Judge until 1948 when he was elected to the U.S. House of

Representatives, in which body he served until January 1969,

when he voluntarily retired. While serving in Congress, Mr.

Herlong was a member of the Post Office and Civil Service Committee, the Agriculture Committee, and, for the last seven terms,

the Ways and Means Committee. Upon retirement from Congress,

he became a consultant to the Association of Southeastern Railroads. He is a past president of the Flonda County Judges Association, the University of Florida Alumni Association and the

Florida State Baseball League. Mr. Herlong received the Good

x
Government Award from the Florida Junior Chamber of Commerce and the Distinguished Alumni Award from the University

of Florida. He took office as a member of the Securities and Exchange Commission on October 29, 1969, for the term of office

expiring June 5, 1971, and was reappointed for the term expinng

June 5, 1976.

PHILIP A. LOOMIS, JR.

Commissioner Loomis was born in Colorado Springs, Colorado,

on June 11, 1915. He receivedan A.B. degree,with highest honors,

from Princeton University in 1938 and an LL.B. degree, cum

laude, from Yale Law School In 1941, where he was a Law

Journal editor. Prior to Joining the staff of the Securities and

Exchange Commission, Commissioner Loomis practiced law with

t.he firm of O'Melveny and Myers in Los Angeles, California, except for the period from 1942 to 1944, when he served as an

attorney with the Office of Price Administration, and the penod

from 1944 to 1946, when he was Associate Counsel to Northrop

Aircraft, Inc. Commissioner Loomis joined the Commission's

staff as a consultant in 1954, and the following year he was

appointed Associate Director and then Director of the Division

of Trading and Exchanges. In 1963, Commissioner Loomis was

appointed General Counsel to the Commission and served in that

capacity until his appointment as a member of the Commission.

Commissioner Loomis is a member of the American Bar Association, the American Law Institute, the Federal Bar Association, the State Bar of California, and the Los Angeles Bar

Association. He received the Career Service Award of the National Civrl Service League in 1964, the Securities and Exchange

Commission Distinguished Service Award in 1966, and the Justice

Tom C. Clark Award of the Federal Bar Association in 1971. He

took office as a member of the Securities and Exchange Commission on August 13, 1971, for the term of office expiring June

5, 1972.

xi

TABLE OF CONTENTS

Organizational Chart

Commissioners and principal staff officers

Regional and branch offices

Biographies of Commissioners

Introduction by William J. Casey

PART I

IMPORTANT DEVELOPMENTS

Investor protection

Securities Investor Protection Corporation

Study of Unsafe and Unsound Practices

Legislation

National Clearing Corporation

Market structure

Policy statement

Commission rates

Nonmember access to exchanges

Exchange membership

Other Market Regulation

NASDAQ

Self-underwriting

Disclosure-related matters

"Hot" issues

Restricted securities: Rule 144

Rule 145

Proxy revisions

Registration statements

Disclosure by defense contractors

Broker-dealer securrties

Form S-16

Regulation B

iv

v

vii

ix

xix

3

3

3

4

5

6

7

7

8

8

8

10

10

10

11

11

12

13

14

14

14

15

15

15

xiii
IMPORTANT DEVELOPMENTS-Continued

Investment companies 15

Proposed Oil and Gas Investment Act 15

Sale of investment adviser 16

Variable life insurance 17

Enforcement matters 17

Penn Central investigation 17

Pyramid sales plans 18

Commission reorganization 19

PART 2

THE DISCLOSURESYSTEM 23

Public offering: The 1933 Securities Act 24

Information provided 24

Reviewing process 24

New registration guides 24

Environment and civil nghts 25

Time for registration 26

Organizational changes 26

Oil and,gas 26

Tax shelters 26

Condominiums 27

Personnel changes 27

Small Issue Exemption 27

Regulation A 28

Regulation B 28

Regulation E 28

Exempt offerings under Regulation F 28

Continuing Disclosure: The 1934 Securities Exchange

Act__________________________________________ 28

Registration on exchanges 29

Over-the-counter registration 29

Exemptions 29

Periodic reports 30

Proxy solicitations 30

Litigation on proxy rules 31

Takeover bids, large acquisitions 32

Insider reporting 32

Short-swing trading litigation 33

Accounting 34

Relations with the accounting profession 35

Accounting and auditing standards 35

other developments 36

Exemptions for international banks 37

Trust Indenture Act of 1939 39

Information for pUblic inspection; Freedom of Infor- mation Act 39

Publications 41

Freedom of Information Act litigation 42

xiv
PART 3

REGULATION OF SECURITIES MARKETS 47

Regulation of exchanges 47

Registration 47

Exchange rules 48

litigation on exchange rules 49

Delistings 50

Exchange disciplinary actions 51

Inspections 51

Supervision of NASD 52

NASD Rules 52

litigation on NASD rules 53

Inspections 54

NASD disciplinary actions 55

Review of NASD disciplinary actions 55

Review of NASD membership action 56

Broker-dealer regulation 56

Registration 56

Financial reports 57

Income and expense reports 57

Broker-dealer examinations 57

Rule changes 58

Reserve and segregation requirements 59

"Box-Count" Rule 59

Financial and operational condition 59

New broker-dealer disclosure 60

Net capital 60

Financial reports 61

Clearing arrangements 61

Stabilization reports 62

SECD broker-dealers 62

SIPC litigation 62

PART 4

ENFORCEMENT 67

Detection 67

Complaints 67

Market surveillance 68

Investigations 68

litigation 68

Enforcement proceedings 69

Administrative proceedings 70

Disciplinary Proceedings 71

Disqualification of attorneys 72

Registration statements/reports 73

Trading suspensions 74

Judicial review 75

Civil proceedings 75

Participation as amicus curiae 82

xv
ENFORCEMENT-Continued

Criminal proceedings 85

Organized crime program 86

Proposed Swiss treaty 88

Cooperation with other enforcement agencies 88

Foreign restricted list 89

PART 5

INVESTMENT COMPANIES AND ADVISERS 95

Economic, regulatory matters 96

Mutual fund distribution 97

Number of registrants 98

Specialized investment companies 98

Applications 100

Rules and guidelines 101

Performance fees 101

Series companies 101

Capital gains distribution 101

Combined orders 102

Fidelity bonds 102

Adjournment of shareholder meetings 102

Small business investment companies 102

Registration guides 103

PART 6

PUBLIC-UTILITY HOLDING COMPANIES 107

Composition 107

Proceedings 108

Financing 109

legislation 110

PART 7

CORPORATEREORGANIZATIONS 113

Summary of activities 114

Administrative matters 114

Trustee's investigation 118

Reports 120

Allowances 124

Intervention in chapter XI 126

PART 8

SEC MANAGEMENT OPERATIONS 133

Reorganization 133

Other changes 133

Executive Director 133

Office of Public Information 134

Others 134

OMS Study 135

Financial management 135

xvi
SEC MANAGEMENT OPERATION5-Continued

Personnel management 135

Recruiting 135

Reduction in average grade 136

Service and merit awards 136

Training and development 137

New classification standard for investigator posi- tions 137

Position management and control 138

Electronic data processing 138

PART 9

STATISTICS 141

The securities industry 141

Securities industry dollar 141

Chart: Securities Industry dollar: 1971 142

Income and expenses 143

Table: Broker-dealer Income and expenses 143

Assets and liabilities 144

Table: Broker-dealer assets and liabilities 144

Registered broker-dealers 146

Table: Registered broker-dealers 146

Table: Location of broker-dealers 147

Broker-dealers, branch offices, employees 149

Chart: Broker-dealers and branch offtces-sEmployees 148

SECObroker-dealers 149

Table: Principal business of SECObroker-dealers 149

Financial Institutions 150

Stock transactions 150

Table: Institutional stock transactions 150

Stock holdings 151

Table: Institutional stock holdings 151

Investment companies 152

Table: Registered investment companies 152

Chart: Number and assets of registered investment companies 153

Investment company registrations 154

Table: New investment company registrations __ 154

Table: Investment company registrations terminated 154

Private noninsured pension funds: market value 155

Table: Market value of private noninsured pension funds 155

Private noninsured pension funds: book value __ 155

Table: Book value of private noninsured pension

funds 155

Securities on exchanges 156

Exchange volume 156

Table: Exchange volume: 1971 156

488-483 0 73 2

xvii

• -
xvih

STATISTICS--Continued

Secunties on exchanges-Continued

Stock volume by exchanges; NASDAQ volume __ 157

Table: Share volume by exchanges 157

Table: Dollar volume by exchanges 157

Third market volume 158

Chart: 'Third market' volume in NYSE stocks 158

Block distrlbutrons 159

Table: Block distnbutions reported by exchanges 159

Value and number of exchange securities 160

Table: Value of securities on exchanges 160

Chart: Market value of stocks on exchanges 161

Table: Value of stocks on exchanges 161

Securities on exchanges 162

Table: Unduplicated count of secunties on ex- changes 162

Table: Securities traded on exchanges 162

1933 act registrations 163

Effective registrations; statements filed 163

Table: Effective registrations 163

Chart: Securities effectively registered 164

Purpose of registration 165

Table: Effective registrations by purpose and type

of security: fiscal 1972 165

New corporate securities for immediate cash sale 166

Chart: New corporate securities effectively regis- tered 166

Regulation A offerings 166

Table: Regulation A offerings 166

Enforcement 167

Types of proceedings 167

Table: Types of proceedings 167

Enforcement proceedings 170

Table: Administrative proceedings 170

Table: Injunctive actions 170

Table: Cnminal cases 170

Public utrltty holding companies 171

Assets 171

Table: Public-utility holding company sysems 171

Financing 172

Table: Financing of holding company systems __ 172

Corporate reorganizatrons 173

Commission participation 173

Table: Proceedings under chapter X of bankruptcy act in which the commission participated: fiscal year 1972 173

SEC operations 175

Net cost 175

Chart: Appropriated funds vs fees collected 175

Table: Budget estimates and appropriation 176
INTRODUCTION

ByWilliam J. Casey, Chairman

Securities and Exchange Commission

CHANGE IN THE SECURITIES

MARKETS

As the June 30. 1971 fiscal year

came to an end. there were many problems clamoring for attention in the

structure and operation both of the securities markets and of the institutions

on which these markets depend.

In assigning priorities to these problems. the Commission focused its attention first on the economic soundness of

the firms making up the securities industry. their financial responsibility and

the safety of Investors' cash and secunties left in their custody. During the

previous years. the failure of substantial

firms had brought about Congressional

enactment of the Secunties Investor

Protection Act potentially committing a

billion dollars of public funds to guaranteeing the safety of cash and securities left with brokerage firms by public

customers. There was a widespread recognition that brokerage firms needed

xix
.'~

more adequate, more liquid and more

permanent capital, that their procedures

and accountability had to be tightened

up and that there had to be closer surveillance over their financial and operational soundness. At the same time,

there was a clear need to reshape the

structure of the markets themselves to

modernize the way securities were both

traded and transferred. Thus, going into

the fiscal year, the Commission sought

to strengthen the industry and' its accountability to, and financial protection

for, its customers while developing a

policy and a framework for modernizing

the structure of the markets. To lay the

basis for the latter, it scheduled hearings at which investors, members of the

industry and all those interested were

asked to present their views on the future structure of the securities markets.

At the same time, there was strong emphasis on developing greater clarity and

certainty in the rules governing the sale

of securities and on making financial information on more companies available

to the public as well as improving the

quality and sensitivity of financial reporting and disclosure. These three concerns-financial responsibility of the industry, the structure of the markets and

better disclosure to investors-were the

foci of major actions taken by the Commission during the 1972 fiscal year.

Additionally, through staff studies, advisory committees or public hearings,

the Commission undertook a thorough

review of its policy, rules and practices

In these areas:

(1) unsound and unsafe practices in the securities industry,

(2) the future structure of the

markets,

(3) enforcement policy and procedures,

(4) disclosure and marketing

practices with respect to hot

or new issues,

xx

(5) rules governing the resale of

restricted stock, stock issued

in acquisitions, private offerings and intra-state offerings,

(6) real estate securities,

(7) use of earnings forecasts in

disclosure documents,

(8) use, coordination and simplification of reports and other

requirements imposed on issuers, broker-dealers and investment companies by the

Commission and the selfregulatory agencies,

(9) oil and gas offerings in the

course of developing an improved Regulation B and formulation of an Oil and Gas

Investment Act pursuant to

Congressionalrequest, and

(10) advertising, sales compensation, pricing and related

problems in the economics

and marketing of mutual

funds.

Financial Responsibility and

Accountability

Investor confidence is the cornerstone of public participation in the securities markets. Much was lost in the

broker-dealerfailures of 1969 and 1970.

The lessons of that financial crisis in'

the securities industry, the creation and

operation of the Securities Investor Protection Corporation and new emphasis

on early detection and prevention of potential firm failures have led to major

new rules to assure financial responsibility and accountability in the securities

industry and justify renewed investor

confidence.

A major undertaking during the 1972

fiscal year was the working out of basic

provisions for a comprehensive rule governing the day-to-day control and protection of customer cash and securities

left with brokerage firms. Congress in

passing the SIPC legislation in late

1970 gave the Commission specific

"
powers to develop rules to prevent misuse, improper segregation and loss of

control over customer assets.

It was important that this be effected

without disrupting the flow of certifrcates to consummate transactions, and

without placing an unnecessary strain

on the banking and brokerage system

by requiring billions of dollars to lie fallow.

This was substantially accomplished

in a rule proposal circulated in May.

The new Rule (15c3-3) controls use of

customer funds by requiring broker-dealers to set up reserve bank accounts to

cover all customer assets not being

used in specified, limited, non-risk areas

of customer service. The size of the reserve account for each firm is calculated continually through a formula applied to all broker-dealers carrying

public accounts. For customer secunties

left with the firm, broker-dealershave to

show actual possession or control of

such securities in such locations as

banks or certificate depositories. Specific time limits are set for establishing

and verifying control or possession of

these securities and penalties are imposedfor exceedingthem.

The many provisions of this rule accomplish the major intent of Congress

by isolating customer assets from the

risk of the broker-dealer's business in

such areas as underwriting or firm trading for its own account. They also prohibit unwarranted expansion of a firm's

business which had been accomplished

by some broker-dealersthrough use of

customer funds, a major factor in the

collapse of many broker-dealers in recent years, The rule penalizes faulty

record-keepingby increasing the amount

of reserve that must be set aside

against customer assets. Finally, these

provisions are fully consistent with efforts by the Commission, the industry,

and others to bring about a total systems approach to the processing of securities transactions and the changing

of ownership through improved clearance and settlement operations, computerized deposrtories and eventual ellrnlnation of the stock certrficate. The rule,

with minor modifications and amendments, went into effect around the turn

of the 1972 calendar year.

The protection given investors

through this rule should be looked at as

only part of a total program covering a

series of interrelated and comprehensive

new requirements. In July, 1971, thel

Commission required Immediate reporting by broker-dealers of any VIolations

of rules governing net capital or any

non-current status of books or records.

At the same time, any broker-dealer

whose aggregate debt was more than

12 tunes ItS net capital was required to

report in full its operational and financial condition within 15 days after the

end of the month in whrch this ratio occurred. In November, 1971, the Commission passed a rule mandating quarterly box counts by broker-dealersof all

securities and certrficatron of secuntles

not in the broker's possession. To increase reporting of financial condition

of firms to their customers, the Commission last June passed an amendment to Rule 17a-5 requiring drstnbunon of balance sheets on a quarterly

basis to all customers. And to provide

for effectrve screening and regulation of

new firms entering the securities business, the Commission in the same

month passed amendments to Rules

15c3-1 and 15bl-2, increasingminimum

required net capital for new firms entermg the secunnes business and requiring

detailed presentations on the firm's facilities, personneland financing.

These amendments, like many others,

were an outgrowth of the Commission's

1971 Study of Unsafe .and u'CSOJ!11Ji

Practices detaillng the causes of the

1969-70 financial crisis in the securities industry.

Steps to insure financial soundness

and operatronal efficiency in the indusxxi
try were not limited to rule changesand

new requirements. The Commission has

also established the Office of Chief Examiner to intensify its inspection of

broker-dealers and its oversight over

self-regulatory agencies. In March,

1972, the Commission submitted to

Congressthe draft of a proposed bill to

give to the Commission additional authority over the entire paperwork processing mechanism in securities transactions. Two other bills were subsequently

introduced, both in the House and

Senate. All contemplate that the Commission will set standards for performance, operational compatibility, access

to facilities and standards for safety of

cash and securities. The thrust of this

legislation is to provide coordination

and direction for a nation wide system

for clearance, settlement and ownership

transfer in securities transactions. In

addition, to speed the development of

new systems for securities processing,

the Commission in the 1972 fiscal year

created a special operations group composed of former securities industry operations personnel to work closely with

the industry on stock deposltones,

clearing and settlement systems and

elimination of the stock certificate.

Restructuring of the Markets

In addition to knowing that the bro-

'ker he is dealing with is financially

C 'sound and operating under close regula-

~, :tory supervision, the investor should be

'able to exercise investment judgments

! in markets that are liquid, free from

l manipulation, fair to large and small

investors and geared to make the best

price available to investors in all parts

f the country at all times. These factors, plus an emphasis on making available to investors the most professional

service possible, are the continuing

thrust of the Commission's efforts in

the restructuring of the securities markets.

xxii

Both the nature of the securities markets and the economics of the securities business have undergone rapid

and radical change with increasing

institutionalization of the market. Today,

while individuals still own most of the

stock, institutions do most of the trading. In recent years, the massive flow of

large block trades from institutions has

required new market mechanisms outSide the specialist and the auction market for their absorption. Increased institutional emphasis in brokerage services

has led to new research, positioning

and execution functions unknown until

recently. A commission rate structure

often not reflective of the economic

realities of the business and pressure

from institutions to cut or reallocate

commissions has led to a maze of practices which themselves affected the pattern of securities trading. The overall results, on the one hand, have been the

creation of substantial new market

mechanisms for handling of today's volume and a greater professionalism in

brokerage services, particularly in research. On the other hand, these

changes had brought a fragmentation of

markets, an absence of information on

many trades, a directing of transactions

to some markets on the baSISof commission practices rather than best price,

and a growing gap in the quality of investment research services available to

individuals as compared with institutions.

The concern of the Commission is

that in the future structure of the securities markets competition be made to

work for the investor. Our intent is that

markets become more publicly oriented,

more liquid and that full information on

transactions, quotations and the performance of issuers put the individual

and the institution on an equal footing

in getting information neededfor investment decisions and in obtaining the

best available price.

Accordingly, in October, 1971, the

~
Commission began two months of hearings to get the views of all concerned

with the structure of the markets and

the economics of the securities industry: investors and investor groups, stock

exchanges, other self-regulatory agencies, Institutions, brokerage firms and

securities industry groups. Out of these

hearings, we developed our Policy Statement on the Future Structure of the Secunties Markets, published In February,

1972.

At the heart of the Commission's

market structure policy is a central market system for listed securities. The development of competing markets to

handle the increasing number and complexity of securities transactions should

be directed so that these markets are

part of an all-inclusive system with full

disclosure of activrty, comparable regulation and standards, and direct competition between market-makers based on

performance. The central market would

not be one market, but in fact a communications system tying together all

competing markets so that investors

can see where the best pnce is

available. In this way, trades will flow to

the best market, whether it be in New

York, California, cmcago and whether it

be on the floor of an exchange or in the

office of a market-maker. Only in this

way can competition be put to work for

the investor. Only through centralization

of information can the separate capabilities of our markets be combined to

strengthen the overall ability of the riation to mobilize and allocate capital.

To implement the development of the

central market system and other policy

recommendations, the Commission

sought to utilize the practical expertise

of those most directly involved. Advisory

committees comprised of experienced

members of the industry and other

qualified experts were named to provide

the Commission with a full range of options and suggestions. One committee,

the Advisory Committee on Market Dis,

closure, has recommended the structure

and governance of a reporting system to

include last sale and volume information from all markets In a composite

presentation, With trades identified by

market. Thrs Committee now is at work

on recommendations for a system that

will provide the heart of the central

market: a quotations network that would

capture and display current quotations

from all competing market makers so

brokers can direct investor orders to the

best market. Another committee, the

Advisory Committee on a Central Market

System, IS developing recommendations

on regulation and operating standards

for competing markets in the system,

as well as the proper means for providing economic access among such markets. The third group, the Advisory

Committee on Block Trading has sub.

mitted recommendations relating to the

impact of large blocks on secuntres

markets and methods of handling them,

which are now under study by the Commission's staff. The staff IS also conducting its own analysis of how the central market system should be designed,

implemented and regulated.

During the fiscal year the Commission developed two rule proposals as a

first step toward a regulatory framework

for the central market system. One Rule,

17a-14, requires registered exchanges

and the National Association of Securities Dealers to make quotations of

listed secunties traded by their members available on a continuing baSIS;the

second, 17a-15, requires these agencies

to make last sale and volume information available on a current, real-time

basis. The next step in this process will

be the promulgation of short sale and

other rules necessary to make the

transaction and quotation disclosure

systems not misleading. Once these

communications systems are operational, the course toward the development of a truly national central market

system will have been set.

xxiri
The central market system is not an

end in itself. It IS a crucial part, but

only a part, of what should be a totally

professional investment service to the

public. The system would inform the

broker of all markets being made in a

security and enable him to achieve the

best possible price for his customer.

But the best execution in the world is

worth little If the investment decision is

based on service that is unprofessional

and Hl-lnformed.The second critical recommendation of the Commission's policy statement sought to improve the

quality of service to all investors by directly addressing the problems of commission rates, investment research and

suitability, reciprocal practices in sale of

investment company shares, and institutional membership. Together these issues present a complex, Interrelated,

often jumbled picture that can be clarified only by policies that bring all practices into the open and subject them to

the test of public Interest.

In the case of brokerage commissions, a drastic overhaul of the rate

system clearly is called for and IS taking place. In April. 1971, negotiated

rates were introduced into the fixed-rate

system for the first time, covering portions of orders over $500,000. In this

fiscal year, the negotiated rate sector

was expandedto portions of orders over

$300,000. Over the full range of the

commission schedule, the Commission

reviewed and allowed implementation of

a new rate schedule by the New York

Stock Exchangewhich eliminated a temporary surcharge on smaller trades

while at the same time It provided rate

relief for the industry on these transactions. Because the rate structure bears

so closely on the availability of investment services, the policy of the Comrnissron IS to weigh the pace of expansion of competitive rates against its

economic impact on firms.

The Cornrnissron's policy statement

described research as an integral and

vital part of any truly professional investment process. In an elaboration of

that statement last May, the Commission said that investment managers

need not necessarily seek the lowest

price for brokerage services in discharging their fiduciary obligations, providing

that the quality of research and other

brokerage services available at a higher

cost can justify that cost difference. Our

concern for the quality of service available to Investors extends also to creation of new services by broker-dealers

and others that will provide individualized investment advisory services, probably computerized, to direct investors

With relatively small amounts of money

to invest. The Commission after the

close of the fiscal year appointed an industry advisory committee to review its

rules with a view to encouragingthe development of such services and recommending standards for them.

In another area, the Commission has

been concerned about reciprocal practices whereby mutual funds reward

broker-dealersfor the sale of fund shares

by directing commission business

through them. Aside from the conflict of

interest this creates for the broker in

recommending fund shares, and the investment manager in seeking best execution, there are very substantial problems of non-disclosureto buyers of the

compensation paid to sell to them and

of improper cost to fundholders who in

effect may pay for the distribution of

shares to others through commission

dollars. The Commission in ItS policy

statement recommended that these

practices be terminated. The NASD at

mid-year published for comment [or

proposed] a rule barring the directing

of brokerage by mutual funds on the

baSISof the sale of fund shares.

Finally, the question of who should

be members of exchanges is closely

tied to any consideration of quality of

service to the investor. The view of the

Commission expressed in its policy

XXIV
___A-(

statement was that as the central market system develops it should have at

its heart a core of professional brokers

and market makers serving investors.

The primary purpose of these professionals would be to execute orders for

investors. This means that membership

on exchangeswould depend not on the

nature of the brokerageorganization but

whether it contributes to the purpose of

the market by serving investors other

than itself. After requesting the advice

and recommendations of exchanges,the

Commission issued for comment a proposed rule which would allow exchange

membership for broker-dealers if at

least 80 percent of the value of their

exchange securities transactions represents orders from non-affiliated customers.

As a further part of its efforts to implement a policy of maintaining the

fundamentally public character of the

securities markets, the Commission during the fiscal year sent to Congress a

bill that would empower it to further

regulate trading by existing exchange

members for their own or for affiliated

accounts. In essence, it would require

that all members, when trading for their

own accounts, be required to yield

priority, parity and precedenceto public

customers. This must not be confused

with our belief that all exchange members must do a predominantly public

business when transacting business on

an exchange;we are merely saying that

exchange members, when they do trade

for their own or for affiliated accounts,

even as market makers, must fully recognizetheir responsibility to the general

public and be prepared to yield to public orders.

Disclosure

American securities markets are the

strongest in the world in large measure

because the investor in the American

market is the best informed investor in

the world. Important steps were taken

or started in fiscal 19{2 to strengthen

this system of disclosure. These

changes were based on three concepts:

(1) that investor protection and confidence could be improved by converting

much of the "boiler plate" and other

meaningless language of the new offering prospectus and other documents

into meaningful disclosure about the issuer; (2) that greater certainty and clarity was needed in rules governing securities transactions, particularly those

involving the securities offering and resale process; and (3) that financial reporting should be made more comparable, more comprehensive, and more

meaningful.

Significant new disclosure concepts

grew out of hearings held in 1972 by

the Commission on new issues. These

so-called "hot issue" hearings dealt

with the role of the issuer, underwriter

and market-makers in the handling of

these first-time securities, many of a

highly speculative nature. Commission

proposals issued last July outlined potential requirements for companies

bringing their securities to the public

for the first time to discuss busrness

plans, budget projections, plans for use

of proceeds, and analysis of expected

markets. Equally important, these proposals spoke to the problem of meaningless prospectus language oriented

more to considerations of liability than

disclosure by requiring specific and direct description of this information and

other factors, as well as better organization and presentation of information to

highlight and clarify the elements of

risk and potential gain.

Commission emphasis on making disclosure more available, significant and

meaningful also extended to the volume

of information filed by companieswhose

securities already are publicly held. This

involved computerization to speed availability of reports on company insider

transactions; introduction of a requirement that companies specifically report

xxv
changes in auditors, with more detailed

disclosure when the change results from

a conflict of views; examination of a potential requirement that companies note

items for stockholders that are reported

in their annual reports to the Commission but not in their reports to shareholders; and the launching of a major

information dissemination program

aimed at getting more SEC data to the

public through inforrnatron vendors,

public libraries, broker-dealers, news

media and Commission publications.

To create greater clarity and certainty

in securities transactions, the Commission Implemented rules covering sale of

restricted stock. Rule 144 is only the

first of a series of rules governing troublesome aspects of securities offering

and resale. Work was completed in

fiscal 1972 which led to drastic revisions of disclosure and resale rules involved in mergers and acqursrtions of

companies. Work also began on examination of potentially more objective

rules In the private placement area. Our

objective in these changes is to remove

artificial barriers which have been troublesome to issuers in these areas and

at the same time create greater disclosure for investors.

The third phase of our disclosure activity Involved financial reporting. The

Commission is considering acceleration

of requirements for supplemental disclosure on the meaning of different accounting policies, the effect of changes

in these policies, the nature and significance of accounting choices and the

basis for and changes in assumptions

and estimates which could be Critical to

the financial results a company reports.

The independence of auditors and

their continuing responsibility was of

special concern. As mentioned, we now

require notice of auditor changes and

special notification if thrs resulted from

difference of views. We issued Accounting Series Release 123 recommending

that corporations establish audit committees composed of outside directors

to create a direct channel of communication between auditors and the Board

to give greater objectivity to financial

statements. In the fall of 1972, we issued another release proposing that

auditors report in timely fashion on the

fairness of material unusual changes or

credits reported to the Commission on

Form 8-K, our interim material information report form. At the same time, the

Commission proposed amending disclosure forms to require more comprehensive and timely disclosure on writedowns, writeoffs and extraordinary

charges. The thrust of this proposal

was to discourage arbitrary timing and

limited explanations on these often

highly sigrufrcant charges.

The Commission also looked into special problems of financial reporting encountered by companies engaged in defense and other long-term contracts,

and cited the need for companies to

specifically assess for investors the

problems and developments in contracts

and programs of a long-term nature.

This statement was an outgrowth of a

staff study on the severe problems encountered by LockheedAircraft Corporation in the C5Acontract.

The sale of real estate interests to

public investors, a business that has

emerged in recent years perhaps as the

largest user of public equity funds, was

also the subject of Commission disclosure activity. A special advisory committee of professionals was named during

the fiscal year to make recommendations for disclosure standards in this

complex and growing area. This group

completed its work in the fall of 1972

in a report with a principal recommendation calling for uniformity of regulanon on real estate offerings among

states, self-regulatory agencies and the

Commission.

xxvi
Enforcement Policy and Practices

The Commission undertook a sweeping review of Its enforcement operations

in fiscal 1972. A special advisory committee on enforcement policies and

practices in June issued a series of recommendations to improve, speed and

clarify enforcement procedures. The

Commission in September outlined, as a

result of the report, a policy to clarify

informal procedures in effect to provide f \I

persons under investigation with the op-

\portunity to present their positions prior

~o authorization of an enforcement pro-

'ceeding.The release also expanded the

authority of hearing examiners in the

conduct of administrative hearings.

Reorganization of Commission's

Staff

In its first major reorganization in 30

years, the Commission restructured its

staff into five operating divisions instead of three. The overall effect is to

concentrate resources by focusing all

enforcement and investigative activity in

one division, all disclosure activity in

another and all regulatory activity into a

third area composed of three divisions,

one dealing with markets, another with

money management and the third with

the Commission's public utility holding

company and reorganization responsibilities. This reorganization will enhance , r -'~

the ability to focus our talent and re- '-

sources and deal effectively with our

continuing problems of greatest priority

-those concerning the structure and

efficiency of the markets, the financial

responsibility and professional service

of the broker-dealer community, the

economics, distribution methods and

services of investment companies and

investment advisors, corporate disclosure and enforcement in all of these

areas. A major assignment of the divisions regulating trading market and

money management activity will be education and oversight to foster self-regulation and voluntary compliance. These

divisions have developedor are developing inspection manuals and compliance

manuals for broker-dealers and investment advisors, guidelines on insider

transactions, and a manual of policies

and procedures on the oversight of

self-regulation.

xxvii



PART 1

IMPORTANT DEVELOPMENTS

INVESTOR PROTECTION

A focus of Commission concern and

activity during the 1972 fiscal year was

the development of further safeguards

for investors in light of the securities industry problems revealed by the

1967-1970 operational and financial criSIS. The various steps that were taken

by the Commission, together with the

investor protection legislation previously

enacted by Congress and various measures adopted by the industry itself, were

designed to prevent a recurrence of the

conditions which then prevailed and to

provide a sound basis for renewed

Investor confidence.

Securities Investor Protection

Corporation

The enactment by Congress in December 1970 of the Secunties Investor

Protection Act ranks high among the

measures taken to provide increased

protection to investors. The Act created

a Securities Investor Protection Corporation (SIPC) to insure, up to specified

limits, cash and securities In accounts

of broker-dealer customers. WhIle SIPC

is funded pnmarily through assessments

on its members (membership consists

of all registered broker-dealers and exchange members, with limited exceptions), it has access to emergency

3
4 SECURITIES AND EXCHANGE COMMISSION

financing of up to $1 billion from the

U.S. Treasury.

As of June 30, 1972, following 18

months of operation, SIPC was Involved

in the liquidation of 43 broker-dealers in

17 states. It was estimated that over $7

million of SIPC funds would be required

to meet the claims of customers of

those firms. One of the major problems

encountered In SIPC liquidation proceedings has been that debtor firms

had senously inadequate, inaccurate or

even nonexistent books and records. As

a result, delays have been encountered

in satisfying customers' claims for

money and secuntres,

Study of Unsafe and Unsound

Practices

In the SIPC Act, Congress directed

the Commission to compile a list of unsafe and unsound practices by brokerdealers and to report to the Congress,

within a year, on the corrective steps

being taken under existing law and recommendations for additional legislation

which might be needed. The Commission's study was submitted to the Congress on December 28, 1971.1

In preparing Its report, the Commission drew on information In ItS own

flies and those of the self-regulatory organizations, including financial reports

filed by broker-dealers. The report also

referred to case studies of mdivrdual

firms With financial and operational difficulties, as well as industry surveys and

studies in the operational area by management consultant groups. Among the

areas analyzed in the report were the

1967 paperwork crisrs, the Impact of

the 1969-1970 market decline, the nature and use of broker-dealer capital,

management and operational deficiencres, the use of customers' funds and

securities, and stolen securities. The report also documented the need for an

early warning system, and Included a

critique on deficiencies in the self-regulatory scheme.

The report cited the following unsound

practices: (1) Inadequacy and impermanence of capital; in some cases, the

injudicious employment of capital that

did exist. (2) Over-emphasis on sales

and trading activitres at the expense of

operational resources. (3) There was an

absence of control of securities traffic

to provide assurance of prompt delivery

of securities and remittance of payments. The result was a virtual breakdown In the control over the possesSIOn, custody, location and delivery of

securrtres, and In the payment of money

obligations to customers, exposing customers to risk of loss. The industry, and

to an extent the self-regulatory bodies

themselves, had not implemented or

planned broad-based solutions to the

settlement process and the related flow

of paper. (4) Inability of self-regulatory

organizations to respond to the crisrs

With meaningful corrective measures.

The absence of an effective early warning system caused belated action when

the full impact of the cnsis was finally

ascertained. (5) Lack of experience of

princrpal members of many, pnncrpally

small, concerns, pointing up problems

in entrance requirements to the industry.

The Commission's Study detailed the

corrective measures already taken or

proposed by the Commission and the

industry, and the areas where the Commission deemed further legislation necessary. The most significant of these

measures (Including several adopted

after submission of the Study) and the

proposed bills are discussed elsewhere

in this annual report. Briefly, capital requirernents were made more stringent.

Control over securities was strengthened

by requiring broker-dealers to make

a quarterly physical examination and

count of firm and customer securities.

Rules were proposed to provide greater

protection for customers' free credit

balances, and for securities left With

brokers. Broker-dealers were required to
THIRTY-EIGHTH ANNUAL REPORT 5

furnish information concerning their financial condition to customers. New entrants into the securities business were

required to disclose details concerning

their personnel, facilities and financing.

Measures were taken to provide the

Commission and self-regulatory authonties with more effective early warning

systems. The staffs of the Commission

and the self-regulatory agencies were

augmented to permit more frequent and

intensive Inspections of broker-dealers.

Units were established within the Commission and the Industry to develop

more efficient clearing and settlement

procedures, including the anticipated

imrnobrhzatron or elimination of the

stock certificate.

Legislation

During the 1972 fiscal year the Commission submitted to Congress proposed legislation to amend the Securities Exchange Act to increase and unify

the Commission's oversight of national

securities exchanges and the NASD and

to make the self-regulatory pattern of

the Act more effective. Generally, the

provisions of the bill would have given

the Commission more Uniform and

strengthened review powers over rules

of the self-regulatory organizations, and

the authority to ensure enforcement of

such rules and review disciplinary actions taken by those organizations.

The Commission's present authority

over the rulernakmg of the self-regulatory bodies is an Illogical patchwork of

provisions which falls short of giving

the Commission authority to act

promptly and effectively where a rule,

or a proposed rule, IS or might be injunous to the public interest. Specifically,

the Commission has little power to prevent the adoption of a particular rule by

an exchange, nor to abrogate It once it

has been adopted. It does have the

power to require alterations in exchange

rules, but only insofar as the rules re488-483 0 - 73 - 3

late to certain matters, and after following cumbersome procedures. On NASD

rules, the Commission has broad powers to block a rule from being put Into

effect and to abrogate an existing rule,

but ItS power to alter or supplement

rules IS very limited. The proposed bill

would have given the Cornrrussron the

power to approve or disapprove of any

new rule proposal or any proposed

amendment, supplement or repeal of an

exrsting rule, as well as the authority to

require rule amendments and supplements and to abrogate rules Action

pursuant to such authority would be

preceded by appropriate notice and afford an opportunity for comment or

hearing.

The Commission is limited In ItS oversight of self-regulatory bodies In that it

cannot directly enforce their rules

against their members. The proposed

bill would have empowered the Commission to enforce these rules, but only If

the self-regulatory body falls to act. The

grant of this additional authority to the

Commission would not only allow Commission action where there was a breakdown in self-regulation, but would also

promote action by the self-regulatory

bodies by providmg them With greater

incentive and by strengthening the hand

of these agencies in dealing With members.

The bill would also have expanded

the Commission's review authority of

disciplinary proceedings to Include actions taken by exchanges. Currently, the

Commission has such authonty only on

NASD discrphnary actions, and in those

cases It cannot increase the penalty assessed. Under the proposal, the Commission could have Increased sanctions

other than fines, that are imposed by

any of the self-regulatory bodies. Before

this could be done, the disciplinary action would have to be referred back to

the self-regulatory organization for additional consideration to give It an opportunity to reappraise the sanction In light
6 SECURITIESAND EXCHANGECOMMISSION

of the Comrrussion's indication that it

might be inadequate.

In the operations area, the Commission In March 1972 submitted to Congress a draft of a proposed bill to give

the Commission additional authority

over the handling, processing and sett~ement of securities transactions, particularly as those functions are performed by secunties deposrtones,

clearing agencies, transfer agents, registrars, and broker-dealers. In addition,

the proposed bill would have conferred

upon the Cornmissron the power to determine the form and format of the

stock certificate. The ultimate objective

of the bill was to provide a basis for

the development of an efficient national

system for clearance and settlement of

securrtres transactions. Two similar bills

were also Introduced, one In the House

and one In the Senate.

All three bills were directed at providing a public entity with authority to insure that standardization and automation within the limits of technological

feasibility are accomplished as rapidly

as possible, and that there be a coordinated systems approach to the clearance and settlement of secuntres transactions. They contemplated that the

Cornrnissron set standards and procedures In four principal areas: performance, particularly accuracy and prompt

handling and settlement of securities

transactions; operational compatibility;

pohcies for reasonably nondiscriminatory access to the facilities; and

standards for safety of cash and securities in the custody of these entitles.

No legislation on the above matters

was enacted by the 92nd Congress.The

Commission anticipates that similar legrslation Will be Introduced at the next

Congress.

In related action, the Commission in

early 1972 established an Industry Operations Technical Staff composed of

former securities industry operations

personnel. The assignment of this group

is to prepare, in cooperation with the

Industry, for the elimination or immobilization of the stock certificate, and generally to work on Improvement of industry operational methods.

National Clearing Corporation

In the latter part of 1969, the NASD

established the National Clearing Corporation (NCC) as a wholly owned subsidiary to provide a nationwide system for

clearing and settling over-the-counter

transactions. NCC began operations in

New York In November, 1970. Clearing

facilities were extended on a pilot basis

to Boston and Philadelphia In May,

1972. The Philadelphia-Baltimore-Washmgton and Boston Stock Clearing Corporations provide the operational support required In these two cities. NCC's

objective IS to be able to clear all

trades Within and among the three cities

by the end of calendar 1972. It believes

that such trades account for over 40

percent of total over-the-counter activity

by NASD members, now estimated at

50,000 to 60,000 transactions daily.

NCC IS also operating a pilot interregional clearing procedure between several of its New York firms and several

Pacific Coast Stock Exchange members

on the West Coast.

In connection with the NASD's establishment and operation of the NCC,the

Commission, in early 1972, adopted

Rule 15Aj-3 under the Exchange Act

which prescribes certain requirements

for a national association of securities

dealers which establishes and operates

facilities for clearing and settling securities transacttons.t These Include the reo

qurrernents that the applicable rules of

the association incorporate as guides to

Interpretation and application certain

public interest standards set forth in

the Exchange Act, and also that such

rules provide a fair procedure with respect to any refusal or limitation of access to such system by a customer, issuer, broker or dealer. The rule also
THIRTY-EIGHTH ANNUAL REPORT 7

provides for Commission review of adverse action by the association with respect to such matters. The Commission

has determined that the by-laws and operating rules of the NCC, including

those relating to access to the system,

are consistent with Rule 15AJ-3 and

other applicable requirements of the Exchange Act,

MARKET STRUCTURE

Policy Statement

DUring the last fiscal year, the Commission completed another segment of

a series of hearings and special studies

which began three and a half years ago.

Earlier heanngs had dealt pnmanly with

questions relating to commission rates

and give-up practices. The Commission's Institutional Investor Study Report, submitted to Congress on March

10, 1971, developed extensive data

which documented the burgeoning of financial intermediaries such as ban ks,

mutual funds, pension funds and insurance companies, often referred to simply as "institutions", and their increasing impact on the secunties markets.

The most recent set of hearings, held

between October 12 and December 21,

1971, focused on the structure, operation and regulation of the secunties

markets and provided the most comprehensive collection of information on

market structure since the Commission's Special Study of Secunties Markets in 1961-1963. During these hearings, the Commission obtained a broad

spectrum of views. A total of 182 persons testified, covering almost 4,000

pages of transcript, in addition to 74

persons who supplied written statements.

Following the heanngs, the Commission released its Statement on the Future Structure of the Secuntres Markets,

on February 2, 1972. In this general

policy statement, the Commission crystallized and plnpointed many of the

problems and deficiencies existmg in

the structure, operation and procedures

of the secunties industry, and presented

In comprehensive form its views concerning the appropriate evolution of the

secuntres markets.

The statement called for creation of a

central market system for listed securtties, in order to rnaxrrruze the depth

and liqurdrty of the markets. Essentially,

such a system would be designed to

strengthen cornpetrtion and to make its

operations open and fully cornprehensrble to the publrc, The Commission

stated that these objectives could best

be accomplished by: implementation of

a nationwide disclosure, or market rntormatron, system; elimination of artificial

Impediments created by exchange rules

or otherwise to dealing in the best

available market; establishment of more

open economic access to all exchanges

by broker-dealers; and integration of

third market firms Into thrs comprehensive disclosure, or central market, system. The Commission subsequently proposed rules to make composite

information on pnces, volume and quotations for all listed securities generally

available 3

The Commission's policy statement

also addressed other Important questions, such as the Impact of block trading, the quality of service to Investors,

cornrrnssion rates, research and SUitability, reciprocal portfolio brokerage for

sales of Investment company shares,

and membership on national secunties

exchanges for other than public purposes.

To assist in developing the views it

had articulated in its policy statement,

the Commission designated three committees comprised of the Commission

staff, industry leaders With broad-based

expertise In market concepts and funcnons, and a staff member as secretary

to study (1) development of a comprehensrve market disclosure system, (2)

structure, regulation and governance of
8 SECURITIESAND EXCHANGECOMMISSION

a central market system, and (3) necessary and desirable rules for block trading.

The Commission took other action to

increase the portion of institutionalsized orders on which commission rates

should be competitively determined,

from ItS prior level of that portion of all

orders over $500,000, to the portion of

orders exceeding $300,000. It also directed the National Association of Securities Dealers to formulate and Implement rules to prohibit the practice of

using Investment company portfolio brokerage to reward broker-dealers for

sales of Investment company shares.s In

the area of exchange membership, the

Commission requested all registered securrties exchanges to adopt rules to exclude from membership any organization whose primary function is to route

orders for the purpose of rebating or recapturing commissions, directly or indirectly. It also expressed its intention to

exercise appropriate authority to ensure

that the exchangesadopt rules requiring

that members must conduct a predominant portion of their brokerage commission business with and for nonaffiliated,

public customers.

Commission Rates

On September 24, 1971, the Commission advised the New York Stock

Exchangethat, with certain stipulations,

it would not object to that Exchange's

implementation of a new minimum commission rate schedule proposed by the

Exchange. Upon agreement by the Exchange, and following clearance by the

Price Commission, this new schedule

became effective on March 24, 1972. A

principal feature of the schedule IS the

incorporation of a volume discount beginning at 200 shares.

Nonmember Access. to Exchanges

Since 1960, six regional stock exchanges have amended rules to give

NASD-member dealers who were not

members of those exchangesa discount

from full commission rates. Until recently, however,the New York Stock Exchange did not provide such a discount.

Thrs policy created competitive disadvantages for brokers who were not

members of the NYSE.

In October, 1970, the Commission requested that the NYSE submit a plan

for "reasonable economic access . . .

for non-member broker-dealers." And, in

September, 1971, the Commission conditioned implementation of the Exchange's new comrnissron rate schedule

on adoption of a 40 percent discount

for nonmember broker-dealers.sThe 40

percent discount became effective on all

exchanges on March 24, 1972. By permitting qualified nonmember brokerdealers to retain a portion of the

amount they would otherwise expend in

commission costs, the new rules recognize the costs to such broker-dealersof

secunng and transacting securities orders. The rules also encourage greater

participation by nonmember brokers and

their customers in exchange securities

markets.

Exchange Membership

For many years, the fixed commission

rate structure maintained by the nation's exchangesfailed to reflect economies of scale associated With the large

orders of institutional customers. This

fact, coupled With the increasing tempo

and magnitude of institutional transactions In recent years, combined to produce serious distortions In the existing

market system. Large institutions sough

to avoid what were regarded as excessively high commission fees, either by

devising various rebatrve and reciprocal

dealing practices, or by obtaining exchange membership to avoid the fixed

nonmember commission rate entirely.

The question of the appropriate utilization of exchange membership took on

added significance In light of the Com-
THIRTY-EIGHTH 9

mission's desire to effectuate a central

market system.

In reviewing recent trends of the markets, the Commission was concerned

about the continued confidence and

participation of all investors-including

small investors who were found by the

Institutional Investor Study to be essential to the proper functioning of the

markets. The Commission was further

concerned with the pattern of rnstrtutronal trading and the Impact of large

block transactions on the functiomng of

those markets.

The Commission enunciated ItS broad

policy determinations concerning these

problems In ItS market structure statement. Specifically, the Commission

stated its view that the rebating, recapturmg and redirecting of commissions

were to be terminated. As noted above,

commission rates gradually will be adjusted to a competitive system which

will more properly reflect the costs of

handling institutional-sized transactions.

Finally, the Commission stated it would

request that the exchanges admit or retain in membership only those individuals or organizations which intend to

conduct a predominantly public bustness with nonaffiliated customers.

On April 20, 1972, the Commission

Issued its WhIte Paper on Institutional

Membership which traced in detail the

origins of the institutional membership

problem and its relationship to the issues of commission rates and market

structure, and further specified the

Commission's position on the steps it

Intended to take to implement ItS policies. On May 5, 1972, the Cornrrussion

submitted legislation to the Congress to

clarify the scope of the Commission's

authority to deal with these questions.

One proposed bill would amend Section

6 of the Securities Exchange Act to require, in effect, that membership on national securities exchanges contribute to

the public nature of the exchange trading markets. A second bill, submitted

ANNUAL REPORT

on the same day, proposed an amendment to Section l1(a) of the Exchange

Act to provide for more effective and

comprehensive regulation of trading by

all exchange members, either for themselves or those standing In a control relatronship with them regardless of

whether such trading occurs on or off

the exchange floor.

On May 26, 1972, the Commission,

pursuant to its existing authority under

Section 19(b) of the Exchange Act, sent

a letter to the presidents of all national

securities exchanges requesting adoption by the exchanges of rules on the

appropriate utilization of exchange

membership, comparable to a rule suggested by the Commission In ItS letter.

The Commission's rule suggestion

provided that membership In national

sscuntres exchanges should be open to

any and all persons or organizations,

provided that every member or member

organization would have, as the principal purpose of ItS membership, the conduct of a public securities business. For

purposes of the Cornrrussion's proposed

rule, it was stated that an exchange

member presumptively would be

deemed to have such a public securities

business If at least 80 percent of the

value of exchange secunties transactions effected by the member during the

preceding six calendar months were effected for or With customers other than

those affiliated With the member or

were transactions contributing to the

stability and effectiveness of the markets. Conversely, the rule would bar

from exchange membership those persons or organizations whose pnrnary

function IS to rebate, recapture or redirect commissions or otherwise execute

portfolio transactions exclusively for the

member's own account or for the accounts of persons affiliated With the

member.

In August, 1972, the Commission,

under authority of the Exchange Act,

proposed for comment a rule on mern-
10 SECURITIES AND EXCHANGE COMMISSION

bership on registered securities exchanges for other than public purposes.s

The rule proposed was substantially the

same as that which had been the subject of the Commissron's prior request.

The initial comment period, after the

grant of an extension of time, expired

on October 16, 1972. The Commission

announced that it also would receive

supplemental written comments and

oral statements before It concluded its

consideratron of the appropriateness of

ItS proposed rule.?

OTHER MARKET REGULATION

NASDAQ

In February, 1971, the NASD formally

commenced operations of the NASDAQ

automated quotations system With approximately 2,300 over-the-counter securitres, The system, which IS operated by

Bunker-Ramo Corporation for the NASD,

has three levels of operating service.

Level I service provides a current, representative inter-dealer bid and ask quotatron for any secunty registered In the

system for the Information of registered

representatives and customers of retail

firms. Levell/Is designed to supply

upon request of trading rooms a list of

market-makers and their current bid

and ask quotations for any such secunty. Levell/I service is SImilar to Level

1/ service, but also has input facilities

through which authorized NASDAQ market makers enter, change or update bid

and ask quotations.

By the end of the 1972 fiscal year,

the number of secunties quoted on the

system had reached approximately

3,350 (including about 90 stocks listed

on exchanges) WIth a total market value

of over $140 billion (excluding the

listed stocks). There were about 620

registered NASDAQ market makers, and

the system averaged approximately

1,150,000 interrogation requests daily.

The NASD also Instituted a "stock

watch" surveillance program for the

new system, and has been cooperating

with the Commission's surveillance staff

in looking into unusual market activity

in NASDAQ securities.

During the year, the NASD also

began to compile price indices for NASDAQ securities and to release them to

the news media for public information.

To assist the Association in compiling

these indices, the Cornmrsslon adopted

Rules 13a-17 and 15d-17 under the

Securities Exchange Act and a new reporting form to require the submission of

certain information to the Commission

and the NASD by issuers of securities

quoted on NASDAQ on any aggregate

net change exceeding 5 percent or

greater in the amount outstanding of a

class of securities quoted on the

system.s Since November I, 1971, the

NASD has also been releasing daily

NASDAQ volume to the media for publication. Thus, for the first time, the public was able to obtain daily volume data

for many over-the-counter securities.

On March 17, 1972, the Association,

on an experimental basis and in response to a request by the PBW Stock

Exchange, authorized the inclusion of

quotations of exchange specralists in

the NASDAQ system.

The NASD also announced ItS plans

to expand the NASDAQ system to allow

subscribing frrrns to report the details

of each securities transaction to the

NASDAQ central computer. The proposed trade reporting system, which will

probably take about a year and a half

to put into effect, would make it possible for traders to verify each trade

Within minutes of its execution and to

detect irnrnedrately any errors. It is expected that such a reporting system will

provide more Information to investors

and Will speed up the clearing and settling of over-the-counter transactions.

Self-Underwriting

In March, 1970, the New York Stock

Exchange amended its rules to permit
THIRTY-EIGHTH ANNUAL REPORT 11

public ownership of member firms. Subsequently, the NASD, in view of its

members' need for additional capital,

abandoned Its position that members

could not participate in drstnbutions of

their own securities and published proposed regulations for public offenngs of

securities of member firms or their affiliates, whether through an independent

underwnter or by the firm itself. The

regulations were cleared by the Commission and adopted by the NASD. As a

result, numerous broker-dealers were

able to register with the Commission offenngs of their secunties which were

self-underwritten in whole or part.

Generally, NASD regulations permit a

member to sell Its shares to the public

If: (1) detailed financial statements are

submitted with the registration statement; (2) no more than 25 percent of

the equity interest of the owners of the

member is offered as part of the issue;

(3) the amount of the offenng does not

exceed three times the member's net

worth; and (4) the member's net capital

ratio would not exceed 10:1 at the termination of the offering. Also, a member IS prohibited from making a subsequent public offenng for at least one

year and is required to send to each of

its shareholders a quarterly statement

of its operations and an annual independently audited and certified financial

statement. In addition, If the member

participates in the distribution of its

own securities or those of an affiliate, It

must obtain two independent underwnters with at least five years' expenence

In the securities business, three of

which are profitable, to certify to the

fairness of the offering and to exercise

the usual standards of due diligence in

connection with the preparation of the

registration statement.

Seasoning and profitability requirements also apply to the member-issuer.

In self-underwritings, persons actively

engaged In the member's business and

their immediate families are prohibited

from selling any portion of their equity

Interest In the member firm. If the

member recommends ItS secuntres to a

customer, It must have reasonable

grounds to believe that the recommendation IS SUitable and maintain a record

showing the basis on which It reached

ItS suitability determination.

Dunng fiscal 1972, the Commission

announced a proposal to adopt rules

under the Secuntres Exchange Act for

public offerings of their securitres by

broker-dealers who are not NASD

rnernbers,s These proposed rules are

comparable to the NASD regulations.

DISCLOSURE-RELATED

MATTERS

"Hot" Issues

In February, 1972, the Commission

began public, fact-finding investigatory

proceedings on "hot issues" secuntres

markets (r.e., markets In which new ISsues have expenenced substantial pnce

rises in their after-markets) to determine adequacy of existing disclosure

and regulatory protection for Investors.

Dunng the first phase of the hearings, which ended In June, a total of 69

witnesses testified, including representatives of the secunties industry, investment banking and state securities

commissions, along with a number of

professional venture capital Investors.

These hearings focused on the following

questions; (1) Are there viable methods

of financing available to new ventures

which are more appropnate than the

public securities markets? (2) Does information provided to the public of new

ventures reflect economic reality and IS

it in a format which can be easrly understood? and (3) Are public markets

for new issues subject to methods and

patterns of drstnbution and aftermarket

trading which artificially cause such issues to become "hot"?

The second phase of the heanngs

began in September and focused on dis-
12 SECURITIES AND EXCHANGE COMMISSION

tnbution and aftermarket trading. Case

studies were selected from among the

64 companies previously Identified In

the heanngs which had first-time public

offenngs dunng the hot Issues market

of 1968-69.

On July 26, 1972, followmg the first

phase of the heanngs, the Cornrnlssion

released for public comment proposals

for initial steps to curtail hot Issues, to

provide more meaningful disclosure relating to new Issues, and to Integrate

further the disclosure provisions of the

securitres laws.lO The Commission also

requested that the National Association

of Securrtres Dealers and the stock exchanges take steps to help alleviate the

problems of hot Issues markets.

Actions taken or proposed by the

Commission Included:

1. The Commission stressed the need

for underwriters to diligently investigate

the disclosure in a registration statement, particularly where the offenng involves a high risk venture. The Commissron again suggested that the NASD

formulate standards for "due diligence"

investigations, requested the NASD to

establish guidelines specifying what constitutes a bona fide public offering, resulting In an adequate "float" in the

hands of public investors, and requested the NASD and national stock

exchanges to consider the development

of suitability standards for hot Issue

markets.

2. To provide public investors with

meaningful information approaching

that received by professional investors,

the Cornrnissron proposed changes in

some registration and reporting forms.

These would require improved disclosure of competitive conditions in the industry and the issuer's posrtion. For the

first time, descnptions of corporate

plans and budgets and market penetration studies would be included. A company filing a first registration statement

which has not conducted bona fide operatrons for at least three years would

be required to describe ItS plan of operations for the ensuring months, if available. The description would Include

such matters as a budget of anticipated

cash resources and expenditures. Companies which have entered or Intend to

enter a new line of business, or have

Introduced or intend to Introduce a new

product, involving expenditure of a materral amount of resources, would have

to disclose the results of any market

studies and the status of product development in a registration statement or

penodic report.

3. To make prospectuses more readable, the Commission revised rules and

registration guides and proposed further

revisron of the guides.

Restricted Securities: Rule 144

In January, 1972, the Commission

adopted Rule 144 under the Securities

Act dealing with the resale of "restricted" securities and sales by controlling persons, together with related rule

and form changes. This represents the

culmination of several years of work by

the Commission and ItS staff, ansing

out of recommendations of the Commission's Disclosure Policy Study.ll They

are designed to provide full disclosure

regarding securities sold In trading

transactions, and to create greater certainty in the application of registration

provisions by replacing subjective standards With more objective ones.

Rule 144 provides that any affiliate

(i.e., control person) or other person

who sells restricted secunties for his

own account, or any other person who

sells either restricted or other securities

for the account of an affiliate of the issuer, shall be deemed not to be engaged In a "distribution" of the securities and therefore not to be an

"underwnter" of the securities If all the

terms and conditions of the rule are

met. The term "restricted secunties" is

defined to mean securities acquired

from their Issuer or from an affiliate of
THIRTY-EIGHTH

the issuer in a transaction or chain of

transactions not involving any public offering.

Before Rule 144 may be utilized,

there must be available public information on the issuer. This condition IS met

if the Issuer is subject to the reporting

requirements of the Securities Exchange

Act and is current in its reporting. If

the issuer IS not subject to the reporting requirements, there must be publicly available specrfied information on

the issuer.

If the secunties sold are restncted

securities, Rule 144 requires that they

must have been beneficially owned and

paid for by the seller for a period of at

least two years. The amount of securities which may be sold dunng any 6-

month period may not exceed the lesser

of one percent of the class outstanding,

or the average weekly volume of trading

on all exchanges for a 4-week period, If

the secuntres are traded on an exchange. In sales by affiliates, the

amount is computed by aggregating all

restricted and other secunties sold. For

sales by other persons, the amount is

based only on restncted secunties sold.

In certain Situations, sales must be aggregated with those made by other persons.

The securities must be sold in "brokers' transactions" Within the meaning

of the Securities Act. There can be no

solicitation of buy orders either by the

broker or the seller, and the broker can

receive only the usual and customery

commission.

Except for transactions during any 6-

month period not exceeding 500 shares

or $10,000, a notice of a proposed sale

under the rule must be sent to the

Commission concurrently with the sale.

In the adoption of Rule 144, the

Commission also adopted other rule and

form changes.rz One, new Rule 237, exempts from registration outstanding securities held by persons other than the

issuer, control persons or brokers or

ANNUAL REPORT 13

dealers, if certain conditions are met.

The rule is designed to permit sales In

small amounts by non-controling persons owning securities of Issuers which

do not satisfy the conditions of Rule

144.

The Commission also Issued a release stating its oprruon that the antifraud provrsrons of the secunties acts

are Violated when an issuer, a control

person, or any other person, In connection with a private placement of secunties, fails to inform the purchaser fully

as to the circumstances under which he

is required to take and hold the securities and the limitations upon their resale.

In September, 1972, the Commission

released Interpretations of Rule 144 by

ItS DIVISion of Corporation Fmance.P

The interpretations, In question and answer form, were Intended to c1anfy aspects of the rule. At the same time, the

Commission amended the rule to require that the notice of proposed sale

must also be filed With the principal secunties exchange on which the securities are hsted.tRule 145

The Commission's Disclosure Policy

Study in 1969 15 recommended recisron

of Rule 133 under the Securitres Act,

which then exempted from registration

securities Issued in certain types of

business combinations under a "nosale" theory, and adoption of a special

form for registration of secuntres issued

in such transactions. In 1969, the Commission published a proposal to Implement these recommendations,16 but it

subsequently deferred action pending

final action on Rule 144.

In May, 1972, the Commission published for comment proposed Rule 145

and related proposals,17 and in early

October, 1972, It adopted the proposals

in modified form.1S Rule 145 provides

that the subrnissron to a vote of stockholders of a proposal for certain merg-
14 SECURITIESAND EXCHANGECOMMISSION

ers, consolidations, reclassifications of

securities or transfers of assets is

deemed to involve an "offer" or "sale"

of the securities to be Issued in the

transaction. The effect of the rule is to

require regrstration of such securities

unless an exemption is available. Rule

133, being inconsistent with Rule 145,

was rescinded.

In order to facilitate the registration

of securities Issued In transactions of

the kind referred to in Rule 145, the

Cornrnission revised Form 5-14. This

form permits the prospectus to be in

the format of a proxy or information

statement.

Proxy Revisions

In December, 1971, the Commission

invited public comments on proposed

amendments to Rules 14a-5 and 14a-8

of its proxy rules, relating to proposals

of security holders for inclusion in an

issuer's proxy rnatenal.tv These amendments were adopted In modified form in

September, 1972.20 The provisions of

Rule 14a-8 relating to the grounds on

which management may omit shareholder proposals were amended to substitute objective standards (to the extent feasible) for previously subjective

elements. Other changes include an increase from 100 to 200 words In the

maximum length of a secunty holder's

statement In support of a proposal.

In related action, the Commission

amended its rule on avarlabrlity of materials for public Inspection and copying

to extend to materials filed relating to

the proposed omission of a security

holder's proposal from proxy material

and any written staff comments.21

Registration Statements

The Commission published two releases in fiscal year 1972 on procedures

used by the Divrsion of Corporation Finance in processing registratlon statements under the Securities Act. One

release,22noting the increase in workload and need to curtail time in registration, called attention to procedures

-some old and some new-for review

of registration statements: those whrch

are so poorly prepared or present such

senous problems that the use of further

staff time cannot be justified are deferred until the Issuer takes appropriate

corrective action; "Cursory review" or a

somewhat more detailed "summary review" is afforded filings (usually repeat

filings) which do not present unusual

disclosure problems and for which few,

if any, comments are necessary; and

"customary review" is given those registration statements deemed to warrant a

complete accounting, financial and legal

review.

The other release23 stated that the

DiVISIonwould ordinanly defer processing registration statements filed by issuers who are delinquent in their periodrc reporting. It pointed out that

failure to observe reporting requirements is a serious obstacle to the maintenance of fair and informed trading

markets, precludes the use of certain

registration forms, and deprives the

staff of information necessaryfor review

of registration statements.

Disclosure by Defense Contractors

In June, 1972, the Commission issued a notice to registrants engaged in

defense and other long-term contracts

regarding the need for prompt and accurate disclosure of material

information.24 The Commission noted

that because of cornplexrtles and uncertainties inherent in such contracts,

costs to be incurred and ultimate profit

are often difficult to estimate. It

stressed that registrants nonetheless

have an obligation to make every effort

to assure that progress on contractssuch as earnings, losses, anticipated

losses or material cost overruns-is

properly reflected in disclosure documents. The Commission's notice was issued following release of a staff report
THIRTY-EIGHTH ANNUAL REPORT 15

on disclosure practices of defense contractors, including case studies of disclosure problems.

The staff report concluded that the

Commission's present rules and disclosure forms were generally adequate but

that disclosure by some defense con.

tractors could be Improved. It noted

that differences sometimes appear between disclosures In the annual report

filed with the Commission and the annual report to stockholders, which receives wider dissemination. The Commission urged Issuers to make every

effort to assure that disclosures in annual reports are as complete and accurate as those In filings With the Comrrussron.

Broker-Dealer Securities

Until recently, the great majority of

registered broker-dealers were privately

financed. During the fiscal year, however, some broker-dealers filed registration statements to offer equity securities to the investing public. Among

these registrants were several of the

largest firms in the securities industry.

In view of the Commission's limited

experience with publicly-held brokerdealers, it determined not to propose a

special registration form or disclosure

guidelines. However, to minimize delays

In the review of broker-dealer registration statements, it published comments

and suggestions by ItS staff to assist

those concerned with the preparation of

such statements.25

Form 5-16

As noted in last year's annual

report,26 the Commission in December,

1970, adopted Form S-16, a new short

form for the registration of securities

under the Securrtles Act. The form is

available only to issuers which have an

established record of earnings and continuity of management, and file reports

under the Securities Exchange Act. The

Form S-16 prospectus consists largely

of the latest annual report and other reports and proxy or information state.

ment filed by the Issuer, which are incorporated by reference. At the time it

adopted the form, the Commission

noted that this was in the nature of an

expenment and subject to revisron.

In June, 1972, amendments to Form

S-16 were adopted.27 Their pnmary purpose was to increase the types of transactions for which the form may be

used. Before the amendments, the form

could be used only for sales of outstanding secunties "In the regular way"

on a national secuntres exchange, and

for certain other transactions rnvolvmg

convertible securities and warrants. The

amendments provide that the form may

also be utilized for sales of listed securities in the "third market" or otherwise

and for sales of securities quoted on

NASDAQ.

Regulation B

In February, 1972, the Cornmission

published for publrc comment proposed

amendments to Regulation B under the

Secunties Act, which exempts from reg.

istratron certain offerings of fractional

undrvrded Interests in 011 and gas

rlghts.28 The proposed revisions were

adopted In October, 1972.29 This was

the first Significant change In Regulation

B since 1937.

The general structure of the Regulation was retained. The changes Include

an Increase from $100,000 to $250,000

in the maximum amount of the offenng,

and new provisrons designed to give

prospective purchasers a better opportunity to consider the ments of the offering before a purchase and to curb

abuses in the use of sales literature.

INVESTMENT COMPANIES

Proposed Oil and Gas Investment

Act

In June, 1972, the Cornrnlssron submitted to Congress legislation to provide
16 SECURITIESAND EXCHANGECOMMISSION

mcreased protection for investors in 011

and gas drilling funds and programs.

The House-Senate Conference Committee on the Investment CompanyAmendments Act of 1970,30 in deletmg a provision which would have subjected

certain oil and gas funds to the regulatory pattern of the Investment Company

Act, acted with the understanding that

representatives of the oil and gas industry would cooperate with the Commission "in workmg out a reasonable regulatory statute consistent with the need

for protection of investors In this

area." 31

The proposed bill was prepared in cooperation with the 011 Investment Institute, a trade association of oil program

sponsors and managers, and, while patterned after the Investment Company

Act, is tailored to the specific practices,

problems and operating methods of the

011 and gas industry.

The legislation is intended to deal

only with oil programs which provide

flow-through tax treatment to their

investors and sell their securities to the

public. It does not cover conventional

oil companies or financing arrangements used by many small independent

oil operators.

011 programs are generally unincorporated associations which are primarily

engaged in the business of holding or

investing in oil or gas interests and of

exploring, drilling or producing oil or

gas. The structure of the programs is

generally characterized by externalized

management with beneficral ownership

separated from control. As a result,

management of oil programs may mvolve self-dealing and other transactions

and practices which may be unfair to

investors.

The draft bill would provide investor

protection by requiring registration of

oil programs and subjecting them to

comprehensive regulation. It would proVide controls designed to prevent conflicts of interest and unfair transactions

between oil programs and their managers, and to insure financial responsibility of program managers; prohibit

changes in fundamental policies of

an 011 program without approval of the

participants; and require that a person

acting as program manager do so under

a written contract which contains certain provrsions. Some provisions of the

proposed statute would be administered

primarily by the National Association of

Securities Dealers with Commission oversight. These relate to sales charges,

sales literature, suitability of an investment and a classification system for the

various forms of management compensation.

Sale of Investment Adviser

During the year, the Commission also

proposed legislation 32 to modify those

sections of the Investment Company Act

that were affected by the decision of

the Court of Appeals for the second Circuit in Rosenfeld v. Black.33 In that

case, the court held that the general

principle in equity that a fiduciary cannot sell his office for personal gain is

impliedly incorporated into Section

15(a) of the Act requiring shareholder

approval of any new investment advisory contract. Consequently, a retiring

investment adviser of an investment

company Violates the Act by receiving

compensation which reflects either (1) a

payment contmgent upon the use of influence to secure approval of a new adviser or (2) an assurance of profits for

the successor adviser under a new advisory contract and renewals.

In submitting the proposed legislation, the Cornrnlssronexpressed its view

that the principles of equity were appropriately applied to the facts of the case,

which involved an outright sale by an

investment adviser of its advisory contract with a registered investment company. While the Rosenfeld case did not

involve the sale of an outgoing invest.

ment adviser's assets, the sweep of the
THIRTY-EIGHTH

Court's language nevertheless cast

doubt on whether an Investment adviser

could profit when it sold its business in

that manner.

In Its statement accompanying the

legislation, the Commission suggested

that It would be in the public interest to

remove the uncertainty in the mutual

fund industry generated by the Rosenfeld decision. Thus, the proposed

amendments are intended to permit an

investment adviser, or an affiliated person of an adviser, to obtain a profit In

connection with a transaction which results in an assignment of the advisory

contract if certain conditrons are met.

These conditions are designed to prevent a retiring investment adviser or an

affiliate, In connection with the sale of

the adviser's business, from receiving

any payment or other benefit which includes any amount reflecting assurance

of continuation of the investment advisory contract.

Variable life Insurance

In the past year, the American Life

Convention and the Life Insurance Association of Amenca filed a petition proposing adoption or amendment by the

Commission of various rules so as to

exempt certain variable life insurance

contracts and the issuers of such contracts from the Federal secunties laws.

Variable life insurance refers to insurance contracts in which the death benefit, cash surrender value and other

benefits vary to reflect the Investment

experience of a life Insurance company's separate account which Invests primarily In equity securrtres. According to

the petition, neither the Commission

nor the courts had determined the applicability of the secuntres laws to contracts of that nature. As a result, the

petition claimed, life insurance companies had been reluctant to develop and

introduce variable life insurance. The

proposed rules would exempt from the

securities laws variable life insurance

ANNUAL REPORT 17

contracts possessing specified characteristics which the petition contended

were designed to assure that the baSIC

function of the contracts IS to provide

protection against death.

On February 15, 1972, the Commission ordered a rulernakmg proceedmg.ss

It invited Interested persons to submit

their views In writing and to appear personally In a public hearing on the proposed rules. Heanngs began in April

and concluded on June 7, 1972.

ENFORCEMENT MATTERS

Penn Central Investigation

In August, 1972, the Commission

transmitted the staff report on the "Financial Collapse of the Penn Central

Company" to the Chairman of the Special Subcommittee on Investigations of

the House Committee on Interstate and

Foreign Commerce.35 The report contained the pnncipal findings based on a

two-year Investigatron-e-one of the largest ever undertaken-into the relationship between the Federal securities laws

and the collapse of the Penn Central

Company, which was the largest transportation company In the world and one

of the largest companies in the United

States. Because a pnncipal question

was whether adequate and accurate disclosure of the company's condition had

been made, an examination Into the operations, accounting and finances of the

company was necessary. This required

the review of hundreds of thousands of

pages of documents. Nearly 200 Witnesses were called to testify and approximately 25,000 pages of testimony

were taken. In the course of the investigation, the roles of approximately 150

fmancral institutions were reviewed.

The staff report is arranged in four

parts. Part I involves the company's

possible failure to disclose adverse information to the investing public. Part II

relates to possible trading on non public

information by lndrvrduals and mstrtu-
18 SECURITIESAND EXCHANGECOMMISSION

tions. Part III describes the role of Penn

Central's commercial paper dealer and a

commercial paper rating service. Part IV

involves an examination of a pnvate investment club in which several Penn

Central financial officers were members

and which raised issues of possible misuse of position by these officers.

Following submission of the report,

Subcommittee Chairman Harley O. Staggers was quoted in the Congressional

Recordat stating:

"I believe one of the immediate

lessons taught by the collapse of

the Penn Central is that we cannot

contmue to have one standard of

regulation over the secuntres of

rail and motor carriers, and a different standard over the securities

of all businesses in America. This

has been the result of exceptions

which were written into the secunties laws many years ago by which

the ICC, and not the SEC, regulates the issuance of secunties by

rail and motor carriers. I have introduced H.R. 12128 to eliminate

the distrnctron and to insure that

minimum standards of responsrbllity are clearly imposed for the protection of the investing public. I

think the need for other legislatrve

measures may become apparent

once this report has been fully

evaluated. I commend the SEC for

the Job they have done on this report. It is going to be a valuable

reference for the public and for the

Congress. The Penn Central disaster should not have taken place.

We must do everything we can to

make sure it does not happen

again."

Pyramid Sales Plans

For some time, the Commission has

been concerned with the spread of pyramid sales schemes in the United States.

Recently, It was estimated that 150

such schemes were being operated in

the various states and that the public

has invested more than $300 million in

them.

In conjunction with the Special Assistant to the President for Consumer

Affairs, the Commission in November,

1971. published a release36 cautioning

persons offering multi-level distributorships and other business opportunities

through pyramid sales plans that they

may be violating the Federal securities

laws. Generally, these plans contemplate

specified investments in return for the

right to recruit and manage other "distributors" or "salesmen."

The release stated that the operation

of these plans often involves the offering of an "investment contract" or a

"partlcrpation in a profit sharing agreement," which are securities as defined

in the Securities Act. In such cases, the

security-the agreement between the

offering company and the investormust be registered with the Commission

unless an exemption is available. In the

absenceof registration or an exemption,

sales of these securities violate the Securities Act. Moreover, a person who

partlcrpates in the distnbution of such

secunties may be a "broker" as defined

In the Securities ExchangeAct and, absent an exemption, must register under

that Act.

The Commission stated that pyramid

sales promotions may be inherently

fraudulent. Emphasis is often placed on

the allegedly unlimited potential to

make money by recrurtlng others. However, the finite number of potential particrpants in any geographic area limits

the ability of those induced to participate at later stages to recruit others

and thus realize a return on their investment. Failure to disclose these factors to prospective investors m a meaningful way would be fraudulent.

The Commission acted to obtain injunctive and other relief against Glenn

Turner-the largest promoter of pyramid plans-and some of his enter-
THIRTY-EIGHTHANNUAL REPORT 19

prlses, beginning in May, 1972, when it

filed a complaint in the United States

Distnct Court for the District of Oregon.

On August 30, 1972, the court prehrninanly enjoined Glenn W. Turner Enterprises, Inc., and its subsidiary Dare To

Be Great, Inc. from offering and selling

interests or participations In the pyramid promotion of Dare To Be Great, in

violation of the registration requirements of the Securities Act or otherwise

in violation of the securities laws.37 The

complaint alleged that members of the

public had been Induced to Invest in a

common enterprise in which each investor would share in the profits derived

from the success of the defendants in

inducmg other persons, who had been

Introduced by the investor, to particrpate in the scheme. The district court

agreed with the Commission that this

involved the offer and sale of securities.

The court declined, however, to appoint

a temporary receiver or to order an accounting, as requested by the Commission, although it expressly authorized an

application for further preliminary relief

should events prove that to be necessary.

The defendants have appealed the

district court's decision.38 That court

and the court of appeals denied a stay

pending appeal.

On September 13, 1972, the Commission filed a complaint in the United

States Distnct Court for the Middle Distnct of Georgia seeking to enjoin Koscot

Interplanetary, lnc., its parent corporation Glenn W. Turner Enterpnses, Inc.,

and five individual defendants, including

Turner (the founder of both companies),

from further Violations of the registration and antifraud provisions in connection with the offer and sale of interests

In the pyramid promotion of Koscot.39

In addition to injunctive relief, the Commission requested the court to appoint

a temporary receiver for the corporate

defendants and to compel an accounting of the proceeds of sales by them.

Because of the pervasive nature of

the pyramid plans and doubts raised by

the structure of certain of the plans as

to whether a security is Involved, Chairman Casey, in September, 1972, sent a

letter to the Commission's Congressional oversight committees to ask their

assistance In obtaining legislation to

protect investors in pyramid plans. He

urged that at a minimum the secuntres

laws be amended to further clanfy the

fact that an investment In a pyramid

promotion IS a secunty, suggesting that

what appears to be needed in this area,

however, is a blend of disclosure and

regulatron-e-drsclosure alone may not be

enough.

COMMISSION REORGANIZATION

In August, 1972, a major reorganization of the Commission's structure was

completed, resulting in five operating divisions instead of three. The Division of

Trading and Markets was divided into a

Divrsron of Enforcement with responsibility for all investigative and enforcement activities, and a Division of Market Regulatron to regulate secunties

markets and broker-dealers, with particular emphasis on the structure and

efficrency of the markets and the financral responsrbrlity and professional service of the broker-dealer community. A

new Division of Investment Company

Regulation was spun off from the DiVIsron of Corporate Regulation, which retained responsrbility for public-utility

holding company and bankruptcy and

reorganization matters. The new Division, which Will also regulate Investment

advisers, was assigned the task of concentrating on problems concerning the

economics, dlstnbution methods and

services of investment companies. Investment company disclosure activity

was transferred to the Division of Corporation Finance, which now has responsibility for all disclosure matters.

The Commission took thrs action in

the belief that the new functional struc-
20 SECURITIESAND EXCHANGECOMMISSION

ture will provide a sharper focus on its

prlorrty tasks, more effective use of

available resourc~s, and the development, through closer supervision and

broader avenues of advancement, of

effective leadership capabilities for the

future.

This separation of disclosure and enforcement activities from the three regulatory divisions should encourage positive, forward-looking supervision and

planning in areas of regulatory concern

and a co-ordinated and experienced direction of all enforcement and division

activities.

NOTES FOR PART 1

1Study of Unsafe and Unsound Practices of Brokers and Dealers: Report

and Recommendations of the Securities

and Exchange Commission. House Doc.

No. 92-231, 92d Congress., 1st Sess.

(1971).

2Securities Exchange Act Release

No. 9545 (March 29, 1972).

3 Securities Exchange Act Releases

Nos. 9529 and 9530 (March 8, 1972)

and 9731 (August 14, 1972).

4 In response to this directive, the

NASD prepared a proposed rule prohibiting this practice. On July 27, 1972,

after approval by the NASD Board of

Governors, the proposal was sent to the

NASD's membership for comment.

5The Exchange had proposed a 30

percent discount. Securities Exchange

Act Release No. 9351 (September 24,

1971).

6Securities ExchangeAct ReleaseNo.

9716 (August 3, 1972).

7See Securities ExchangeAct Release

No. 9808 (October 5, 1972).

8 Securities ExchangeAct ReleaseNo.

9255 (August 2, 1971).

9Securities ExchangeAct ReleaseNo.

9555 (April 12, 1972).

10Securities Act Releases Nos. 5274

through 5279, Securities Exchange Act

ReleaseNo. 9673 (July 26, 1972).

11 See35th Annual Report, pp. 18-22;

36th Annual Report, pp. 9-13; 37th

Annual Report, pp. 21-23.

12Securities Act Release No. 5224

(January 10, 1972), as revised 37 Federal Register 4327 (March 2, 1972);

Securities Act Release No. 5225 and

Securities Exchange Act Release Nos.

9442 and 9443 (January 10, 1972).

13Securities Act Release No. 5306

(September 26, 1972).

14Securities Act Release No. 5307

(September 26, 1972).

15See 35th Annual Report, p, 21.

16Securities Act Release No. 5012

(October 9, 1969).

17Securities Act Release No. 5246

(May 2, 1972).

18Securities Act Release No. 5316

(October 6, 1972).

19Securities ExchangeAct ReleaseNo.

9432 (December 22, 1971).

20Securities ExchangeAct ReleaseNo.

9784 (September 22, 1972).

21Securities ExchangeAct ReleaseNo.

9785 (September 22, 1972).

22 Securities Act Release No. 5231

(February 3, 1972).

23Securities Act Release No. 5196

(September 27, 1971).

24Securities Act Release No. 5263

(June 22, 1972).

25Securities Act Release No. 5222

(January 3, 1972).

2637th Annual Report, pp, 29-31.

27Securities Act Releases Nos. 5265

(June 27, 1972) and 5265A (August 8,

1972).

28Securities Act Release No. 5233

(February 14, 1972).

29Securities Act Release No. 5314

(October 11, 1972).

30P.L 91-547, approved December

14, 1970. See 37th Annual Report, pp.

13-19.

31House Rep. 91-1631, 91st Cong.,

2d Sess. (1970), p. 27.

32S. 3681, H.R. 15304 (92nd Congress, 2d Session)

33445 F.2d 1337 (C.A. 2, 1971).

34Securities Act Release No. 5234.

35The Report is for sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, D.C.

20402, for $1.50.

36Securities Act Release No. 5211

(November 30, 1971).

37 S.E.C. v. Glenn W. Turner Enterprises, Inc., No. 72-390.

38 C.A.9, No. 72-2544.

39S.E.C. v. Koscot Interplanetary,

tnc., No. 17134.


PART 2

THE DISCLOSURE SYSTEM

A baste purpose of the Federal securi- sales, Investors must be furnished a

ties laws IS to provide disclosure of ma- prospectus containing the most Signifiterial financial and other information on cant information In the registration

companies seeking to raise capital statement

through the public offering of their se- The Securrtres Exchange Act of 1934

curities, as well as companies whose se- deals In large part with secunties alcurrtres are already publicly held. This ready outstanding and requires the regaims at enabling Investors to evaluate istratron of securities listed on a nathe securities of these companies on an tional securities exchange, as well as

Informed and realistic basis. over-the-counter secuntres In which

The Secunties Act of 1933 generally there IS a substantial public Interest Isrequires that before securities may be suers of registered secunties must file

offered to the public a registration annual and other penodic reports destatement must be filed with the Com- signed to provide a public file of current

mission disclosing prescribed categories material information. The Exchange Act

of information. Before the sale of secu- also requires disclosure of material inrities can begin, the registration state- formation to holders of registered secument must become "effective." In the ntres In solicitations of proxies for the

23
24 SECURITIES AND EXCHANGE COMMISSION

election of directors or approval of corporate action at a stockholders' meeting, or In attempts to acquire control of

a company through a tender offer or

other planned stock acqursrtion. It provides that insiders of companies whose

equity securities are registered must report their holdings and transactions in

all equity securities of their companies.

PUBLIC OFFERING: THE 1933

SECURITIES ACT

The basic concept underlying the Securities Act's registration requirements

IS full disclosure. The Cornrrussron has

no authority to pass on the merits of

the securities to be offered or on the

fairness of the terms of distribution. If

adequate and accurate disclosure IS

made, it cannot deny registration. The

Act makes It unlawful to represent to

Investors that the Cornrrussion has approved or otherwise passed on the merItS of registered securities.

Information Provided

While the Securities Act specifies the

information to be included in registration statements, the Cornrrnssion has

the authority to prescnbe appropriate

forms and to vary the particular items

of inforrnatron required to be disclosed.

To facrlrtate the registration of securities by different types of Issuers, the

Commission has adopted special registration forms which vary In their disclosure requirements so as to provide

maximum disclosure of the essential

facts pertinent in a given type of offering while at the same trrne rnlnirruzmg

the burden and expense of compliance

with the law. In recent years, It has

adopted certain short forms, notably

Forms S-7 and S-16, which do not require disclosure of matters covered in

reports and proxy material filed or distributed under provisrons of the Securities Exchange Act

Reviewing Process

Registration statements filed With the

Comrnission are examined by its Division of Corporation Finance for compliance With the standards of adequate

and accurate disclosure. The various

review procedures employed by the

Divisron are summarized in Part 1 of

the report While most deficrencres are

corrected through an informal letter of

comment procedure, where the Commission finds that material representations

In a registration statement are misleadrng, inaccurate, or incomplete, It may,

after notice and opportunity for hearing,

issue a "stop-order" suspending the

effectiveness of the statement.

New Registration Guides

To advise Issuers of the policies generally followed by its staff in the review

of registration statements and other

documents, the Commission from time

to time authorizes the publication of

guides describing the type of information which mayor should be included,

and the method of ItS presentation.

DUring the past fiscal year, several

new guides were published. One covers

so-called Insurance premium funding

prograrns.! These involve the offering of

secunties, usually mutual fund shares,

and the use of such shares as collateral

for a loan, the proceeds of which are

used to pay the premium on a life insurance policy which IS sold to the customer at or about the same time. The

Commission has taken the position that

such a program Involves an Investment

contract which IS a security under the

Securrties Act. The gurde sets forth the

staff's positron With respect to disclosure, among other things, of risks associated with a decline in value of the

fund shares which would require the

Investor to furnish additional collateral,

and the nature of tabular Illustrations of

program results which may be used,

In an effort to make prospectuses

more readable and understandable, the
THIRTY.EIGHTH 25

Commission authorized publication of

an amended guide on pictorial or

graphic representations In prospectuses.s

It provides that photographs of members of the management, principal

properties or important products are

permissible, provided they do not give

a misleading Impression. The existing

policy that artists' or architects' conceptions may not be used was not

changed.

The Commission also published

gurdelines for use in the preparation of

Securities Act registration statements by

Investment companies 3 and a proposed

guideline on disclosure regardrng an

investment company's investment advlser.s In addition, as discussed In

Part 1, it published suggestions for disclosure in registration statements of

broker-dealers proposing to sell their

shares to the public.

Printing expenses represent one of

the major costs associated with a public

offering of securities. The Commission

indicated ItS rules do not require prospectuses to be printed and that less

expensive means of reproduction may

be used.s

Environment and Civil Rights

In a release Issued in July 1971, the

Commission called attention to the disclosure requirements rn its forms and

rules under the Securities Act and the

Securities Exchange Act on legal proceedings and description of business involving the environment and CIVil

rlghts.s Compliance with statutory environmental requirements such as antipollution laws may require sigrufrcant

capital outlays, materially effect the

earning power of the business, or cause

material changes in present or future

business. The Commission said requirements on legal proceedings call for drsclosure of material litigation under environmental laws. The release also

stressed the need for disclosure of mao

terial proceedrngs under civil rights legANNUAL REPORT

rslation which could, for example, result

in cancellation of a government contract

The Cornrrussron, m a related announcement rn February 1972, said it

was considering amendments to some

registration and report forrns.? These

would require, as a part of the description of an issuer's business, appropriate

disclosure of material effects which

compliance With environmental laws and

regulations could have on capital ex.

pendrtures, earnings and competitive

position of the Issuer and ItS subsrdrarres. Information would also be required

on pendrng governmental, private legal,

or administrative enforcement proceedings under environmental laws or regulations, and any such proceedings contemplated by governmental authontres,

The Natural Resources Defense

Council, Inc. and the Project on Corporate Responsibility had previously reo

quested the Commission to adopt

certain changes rn ItS reporting, registration and proxy forms to encompass disclosures concerning environmental and CIVil rights matters. After

the July 1971 release was issued, the

Commission advised the petitioners that

It would deny the request at that time

to study the disclosures brought by the

general gurdelines. The Commission

subsequently proposed to amend certarn

forms to provide more specrftcally for

environmental disclosures.

The petitioners subsequently filed a

petition with the United States Court of

Appeals for the District of Columbia

Circurt 8 seekrng review of what they atleged to be the Commission's "order"

denying their request. The Cornrrussrcn

moved to dismiss the petition, asserting

that It had neither entered any "order"

nor taken any action directly reviewable

by the court of appeals under the judi.

cial review provisrons of the Securities

Act or the Securities Exchange Act. In

June 1972, the court of appeals referred the Commission's motion to the
26 SECURITIES AND EXCHANGE COMMISSION

panel of the court assigned to hear the

case on the merits of the petition.

Time for Registration

The Commission's staff tnes to complete examination of registration statements as quickly as possible. The Secunties Act provides that a registration

statement shall become effective on the

20th day after It IS filed (or on the 20th

day after the filing of any amendment).

Most registration statements require

one or more amendments and do not

become effective until some time after

the original 20-day penod. The penod

between filing and effective date IS intended to give Investors opportunity to

become familiar with the proposed offenng through the drsserrunatron of the

preliminary form of prospectus. The

Commission can accelerate the effective

date to shorten the 20-day waiting period-taking into account, among other

things, the adequacy of the information

on the Issuer already available to the

public and the ease with which facts

about the offenng can be understood.

DUring the 1972 fiscal year a record

3,716 registration statements became

effective. Of these, 231 were amendments filed by Investment companies

pursuant to Section 24(e) of the Investment Company Act of 1940, which provides for the registration of additional

secuntres through amendment to an

effective registration statement rather

than the filing of a new registration

statement. For the remaining 3,485

statements, the median number of calendar days between the date of the

original filing and the effective date was

56, only slightly more than was needed

to process a far smaller number of

statements In the prior year.

Organizational Changes

To improve the review of registration

statements involvrng specialized and

complex disclosure problems, the Division of Corporation Finance made organization and personnel changes.

Oil and Gas

In Apnl 1971, the Division assigned

to ItS 011 and Gas Section processing responsibility for all oil and gas drilling

program filings as well as filings on

Form 5-10 covenng fractional undivided

Interests In 011 and gas rights. This assignment was the first attempt by the

DIVISion to concentrate all filings of one

Industry type In one processing unit.

The result has been an Improved handling of the registrations and more uniform and complete disclosure. Filed during the fiscal year were 106 registration

statements for 011 and gas drilling

programs, totaling $940 million, and

eight statements covering fractronal undrvided interests In oil and gas rights,

aggregating $9 8 million.

Tax Shelters

In February 1972, a branch of the DIvision was designated to process all registration statements covering tax shelter

programs other than 011 and gas and

real estate Investment trusts. These programs include real estate syndications,

cattle feeding, cattle breeding, and Citrus and pistachio groves and other

agrt-busmesses. During the balance of

the fiscal year, 55 tax shelter registration statements were filed, including 10

for cattle offerings. As of the end of the

fiscal year, 50 tax shelter filings, aggregating about $470 million, were pending.

Disclosure generally emphasized in

tax shelter filings mvolvmg a partnership covers fees and payments by the

partnership to the general partner and

hrs affiliates, conflicts of interest, the

record of the general partner, and delineation of Investment objectives.

In real estate syndications, the trend

seems to be strongly In the direction of

"blind pool"-i.e., programs which do

not as yet have any specific properties
THIRTY.EIGHTH ANNUAL REPORT 27

or contracts to acquire specific properties. For such programs, the DIVISion

has rnsisted on an undertaking In the

registration statement to file a post.

effective amendment and send a report

to security holders disclosing information on any material acquisitron of property.

Condominiums

Since May 1972, registration statements for offenngs of condominium

securities have also been directed to a

separate branch within the DIVIsIon. In

ftscal year 1972, a total of 15 registration statements were filed for offenngs

of condominiums with rental arrange.

ments, aggregating approximately $134

million.?

Personnel Changes

Dunng the past fiscal year, the Division created and staffed new posrtrons

of Chief Financial Analyst and Tax

Counsel.

The position of Chief Financial Analyst was created pnncipally to Improve

anticipation of new developments In

financing, provide the Commission with

the viewpornt of the Investment analyst

on disclosure requirements, and improve communications with the professional investment community. The new

Chief Financial Analyst IS working actively with the accountants on the staff

In their efforts to develop consistent

and meaningful fmancial reporting, as

well as with staff attorneys and analysts

concerned With providing disclosure that

reflects economic reality.

The position of Tax Counsel IS mtended to strengthen the DiVISIon's capacity to determine the accuracy and

adequacy of tax disclosures, particularly

those relating to tax shelter programs,

mergers and acquisitions, and the regis.

tration of secunties for employee stock

option, stock purchase, savings or Similar plans.

SMALL ISSUE EXEMPTION

The Cornrrussion IS authonzed under

Section 3(b) of the Secunties Act to exempt secuntres from registration If It

finds that registration for these secunties IS not necessary to the public interest because of the small offenng

amount or limited character of the public offenng. The law Imposes a maximum limitation of $500,000 upon the

size of the Issues which may be exempted by the Cornrnissron.

The Comrmssion has adopted the following exemptive rules and regulations

Regulation A: General exemption for

U S. and Canadian IS'

sues up to $500,000.

Regulation B Exemption for fractional undivided interests mOil or gas

nghts up to $100,000.

Regulation F: Exemption for assessments on assessable

stock and for assess.

able stock offered or

sold to realize the

amount of assessment

up to $300,000

Rules 234- . Exemptions of first

236 lien notes, secunties

of cooperative housmg corporations, and

shares offered In con.

nection With certain

transactions.

Under Section 3(c) of the Secunties

Act, the Commission IS authorized to

adopt rules and regulations exempting

securities issued by a small business investment company under the Small

Business Investment Act. The Commission has adopted Regulation E, which

conditionally exempts such securrtres issued by companies registered under the

Investment Company Act of 1940 up to

a maximum offenng price of $500,000.

The regulation IS substantially Similar to

Regulation A, descnbed below.
28 SECURITIESAND EXCHANGECOMMISSION

Regulation A

Regulation A permits a company to

obtain needed capital not m excess of

$500,000 (includmg underwriting commissions) in anyone year from a public

offering of ItS securities without registration, provided specified conditions

are met. Among other thrngs, a notification and offering circular supplying

basic information about the company

and the securities offered must be filed

with the Commission and the offering

circular must be used in the offering

DUring the fiscal year, the Commission

amended Regulation A so as to permit

selhng shareholders not m a control relationship with the issuer to offer in the

aggregate up to $300,000 of secuntres

which would not be included in cornputrng the issuer's $500,000 ceilmg.10

During the 1972 fiscal year, 1,087

notifrcatrons were filed under Regulation

A, covering proposed offerings of $404

million, compared with 836 notifications

covering proposed offerings of $254 million rn the prior year. A total of 1,171

reports of sales were filed reporting aggregate sales of $107 million. Such reports must be filed every six months

while an offering is in progress and

upon its termination. Sales reported

dunng 1971 had totaled $63 million

Various features of Regulation A offerings over the past three years are presented in the statistical section of the

report.

In fiscal 1972 the Commission temporarily suspended 26 exemptions

where it had reason to believe there

had been noncompliance with the conditions of the regulation or with disclosure standards, or where the exemption

was not available for the secunties

Added to 13 cases pending at the begrnrung of the fiscal year, this resulted

in a total of 39 cases for disposition. Of

these, the temporary suspension order

became permanent in 20 cases; in 15

by lapse of time, in one case after hearings, and in four by acceptance of an

offer of settlement. Nineteen cases were

pendingat the end of the fiscal year.

Regulation B

DUringthe 1972 fiscal year, 1,124 offering sheets and 1,359 amendments

were filed under Regulation B and examined by the Oil and Gas Section of

the Divrsron of Corporation Fmance.The

number of filings reflects continuation

of an upward trend that began In 1965.

A total of 17,998 sales reports were

filed during the year, reporting aggregate sales of $21 million. Sales reported dunng the preceding year had

totaled $16 rnilhon.

Revisrons of Regulation B which were

proposed durrng the year are discussed

rn Part 1.

Regulation E

Two notifications by small business

Investment companies were filed under

Regulation E during the 1972 fiscal year

for offerings totaling $860,000. These

were the first Regulation E filings since

fiscal year 1969_

Exempt Offerings Under Regulation F

DUringthe 1972 fiscal year, 17 notifications were filed under Regulation F,

covering assessments of stock of

$398,025, compared With 19 notifications covering assessments of $407,719

m 1971.

CONTINUING DISCLOSURE:

THE 1934 SECURITIES

EXCHANGE ACT

The Securities ExchangeAct of 1934

contains significant disclosure provisions designed to provide a fund of current material information on companies

in whose securrties there is a substantial public interest. The Act also seeks

to assure that security holders who are

solicited to exercise their voting rights,

or to sell their securities m response to
THIRTY-EIGHTH ANNUAL REPORT 29

a tender offer are furnished pertinent

mforrnation.

Registration on Exchanges

Generally speaking, a security cannot

be traded on a national securities exchange until it is registered under Section 12(b) of the Exchange Act. If it

meets the listing requirements of the

particular exchange, an issuer may register a class of secunties on the exchange by frhng with the Commission

and the exchange an application which

discloses pertinent information concerning the issuer and its affairs. DUring

fiscal year 1972, a total of 286 issuers

listed and registered securities on a national securities exchange for the first

time, and a total of 692 registration applications were filed. The registrations

of all securities of 129 issuers were terminated. Detailed statistics regarding

securities traded on exchanges may be

found in the statistical section.

Over-the-Counter Registration

Section 12(g) of the Exchange Act requires a company with total assets exceeding $1 million and a class of equrty

secuntres held of record by 500 or

more persons to register those securities with the Commission, unless one of

the exemptions set forth In that section

IS available, or the Commission Issues

an exemptive order under Section

12(h). Upon registration, the reporting

and other disclosure requirements and

the insider trading provisions of the Act

apply to these companies to the same

extent as to those with secunties registered on exchanges.

During the fiscal year, 701 registration statements were filed under section

12(g). Of these, 431 were frled by ISsuers already subject to the reporting

requirements, either because they had

another security registered on an ex.

change or they had registered secunties

under the Securities Act.

Exemptions

Section 12(h) of the Act authorizes

the Commission to grant a complete or

partial exemption from the registration

provisions of Sections 12(g) or from

other disclosure and insider trading proVISions of the Act where It IS not contrary to the public mterest or the protection of mvestors.

At the begrnrung of the fiscal year,

nine exemption apphcatrons were pendrng, and 14 apphcations were filed durrng the year. Of these 23 applications,

two were Withdrawn, three were granted,

and one denied. The remaining 17 appllcations were pending at the end of

the fiscal year.

While exemptions are normally sought

by Issuers of over-the-counter securities.

one of the applications on which action

was taken dunng the year involved securities listed on the New York Stock

Exchange. Iowa Beef Processors, Inc.

sought an exemption from the quarterly

financial reporting requirement on the

grounds that its business tended to

have relatively unpredictable cycles

rather than being stable or seasonal In

nature and that quarterly results would

not provide accurate historical comparisons or valid prognostications for an.

nual results. The company said thrs

might be misleading to the average

investor and produce unwarranted fluctuations 10 the price of ItS common

stock. Following hearings, the hearing

officer denied the application. HIs deersion became fmal when Iowa did not

seek Commission review 11 The officer

noted that the company had over

11,000 security holders and that there

was active trading Interest In ItS stock.

He said quarterly reports would furnish

useful financial information He held

that the policy of the Federal securities

laws favonng disclosure outweighed the

company's speculative fears.
30 SECURITIESAND EXCHANGECOMMISSION

Periodic Reports

Section 13 of the Securities Exchange

Act requires Issuers of securities registered pursuant to Section 12(b) and

12(g) to file periodic reports, keeping

current the Information contained In the

registration application or statement.

During the fiscal year, the Commission

monitored the results of substantial reVISions made in the prior year In the

annual report form, and through the introduction of quarterly financial reports.

Experience to date indicates that these

revisions have served to provide more

adequate and current disclosure of material information, without imposing

undue burdens on Issuers. In 1972,

45,671 reports-annual, quarterly and

current-were filed.

Proxy Solicitations

Where proxies are solicited from holders of securities registered under Section 12 or from security holders of registered public-utility holding companies,

subsidiaries of holding companies, or

registered investment companies, the

Commission's proxy regulation requires

that disclosure be made of all material

facts concerning the matters on which

the security holders are asked to vote,

and that they be afforded an opportunity to vote "yes" or "no" on any matter other than the election of directors.

Where management is sohcrtrng proxies,

a security holder desiring to communicate With the other security holders may

require management to furnish him with

a list of all security holders or to mail

hrs communication for him. A security

holder may also, subject to certain limitations, require the management to include In proxy material any appropriate

proposal which he wants to submit to a

vote of security holders, or he may

make an independent proxy solicitation.

The rules on security holders' proposals

were recently revised, as described In

Part 1.

Copies of proposed proxy material

must be filed with the Commission in

prelimmary form prior to the date of

the proposed solicitation. Where preliminary material fails to meet the prescnbed disclosure standards, the management or other group responsible for

its preparation is notified informally and

given an opportunity to correct the deficrencies In the preparation of the definitive proxy material to be furnished to

security holders.

Issuers of securities registered under

Section 12 must transmit an information statement comparable to proxy rnatenal to security holders from whom

proxies are not sohcrted with respect to

a stockholders' meeting.

Dunng the 1972 fiscal year, 6,556

proxy statements in definitive form were

filed, 6,534 by management and 22 by

nonmanagement groups or individual

stockholders. In addition, 149 information statements were filed. The proxy

and mformation statements related to

6,367 companies, and pertained to

6,328 meetings for the election of directors, 350 special rneetmgs not involving

the election of directors, and 27 assets

and authorizations.

ASide from the election of directors,

the votes of security holders were solicrted with respect to a variety of matters, including mergers, consolidations,

acquisitions and sales of assets and dissolution of companies (414); authorizations of new or additional securrtres,

modifications of existing securities, and

recapitalization plans (1,149); employee

pension and retirement plans (48);

bonus or profit-sharing plans and

deferred compensation arrangements

(136); stock option plans (736); approval of the selection by managementof

independent auditors (2,702) and miscellaneous amendments to charters and

by-laws,and other matters (2,013).

DUring the 1972 fiscal year, 411 proposals submitted by 53 stockholders for

action at stockholders' meetings were
THIRTY.EIGHTH

included in the proxy statements of 193

companies. Typical of such proposals

submrtted to a vote of security holders

were resolutions on amendments to

charters or by-laws to provide for cumuIatrve voting for the election of drrectors, preemptive rights, limitations on

the grant of stock options to and their

exercise by key employees and management groups, the sending of a postmeeting report to all stockholders, and

limitations on charitable contributions.

A total of 234 additional proposals

submitted by 50 stockholders were

omitted from the proxy statements of

63 companies In accordance with the

provisions of the rule governing such

proposals. The most common grounds

for omission were that proposals were

not a proper subject for secunty holder

action under pertinent state law; were

not submitted on time; related to the

ordinary business operations of the

company; or involved a personal gnevance against the company.

The figures do not Include 224 proposals submitted to 36 companies by a

single individual which were omitted by

the managements of those companies

because, among other reasons, the proponent appeared to be repeating a pattern of conduct he had engaged in durmg the previous proxy season which

seemed to be contrary to the purpose

and Intent of the stockholder proposal

rule. This pattern involved the purchase

of a minimal interest, In many cases

one share of stock, in a number of

companies, the submission of a multiple number of proposals to such companies accompanied by statements of

notice of intention to present the proposals for action at the shareholder

meetings, and the subsequent failure to

appear at almost all of the meetings.

In fiscal 1972, 23 companies were involved in proxy contests for the election

of directors which bring special requirements Into play. In these contests, 567

persons, including both management

ANNUAL REPORT 31

and nonmanagement, filed detailed

statements required of participants

under the applicable rule. Control of the

board of directors was involved In 16

instances. In 11 of these, management

retained control. Of the remainder, two

were settled by negotiation, two were

won by non management persons, and

one was pending at year end. In the

other seven cases, representation on

the board of directors was Involved.

Management retained all places on the

board in four contests, opposition candidates won places on the board In two

cases; one was pending as of June 30,

1972.

litigation on Proxy Rules

SEC. v. Medical Committee for

Human Rlghts.12 The United States Supreme Court vacated as moot a deersion by the Court of Appeals for the

District of Columbia crrcuit that when

the Comrnission expresses a determination to take no enforcement action, at

least with respect to disputes over the

lncludabrhty of shareholder proposals In

management's proxy soliciting matenals, that determination IS reviewable

by an appellate court.

The litigation had ansen out of the

refusal by Dow Chemical Company to

Include in ItS proxy matenal a proposal

submitted by the Medical Committee.

However, Dow included the proposal In

its proxy matenal for the May 1971 annual meeting. At that meeting less than

three percent of the votes cast supported the proposal. The Supreme Court

ruled that the controversy was moot

since, under the Commission's proxy

rules, the same or substantially the

same proposal could be excluded from

Dow's proxy materrals for the next three

years.

Kixmiller v : S.£.C.13 The petitioner,

relying on the court of appeals deCISIOn

In the MedIcal Committee case, sought

review In the Court of Appeals for the

District of Columbia Circurt of a staff
32 SECURITIES AND EXCHANGE COMMISSION

decision not to recommend to the Comrrussion that enforcement action be instituted against the Washington Post

Company in the event that that company excluded petrtioner's proposals

from ItS proxy solicitation materrals and

of the Commission's deterrninatron not

to review the staff's position. The Commission has moved to dismiss the petrnon for review, asserting that It has

taken no action that is judicially reviewable.

Takeover Bids, Large Acquisitions

Sections 13(d) and (e), and 14(d),

(e) and (f) of the Secuntres Exchange

Act, enacted In 1968 and amended in

1970, provide for full disclosure In cash

tender offers and other stock acquisitions involving changes In ownership or

control. These provisions were designed

to close gaps In the full disclosure provisions of the securities laws and to

safeguard the interests of persons who

tender their securities in response to a

tender offer.

During the 1972 fiscal year, 1,006

Schedule 13D reports were filed by persons or groups which had made acquisitions resulting In their ownership of

more than five percent of a class of securities. Fifty such reports were filed by

persons or groups making tender offers,

which, if successful, would result in

more than five percent ownership. In

addition, 16 Schedule 14D reports were

flied on solrcrtatrons or recommendations

In a tender offer by a person other than

the maker of the offer. Sixteen statements were filed for the replacement of

a rnajority of the board of directors otherwise than by stockholder vote. One

statement was filed under a rule on cor,

porate reacquisttions of securities while

an Issuer is the target of a cash tender

offer.

Insider Reporting

Section 16 of the Securitres Exchange

Act and corresponding provisions in the

Public Utility Holding Company Act of

1935 and the Investment Company Act

of 1940 are designed to provide other

stockholders and investors generally

With information on insider securities

transactions and holdings, and to prevent unfair use of confidential information by insiders to profit from shortterm trading in a company's securities.

Section 16(a)' of the' Exchange Act

requires every person who beneficially

owns, directly or indirectly, more than

10 percent of any class of equity security which IS registered under Section

12, or who IS a director or an officer of

the issuer of any such security, to file

statements with the Cornrnissron disclosing the amount of all equity securities of the issuer of which he is the

beneficial owner and changes in such

ownership. Copies of such statements

must be filed with exchanges on which

securities are listed. Similar provisions

applicable to insiders of registered pubhc-utrlrty holding companies and registered close-end investment companies

are contained in the Holding Company

Act and Investment Company Act.

Dunng the year, the Commission

amended Rule 16a-6 under the Exchange Act to provide that the granting,

acquisition, disposition, expiration or

cancellation of any presently exercisable

put, call, option or other right or obligation to buy secunties from, or sell secuntres to, another person, whether or not

It is transferable, shall be deemed a

change In the beneficial ownership of

the securities to which the right or obligation relates.14 At the same time, the

reporting forms (Forms 3 and 4) were

revised to reflect the above amendment

and to require certain additional informatlon.l5

In fiscal 1972, 103,206 ownership reports were filed. These included 19,867

initial statements of ownership on Form

3, 79,339 statements of changes in

ownership on Form 4, and 4,000

amendments to previously filed reports,

most of which were necessitated by the
THIRTY-EIGHTH 33

form revisions discussed above.

All ownership reports are made available for public inspection when filed at

the Commission's office in Washington

and at the exchanges where copies are

filed. In addition, the information contained in reports filed with the Commission is summarized and published In

the monthly "Official Summary of Security Transactions and Holdings," which

is distributed by the Government Printing Office to about 10,000 subscribers.

To prevent Insiders from making unfair use of information which they may

have obtained by reason of their relationship with a company, Section 16(b)

of the Exchange Act and corresponding

provisions In the Holding Company Act

and the Investment Company Act provide for the recovery by or on behalf of

the Issuer of any profit realized by msiders from trading securities of the company within six months.

Short-Swing Trading Litigation

Reliance Electric Co. v, Emerson

Electric CO.I6 A significant decision interpreting Section 16(b) was rendered

by the Supreme Court in this case. The

Court held, (4 to 3), that profits real.

ized by a beneficial owner are not recoverable on the second sale of an issuer's stock where the first sale had

reduced his holdings to 10 percent or

less. It relied on a proviso in Section

16(b) which excludes from coverage

under that section transactions by a

shareholder who was not a more-than10'percent beneficial owner "both at the

time of the purchase and sale . . . of

the security involved." Although recognizing that its ruling might be inconsistent with Its assessment of the "wholesome purpose" of Section 16(b), and

that, where alternative constructions

were possible, that section should be

given the construction "that best serves

the congressional purpose of curbing

short-swing speculation by corporate insiders," the Court concluded that the

ANNUAL REPORT

literal language of the proviso "clearly

contemplates that a statutory Insider

might sell enough shares to bring his

holdings below 10 percent, and laterbut within six months-sell additional

shares free from liability under the

statute." 17

The Court declined to adopt the POSI'

non urged by the Cornrrussion, as amicus cunae, which would have both imposed liability on the second sale

transaction and preserved the objective

quality of Section 16(b) by Interpreting

the phrase "at the time of the . . .

sale" as meaning at any time during

the penod in which the sale transactions occurred.

The dissenting Opinion charged that

the result reached by the majonty,

under "the guise of an 'objective' approach," was a "mutilation" of and

"undermines" the statute. Noting that

words such as "purchase," "sale" and

"at the time of" are not defined words

With precise meanings, and reasoning

that insiders must not be permitted to

circumvent Section 16(b)'s broad mandate if the statute IS to have the "Optimum prophylactic effect" of deterring

unfair use of inside information, the

dissenters concluded that the statute

should be construed as allowing a rebuttable presumption that any series of

sales made by a beneficial owner of

more than 10 percent Within six

months, In which he disposes of a

major part of hrs holdings, will be

deemed to be part of a single plan of

disposition and treated as a Single

"sale" for the purposes of Section

16(b).

At the request of the Senate Committee on Banking, Housing and Urban Affairs and the House Committee on Interstate and Foreign Commerce, the

Cornrnlssron prepared and transmitted

to the Congress a draft bill to amend

Section 16(b) which is designed to overcome the Court's decision.

Gold v. Scurlock. IS The Commission

submitted a brief as amicus curiae, urg-
34 SECURITIES AND EXCHANGE COMMISSION

ing the court to rule that the defendants' acquisition of secunties of Susquehanna Corporation In a merger

between Susquehanna and the company

of which they were shareholders, constituted "purchases" of Susquehanna se.

curitres within the meaning of Section

16(b). The defendants sold the Susquehanna stock acquired in the merger less

than six months later, at a time when

they were officers or directors of Susquehanna. The Commission argued that

the defendants' receipt of Susquehanna

stock in the merger presented them

with the opportunrty for engaging in the

abuses that Section 16(b) was designed

to prevent.

ACCOUNTING

The Securrtres Acts reflect a recogrunon by Congress that dependable financial statements are indispensable to informed Investment decisrons. A major

objective of the Commission has been

to Improve accounting and auditing

standards and to assist In the establishment and maintenance of high standards of protessional conduct by public

accountants. The primary responsibility

for thrs program rests with the Chief

Accountant of the Commission

Under the Commission's broad rule.

making power, It has adopted a baSIC

accounting regulation (Regulation S-X)

which, together with oprruons on accounting pnnciples published as "Accounting Senes Releases", governs the

form and content of fmancial statements filed under the securrtres laws.

Dunng the fiscal year, Regulation S-X

was comprehensively revised The Commission has also formulated rules on

accounting and auditing of broker-dealers and prescnbed Uniform systems of

accounts for companies subject to the

Public Utility Holding Company Act of

1935 The accounting rules and opinions

of the Cornrnissron, and of its decrsions

in particular cases, have contnbuted to

clarification and WIder acceptance of the

accounting pnnciples and practices and

auditing standards developed by the profession and generally followed In the

preparation of financial statements.

However, the specific accounting

rules and regulatrons-e-except for the

uniform systems of accounts which are

regulatory reports-prescribe accounting

principles to be followed only In certain

limited areas. In the large area of financial reporting not covered by ItS rules,

the Commission's principal means of

protecting Investors from inadequate or

Improper frnancral reporting IS by requir109 a report of an Independent public

accountant, based on an audit performed In accordance with generally accepted auditing standards, which expresses an opinion whether the financial

statements are presented fairly in

conformity with accounting pnncrples

and practices that are recognized as

sound and have attained general acceptance. The requirement that the opinion

be rendered by an Independent accountant is designed to secure for the benefit

of pubhc Investors the detached objectivrty and the skill of a knowledgeable

protessronat person not connected WIth

the management.

The accounting staff reviews the fmancral statements filed With the Cornrrussion to Insure that the required stand.

ards are observed and that the

accounting and auditing procedures do

not remain static In the face of changes

and new developments In frnancral and

economic conditions. New methods of

doing business, new types of busmess,

the combining of old businesses, the

use of more sophisticated securities,

and other innovations create accounting

problems which require a constant reappraisal of the procedures. It is antrcrpated that In fiscal 1973 a program of

Increased publication of staff interpretations on matters of accounting principles and procedures Will be undertaken

to better inform the public of the

ground rules currently being followed in
THIRTY.EIGHTH ANNUAL REPORT 35

the review of financial information filed

with the Commission.

Relations with the Accounting

Profession

In order to keep abreast of changing

conditions and In recognition of the

need for a continuous exchange of

views and information between the

Commission's accounting staff and outside accountants regarding appropriate

accounting and auditing policies, procedures and practices for the protection

of Investors, the staff maintains continuing contact with individual accountants and various professional organizations, including the American Institute

of Certified Public Accountants (AICPA),

the principal professional organization

concerned with development and Improvement of accounting and auditing

standards and practices. The Chief Accountant also meets regularly with his

counterparts In other regulatory agencies to Improve coordination on policies

and actions between the agencies.

Because of its many foreign registrants and the vast and Increasing foreign operations of American companies,

the Cornrnissron has an interest in the

improvement of accounting and auditing

principles and procedures on an international basis. In this connection, the

Chairman addressed an international

meeting on stock exchanges in Milan,

Italy, in March, 1972, and a conference

on financial reporting, Commission des

Operations des Bourse, Pans, France, in

May 1972. To promote such Improvement, the Chief Accountant in June,

1972, conferred with foreign accountants in London, England, and in October he participated in the Tenth International Congress of Accountants In

Sydney, Australia.

Accounting and Auditing Standards

In early 1971, the AICPA appointed

two committees to explore ways to irnprove the Institute's function of estabhslung standards of financial reporting.

One committee, chaired by former SEC

Commissioner Francis M. Wheat, studred the operations of the Accounting

Pnnciples Board (APB) and possible alternatives, and made recommendations

for a new structure to supplant the

APB. The governing council of the

AICPA approved the structure In May

1972 and set a target date of January

1, 1973, for establishment of a new

board, to be known as the Financial Accounting Standards Board. The seven

members of the board, who are to be

appointed by a financial accounting

foundation which Includes representatives from leading professronal organizations, Will serve on a salaned, full-time

baSIS. The Commission endorsed this

new structure, which It feels should proVide operational efficrencres and Insure

an Impartial viewpoint in the development of accounting standards on a

timely basis.

The other committee appointed In

early 1971 was formed to study and refine objectives of financial statements.

It is studying the baSIC questions of

who needs financial statements, what

information should be provided, how it

should be communicated, and how

much of It can be provided through the

accounting process. The committee's

conclusions and recommendations, expected to be ready In early 1973,

should also provide valuable guidance

to the Fmanctal Accounting Standards

Board in determining the direction and

the pnoritres of ItS efforts in establishing standards.

During the fiscal year, the Accounting

Pnnciples Board published five opinions.

One, on "Accounting Changes", provrdes detailed guides for reporting on

changes In accounting principles, accounting estimates and reporting entities, and specrfres that a company

should demonstrate that changes which

are made in accounting principles will

provide more useful information than

the prior method of accounting. Another
36 SECURITIES AND EXCHANGE COMMISSION

oprruon, on "Interest on Receivables

and Payables," adopted the concept of

present value as a basis for accounting

valuation and provided needed guides

for its use under circumstances when

notes which are received or issued bear

an Interest rate diffenng matenally from

the prevailing market rate.

The opinion on "Disclosure of Accounting Policies" requires a descnption

of all significant accounting policies to

be included as an Integral part of the

financial statements when such statements purport to present fairly financial

position, changes In financial position,

and results of operations In accordance

with generally accepted accounting principles. Thrs disclosure should increase

the usefulness of financial statements

by providing users with more information about accounting policies followed

by the company,

Two opinions provide guidance In accounting for Income taxes In areas of

(1) undistributed earnings of subsrdiaries, general reserves of stock savings

and loan associations, and amounts

designated as policyholders' surplus by

stock life Insurance companies; and (2)

investments In common stock accounted for by the equity method (other

than subsidiaries and corporate joint

ventures).

Other Developments

During the fiscal year, the Commission issued SIX Accounting Senes Releases. The first three, described in the

37th Annual Report, 19 related to (1) revisions of annual report Form N-1R for

management investment companies; 20

(2) amendments to certain registration

and reporting forms and Regulation S-X

removing the exemption from certification of financial statements of banks; 21

and (3) an Interpretation of the computation of the ratio of earnings to fixed

charges which IS required to be shown

in certain registration statements under

the secuntres Act and is permitted to

be shown in certain registration and report forms under the Secunties Exchange Act. 22

In an advisory release,23 the Commission endorsed the establishment of

audit committees composed of outside

directors by publicly held companies,

and urged the business and financial

cornrnuruties and shareholders of companies to lend their support to the implernentatron of a program to establish

such audit committees to afford the

greatest possible protection to Investors

who rely on financial statements.

In another advisory release,24 on

pro rata stock distributions to shareholders, the Commission emphasized

that It Will deem distributions of shares

which are less than 25 percent of the

same class outstanding to be misleading if the accounting IS improper or disclosure is Inadequate; and if there IS a

question of whether the condrtron of the

business warrants the drstnbution, a

further investigation will be considered

to determine whether such drstrlbutrons

may be part of a manipulative or fraudulent scheme. If drstnbutions of more

than 25 percent of the same class outstanding appear to be part of a program of recurring distributions designed

to mislead shareholders, Similar interpretations and considerations may

apply.

A release 25 was Issued on major

amendments to Regulation S-X, consisting of revisrons of Articles 1, 2, 3, 4, 5

and 11 and Rules 12-01 to 12-16 (exelusive of 12-Q6A), and the addition of

new Rules 12-42 and 12-43. These are

the first general revlsions of these parts

of the regulation since 1950 and they

compnse changes, additions and deletions that have become necessary with

changing conditions. After the fiscal

year, a general revision of Article 9 of

the regulation, pertaining to financial

statements of banks and bank holding

cornparues, was also adopted.ee A comprehensive release was developed to set
THIRTY-EIGHTH ANNUAL REPORT 37

forth current guidelines employed in resolving questions of Independence of

accountants in relation to their clients

who are registrants of the Commission.

This release 27 was adopted by the

Commission after the end of the fiscal

year.

Reporting forms were amended to require registrants to furnish additional

Information regarding any unusual material charges or credits to Income; to

report a change In the certrfymg accountants and the reasons for the

change and to request that the replaced

accountant furnish a letter to the Commission commenting on the reasons

stated by the registrant; and to report

changes in accounting principles and

practices materially affecting the financial statements including a letter from

the independent accountants regarding

the changes.28

After the fiscal year, an amendment

to Rule 17a-5 under the Securities Exchange Act was adopted requiring bro.

ker-dealers to provide similar notifications of changes in certifying accountants and the reasons for the changes.sv

EXEMPTIONS FOR

INTERNATIONAL BANKS

Section 15 of the Bretton Woods

Agreement Act, as amended, exempts

from registration securities Issued, or

guaranteed as to both principal and In'

terest, by the International Bank for Reconstruction and Development. The

Bank is required to file with the Commission such annual and other reports

on securities as the Commission determines to be appropriate. The Cornrrussion has adopted rules requiring the

Bank to file quarterly reports and copies

of annual reports of the Bank to ItS

Board of Governors. The Bank IS also

required to file advance reports of any

distribution In the United States of its

primary obligations. The Commission,

acting In consultation With the National

488-483 0 - 73 - 5

AdVISOry Board on International Monetary and Financial Problems, IS authorized to suspend the exemption for securities Issued or guaranteed by the Bank.

The followmg summary of the Bank's

activities reflects mforrnatron obtained

from the Bank. Except where otherwise

indicated, all amounts are expressed in

U.S. dollar equivalents as of June 3D,

1972

Net income for the year was $183

million, compared With $212 million the

previous year. The decrease was due

primarily to higher Interest on borrowmgs, lower yields on short-term invest.

ments and lower capital gains. At July

31, 1972, the Bank had taken no action

regarding drsposrtron of ItS net Income

for fiscal year 1972.

Repayments of pnncrpal on loans received by the Bank dunng the year

amounted to $385 million, and a further $126 million was repaid to purchasers of portions of loans. Total pnncrpal repayments by borrowers through

June 3D, 1972, aggregated $4.7 billion,

including $2.8 billion repaid to the Bank

and $1.9 billion repaid to purchasers of

borrowers' obligations sold by the Bank.

Outstanding borrowings of the Bank

were $7.0 billion at June 30, 1972. Durmg the year, the bank borrowed $425

rrullron in the United States market:

$371 million through the Issuance of 2-

year U S. dollar bonds to central banks

and other governmental agencies In

some 60 countries; D.M. 1 3 billion

(U.S. $341 million) In Germany; 54 billion yen (U S. $150 million) in Japan;

SwF 575 million (U.S $141 million) in

SWitzerland; KD 50 million (U.S. $140

million) in Kuwait, and the equivalent of

U.S. $176 million In other countries

outside the United States. The above

U.S. dollar equivalents are based on official exchange rates at the times of the

respective borrowings. The Bank also IS'

sued $13 million in bonds that had

been sold In previous years under de.

layed delivery contracts.
38 SECURITIESAND EXCHANGECOMMISSION

These borrowings, in part, refunded

maturing issues amounting to the equrvalent of $549 million. After retirement

of $59 million equivalent of obligations

through sinking fund and purchase fund

operations, the Bank's outstanding borrowings showed an increase of $1.5 billion from the previous year, of which

$385 million represented appreciation In

terms of U.S. dollars of the value of the

non-dollar currencies in which the debt

was denominated.

The Inter-AmericanDevelopmentBank

Act, which authorizes the United

States to participate In the Inter-American Development Bank, provides an exemption for certain securities which

may be Issued or guaranteed by the

Bank similar to that provided for securities of the International Bank for Reconstruction and Development. Acting pursuant to this authority, the Commission

adopted Regulation lA, which requires

the Bank to file with the Commission

substantially the same type of information, documents and reports as are required from the International Bank for

Reconstruction and Development. The

following data reflects information submitted by the Bank to the Commission.

On June 3D, 1972, the outstanding

funded debt of the Ordinary Capital resources of the Bank was the equivalent

of $1.1 billion, reflecting a net increase

In the past year of the equivalent of

$107 million. During the year, the

funded debt was increasedthrough pub.

IIc bond issues totaling the equivalent

of $55.6 million as well as pnvate

placements for the equivalent of $68.8

million including, with respect to Japan,

$31.6 million of undrawn commitments

at June 30, 1972, and $5.7 million of

drawings under arrangements entered

Into during the previous year. Addition,

ally, $32.5 million of two-year bonds

were sold in Latin Amenca, essentially

representing a roll-ever of a maturing

borrowmg of $34.3 million. As a result

of the world currency realignment in De.

member 1971, the funded debt in.

creased by $42.5 million due to upward

adjustment of the U.S. dollar equivalent

of borrowings denominated in non-member currencies, including the equivalent

of $2.6 million relating to borrowings

during the last half of 1971 but pnor to

the December 1971 currency realignment. The funded debt was decreased

through the retirement of $23.5 million

from sinking fund purchasesand scheduled debt retirement.

The Asian Development Bank Act,

adopted in March 1966, authorized

United States participation in the ASian

Development Bank and provides an ex.

emption for certain securities which

may be issued or guaranteed by the

Bank, similar to the exemptions accorded the lnternatronal Bank for Reconstruction and Development and the

Inter-American Development Bank. Acting pursuant to this authority, the Com.

mission has adopted Regulation AD

which requires the Bank to file with the

Commission substantially the same type

of information, documents and reports

as are required from those banks. The

Bank has 37 members with subscnptions totaling $1 billion. Of the $502.7

million of paid-up shares subscribed,

$494.6 million had matured by June 3D,

1972.

As of June 3D, 1972, eight countries

had contributed or pledged a total of

$174.6 million to the Bank's Special

Funds. In addition to the $14.6 million

set aside from Ordinary Capital in 1969

by the Board of Governors for Special

Funds purposes, another $9.9 million

were set aside In April 1971, making a

total of $24.5 million set aside. In addition, the United States Congress has

authorized a $100 million U.S. contribution to the Bank's Special Funds, and is

consrdenng the appropriation of these

funds In fiscal 1973. There have been

indications from four other countries of

additional contributions and Japan has

pledgedan additional $40 million.

Through June 30, 1972, the Bank's

borrowings totalled the equivalent of
THIRTY-EIGHTH

$201 million. In 1971, the Bank sold

$20 million U.S. bonds to regional central banks and borrowed In Switzerland,

the United States, Japan, Belgium and

Austria. The U.S. borrowing was $50

rrullion, half In 5.year notes at 6% percent and half in 25-year bonds at 7%

percent. Before selling securities In the

territory of a country, the Bank must

obtain that country's approval.

TRUST INDENTURE ACT OF

1939

This Act requires that bonds, debentures, notes and similar debt secunties

offered for public sale, except as specifreally exempted, be issued under an indenture which meets the requirements

of the Act and has been duly qualified

with the Commission.

The provisions of the Act are closely

integrated with the requirements of the

Securities Act. Registration pursuant to

the Securities Act of securities to be issued under a trust Indenture subject to

the Trust Indenture Act IS not permitted

to become effective unless the indenture conforms to the requirements of

the latter Act designed to safeguard the

rights and Interests of the purchasers.

Moreover, specified information about

the trustee and the Indenture must be

included In the registration statement.

The Act was passed after studies by

the Commission had revealed the frequency with which trust indentures

failed to provide minimum protections

for security holders and absolved socalled trustees from minimum obligations in the discharge of their trusts. It

requires, among other things, that the

indenture trustee be a corporation With

a minimum combined capital and surplus and be free of conflicting Interests

which might interfere With the faithful

exercise of its duties in behalf of the

purchasers of the securities, and it Imposes high standards of conduct and responsiblllty on the trustee. During fiscal

year 1972, 492 trust indentures relating

ANNUAL REPORT 39

to securities in the aggregate amount of

$20.2 billion were filed.

INFORMATION FOR PUBLIC

INSPECTION; FREEDOM OF

INFORMATION ACT

The many thousands of registration

statements, applications, declarations,

and annual and penodic reports filed

With the Cornrrussron each year, as well

as many other public documents, are

available for public inspection and copying at the Commission's public reference room In Its principal offices In

Washington, DC and, in part, at its regronal and branch offices.

The categories of materials available

for public inspection and copying and

those categories of records that are

generally considered to be nonpublic as

permitted under the Freedom of Information Act are specified in the Commission's rules concerning records and in.

formation (17 CFR 200.80 to 200.82).

The Rule adopted by the Commission to

Implement the provrsions of the Freedom of Information Act (5 U.S.C. 552),

became effective July 4, 1967 (17 CFR

200.80). Among other things, that rule

establishes the procedure to be followed

In requesting records or copies, provides a method of administrative appeal

from the denial of access to any record,

and provides for the imposition of fees

when more than one-half man-hour of

work IS performed by members of the

Cornrrussron's staff to locate and make

available records requested. In addition

to the records described, the Commission also makes available for inspection

and copying all requests for no action

and interpretive letters received after

December 31, 1970, and responses (17

CFR 20081). After the fiscal year, the

Cornrntssron further provided (Rule 17

CFR 200.82) that after November 1,

1972, It would make available for

inspection and copying materials filed

under proxy Rule 14a-8(d), which deals

With proposals offered by shareholders
40 SECURITIESAND EXCHANGECOMMISSION

for mclusion in management proxy-solicrtrng rnaterrals, and that it would likewise make available related materials

submitted to the Commission by any

person and written comrnunicatrons prepared by the staff on these materials.

The Commission has special public

reference facrlltres in the New York, Chicago and Los Angeles Regional Offices

and some facilities for public use In

other regional and branch offices. Each

regional office has available for public

examination copies of prospectuses

used in recent offenngs of securities

registered under the Secunties Act; registratron statements and recent annual

reports filed under the secunties Exchange Act by companies having their

pnncipal office In the region; recent annual reports and quarterly reports filed

under the Investment Company Act by

management investment companies havrng their principal office In the region;

broker-dealer and investment adviser

applications originating in the region;

letters of notification under Regulation

A filed in the region, and mdeses of

Commission decisions.

During the 1972 fiscal year, 14,683

persons examined matenal on file m

Washmgton; several thousand others examined files in New York, Chicago, and

other regional offices. More than 36,283

searches were made for information reo

quested by indrvrduals, and approxrmately 4,198 letters were wntten on information requested

The Cornrmssron's records do not

drstmguish between records disclosed

under the federal secunties laws and

those made available under the Freedom of Information Act. Dunng the

fiscal year, the Commission in 33 Situations, either upon request or on ItS

own motion, considered whether to per.

mit disclosure of records that under its

rule implementing the Freedom of Information Act (17 CFR200.80) would generally not have been disclosed.30 In 18

cases disclosure was made; In the reo

rnarrung 13 situations disclosure was

denied. Of the matters considered by

the Commission, 9 involved requests

for access to the contents of investigatory files compiled for law-enforcement

purposes. While the Commission generally declined to permit access to investigatory files, in 3 cases the requesting party was provided With a list of the

names and addresses of those persons,

other than confidential informants, who

provided evidence in the course of the

investigation.

The public may make arrangements

through the Public ReferenceSection at

the Commission's principal offices to

purchase copies of material in the Commission's public files. The copies are

produced by a commercial copying company which supplies them to the public

at prices established under a contract

with the Commission. Current prices begin at 12 cents per page for pages not

exceeding811z" x 14" in size, with a $2

minimum charge. Under the same contract, the company also makes microfiche and microfilm copies of Comrnissron public documents available

on a subscription or Individual order

basis to persons or firms who have or

can obtain viewing facilities. In microfiche services, up to 60 images of document pages are contained on 4" x 6"

piecesof film, referred to as "fiche."

Annual microfiche subscriptions are

offered In a variety of packages covering all public reports filed on Forms

1Q-K, 1D-Q, 8-K, N-1Q and N-1R

under the Secuntres Exchange Act or

the Investment CompanyAct; annual reports to stockholders; proxy statements;

new Issue registration statements; and

final prospectuses for new issues. The

packagesoffered include vanous categones of these reports, mcludmg those of

companies listed on the New York Stock

Exchange, the Amencan Stock Exchange, regional stock exchanges, or

traded over-the-counter; reports are also

available by standard Industry classifications. Arrangements also may be made

to subscnbe to reports of companies of
THIRTY-EIGHTH ANNUAL REPORT 41

one's own selection. Over one hundred

million pages (rrncroirnagery frames) are

being distributed annually. The subscription services may be extended to fur.

ther groups of filings In the future If demand warrants. The company also will

supply copies In microfiche or microfilm

form of other public records of the

Commission desired by a member of

the public.

Mlrcofrche readers and reader-printers

have been installed in the public reference areas In the Commission's headquarters office, and the New York and

Los Angeles regional offices, and sets of

microfiche are available for inspection

there. After January I, 1973, similar facrlltres will be available in the Chicago

Regional Office. VISitors to the public

reference room of the Commission's

headquarters office may also make Immediate reproductions of material in

those offices on photostatic-type copymg machines. The cost to the public of

copies made by use of all custorner-operated equipment will be 10 cents per

page after January 1, 1973. The charge

for an attestation with the Commission

seal is $2. Detailed Information concerning copying services available and

prices for the various types of service

and copies may be obtained from the

Public Reference Section of the Com.

mission.

Publications

In addition to releases concerning

Commission action under the securities

laws and litigation involving secunties

Violations, the Cornrrussron Issues a

number of other publications, including

the followmg:

Daily:

News Digest; reporting Commission announcements, decisions, orders, rules and rule

proposals, current reports and

applications filed, and litigation developments.

Weekly:

Weekly trading data on New

York and American Stock Exchanges; Weekly trading data

on New York and American

Stock Exchanges (Information

is also included In the Statistical Bulletin).

Monthly:

Statistical Bulletin.a

Officral Summary of Securities

Transactrons and Holdings of

Officers, Directors and Principal Stockholders.a

Quarterly:

Working Capital of U.S. Corporations

Stock Transactions of Financial

Institutions

Annually:

Annual Report of the Cornrnrssion.e

Securities Traded on Exchanges

under the Securities Exchange

Act of 1934

List of Companies Registered

under the Investment Company Act of 1940

Classiftcatlon, Assets and Location of Registered Investment

Companies under the Investment Company Act of 1940 b

Private Noninsured Pension

Funds (assets available quarterly In the Statistical Bulletin).

Directory of Companies Filing

Annual Reports With the Commission under the Securities

Exchange Act of 1934 a

Other Publications:

Decisions and Reports of the

Commission a (Out of print,

available only for reference

purposes in SEC Washington,

D.C. and Regional Offices.)

Securities and Exchange Comrrussron-e--The Work of the Securrtres and Exchange Commission
42 SECURITIESAND EXCHANGECOMMISSION

Commission Report on Public Investment Company Act of

Policy Implications of Invest- 1940

ment CompanyGrowth a

Cost of Flotation of Registered

Equity Issues, 1963-1965 a

Report of SEC Special Study of

Secunties Markets, H. Doc. 95

(88th Congress)a

Institutional Investor Study Report of the Securities and Exchange Commission, H. Doc.

64 (92nd Congress) a

Part 8 of the Institutional Investor Study Report, containing

the text of the Summary and

Conclusions drawn from each

of the fifteen chapters of the

report. a

Study on Unsafe and Unsound

Practices of Broker Dealers,

H. Doc. 231 (92nd Congress)a

Statement of the secuntres and

Exchange Commission on the

Future Structure of the Securities Markets, February2, 1972.

The Financial Collapse of the

Penn Central Company, Staff

Report of the Secunties and

Exchange Commission to the

Special Subcommittee on Investigations, August 1972 a

Report of the Real Estate Advisory Committee to the Secunties and Exchange Commission a

Acts and General Rules and Regulations for all Securities Acts

Compilation of Releases Dealing

with Matters Frequently Ansing under the Securities Act of

1933

Compilation of Releases Dealing

with Matters Ansing under the

Securities Exchange Act of

1934 and Investment Advisers

Act of 1940

Compilation of Releases, Commission Opinions, and Other

Matenal Dealing with Matters

Frequently Ansing under the

a Must be ordered from the Superintendent of Documents, Government

Pnnting Office, Washington, D.C. 20402.

b This document is available in photocopy form Purchasersare billed by the

pnntmg company which prepares the

photocopies.

FREEDOM OF INFORMATION

ACT LITIGATION

The meaning of various exemptions

from the general disclosure requirements of the Freedom of Information

Act, was the subject of litigation involving the Comrnisston during the fiscal

year.

Frankel v. SEC. After the Commission had brought an action which

resulted in a court injunction, plaintiffs

sought the contents of the investigatory

file compiled by the Comrnissron upon

which ItS action had been based. The

drstnct court held that the exemption

applicable to "Investigatory files compiled for law enforcement purposes"

was not available because the Commission had not demonstrated that further

enforcement action was anticipated.31 It

also rejected the argument that some or

all of the records were exempt as matters that are specifically exempted from

disclosure by statute by virtue of the

Trade Secrets Act, because, in ItS view,

that Act only penalized unauthorized

disclosure of non-exempt information.

The court ordered the Commission to

turn over that portion of the file which

was not exempt by virtue of other exemptions which the Commission had asserted. On appeal by the Commission,

the Court of Appeals for the Second CirCUIt reversed the order of the district

court and remanded the matter with

directions to enter summary judgment

for the Cornrrusslon.w It held that the

requested records came within the investigatory files exemption which it said

was available whether or not further en-
THIRTY-EIGHTH ANNUAL REPORT 43

forcement proceedings were contemplated.

Vlnlck v. S.E.C.33 The plaintiff requested, among other things, the en.

tire investigatory file compiled by the

Commission in a non-public investigation of Memorex Corporation which led

the Commission to file suit against Memorex and others.s- The answer filed by

the Commission raises Issues similar to

those In the Frankel case. The SUIt was

pending at the close of the fiscal year.

Commercial Envelope Mfg. Co., Inc.

v. S.E.C.35 A petition was filed in the

Court of Appeals for the Second Circuit

to review the Commission's refusal to

make public a document obtained from

an Informant relating to the completeness and accuracy of a registration

statement filed under the Securities Act

During the fiscal year thrs petition was

dismissed by the court of appeals for

lack of JurisdictlOn.36 Commercial Envelope thereafter filed suit In the United

States District Court for the Southern

District of New York, seeking an order

compelling the Commission to turn over

the docurnent.s? In ItS answer to the

complaint, the Commission has again

asserted that the document is exempt

from disclosure under the Freedom of

Information Act because it (1) IS part of

an investigatory file compiled for law

enforcement purposes; (2) IS specifically

exempted from disclosure by virtue of

the Trade Secrets Act; and (3) contains

matters which are commercial or financial Information obtained from a person

and prlvrleged or confidential.

M. A. Schapiro & Co., Inc. v S.E C.38

Plaintiff had asked that the Commission

be required to make public a staff study

on Rule 394 of the New York Stock Exchange and transcripts of testimony

taken and other records compiled In the

course of the staff investigation of that

rule. Before the court had ruled on the

issues involving the staff study, the

Commission voluntarily made the study

public. The district court then directed

the Commission to produce for plaintiff's inspection and copying the remainmg records requested by plaintiff, but

allowed the Commission to delete

"[a]1I rdentrfyrng material that would

indicate who the indivrdual grvmg the

information was .. where the person so

requested" The court rejected the applicability of each of the exemptions relied

upon by the Cornrnissron. It held that

the records had not been shown to

have been compiled for law enforcement purposes, because the Commission proffered no proof that It contemplated a law enforcement proceeding

based upon the material sought within

the reasonably near future The records

were held not to be matters that are

"contained In or related to examination,

operating, or condition reports prepared

... [for the use of] an agency responsible for the regulation or supervision of

frnancral institutions," because the materials were gathered "for the express

purpose of changing trading rules and

related practices of national secunties

exchanges." The court further held that

the records were not exempt from disclosure as matters that are specifically

exempt by statute by virtue of the

Trade Secrets Act, or as matters that

are "commercial or fmancral information . . . and privileged or confidential." The Commission determined not

to appeal the decrsron, and It disclosed

the records with identrfymg details deleted.

NOTES TO PART 2

1Securities Act Release No 5209

(November 8, 1971) 2 Secunties Act Release No. 5171

(July 20, 1971).

3 Investment Company Act Release

No. 7220 (June 9, 1972). 4 Investment Company Act Release

No. 7219 (June 9, 1972).

5 Securities Act Release No. 5201 (October 12, 1971).

6 Securrtles Act Release No. 5170

(July 19, 1971).

_
44 SECURITIES AND EXCHANGE COMMISSION

7 Securities Act Release No. 5235

(February 16, 1972).

8 Natural Resources Defense Council, Inc. v. S.E.C., C.A. D.C., No. 72-

1148. 9 The Division has consistently taken

the position that offers of resort condominiums, In conjunction with certain

types of rental arrangements, constitute

offers of "investment contracts" which

must be registered as securities under

the Securities Act.

10 Securities Act Release No. 5225

(January 10, 1972).

11 Securities Exchange Act Release

No. 9348 (September 28, 1971).

12432 F. 2d 659 (C.A. D.C., 1970),

vacated as moot, 404 U.S. 403 (1972).

Previously discussed In 37th Annual Report, pp. 54-55; 36th Annual Report,

pp. 49-50.

13 C.A. D.C., No. 72-1285.

14 Securities Exchange Act Release

No. 9499 (February 23, 1972).

15 Securities Exchange Act Release

No. 9500 (February 23, 1972).

16404 U.S. 418 (1972).

17 404 U S. at 423. Since the proviso

In Section 16(b) relates only to 10 percent beneficial owners, the Court's de.

crsion does not affect lower court holdmgs that Section 16(b) applies to the

purchase and sale within SIX months by

an officer or director who IS found to be

in such statutory Insider status either at

the time of purchase or at the time of

sale. See, e.g., Feder v. Martin Manetta

Corp., 406 F. 2d 260 (C.A. 2, 1969),

certiorari denied, 396 U.S. 1036 (1970);

Adler v. Klawans, 267 F. 2d 840 (C.A. 2,

1959).

18 C.A. 4, Nos 71-2180, 71-2181

and 71-2182.

19 See pages 65 and 15D-151

20 Accounting Series Release No. 120

(July 15, 1971).

21 Accounting Series Release No. 121

(July 19, 1971).

22 Accounting Series Release No. 122

(August 10, 1971).

23 Accounting Series Release No. 123

(March 23, 1972).

24 Accounting Series Release No. 124

(June 1, 1972).

25 Accounting Series Release No. 125

(June 23, 1972).

26 Accounting Series Release No. 128

(September 20, 1972).

27 Accounting Series Release No. 126

(July 5, 1972).

28 Securities Exchange Act Release No.

9344 (September 27, 1971).

29 Securities Exchange Act Release No.

9691 (July 27, 1972).

30 In addition, the Commission provrded disclosure of records in substantially all Instances where requests were

made by the Congress, Federal agencies,

state and local government officials,

foreign governments and court trustees

and receivers.

31336 F. Supp. 675 (S.D. N.Y., 1971).

See prior discussion In 37th Annual Report, p. 210. 32460 F. 2d 813 (C.A. 2, 1972),

certiorari denied, 41 U.S.L.W. 3188, (No.

72-49) (October 10, 1972).

33 N.D. Cal., No. C-71-2987.

34 S.E.C. v. Memorex Corp., S.D.N.Y.,

71 CIV. 2812.

35 C.A. 2, No. 71-1171. Previously

discussed in 37th Annual Report, p. 210.

36450 F. 2d 342 (C.A. 2, 1971).

37 Commercial Envelope Mfg. Co.,

Inc. v. S.E.C., S.D. N.Y., No. 72 Civ.

1660.

38339 F. Supp. 467 (D.D.C., 1972).

Previously discussed in 37th Annual Report, p. 210.


PART 3

REGULATION OF

SECURITIES MARKETS

In addition to the disclosure provi- deceptive, and manipulative acts and

sions discussed in the preceding chap- practices on the exchanges and in the

ter, the Securities Exchange Act assigns over-the-counter markets. Some recent

to the Commission significant regulatory developments of significance in market

responsibilities for securities markets regulation are discussed in Part 1.

and persons In the secunties business. REGULATION OF EXCHANGES It requires secunties exchanges to register with the Commission and provides Registration

for Commission supervision of the self- The Secunties Exchange Act requires

regulatory responsibilities of registered an exchange to register with the Comexchanges. The Act requires registration mission as a national securities exand regulation of brokers and dealers change unless the Commission exempts

doing business in the over-the-counter it from registration because of the limmarkets, and permits registration of as- ited volume of transactions. As of June

sociations of brokers or dealers exercis- 3D, 1972, the following 12 stock exing self-regulation under Commission changes were registered:

supervision. The Act also contains provr- American Stock Exchange, Inc.

sions designed to prevent fraudulent, Boston Stock Exchange

47
48 SECURITIESAND EXCHANGECOMMISSION

Chicago Board of Trade 1

Cincinnati Stock Exchange

Detroit Stock Exchange

Midwest Stock Exchange, Inc.

National Stock Exchange

New York Stock Exchange, Inc.

Pacific Coast Stock Exchange, Inc.

PBWStock Exchange, Inc.2

Intermountain Stock Exchange3

Spokane Stock Exchange

The Honolulu Stock Exchange and

the Richmond Stock Exchange were exempt from registration dunng the fiscal

year. On Apnl 21, 1972, the Richmond

Stock Exchange was dissolved by Its

members, and the Commission thereafter issued an order withdrawing the Exchange's exemption from registration,

effective May 10, 1972.

During the fiscal year, two prospective new exchanges, the Chicago Board

Options Exchange, Incorporated, and

the Southeastern Stock Exchange, Incorporated, submitted informal applications

for staff review.

The Chicago Board Options Exchange

intends to limit Its initial operations to

call options 4 in approximately 20 underIymg stocks. It Intends to increase that

number gradually and to extend operations to other types of options as expenence is gained and the market and its

regulatory arrangements are tested. The

Exchange not only would provide a market place for the irutral buyrng and selling of option contracts but also would

facilitate the development of a secondary market for the resale of options

during their lifetime. Presently, options

are initially bought and sold over-thecounter, and there IS only a very limited

secondary, over-the-counter market.

The Southeastern Stock Exchange,

which would be located In Miami, Florida, would serve primarily the southeastern part of the United States as a

regional exchange.

Exchange Rules

The Commission's staff maintains a

continuous review of the rules and practices of the securities exchanges to determine adequacy and effectiveness of

self-regulation. To facilitate Commission

oversight, each national securities exchange IS required to file with the Commission a report of any proposed rule

or practice change not less than 3

weeks (or such shorter period as the

Commission may authorize) before acting to effectuate the change.

During the 1972 fiscal year, 176 proposed changes in exchange rules and

practices were submitted to the Commission. Among the more significant:

1. Since February 1971, when the

New York Stock Exchange was incorporated, the Amencan Stock Exchange,

Midwest Stock Exchange, Pacific Coast

Stock Exchange, and Philadelphia-Baltimore-Washington Stock Exchange have

also been incorporated, like the New

York Stock Exchange, the American

Stock Exchange was incorporated under

the New York Not-for-Proflt Corporation

Law. The other exchanges were incorporated as membership corporations

under the Delaware General Corporation

Law. At the request of the Commission's staff, the certificates of incorporation of all the above exchanges permit

the payment of dividends only in the

event of liquidation. This limitation will

assure preservation of exchange assets

for the protection of investors and help

Insure proper functioning of exchanges

as self-regulatory bodies by eliminating

any incentive to operate as profit-making entities.

In connection with the incorporation

of these exchanges, the staff reviewed

provisions concerning indemnification of

officers, directors and employees. Because indemnification might be against

public policy where violations of the Exchange Act are involved, the staff requested each exchange to inform it

whenever indemnification is proposed in

order to permit review of the particular

circumstances.

2. The New York Stock Exchange
THIRTY.EIGHTHANNUAL REPORT 49

amended its rules to permit member

firms to sell life insurance. This action

was designed to enable members to

offer a wider range of financial services

to their customers, to diversify their

sources of income to help offset cyclical

swings In the securities business, and

to offer more attractive employment opportunities to Qualifiedsalesmen.

3. The New York Stock Exchange

adopted a uniform point per share

charge (known as an odd-lot differential) for all stocks purchased or sold in

odd-lots. Previously, an odd-lot customer paid point per share when the

stock sold for less than $55 per share,

and 1,4 point per share on higher priced

stocks. The Pacific Coast Stock Exchange also amended its rules to set a

uniform differential on odd-lot transactions in all securities traded on the

Exchange. The Midwest Stock Exchange

adopted a odd-lot differential for all

stocks listed on the Exchange, as well

as those which are traded on the Exchange and listed on the New York

Stock Exchange. The Boston and PBW

Stock Exchanges implemented a lfs

odd-lot differential on all stocks traded

on those exchanges which are listed on

the NewYork Stock Exchange.

The Midwest, Pacific Coast and PBW

Stock Exchanges eliminated the odd-lot

differential on odd-lots which are part of

an order for one or more round-lots.

4. The New York and American Stock

Exchanges revised their governing structures to provide for an Increased number of public directors or governors

(persons not engaged in the securities

business) on their governing boards.

Each of these exchanges now has 10

public representatives on its 21-man

board, compared to 3 out of 33 before.

Litigation on Exchange Rules

The past year saw the further proliferation of attacks, under the antitrust

laws, on various rules or practices of

the New York Stock Exchange (NYSE)

and other self-regulatory organizations.

In a number of these cases, the Comrnissron has filed briefs as amicus curtee or has intervened. It has taken the

position that, to the extent the Commission has regulatory JUrisdiction with respect to the rules and practices challenged, they should be tested by the

Commission against the standards and

by the procedures of the Securities Exchange Act and not by a district court

applyrng antitrust standards. The Commission noted that in the landmark decision in Silver v. New York Stock

Exchange,S the Supreme Court had held

that the "guiding principle" to reconciliation of the two statutory schemes is

that the antitrust laws must be regarded as having been repealed to the

extent "necessary to make the Securities ExchangeAct work." And the Commission has pointed out that the Securities Exchange Act cannot be expected

to work if district courts may render ad

hoc decrsions which preempt the Commission's judgment in areas of the

Commission's basic regulatory responsibilities.6

Among more significant cases in this

area: Robert W. Stark, Jr., Inc. v. New

York Stock Exchange, IncJ Stark, Inc.

and Robert W. Stark, Jr., its president,

and Kansas City Securities Corporation,

a brokerage subsidiary of a mutual fund

manager and a nonmember of the

NYSE,charged the NYSEwith having violated the antitrust laws through the

promulgation and enforcement of Rule

318, which requires that "[the] primary

purpose of every member organization,

and any parent of any member corporation, shall be the transaction of business as a broker or dealer in securities." Stark and Stark Inc. sought a

preliminary injunction enjoining the

NYSEfrom expelling them for Violations

of that rule involving the injection of

capital by Kansas City Into the Stark

firm.

The Cornrnlssron filed a memorandum, amicus curiae, urging that the re-

~

~

~

~
50 SECURITIESAND EXCHANGECOMMISSION

quest for a preliminary injunction be denied. It pointed out that Rule 318 is

subject to the Commission's regulatory

oversight, and that if a district court

were to enjoin the rule it would interfere with the exercise of policy-makmg

functions entrusted to the Commission

by the Congress. The district court, in

denying injunctive relief, agreed in large

part with the Commission's positlon.e

The court noted that Rule 318, together

with other venous rules and customs,

was the subject of a pending request by

the SECthat NYSEand other exchanges

effectuate certain alterations in rules

and practices. It concludedthat:

"[T]here IS adequate power in the

SEC to take all steps necessary

with respect to the access of institutional investors to the NYSEand

... this Court should take no step

in private litigation which might in

any way prejudice the effectiveness

of such a scheme, or create any

grandfather rights for plaintiffs, or

otherwise Impair by implication or

other[wise] the full and complete

right and power of the SEC to do

the regulatory work for which it

was constituted, in an area of market action which cries out for some

rational plan."

The district court's decision was affirmed per curiam by the Court of Appealsfor the SecondCircuit.9

Thill v. New York Stock Exchange.IO

The Court of Appeals for the Seventh

Circuit in 1970 reversed a district court

order granting summary judgment to

the Exchange.ll This case is now proceeding toward a trial of the question

whether the NYSE's anti-rebate rule is

"necessary to make the Securities Exchange Act work." The NYSEmoved to

refer this question to the Commission

on a primary.jurisdiction theory. The

district court denied the motion because, in its View, the Securities Exchange Act does not establish a sufficiently pervasive regulatory scheme to

warrant such referral. The NYSEhas appealed this ruling.I2 The Commission,

as intervenor, filed a brief in the court

of appeals in which it argued' that the

ruling should be affirmed, although not

on the theory of the district court. Instead, the Commission pointed out that

the current anti-rebate rule, which provides for a 40 percent discount from

the fixed minimum commission rate to

nonmember broker-dealers,was promulgated by the NYSEat the Commission's

request. Implicit in the Commission's request was a preliminary determination

that this test rule was "necessary or appropriate" under the standards of Section 19(b) of the ExchangeAct. Accordingly, no purpose would be served by

referral of a question, the answer to

which the Commission had already given-the anti-rebate rule as it currently

exists appears proper under the ExchangeAct.

Eisen v. Carlisle & Jacquelin.13 In this

case, in which the Commission has not

participated, the plaintiff filed a class

action on behalf of himself and other

odd-lot investors against the NYSEand

the two major odd-lot dealers on the

NYSE, attacking the Exchange's odd-lot

tradrng differential as violative of the

anti-trust laws and claimmg that the

NYSEwas required to but had failed to

regulate odd-lot transactions. In preliminary rulings, the Federal district court

held that the case could be maintained

as a class action on behalf of some 6

million investors who had engaged in

odd-lot transactions on the Exchange

between 1962 and 1966 and that, since

the class was more than likely to pre.

vail on its claims, the defendants

should bear the major share of the cost

of notice to the class.

Oelistings

Under the Securities Exchange Act,

securities may be stricken from listing

and registration upon application to the

Commission by an exchange, or withdrawn from listing and registration upon
THIRTY-EIGHTHANNUAL REPORT 51

application by an issuer, in accordance

wrth the rules of the exchange and

upon such terms as the Cornmlssron

may impose for the protection of mvestors.

The various exchanges have different

delisting standards. However, delisting

actions are generally based on one or

more of the following factors: the number of publicly held shares or shareholders is insufficlent: the market value of

outstanding shares or the trading volume IS too low; the company does not

meet requirements as to earnings or fInancral condition or has ceased operations; or required reports have not been

filed with the exchange.

During the fiscal year ending June

30, 1972, the Commission granted exchange applications for the removal of

77 stock issues and 14 bond issues

from listing and registration. The largest

number of applications came from the

American Stock Exchange (18 stocks

and 9 bonds). Other exchanges were

represented as follows: National (21

stocks); New York (16 stocks and 3

bonds); Midwest (7 stocks and 2

bonds); Pacific Coast (6 stocks); Detroit

and PBW (4 stocks each); and Intermountain (1 stock).

The Commission also granted the applications of two issuers to withdraw se.

curities from listing and registration on

the National Stock Exchange.

In judicial review of a delisting action, in Intercontinental Industries, Inc.

v. American Stock Exchange,I4 the

Court of Appeals for the Fifth Circuit

upheld a Cornrnlssron decisron granting

the American Stock Exchange's application to delist the stock of Intercontinental Industries, Inc. (INI). That application was based on INI's dissemination

of misleading information in violation of

ItS listing agreement with the Exchange

The court agreed with the Exchangeand

the Commission that INI failed to take

"prompt corrective action". It noted

that INI did not make full disclosure

until enforcement action was taken

against it some two to three months

after It had made rrusleadmgannouncements. The court also rejected INI's argument that It was denied due process

In the delisting procedures.

Exchange Disciplinary Actions

Although the ExchangeAct does not

provide for Commission review of disci.

plrnary action by exchanges.ts each national securrtresexchange reports to the

Commission actions taken against members and member firms and their

associated persons for violations of any

rule of the exchangeor of the Exchange

Act or of any rule or regulation under

the Act.

During the fiscal year, eight exchanges reported 236 separate actions,

including the imposrtlon In 120 cases of

fines ranging from $10 to $25,000, With

total fines aggregating $266,400; the revocation of 24 member frrrns and expulsion of 4 individuals; the suspension

from membership of 13 member firms

and 30 individuals; and censure of 99

member firms. The exchanges also reported the imposition of various other

sanctions against 22 registered representatives and other employees of

member firms.

Inspections

Another Important aspect of the Comrrusslon's supervrsion of exchange selfregulation is its program of regular

inspections of vanous phases of exchange activity. These mspections en.

able the Commission to recommend,

where appropriate, improvements de.

signed to increase the effectiveness of

self-regulation.

In fiscal 1972, the Commission's staff

conducted 15 inspectrons. Two of these

were general inspections of the Philadelphia-Baltimore-Washington and Pacific

Coast Stock Exchanges. At the New

York Stock Exchange, eight separate

inspections were made, covering enforcement and lnterpretatron of its net
52 SECURITIESAND EXCHANGECOMMISSION

capital rule, financial surveillance, stock

watch and floor surveillance, procedures

for compliance with Regulation T of the

Federal Reserve Board, arbitration, and

the Block Automation System.

Inspections of the American Stock Exchange covered stock watch and floor

surveillance procedures, the enforcement and interpretation of its net capital rule and financral surveillance generally, and FACS(a system for rnonltonng

the operational capacity of member

firms). In addition, inspections were

conducted of the Pacific Coast and Midwest Stock Exchange Stock Clearing

Corporations and Service Corporations

and the New York Stock Exchange

Clearing Corporation.

SUPERVISION OF NASD

The ExchangeAct provides for registration with the Commission of national

securities associations and establishes

standards and requirements for such

associations. The Act contemplates that

such associations will serve as a medium for self-regulation by over-thecounter brokers and dealers. Their rules

must be designed to protect investors

and the public interest, to promote just

and equitable principles of trade, and to

meet other statutory requirements. They

are to operate under the general supervision of the Commission, which is authorized to review disciplinary actions

taken by them, to disapprove changes

in their rules, and to alter or supplement their rules relating to specified

matters. The National Association of Securities Dealers, Inc. (NASD) is the only

association registeredunder the Act.

In adoptrng legislation perrnlttrng the

formation and registration of national

securities associations, Congress provided .an incentive to membership by

permitting such associations to adopt

rules which preclude a member from

dealing with a nonmember broker or

dealer except on the same terms and

conditions. as the member affords the

general public. The NASD has adopted

such rules. As a result, membership is

necessary to profitable participation in

underwritmgs smce members may properly grant price concessions, discounts

and similar allowances only to other

members.

At the close of the fiscal year, the

NASD had 4,229 members, reflecting a

net loss of 161 members during the

year. Thrs loss was the net result of

411 admissions to and 572 terminations of membership. The number of

branch offices decreased by 444, to

6,584, as a result of the opening of

1,234 new offices and the closing of

1,678 offices. During the year, the number of registered representatives and

principals (these categories include all

partners, officers, traders, salesmen and

other persons employed by or affiliated

With member firms in capacities which

require registration) decreased by 2,014

to stand at 197,903 as of June 30,

1972. This decrease was the net result

of 23,317 initial registrations, 26,805

re-registrations and 52,136 terminations

of registrations during the year.

During the fiscal year, the NASD administered 58,911 qualification examinations of which approximately 34,806

were for NASDqualification and the balance for other agencies, including major

exchanges,the Commission and various

States.

NASD Rules

Under the Exchange Act, the NASD

must file for Commission review, 30

days in advance of their effectiveness,

copies of any proposed rules or rule

amendments. Any rule change or addition may be disapproved by the Commission if found not to be consistent

with the requirements of the Act. The

Commission also normally reviews, in

advance of publication, general policy

statements, directives, and interpretations proposed to be issued by the Association's Board of Governors pursuant
THIRTY-EIGHTH ANNUAL REPORT 53

to its powers to administer and interpret NASD rules.

During the fiscal year, numerous

changes in or additions to NASD rules,

policies and interpretations were submitted to the Commission. Among the

more significant which were not disapproved by the Commission:

1. Amendments to the Code of

Arbitration Procedure to authorize

the Board of Governors to compel

a member to arbitrate any dispute,

claim or controversy arising out of

a secunties transaction at the instance of another member or a

public customer. Previously, the

Code provided only for the voluntary submission of disputes. Further, provislon was made for the

selection of a representative from

the public at large to serve on the

National Arbitration Committee.

2. Amendments to Schedule D

of the NASD By-laws, which pertains to the NASDAQ system,16 (a)

requiring that NASDAQ market

makers' quotations be good for at

least one trading unit (usually 100

shares) in securities quoted on the

system; (b) requiring NASDAQ market makers to report their volume

data on a daily basis; (c) setting

subscribers' charges for use of the

NASDAQ system; (d) increasing the

size of the Association's NASDAQ

Committee so as to provide a bet.

ter geographical representation;

and (e) revising procedures and

sanctions in connection with alleged NASDAQ violations.

3. Amendments to schedule C

of the NASD By-laws to provide for

revised qualification examinations

for registered representatives of

NASD member firms and to create,

for the first time, a class of "financial principals" who would be required to pass the entire prlncipal's examination including the

488-483 0 - 73 - 6

portion relating to financial matters.

4. Amendments to Schedule B

of the NASD By-laws realigning

the NASD Distncts in accordance

with the administrative needs of

the Association.

5. Amendments to the Associatron's Uniform Practice Code designed to streamline the procedures relating to the partial

delivery of securities.

On May 9, 1972, the NASD Board of

Governors submitted to ItS membership

for comment a proposed Rule of Fair

Practice to establish a system of regula.

non for the distribution of tax-sheltered

programs. This proposed rule, the result

of approximately one year's work by two

committees appointed by the Association, would prohibit members from par.

trcipating In the dlstnbution of tax-sheltered programs which did not meet

prescribed standards of fairness and

reasonableness. These standards relate

to the underwriting or other terms and

conditions of the distribution of Units of

such programs to the public Including

all elements of compensation to be paid

to sponsors or broker-dealers, and con.

cerning the operation, structure, and

management of such programs. SUitability standards for investment in such

programs and requirements concerning

the content and filing with the ASSOCiation of advertisrng and supplemental

sales literature would be established. At

the end of the fiscal year, the comment

penod for the proposed rule had not yet

expired.

Litigation on NASD Rules

Harwell v. Growth Programs, Inc,17 A

class of purchasers of single-payment

contractual plans for the accumulation

of mutual fund shares sued the sponsor

and the underwriter of the plans and

the NASD for an alleged conspiracy in

Violation of the antitrust laws. Plaintiffs

sought treble damages from all defen-
54 SECURITIESAND EXCHANGECOMMISSION

dents and resumption of the nght to

unlimited exercise of the withdrawaland-reinstatement privilege contained In

the plans. The NASD had issued an interpretation of its Rules of Fair Practice,

whrch, 10 effect, prohibited NASD members, including the sponsor and

underwnter of the plans, from continu109to facilitate the unlimited and speculatrve use of this "in-and-out" pnvilege. This rnterpretatron had been

issued at the Commission's urging.

As reported last year,IS the district

court granted the defendants' motion

for summary judgment. On appeal, the

Court of Appeals reversed and remanded the case for a trial on the merItS. Relying on the Thill case, discussed

above, the court held that the fact that

the NASD "acted under close supervision" of the Commission in adopting its

interpretation did not immunize It from

antitrust penalty. The court further

stated that 10 any event, the extent of

the Commission's supervision was not

readily apparent from the record and

that the record was barren of what consideration, if any, was given by the

Commission to the antitrust effects of

the NASD's interpretation.

The NASD sought a reheanng (which

the Commission supported in a statement filed with the court) urging that

the record did 10 fact reflect the extent

of the Commission's supervision over

the issuance of the Interpretation and

that such supervision distinguished the

case from Thill where it was held that

the "mere possibility" of Commission

supervision over the rules of a national

secunties exchange was not sufficient to

rrnrnuruzethe exchangefrom antitrust attack. The court dented rehearing. It apparently acknowledged that the record

did reflect the supervision exercised by

the Commission and It deleted the contrary statement from its original opmion, but it reaffirmed its reliance on

Thill. The NASD thereafter petitioned

the Supreme Court for a writ of certiorari.

The Exchange Act authorizes the

Cornrrussron to abrogate any NASD rule

If necessary or appropriate to effectuate

the purposes of the Act. During the

fiscal year, the Cornrrussron,after hearings, abrogated an NASD rule to the extent that It permitted or had been construed to permit the NASD to bar the

receipt by ItS members of cornrmssions,

concessions, discounts or other allowances from nonmember brokers or

deaters.t? The NASD's interpretation

had 10 effect precluded members from

joining in a distnbutron with a nonrnernber where the concession or discount

flowed from the nonmember to the

member. The Commission held that the

rule, as contrued and applied, was beyond the scope of the authonty granted

to the NASD by a provrsion of the Act

authorizing it to adopt rules prohibiting

a member from dealing With a nonmember except at the same pnces and on

the same terms as it accords to the

general public. This was the first case

in which an NASD rule has been abrogated in whole or 10 part.

Inspections

The Commission is charged With the

general oversight of national securities

assocratrons in the performance of their

self-regulatory activities, and the staff

conducts periodic inspections of various

phases of NASD activity. While in the

past budgetary restnctions have severely limited the number of inspectrons

conducted, during this fiscal year,

largely as a result of a supplemental

appropriation received by the Commission, the staff was able to inspect the

overall operations of the Association's

district offices in Dallas, Denver, Los

Angeles, New York, San Francisco, Seattle, St. LoUISand Washington, D.C. In

addition, the staff reviewed operations

of the National Clearing Corporation

which was established by the NASD to

provide nationwide clearing and settlement facilities in the over-the-counter

market.
THIRTY-EIGHTHANNUAL REPORT 55

NASD Disciplinary Actions

The Commission receives from the

NASOcopies of its decisions in all drscrplinary actions against members and

registered representatives. In general,

such actions are based on allegations

that the respondents violated specified

provisions of the NASO's Rules of Fair

Practice. Where violations by a member

are found, the NASO may Impose sanctions including expulsion, suspension,

fine, or censure. If the violator is an individual, his registration with the Association may be suspended or revoked, he

may be suspended or barred from being

associated with any member, and he

may be fined and/or censured.

During the past fiscal year, the NASO

reported to the Commission its final disposition of disciplinary complaints

against 575 member firms and 486 individuals associated with them, both

records.2o The major factors contributing to the increase in disciplinary actions have been the NASO's expanded

examiner force,21ItS increased frequency

of inspections of member firms, the

adoption of new NASO and Commission

rules, and the NASO's quarterly financial reporting form designed to provide

the Association with advance warning of

impending financial or back office problems.

In the discipllnary actions, complaints

against 37 members and 46 individuals

were dismissed for failure to establish

the alleged violations. The maximum

penalty of expulsion from membership

was Imposed against 38 members, and

36 members were suspended from

membership for periods ranging from 1

day to 6 months. In many of these

cases, the member was fined as well. In

432 cases, members were fined

amounts ranging from $100 to $50,000

and in 32 cases, members were censured.

In disciplinary sanctions imposed on

individuals associated with member

firms, 76 were barred, 26 were revoked,

and 66 had their registrations suspended for periods ranging from 1 day

to 5 years. In addition, 272 other individuals were censured and/or fined

amounts ranging from $100 to $25,000.

Review of NASD Disciplinary

Actions

Oiscipllnary actions by the NASD are

subject to review by the Commission on

its own motion or on the timely application of any aggrieved person. In these

cases, effectiveness of any penalty Imposed by the NASD IS automatically

stayed pending Commission review, unless the Commission otherwise orders

after notice and opportunity for hearing.

If the Commission finds, in ItS review,

that the disciplined party committed the

acts found by the NASD and Violated

the rules specified In the determination,

the Commission must sustain the

NASD's action-unless It finds that the

penalties Imposed are excessive or oppressrve, in which case It must cancel

or reduce them.

At the start of the fiscal year, eight

proceedings to review NASDdisciplinary

decisions were pending before the Comrrussion on review. During the year, 25

additional cases were brought up for

revlew.22 Eight cases were disposed of

by the Commission. In two cases, the

Commission sustained In full the drsciplinary action taken by the NASD.23It

dismissed the review proceedings In two

cases as having been abandoned, and

permitted the withdrawal of two other

applications. In the remaining two

cases, the Commission set aside some

of the NASD findings, but sustained the

penaltles.24Twenty-five cases were pendmg at the end of the year.

One case, R. Danais Investment Co.,

Inc.,25 involved improper use of the

NASD's examination questions in preparing applicants for qualification examinations. The NASD found that the

member's president improperly obtained

copies of the Association's qualification
56 SECURITIESAND EXCHANGECOMMISSION

examination questions for registered

representatives and incorporated those

questions into a practice quiz used in

prepanng the firm's trainees for examination. It expelled the firm and revoked

the president's registration.

In sustaining the NASD actions, the

Commission referred to a prior holding

that:

"In view of the vital importance of

examinations in the program of upgrading the level of competence in

the securities business, we regard

a deception in connection with the

taking of those examinations . . .

to be so grave that we would not

find the extreme sanction of revocation or expulsion to be excessive

or oppressive unless the most extraordinary mitigative facts were

shown."

The Commission was unable to find that

extraordinary rnrtrgative facts had been

shown here.

In Hagen Investments, Inc. v, SEC,26

the Court of Appeals for the Tenth CrrCUIt affirmed the Commission's finding

that certain Emergency Rules of Fair

Practice adopted by the NASD's Board

of Governors during the paperwork and

financial crises of 1968-1970 had been

validly adopted. The court, as had the

Commission, rejected the petitioner's argument that the adoption of some rules

violated NASD By-laws and that the

rules, which petitioner had been found

to have violated, were invalid. The court

held that the NASD has the authority to

promulgate rules of fair practice in an

emergency Situation WIthout submitting

such rules to the full NASD membership

for a vote.

In Benjamin Werner & CO. V. SEC,27

the Court of Appeals for the Distnct of

Columbia Circurt affirmed per curiam

and without opinion an order of the

Commission dismissing petrtioner's application to review disciplmary action

taken against him by the NASD. The

Court of Appeals necessanly rejected,

as had the Commission, petitioner's argument that the NASD could not Impose upon him any penalty except censure since his conduct, while concededly

contrary to just and equitable principles

of trade and therefore in violation of

the NASD's Rules of Fair Practice, was

not also found to be illegal.

Review of NASD Membership

Action

The Exchange Act and NASD By-laws

provide that no broker or dealer can be

an NASD member where he or an associate IS subject to specified disabilities.

These can only be waived under specific

findings of the Commission. A Commission order approving or directing admission to, or continuance in Association

membership IS generally made after initial submission to the NASD by the

member or applicant for membership.

The NASDin its discretion may then file

an application with the Commission on

behalf of the petitioner. If the NASD refuses to sponsor, the broker or dealer

may apply directly to the Cornrnissron

for an order directing the NASD to

adrmt or continue him in membership.

At the beginning of the fiscal year, 9

applications for approval of admission

to or continuance in membership were

pending. During the year, 6 additional

applications were filed, 4 were approved, and 5 were withdrawn, leaving 6

applications pending at the year's end.

BROKER-DEALER REGULATION

Registration

Brokers and dealers who use the

mails or the means of interstate commerce in the conduct of an over-thecounter securities business are required

by the Securities ExchangeAct to register with the Commission.

As of June 3D, 1972, 4,734 brokerdealers were registered, compared with

4,940 a year earlier. The reduction was

attributable mainly to the withdrawal of
THIRTY-EIGHTHANNUAL REPORT 57

688 registrations as against only 561

new applications filed. For further comparative statistics, see the statistical

section.

Financial Reports

Registered broker-dealers are required

to file annual reports of financial condition with the Commission. In most

cases, these reports must be certified

by an independent public accountant

The reporting rule was amended significantly dunng the year to provide more

financial data to the Commission and to

customers. During the fiscal year, 4,224

broker-dealer financial reports were filed

with the Commission, compared to the

1971 total of 4,481.

Income and Expense Reports

The Commission in June 1968

adopted Rule 17a-10 under the Securities Exchange Act, effective January 1,

1969.28 This rule requires registered broker-dealers and exchange members to

file Income and expense reports for

each calendar year with the Commission

or with a registered self-regulatory organization (an exchange or the NASD)

which has qualified a plan under the

rule. The self-regulatory organization

transmits copies of the reports to the

Commission on a confidential basis.

During the fiscal year, the Commission

deleted the provision of the rule which

permitted a self-regulatory organization

to omit the names and addresses of

members when transmitting reports.29

Since 1970, the Commission has approved the plans of the NASD, and the

American, Midwest, New York, and

Philadelphia-Baltimore-Washington Stock

Exchanges.30 These plans provide that

the self-regulatory organization will

adopt and implement appropriate internal procedures for review of the reports

submitted by members, review all reports filed for reasonablenessand accuracy, transmit edited reports to the

Commission, and undertake certain

other obligations.

The reports covering calendar year

1971 of SECO broker-dealers31 and

non-NASDmembers of those exchanges

which have not qualified a plan have

been received and reviewedby the Commission. The 1971 reports of all NASD

members and of non-NASDmembers of

those exchanges which have qualified a

plan have been received by the Commission from the respective self-regulatory organization. Information based on

these reports is Included in the statistical section.

Broker-Dealer Examinations

A corrective measure taken by the

Commission to deal more effectively

With problems detailed In its December

1971 "Study of Unsafe and Unsound

Practices of Brokers and Dealers" was

the establishment In January, 1972, of

an Office of Broker-Dealer and Investment Adviser Examinations. In August,

1972, as part of the reorganization of

the Commission, the functions of this

Office pertaining to Investment advisers

were assigned to the Dlvision of Investment Company Regulation. The new

Office was set up to develop and administer a program for more frequent and

intensive examination of broker-dealers,

both independently <'"" +l-,rough Improved oversight c: coordination

with the examination activrtles of the

self-regulatory agencies, as well as to

step up and improve the Investment adviser examination program.

In March, 1972, shortly after the establlshment of the new Office, the rate

of examination of broker-dealers and investment advisers increased substantially, in part through enlargement of

the Commission's examination staff.

The number of broker-dealer examinations increased from 772 in fiscal year

1971 to 893 the past year.

Broker-dealer examinations used in

the accelerated program are of three

~
58 SECURITIESAND EXCHANGECOMMISSION

types: cause, routine and oversight.

Cause examinations usually result from

complaints received from customers or

other broker-dealers, or from other intelligence which indtcates a need to review

certain aspects of the operations of a

particular broker-dealer, and they are

generally limited to the subject matter

of the complaint. Routine examinations,

which cover all aspects of a broker-dealer's operations, are generally restricted

to broker-dealers which are not members of any of the self-regulatory organizations (SECO broker-dealers), but

members of the self-regulatory organizations are also subject to such exarmnatrons, An attempt is made to examine

each SECObroker-dealer wrthin 60 days

after it becomes registered with the

Commission and to schedule routine examinations of that firm annually thereafter. Oversight axarrunatrons are explained below.

Broker-dealers are frequently members of more than one self-regulatory

organization. A prime concern of the

new Office has been to establish an

effective system of coordination among

the self-regulatory and other regulatory

agencies, including state regulators, to

utihze more effectively total resources

available and to avoid unnecessary and

burdensome duplicate examinations.

The Office is developing a system

whereby each agency concerned will be

notified of exarrunations conducted of

Its members by other organizations.

The Office has also begun review of

examination polrcies and procedures of

the self-regulatory organizations to improve consistency in scope and procedures and has offered to help train examiners of self-regulatory bodies.

The program also contemplates that

the Commission staff will on a sample

basis (1) examine members of self-regulatory bodies directly to determine if

they are in compliance with the securities laws, and (2) examine a member of

a particular self-regulatory organization

directly and at the same time review

the examination report and working papers of the latest examination by that

organization to determine' whether its

exarninatron program is thorough and

effective.

An important function of the new

Office is to perfect an early warning system for the detection of financial and

operational problems of broker-dealers.

This system is also intended to be the

vehicle for coordination of the Commission's broker-dealer examination program with the programs of the various

self-regulatory organizations. The plan is

to organize available information about

all broker-dealers registered with the

Commission, Including their financial

and operational condition, into a data

bank which would be printed out and

distributed regularly to the regional

offices of the Commission and to selfregulatory organizations.

One of the first tasks of the new

Office was the revision of the BrokerDealer Examination Manual, which outlines the procedures and policies of the

Commission's examination program, and

the preparation of a comparable manual

for investment adviser examinations.

The manuals have been distributed to

the Commission's regional offices and

are now in use.

In addition, the Office was engaged

during the fiscal year in the development of a comprehensive examination

training program.

Rule Changes

The Commission adopted or proposed

during the fiscal year a Wide range of

measures designed to correct the practices whi:h led to or intensified the operational and financial problems of the

secuntres industry during 1967-1970.

Among the most significant of these

measures were various rule changes or

proposed changesfor broker-dealers.
THIRTY-EIGHTHANNUAL REPORT 59

Reserve and Segregation

Requirements

Legislation enacted in 1970 creating

the Securities Investor Protection Corporation to provide insurance for customer

accounts explicitly authorized the Commission to prescribe rules regarding the

custody and use of customers' securities and the use of customers' deposits

or credit balances. Such rules were to

require the maintenance of reserves

with respect to such deposits or credit

balances.The initial rule proposals were

made by the Commission in November

1971.32

On May 31, 1972, the Commission

released for public comment a revision

of these proposed rules, in the form of

a proposed new Rule 15c3-3 under the

ExchangeAct.33

The proposed rule deals with the obligation of a broker-dealer to maintain

physical possession or control over securities left with it by a customer and

to have basic reserves against customer

cash and cash realized through utilization of customer securities. It addresses

itself to three primary areas of customer protection: (1) the obligation of a

broker-dealer to promptly take possession or control of all fully-paid

securities and excess margin securities

earned for the account of customers;

(2) a formula for a cash reserve for all

customer funds not used in customerrelated transactions; and (3) separation

of the brokerage operations of a firm

from its other activities.

A number of positive benefits should

flow from this approach for the protection of the funds and securities of customers. The restrictions on the use of

customers' funds and securities and the

requirement that securities be promptly

brought under physical possession or

control are designed to protect customer assets in liquidation. The rule

should also act as a control over the

unwarranted expansion of a broker-dealer's business, since it would prohibit

the utilization of customers' funds and

customer-derived funds 10 areas of the

firm's business such as underwriting,

trading and overhead.

"Box Count" Rule

In its Study of Unsafe and Unsound

Practices, the Commission cited the

lack of adequate physical controls over

secuntres during the 1967-1970 period.

Under the rules then in effect, that part

of the broker-dealer'soperations dealing

with the movement and location of securities had been subject only to the

once-a-yearcheck of the audit required

for ItS annual report of financial condition. In an effort to tighten controls, the

Commission adopted Rule 17a-13

under the Exchange Act to require of

broker-dealers a quarterly physical examination and count of firm and customers' securities held, and to verify securities subject to firm control or

direction but not rn their physical

possesslon.e- In comparing the results

of its examination and verification with

its records, a broker-dealer must note

any differences and must post unresolved differences to its books and records within seven days. At the same

time, the Commission made conforming

changes in Its record-keeping and financial reporting rules.

Financial and Operational

Condition

The Study also noted that an early

warnmg system was needed to identify

those brokers and dealers with financial

or operational difficulties before they

reach a point where liquidation is the

only answer. The Commission adopted

Rule 17a-ll under the ExchangeAct to

provide it and the various self-regulatory

organizations with an adequate and

timely flow of information on the financial and operational condition of

broker-dealers.Pf

The rule has four major provisions:

(1) Immediate telegraphic notice to the
60 SECURITIES AND EXCHANGE COMMISSION

Commission and to any self-regulatory

organization of which it is a member,

followed by a ftnancial report within 24

hours, when a broker-dealer's net capital falls below the level required by any

capital rule to which it is subject; (2)

the fihng of special monthly reports

until Its capital position shows improvement for three successive months when

a broker-dealer ascertarns that Its aggregate indebtedness exceeds 1,200 percent of its net caprtal-e--or that Its total

net capital is less than 120 percent of

the rmnirnurn net capital required of it

by any capital rule to which It is subject; (3) telegraphic notice to the appropriate regulatory authonties, followed by

a wntten report Within 48 hours, when

a broker-dealer's books and records are

not current, and (4) notification to the

Commission by a self-regulatory organization when It learns that a member

has failed to give notice or file any report required by the rule.

New Broker-Dealer Disclosure

A contributrng factor In the failures

of broker-dealers In recent years was

the lack of adequate resources of persons entering the business. In its Study,

the Commission said a number of brokers and dealers who were able to remain in business for only brief periods

following their registration had little or

no background in the secuntres field

and had little recognition of the need

for adequate facilities, personnel and

financmg. It pointed out that since the

Securities Investor Protection Corporation (SIPC) may draw on the United

States Treasury up to a billion dollars

to reimburse customer losses, "to permit unprepared, rrresponsrble parties to

enter the broker-dealer business without

the restraining influence of adequate

entry standards would be tantamount to

the subsidization of incompetent and irresponsible individuals by SIPC and the

United States Treasury."

The Commission amended Rule

15bl-2 under the Exchange Act to require new broker-dealers to make detailed disclosures on adequacy of personnel, facilities and fmancing.36 The

former rule merely required applicants

for registration to furnish venfied statements of their financial condition. As

amended, the rule requires a new registrant to file in addition (1) a computation of aggregate indebtedness and net

capital; (2) a statement describing the

nature and source of his capital and

representation that this capital will continue to be devoted to the business; (3)

a statement that adequate arrangements exist for facilities and fmancing

required to operate the business, detailing as well the nature of the arrangements; and (4) for the first year of

operations a statement specifying arrangements for obtairung funds to operate the business, anticipated expenses,

and arrangements to obtain additional

frnancmg if needed.

Net Capital

The Commission's Study noted the

Inadequacy of existing net capital requirements. During the fiscal year, the

Commission amended Rule 15c3-1

under the Exchange Act, its net capital

rule, to increase the minimum net capital required of most broker-dealers from

$5,000 to $25,000 and to reduce the

maximum net capital ratio (ratio of aggregate indebtedness to net capital) of

new broker-dealers for the first year of

their operations from 20-to-1 to 8-to1.37 For broker-dealers not carrying customer accounts and not holding customers' funds and securities, the $5,000

minimum was retained.

Another amendment covered treat.

ment of c1eanng fund deposits under a

continuous net settlement (CNS) system

for the clearance and settlement of

securities transactions. Under CNS, a

cleanng agency assumes the role of

princrpal party In the clearance and

settlement of both the buymg and sell.

ing sides of a transaction in securities

between members of the clearing
THIRTY-EIGHTHANNUAL REPORT 61

agency. Because of the risks assumed

by these clearing agencies, they have

established clearing funds through deposits by clearing members for use in

payment of liabilities of clearing members to CNSor general liabilities of CNS

arising from clearing and settling activities. These funds are essential to continued operation and financial secunty

of CNS clearing agencies. BecauseCNS

systems appear to offer substantial reductions In the movement of share certificates, and deposits are available to

meet members' current obligations to

CNS clearing agencies, the Commission

amended Rule 15c3-1 to provide that

clearing fund deposits by clearing members of clearing agencies using a CNS

system for the clearance and settlement

of securities transactions need not be

deducted from such members' net worth

in the computation of net capital.38

Other amendments of the net capital

rule were designed to grant necessary

relief to underwriters and depositors of

contractual plans for the accumulation

of investment company shares.39 They

pertained principally to the treatment of

funds in segregated trust accounts

which must be maintained under the Investment Company Act and rules on

possible refund obligations.

Financial Reports

Rule 17a-5 under the ExchangeAct

requires registered broker-dealersto file

annual reports of financial condition

with the Commission. As a result of the

back office and operations crisis of

1967-1970, the rule was amended this

year to require broker-dealers (other

than mutual fund dealers and other broker-dealerswho do not carry customers'

accounts, or hold customer funds and

securities) to file additional information

with the Commission annually. Under

the amendment, the Commission now

receives certified Statements of Income

and Statements of Changes in Capital

Accounts in addition to the balance

sheet information previouslyrequired.

In addition, the amendedrule now requires broker-dealersnot only to file reports with the Commission, but also to

send to customers annual and quarterly

balance sheets with statements containing current net capital computations.

With the annual financial statement, the

broker-dealeralso must furnish the customer With a statement as to whether

the accountants have found material inadequacies in the firm's internal controls and notification that the most recent annual report filed With the

Commission is available for examination

and copying at the Commission and at

the broker-dealer's principal office.4o

Clearing Arrangements

In its present form, Rule 17a-3(b)

under the ExchangeAct in effect prohrbItS broker-dealerswho are not members

of a national secuntrss exchange from

having their customers' transactions

cleared through other broker-dealerson

a fully disclosed basis. The Commission

believes it no longer necessaryto prohibit such clearing arrangements if the

clearing broker-dealer has the financial

responsibility needed for protection of

public customers. By the same token,

exchange members who clear for other

exchange members should be required

to have the same financial responsibility. A proposed amendment of the rule

would permit such clearing arrangements if the clearing broker-dealer

maintains net capital of not less than

$25,000 and is otherwise In compliance

with applicable net capital requirernents.u

The Commission also proposed to

amend the rule to permit a brokerdealer to clear his transactions through

a bank, provided the books and records

respecting those transactions are kept

in accordance with the Commlssrcn's

record-keeping requirements and the

bank files an undertaking with the Com.

mission that such books and records

will be available for Commission examination.
62 SECURITIESAND EXCHANGECOMMISSION

Stabilization Reports

Certain amendments of Rule 17a-2

under the Securities Exchange Act and

the related form respecting stabilization

reports were proposed dunng the fiscal

year and adopted thereafter.42 Under

the rule, the member of an underwnting

syndicate or group which makes stabilizmg purchases for the account of the

syndicate must file "as manager" reo

ports on syndicate transactions in the

stabilized and offered securities. Prior to

Its amendment, the rule also required

other members of the syndicate for

whose account stabilizing purchases

were made to file "not as manager" reports. Under the amendments, the reports "not as manager" are to be made

to the syndicate manager, rather than

directly to the Commission. The manager IS to frle all "not as manager" reports with the Commission.

SECO Broker.Dealers

Under the ExchangeAct, as amended

in 1964, the Commission has the responsibrhty for establishing and adrninistenng rules on qualification standards

and business conduct of broker-dealers

not members of the NASD43to provide

regulation for these SECObroker-dealers

comparable to that provided by the

NASD for its members.sDuring the fiscal year, the number of

nonmember broker-dealers decreased

from 301 to 294, but the number of assocrated persons of such firms (i.e.,

partners, officers, directors and employees not engaged in merely clerical or

ministerial functions) increased from

16,060 to approximately 20,600.45

During the fiscal year, the Commission released a statement of poticy and

gurdelrnes on the comparability of NASD

and SECOregulation and the relevance

of published NASD standards and rules

of conduct to nonmember broker-dealers and their associated persons.w The

Commission also adopted Rule 15b8-2

under the Exchange Act to prohibit a

SECOfrrm from engaging in secunties

activitres if it or an associated person

has been expelled or suspended from

the NASDor from an exchangefor conduct inconsistent with just and equitable principles of trade or barred or suspended from association with any

member of the NASD or an exchange

for such conduct.e?

Rule 15b9-2 under the ExchangeAct

provides for an annual assessment to

be paid by nonmember broker-dealers

to defray the cost of regulation. During

the fiscal year, the Commission

amended the rule by deleting a provision which Imposed a charge for each

office of the brcker-dealer.se It increased the base fee from $100 to

$150 and the fee for each associated

person from $5 to $7.50 and eliminated

the fee ceiling which had previously

been$50,000.

SIPC Litigation

Lohf V. Casey.49The trustee of Sudler, Hart & Co., a registered brokerage

firm that had been adjudicated bankrupt

In 1969, brought SUIt to compel the

Commission and the Securities Investor

Protection Corporation under the Securities Investor Protection Act of 1970, to

bring the customers of the bankrupt

firm under the protections afforded by

the Act. The district court dismissed the

trustee's complaint for failure to state a

claim upon which relief could be

granted. The Court of Appeals for the

Tenth Circuit affirmed the dismissal,

holding that the Act does not extend

coverage to the customers of a registered brokerage firm which had been

adjudicated a bankrupt prior to passage

of the Act. Although the firm's registration had not been officially terminated

(and thus Its automatic membership in

SIPC had continued In form) the court

concluded that the firm did not have

the status of a "broker or dealer" as
THIRTY.EIGHTHANNUAL REPORT 63

contemplated by the Act. The court reasoned that the statutory reference to

"brokers or dealers" meant firms or

persons that were actually in business

In the usual sense at or after the date

of enactment, since Congress had deliberately declined to make the legislation

operate retroactively, drawing the line to

exclude those which had failed. Because

the firm's business was under the

jurisdiction of the bankruptcy court on

the effective date of the Act, the court

of appeals concluded that the firm was

at that time not conducting Its business

as a broker or dealer.

S.E.C. v, Alan F. Hughes, Inc.5o The

Court of Appeals for the Second Circuit,

in a case of first impression under the

Act, considered whether SIPC is required to afford a hearing when it determines that one of its members has

failed or is in danger of failing to meet

its obligations to its customers and that

there exists one or more of the conditions to the appointment of a trustee

that are specified In Section 5(b) of the

Act. The court held that no hearing was

required at the time of SIPC's determination because it "has no binding legal

consequences and deprives no brokerdealer of property." The court noted

that SIPC must make an application to

a district court and that the court is required to make its own findings. The

court found that an appropriate determination had been made by the district

court and that it was supported by the

evidence, and it affirmed the district

court's order appointing a trustee. It

also affirmed the appointment of a receiver in the injunctive action brought

by the Commission which had given rise

to the application for appointment of a

trustee. The court approvingly noted

that the district court's order had appointed a receiver only until SIPC made

a determination whether to seek the appointment of a trustee and that the reo

ceiver had been authorized to liquidate

the broker-dealeronly if necessary.

NOTES FOR PART 3

1In March 1971, the Executive Committee of the Board of Trade of the City

of Chicago adopted a resolutron to close

the Board's secunties market.

2 The Philadelphia-Baltimore-Washington Stock Exchange changed ItS name to PBWStock Exchange,Inc. when It in- corporated.

3This exchange was known as Salt

Lake Stock Exchange prior to May 19,

1972.

4The term "call option" refers to a

negotiable Instrument whereby the seller

of the option, for a certain sum of

money, grants to the buyer of the option the Irrevocable nght to demand.

within a specified time, the delivery by

the seller of a specified number of

shares of a stock at a fixed pnce.

5373 U.S. 341, 357 (1963).

6 In addition to the cases discussed

in the text, thrs position has been urged

in Shumate & Co., Inc., v. New York

Stock Exchange, CIV.No.CA-3-4663-D1

(N.D. Tex.); Shumate & Co., Inc. v.

National ASSOCIatIOn of Securittes

Dealers, Civ. No. CA-3-4361-G (N.D.

Tex.); Shumate & Co., Inc. v. Amencan

Stock Exchange. CIV. No. CA-3-4708-D

(N.D. Tex.); Jefferies & Co., Inc. v.

New York Stock Exchange, 71 CIV.4542

(S.D.N.Y.).

772 CIV.2528 (S.D. N.Y.).

8346 F. Supp. 217 (S.D.N.Y. 1972).

9 C.A. 2, No. 72-1810 August 29.

1972.

10E.D.Wis., No. 63C-264.

11 Thill Securities Corporation v. New

York Stock Exchange, 433 F.2d 264

(1970), certiorari denied, 401 U.S. 994

(1971).

12 Thill v. New York Stock Exchange

(C.A. 7, No. 72-1260).

1366 Civ. 1265 (S.D. N. Y.).

14452 F.2d 935 (C.A. 5, 1971), certiorari denied, 41 U.S.L.W. (October 10,

1972) (No. 71-1378).

15Under legislation proposed by the

Commission and discussed In Part 1

of this report. the Commission would be

given the power to review such action.

16See Part 1 of the report for a discussion of the NASDAQsystem.

17 451 F.2d 240 (C.A. 5, 1971), reo hearing denied, 459 F.2d 461 (1972),

certiorari denied sub nom. National Association of Securities Dealers, Inc. v.

Harwell, 41 U.S.L.W.3187 (October 10,

1972) (No. 72-58).

1837th Annual Report, pp. 88-89.
64 SECURITIES AND EXCHANGE COMMISSION

19 Secuntres ExchangeAct Release No.

9632 (June 7, 1972), petition for review

pending, C.A.D.C., No. 72-1975.

20 Last year's corresponding figures

were 291 member firm actions and 206

actions against individuals associated

with member firms.

21 As of July 26, 1972, the NASD had

170 of its authorized quota of 171 ex- aminers, a 20.6 percent increase from

the end of 1971. 22 Thrs number of review cases is a

significant increase over the number of

review applications filed in previous

years and reflects the NASD's expanded

disciplinary program. 23 Securities Exchange Act Releases

Nos. 9242 (July 9, 1971) and 9475

(February 3, 1972). 24 Securities Exchange Act Releases

Nos. 9325 (September 7, 1971) and

9476 (February 3, 1972).

25 Securities ExchangeAct Release No.

9475 (February 3, 1972). 26460 F.2d 1034 (C.A. 10, 1972).

27 CAD.C., No. 71-1591, January 24,

1972. 28 Securities ExchangeAct Release No.

8347 (June 28, 1968). See also 34th

Annual Report, pp, 14-15. 29 Securities Exchange Act Release

No. 9654 (June 30, 1972). 30 Securities Exchange Act Releases

Nos. 8876 (April 30, 1970); 8896 (May

28, 1970); 8946 (July 28, 1970); 8954

(August 11, 1970); and 9495 (February

15, 1972).

31 Those registered broker-dealers

which are not members of the NASD

are referred to as SECO broker-dealers.

32 These proposals were briefly summarized at pp. 2-3 of the 37th Annual

Report. 33 Securities Exchange Act Release

No. 9622 (May 31, 1972). Subsequent

to the close of the fiscal year, a further

revised rule proposal was issued which

did not however alter the framework

discussed in the text. Securities Exchange Act Release No. 9775 (September 14, 1972). 34 Securities ExchangeAct Release No.

9376 (November 8, 1971).

35 Securities ExchangeAct Release No.

9268 (July 30, 1971).

36 Securities ExchangeAct Release No.

9594 (May 12, 1972).

37 Securities ExchangeAct Release No.

9633 (June 14, 1972).

38 Securities ExchangeAct Release No.

9587 (May 8, 1972). 39 Securities ExchangeAct Release No.

9460 (January 21, 1972). 40 Securities ExchangeAct Release No.

9658 (June 30, 1972).

41 Securities Exchange Act Release No.

9634 (June 14, 1972). 42 Secunties Exchange Act Release No.

9717 (August 14, 1972).

43 The Act does not specifically refer

to the NASD, but to broker-dealers who are not members of a registered "national securities association." However,

the NASD is the only such association.

44 See pp. for the discussion of

NASD regulation.

45 Nonmember broker-dealers must

file a prescribed form (Form SECQ-2)

with the Commission for each associated

person.

46 Securities Exchange Act Release No.

9420 (December 20, 1971).

47 Securities Exchange Act Release No.

9504 (February 29, 1972).

48 Securities ExchangeAct Release No.

9588 (April 27, 1972).

49 CCH Fed. Sec. L. Rep. '193,589

(C.A. 10, 1972). 50461 F.2d 974 (CA 2, 1972).


PART 4

ENFORCEMENT

The Commission's enforcement activities, designed to combat securities

fraud and other misconduct, continued

at a high level during the past year.

These activities encompass civil and

criminal court actions as well as administratlve proceedings conducted internally. Where violations of the securities

laws or rules are established, the sanctions which may result range from censure by the Commission to prison sen.

tences imposed by a court. The

enforcement program is designed to

achieve as broad a regulatory impact as

possible within the framework of reo

sources available to the Commission. In

light of the capability of self-regulatory

and state and local agencies to deal

effectively with certain securities violations, the Commission seeksto promote

effective coordination and cooperation

between its own enforcement actrvrties

and those of the other agencies.

DETECTION

Complaints

The Commission receives a large volume of communications from the public. These consist mainly of complaints

against members of the securities industry and requests for information

about Issuers. During the past year,

some 10,000 complaints and inquiries

on broker-dealers were received, most

involving operational problems, such as

67
68 SECURITIESAND EXCHANGECOMMISSION

a failure to deliver securities or funds

promptly, or the alleged mishandling of

accounts. While this IS a large number

of complaints, it represents a substantial reduction from the 17,000 complaints and inqurnes about broker-dealers receivedthe previous year.

The Commission seeks to assist

persons In resolving complaints and to

furnish requested information. Thousands of investor complaints are resolved through staff inquiry to firms involved. While the Cornmissron does not

have authority to arbitrate pnvate disputes between brokerage firms and

investors or to assist investors in legal

assertion of personal rights, a complaint

may lead to Institution of an investigation or an enforcement proceeding, or It

may be referred to a self-regulatory or

local enforcement agency.

Market Surveillance

To enable the Commission to carry

out surveillance of the securities markets, its staff has devised procedures to

Identify possible manipulative activities.

These include surveillance of listed securities, coordinated with the stock

watching operations of the New York,

Amencan and regional stock exchanges.

The Commission's market surveillance

staff has supplemented its regular reviews of daily and periodic stock watch

reports of exchangeswith a program for

review of special surveillance reports

providrng a more timely analysis of the

Information developed by the exchanges.

The market surveillance staff maintains a continuous watch of transactions on the New York and American

Stock Exchangesand reviews reports of

large block transactions to detect any

unusual price and volume variations.

The financral news tickers, financial

publications and statistical services are

closely followed.

The Cornrnissron has also developed

an over-the-counter surveillance program for securities traded by means of

the National ASSOCiationof Securities

Dealers' NASDAQsystem. This program

IS coordinated with the NASD's market

surveillance staff through a review of

weekly and special stock watch reports.

For those over-the-countersecurities not

traded through NASDAQ,the Commission uses automated equipment to provide more efficient and comprehensive

surveillance of stock quotations distributed by the National Quotation Bureau.

This is programmed to Identify, among

other things, unlisted securities whose

pnce movement or dealer interest varies

beyond specrfied limits In a pre-established time period. When a security is

so Identified, the equipment prints out

current and historic market information.

This data, combined with other available

information, is analyzed for possible further inquiry and enforcement action.

INVESTIGATIONS

Each of the acts administered by the

Commission authorizes Investigations to

determine If Violations have occurred.

Most are conducted by the Commission's regional offices. Investigations are

carried out on a confidential basis, consrstent with effective law enforcement

and the need to protect persons against

whom unfounded charges might be

made. Thus, the existence or findings of

a nonpublic investigation are generally

not divulged unless they are made a

matter of public record in proceedings

brought before the Commission or in

the courts. During fiscal year 1972, a

total of 374 investigations were opened,

as against 410 the preceding year.

Litigation

Project on Corporate Responsibility v.

S.E.C.l In this case, the Project and

three individual shareholders of Union

Carbide Corporation seek judicial review

of the Commission's determination to

investigate privately, rather than

through a public adversary proceeding,

allegations that Union Carbide had vio-
THIRTY.EIGHTHANNUAL REPORT 69

lated antifraud provisions of the securities laws in a distribution to its shareholders of a brochure on its pollution

control program. The Project had requested the Commission to conduct a

public investigation into the Project's allegations, by requiring Carbide to file

with the Commission a public response

to each of those allegations. The Commission's staff had met with Project

representatives and conferred with Carbide to discuss the allegations and sent

inquiries to various federal agencies.

The Commission moved to dismiss

the petition for review, asserting that It

had neither entered an "order" nor

taken any actron that was reviewable

under the judicial review provisions of

the Securities Exchange Act or of the

Administrative Procedure Act. After the

fiscal year, the court of appeals issued

an order referring the motion to the

panel of the court assigned to consider

the merits of the petition.

In the Matter of Four SeasonsSecurties Laws Litigation.2 The Commission,

at the request of the district court, filed

a memorandum on proposed discovery

by plaintiffs from defendants in civil litigation of testimony and documents obtained by the Cornmlssionduring a nonpublic investigation. The court also

asked the Commission to state ItS position if it were served directly with a

subpoena for the production of transcripts of such testimony. The Commission stated that, because its investigation rules permit a witness in an

investigation to obtain a copy of his

own testimony and a person who supplied documents to obtain copies, the

Commission did not object to disclosure

by a witness of a transcript of his testimony or to disclosure of documents by

the person who had supplied them to

the Commission. The Commission

stated that it preferred that no subpoena be served on it directly for the

material in an investigatory file, because

this would not give a witness or person

supplying documents an opportunity to

488-483 0 - 73 - 7

make objections to the court on disclosure of his testimony or documents.

The Commission further stated that it

reserved the right to keep confidential

the identities of persons who had testified or supplied documents In a private

Investigation. The court in its opirnon

concuded that "the positions taken by

the SEC.... are sound." 3

S.E.C.v. First Security Bank of Utah,

N.A.4 The Court of Appeals for the

Tenth Circurt affirmed the decision of

the district court which had ordered enforcement of investigative subpoenas

served by the Commissionon two banks

seeking records of checking accounts of

some depositors. The court of appeals

rejected the argument of two of the depositors, that because they maintained

the checking accounts as attorneys for

their clients the records were protected

by the attorney-client privrlege and thus

immune from production. The court

stated that the records were the property of the bank, not of the depositors,

and that deposrts and disbursements of

money In a checking account are not

confidential communications covered by

the privilege.

S.E.C. v. Mark Petroleum Corporation.s The court of appeals declined to

stay an order of the district court, whrch

directed compliance With subpoenas is.

sued by the Commission in an investigation to determine whether Mark

Petroleum Corporation had violated the

federal securities laws. The defendants

had refused to comply with the sub.

poenas, asserting that they were "illegal," overly broad and had been issued to harass them. The defendants

then requestedMr. Justice Powellof the

United States Supreme Court to stay

the district court's order, pending their

appeal. Justice Powell, however, declined to do so.

ENFORCEMENT PROCEEDINGS

The Commission has available a WIde

range of possible enforcement actions.

It may in appropriate cases refer its
70 SECURITIESAND EXCHANGECOMMISSION

files to the Department of Justice with

a recommendation for criminal prosecution. The penalties upon conviction are

specified in the various statutes and include impnsonment for substantial terms

and fines.

The securities laws also authorize the

Commission to file injunctive actions In

the federal district courts to enjoin continued or threatened violations of those

laws or applicable Cornrnissron rules. In

injunctive actions the Commission has

frequently sought to obtain anculary relief under the general equity powers of

the federal distnct courts. The power of

the federal courts to grant such relief

has been judicially recognized.s The

Commission has often requested the

court to appoint a receiver for a brokerdealer or other businesswhere investors

were likely to be harmed by continuance

of the existing management. It has also

requested, among other things, court

orders restricting future activities of the

defendants, requrring that rescission be

offered to securities purchasers, or requiring drsgorgernent of the defendants'

ill-gotten gams,

The S.E.C.'s primary function is to

protect the public from fraudulent and

other unlawful practices and not to obtain damages for injured individuals.

Thus, a request that disgorgement be

required IS predicated on the need to

deprive defendants of profits denved

from their unlawful conduct and to protect the public by deterring such conduct by others.

If the terms of any injunctive decree

are Violated, the Commission may file

criminal contempt proceedings, as a result of which the violator may be fined

or Imprisoned.

The federal securities acts also authonze the Commission to impose remedial administrative sanctions. Most

commonly, administrative enforcement

proceedings involve alleged violations of

the securities acts or regulations by

firms or persons engaged in the securities business, although the Commissron's jurisdiction extends to all persons. Generally speaking, if the

Commission finds that a respondent

willfully Violated a provision of or rule

under the securities acts, failed reasonably to supervise another person who

committed a violation, or has been convicted for or enjoined from certain types

of misconduct, and that a sanction is in

the public interest. it may revoke or

suspend a broker-dealer's or investment

advisers's registration, bar or suspend

any person from the securities business

or from association With an investment

company, or censure a firm or individual. Proceedings may also cover adequacy of disclosure in a registration

statement or in reports filed with the

Commission. Such cases may lead to an

order suspending the effectiveness of a

registration statement or directing compliance with reporting requirements. The

Commission also has the power summarily to suspend trading in a security

whenthe public interest requires.

Proceedingsare frequently completed

without hearings where respondents

waive their right to a hearing and submit settlement offers consenting to remedial action which the Commission accepts as an appropriate disposition of

the proceedings. The Commission tries

to gear its sanctions in both contested

and settlement cases to circumstances

of the case. For example, it may limit

the sanction to a particular branch

office of a broker-dealer rather than

sanction the entire firm, prohibit only

certain kinds of activity by the brokerdealer during a period of suspension or

only prohibit an individual from engaging in supervisoryactivities.

A chart listing the various types of

enforcement proceedingsas well as statistics on such proceedings is in the

statistical section.

ADMINISTRATIVE PROCEEDINGS

Summarized below are some of the

many administrative proceedings pending or disposed of in fiscal year 1972.
THIRTY.EIGHTHANNUAL REPORT 71

Disciplinary Proceedings

Exchange Bank & Trust Co. of

Dallas.7 In this case,the Commissionissued an order censuring the bank for

Its conduct while acting as escrow agent

in a public offering of common stock of

Transceiver Corporation of America in

1969. The Commission found that the

bank violated antifraud provisions of the

securities laws by releasing from escrow

$404,750 received from subscribers for

Transceiver stock, although only 34,439

shares had been sold. Transceiver's registration statement represented that the

underwriter was obligated to return all

funds received from subscribers unless

at least 130,000 shares were sold for a

total of $1,235,000. Moreover, contrary

to representations in the registration

statement on use of proceeds, the bank

received $100,000 plus interest out of

the funds released from escrow In payment of a loan to Transceiver.The bank

consented to the above findings and

censure, without admitting or denying

allegations in the order for proceedings.

ExecutiveSecurities Corp.8Various respondents submitted settlement offers

consenting to certain findings without

admitting staff allegations against them.

The Commission found that in the sale

of stock of Executive, a broker-dealer,

the firm and its principals violated registration requirements and engaged in

fraudulent practices. They withheld

shares from public sale, placed shares

with persons associated With Executive,

used nominee accounts to conceal true

ownership of Executive stock and evade

registration requirements of certain

states, and made misrepresentations to

customers. In addition, these respondents and an attorney violated registration and antifraud provisions in the sale

of various other securities. Under the

settlement offers, the Executive stock

held by the respondent officials was to

be transferred to an attorney in trust

for three years during which an associate of the attorney would be the firm's

executive director. As provided in those

offers, the Commission suspended the

firm's registration for 10 days and

barred or suspendedthe other respondents from association with a brokerdealer or Investment adviser. The attorney was also disqualified from practice

before the Commission for two years

With the right to apply for reinstatement

after one year.

Gregory & Sons.? In the case of this

New York Stock Exchangemember firm

which went into liquidation, and two of

its partners, It was found that the firm's

record-keeping procedures made inadequate provisron for distinguishing "restricted" secuntres (which cannot be included In a broker-dealer's net capital)

from other securities. As a result, the

firm continued In business when it was

not in compliance with the Exchange's

net capital requirements, and it filed an

inaccurate financial report With the

Commission. On the basis of settlement

offers, in which they consented to these

findings without admitting or denying

the charges against them, the firm's

registration was revoked and the partners suspended from association With a

broker-dealer.

Bohn-Willlams Securities Corporation.IO

After hearings, the Cornrnissron revoked

the broker-dealer registration of this

firm barred its two principals from assoelation With any broker-dealer, and expelled It and one of the principals from

membership in the Spokane Stock Exchange, The Commission found that the

respondents willfully Violated the registration and antifraud provrsrons of the

securities acts In transactions of unregistered common stock of Chamoion Oil

and Mining Company.Among other acts,

they sold a block of shares for control

persons of Champion, a shell corporation; engaged In manipulative trading

activities in connection with transactions

in Champion stock In order to artificially

raise the price of the stock; and used

fraudulent sales literature supplied by
72 SECURITIESAND EXCHANGECOMMISSION

Champion In connection with the sale

of the securities.

Winfield & co., tnc.u In February

1972, the Commission issued detailed

Findings and Opinion. It had previously

issued orders which (on the basis of

consents of the respondents contained

in offers of settlement) imposed sanctions on various firms and individuals

for violations In connection with portfolio transactrons of Winfield Growth

Fund, Inc., a registered investment company.

The Commission found that under arrangements in 1966 between Winfield &

Co., the Fund's investment adviser, and

some of Its principals, and Meyerson &

Co., a New York Stock Exchange member, cornrrussrons on fund portfolio transactions were allocated to Meyerson for

payments to or for the benefit of the

adviser and its principals. The Commission said these arrangements breached

the fiducrary obligation to the Fund and

its shareholders by the adviser and its

principals and violated antifraud provisions of the securities laws. It also violated a provrsion of the Investment

Company Act on acceptance of compensation by investment company affiliates

for the purchase or sale of property to

or for the company. The Commission

found that proper valuation procedures

were not followed for "restricted" securrties in the Fund's portfolio and that

some respondents failed to make reasonable investigations before causing

the Fund to purchase those securities.

Edward A. Merkle.1t In a proceeding

under the Investment Company Act

against the chref executive officer of

Madison Fund, lnc., a registered investment company, it was alleged that Merkle, in violation of the securities acts,

caused Madison Fund: (I) to purchase

time certificates of deposit and place

non-interest bearing demand deposits in

commercial banks in return for loans by

those banks to several companies affiliated with Madison Fund and Merkle; (2)

to enter into transactions involving portfolio securities on a joint, or joint and

several, basis with Mad International

Fund, lnc., an unregistered off-shore in.

vestment company of which Madison

Fund was investment adviser and Merkle, chairman of the board; and (3) to

purchase securities of National Industries, Inc. without disclosing that he

was a salaried employee of National. In

July 1972, the Commission entered into

a settlement with Merkle in which, without admitting or denying the allegations, he consented to findings that he

had committed these violations and to a

6D-<laysuspension.

Proceedingswere also instituted during the fiscal year against Herbert F.

Korholz, chief executive officer and a

director of The Susquehanna Corporation, and a director of Pan American

Sulphur Company (Pasco); Emmett H.

Bradley, also an officer and director of

Susquehanna and Pasco; Susquehanna.

which owned a majority of Pasco's

stock; and four national banks. The proceedings are based on staff allegations

that, among other things, Korholz, Bradley, and Susquehanna caused Pasco,

which is subject to the Investment Company Act, to purchase certificates of deposit from the banks as an inducement

for the banks to extend credit to Susquehanna and a subsidiary. Thereby, it

is alleged, the respondents violated or

aided and abetted violations of a prohibrtion under the Act against joint transactions between a registered investment

company and its affiliates without authorrzation by the Commission.

Disqualification of Attorneys

Elliot S. 81air.13 The Commission entered an order accepting the resignation of Blair, an attorney, from practice

before the Commission. According to a

stipulation of facts entered into solely

for the purpose of the proceeding under

Rule 2(e) of the Commission's Rules

of Practice. Bla;r held a substantial

amount of securities as nominee for

other persons; notifications and offering
THIRTY-EIGHTHANNUAL REPORT 73

circulars filed with the Commission to

obtain exemptions from registration for

proposed public offerings pursuant to

Regulation A under the Securities Act

listed Blair as the owner of such shares

but failed to disclose his interest as a

nominee; and Blair falsely testified in a

subsequent Commission investigation

that he had not acted as nominee although he later recanted that testimony.

Kivitz v. S.E.C.I4Murray A. Krvrtz, an

attorney who, as has been previously

reported,I5 had been suspended for two

years from practice before the Commission in a proceeding under Rule 2(e) of

the Commission's Rules of Practice, petitioned for judicial review of the Commission's order of suspension. In its

brief filed in the Court of Appeals for

the District of Columbia Circurt, the

Commission argued that it has jurisdiction under its general rulemaking power

to promulgate a rule providing for the

discipline or disbarment of attorneys

practicing before it, and that this was

not withdrawn by Congress when It

abolished all agency-imposedadmission

requirements (except those imposed by

the Patent Office) for members of the

bar of the highest court of a state seeking to practice before federal agencies.

The statute in question contains a specific provision excluding disciplinary proceedings from its scope. The Commission also argued that it had properly

suspended Kivitz from practice where it

found that he had allowed a non-lawyer

to control and exploit Kivitz's pnvilege

to practice before the Commission in

connection with the proposed representation of a prospective corporate issuer.

Registration Statements/Reports

Levitz Furniture Corporation.I6 The

Commission, on the basis of an offer of

settlement, issued a stop order suspending the effectiveness of a registration statement filed by Levitz for a proposed offering of 600,000 shares of

common stock. Levrtz admitted the allegations of fact filed by the Commission's staff. These were that the registratron statement, In drscussmg Levitz's

relations with its employees, failed to

disclose that certain Levitz executives

had been Informed by the International

Brotherhood of Teamsters (IBT) that a

nationwide campaign to organize the

company's employeeswould begin on or

about June I, 1972; that one of these

executives had indicated to IBT that

Levitz would not oppose the campaign

If deferred until completion of the proposed offering; and that IBT agreed to

defer such campaign to on or about

July 1, 1972. The staff alleged that the

registration statement was deficient in

failing to disclose those facts and what

effects, if any, a nationwide campaign

to organize the company's employees

would have on its business operations,

relations with its employees, and income from operations. The Commission

subsequently issued its Findings and

Opinion which discussed the deficiencies in the registration statement.l7

Performance Systems, Inc. Proceedings placed In issue the accuracy of a

registration statement and a 1968 annual report filed by the company. The

principal alleged inaccuracy in both documents pertained to the accounting

treatment accorded to installment notes

representing part payment of franchise

fees. These fees resulted from transactions in which PSI sold blocks of from

20 to 100 fast food franchises to seven

newly formed companies. PSI included

the full face amount of the notes In

1968 revenues.

The Commission concluded that the

facts surrounding the transactions mdicated that there was no reasonable

basis for estimating the degree of collectibilrty of the notes and that inclusion of the notes in revenueswas therefore improper. It noted among other

things that the purchasers were undercapitatlzed and had no significant operating history, that some were in default

on their construction schedules, and

that PSI had only limited experience in
74 SECURITIESAND EXCHANGECOMMISSION

franchise operations and that such experience as it had, had been unprofitable.

Pursuant to an offer of settlement

made by PSI in which it consented to

the above findings without admitting or

denying allegations in the order for proceedings, the Commission issued a stop

order, permitted withdrawal of the registration statement, and dismissed the

proceeding with respect to the annual

report, which PSI had corrected by

amendment, on condition that PSI distnbute copies of the Commission's opinion to its stockholders.IS

The Commission also entered orders

in two other proceedings in which its

staff had challenged the accuracy of financial statements included in annual reports filed with the Commission. Both

proceedings were disposed of on the

basis of settlement offers providing for

appropriate amendment of the reports

and notification to stockholders of the

corrections. In one case, Great Southwest Corporation, 19 the company

treated the sale of two amusement

parks and a parcel of raw land as reportable sales and accorded revenue

recognition to the consideration received

even though it retained control over the

management of the properties and retained substantially all risk of loss and

opportunity for gain. In the other case,

the Commission found reports filed by

Fi/trol Corporation, misleading on the

value of certain municipal bonds representing a substantial proportion of the

company's assets, in that they failed to

disclose that a brokerage firm, whose

agreement to repurchase certain bonds

at Filtrol's cost was the principal basis

for their Inclusion in current assets, was

not financially capable of meeting its repurchase obligations.s?

Trading Suspensions

The Securities Exchange Act authorizes the Commission summarily to suspend trading in a security traded on

either a national securities exchange or

in the over-the-counter market for a period of up to 10 days if, in the Commission's opinion, It is required in the public interest.

During fiscal 1972, the Commission

suspended trading in the securities of

47 companies, an increase of about 83

percent over the 26 securities suspended in fiscal 1971. In most instances thrs action was taken because

of substantial questions as to the adequacy, accuracy or availability of public

information concerning the company's

financial condition or business operations or transactions in its securities.

Trading suspensions are frequently a

prelude to other enforcement action.

The following summaries illustrate the

variety of circumstanceswhich may lead

to suspension.

In March, 1972, trading In the securities of First Fidelity Company was suspended at the request of the company

which advised that it was engaged in

negotiations of a material transaction,

and that the results of the negotiations

would be made public shortly. The Comrnissron lifted ItS suspension after First

Fidelity had issued a press release and

disseminated a shareholder letter which

disclosed the transfer of substantially

all the assets of a subsidiary and related financial information.

In the case of Tanger Industries,

trading was suspended on the American

Stock Exchange and in the over-thecounter market in May, 1972 to allow

time for the clarification of questions

raised on the validity of and circumstances surrounding the placing of certain orders for transactions in Tanger

securities. After an intensive investigation, the Commission, in July, filed a

complaint seeking to enjoin Tanger, its

former chairman, and ten others from

violating antifraud and registration provisions of the Federal securities laws.

The complaint alleged that the defendants were involved in an elaborate

scheme to raise the price of Tanger

stock by controlling and absorbing the
THIRTY-EIGHTH ANNUAL REPORT 75

relatively small floating supply, and that

the former chairman looted Tanger of

valuable assets by purchasing certain of

Its subsidiaries through nominees at

grossly inadequate and unfair consideration. Tanger consented to an injunction

without admitting or denying any of the

cllegatlons,

In June, 1972, the Commission suspended trading on the New York, Pacific

Coast and PBW Stock Exchanges and in

the over-the-counter market in the securities of Levitz Furniture Corporation. It

acted as a result of an investigation,

prompted by a review of a then pending

registration statement, that raised questions as to the disclosure of material

facts. The Commission subsequently

filed a complaint seeking an injunction

against Levitz and three of its officers,

charging that the registration statement

was materially misleading, and It also

instituted stop order proceedings (discussed previously). Thereafter it lifted

the trading suspension.

In announcing the termination of

trading suspensions, the Commission

generally cautions investors to consider

all available information in making any

investment decision on the securities in

question, and it reminds broker-dealers

who solicit transactions In such securities of their obligation to make diligent

inquiry to determine all pertinent financial and other information about the issuer and to disclose such information

to prospective purchasers.

Judicial Review

Quinn & Co., Inc. v. S.E.C.21 The

Court of Appeals for the Tenth Circuit

affirmed an order of the Commission

imposing sanctions upon Quinn & Co.,

Inc., a broker-dealer, and Its vice-president, John Dornacker. The court sustained the Commission's finding that

Dornacker and the partnership predecessor of Quinn & Co., had violated the

Securities Act by selling unregistered securrties for one of Quinn's customers

who had recently acquired these securities from the issuer In exchange for

property. The court agreed with the

Commission that the customer had purchased the unregistered shares from the

issuer with a view to "distribution" and

therefore was a statutory underwriter

whose resales were not exempt from

registration, even though the shares

represented less than 1 percent of the

Issuer's outstanding stock. Because the

customer was an underwriter, the exemptions provided for transactions by

brokers and dealers in Sections 4(3)

and 4(4) of the Securities Act were held

to be unavailable. The court further sustained the Cornrrussron's finding that

the violations were Willful, concluding

that the brokerage firm and Dornacker,

as professionals in the securities business, were not entitled to rely upon the

absence of cautionary legends on the

customer's stock certificates but were

under a duty to investigate In order to

assure themselves that the sales complied with the requirements of the Securities Act.

CIVIL PROCEEDINGS

During fiscal year 1972, the Commission instituted a total of 119 injunctive

actions, as well as two civil contempt

actions. Some of the more noteworthy

of these injunctive proceedings and significant developments in actions instituted in earlier years are described

below.

The Commission played a leading role

In the investigation of the so-called

"Texas stock fraud scandal" involving a

scheme to use the assets of banks and

other financial institutions controlled by

Frank W. Sharp and his co-conspirators

to finance a manipulation of the overthe-counter market in several stocks,

particularly the stock of National Bankers Life Insurance Company. As a result

of the facts developed in its investigation, the Commission brought suit In

the United States District Court for the

Southern District of Texas to enjoin 28

defendants, Including Sharp, Waggoner
76 SECURITIESAND EXCHANGECOMMISSION

Carr, a former Attorney General of

Texas, John Osorio, a former Chairman

of the TexasState InsuranceCommission,

National Bankers Life, and others from

violating the registration and antifraud

provisions of the secunties laws. Several defendants consented to a permanent injunction, and the complaint was

dismissed agamst five corporate defendants which were then involved in receivership or conservatorship proceedings

or controlled by a receiver. After a tnal,

the distnct court granted an injunction

against all but one of the rernarrnng

defendants.22 Four of these defendants,

including Carr and Osono, appealed to

the Court of Appeals for the Fifth

Circuit.23 In Its brief in the court of appeals, the Commission argued that, as

found by the lower court, the appellants

had violated the registration provisions

of the secunties Act by pledging unregistered shares of control stock where

there was no reasonable likelihood at

the time of the pledge that the loan

could be repaid otherwise than through

foreclosure and eventual public sale of

the collateral, and that they partrcipated

in a scheme to manipulate the market

pnce of National Bankers Life stock and

two other securities by arranging for

financing to buy up shares of these

securitres on the open market, thereby

taking such shares off the market and

driving up the price.

In February, 1972, the Commission

Instituted a civrl injunctive action

against 20 defendants In SEC. v. Netional Student Marketing Corporation

(NSMC),24 alleging violations of the reporting, proxy and antifraud provisions

of the Securities ExchangeAct, and the

antifraud provisions of the Securities

Act. The defendants include, in addition

to NSMC, six of its present and former

officers and directors; the corporation's

auditors, Peat, Marwick, Mitchell & Co.

(PMM), and a partner and a former employee of that firm; NSMC's outside

legal counsel, the New York law firm of

White & Case, and one of its partners;

four officers and directors of Interstate

National Corporation, with which NSMC

merged; Interstate's outside legal counsel, the Chicago law firm of Lord, Bissell and Brook, and two of its partners,

one of whom was also a director of Interstate; and a lawyer representing the

purchasers of a former subsidiary of

NSMC.

The complaint alleges that various financial reports of NSMCdisseminatedto

the public and filed with the Commission, beginning with its 1968 annual

report, were materially false and

misleading because they included In income certain purported commitments

from customers to use NSMC's services

in the future. According to the com.

plaint, these commitments were nonexrstent or were entered into after the

close of the fiscal period in which they

were recorded as income or contained

guarantees by NSMC which precluded

their being recorded as income. The

complaint also alleges that a large part

of the commitments included as income

In the 1968 annual report was written

off during 1969, but that proper disclosure of the write-off was never made.

A portion of the complaint concerns

NSMC's merger with Interstate, an in.

surance holding company, in 1969. One

of the conditions to the merger was the

issuance by PMM of a "comfort letter"

which was to state, among other things,

that PMM had no reason to believe that

NSMC's unaudited financial statements

for the nine-month period ended May

31, 1969, which were contained in a

proxy statement that had been used to

solicrt shareholder approval of the

merger, required any material adjustments in order that the results of operations for the period be fairly presented. Instead, according to the

cornplarnt, the letter issued by PMM

stated that it believed that adjustments

reducing net Income from $700,000 to

a loss were required. The complaint alleges that the merger was consummated and the lawyers issued favorable
THIRTY-EIGHTH 77

opinions on its legality notwithstanding

their knowledge that shareholder approval had been obtained on the basis

of materially false and misleading financial statements.

It IS further alleged that certain Interstate shareholders present at the closing sold a portion of their newly

acquired NSMC stock on the day of the

closing notwithstanding their knowledge

that the most recent financial statements of NSMC available to the public

were materially false and misleading.

Further, the complaint alleges that

NSMC improperly accounted for a purported gain on the sale of two subsidiaries even though these sales did not

occur until after the close of the fiscal

year In which it was reported, that It

was not disclosed that NSMC retained a

number of financial and other obligations with respect to these subsidiaries,

that it was highly unlikely that the full

sales price would ever be paid to

NSMC, and that NSMC's president had

transferred to the purchasers of the

subsidiaries the NSMC stock they had

pledged as collateral for their promissory notes.

On July 26, 1972, a consent judgment of permanent injunction was entered against NSMC, which neither

admitted nor denied the allegations of

the complaint. The judgment granted

the full relief requested In the complaint, including a provision obligating

the company to file corrected reports

with the Commission after making an

independent investigation of its affairs

from 1968 through early 1970, the period covered by the complaint.

Other cases: SEC v. Umted Frnancia!

Group, Inc.25 A Commission SUIt instituted in the United States District Court

for the District of Oregon alleged that

United, 17 of its subsidiaries or affiliates and six officers of various corporate defendants violated the registration

and anti-fraud provisions of the securities acts. According to the complaint,

United is a world-wide complex of more

ANNUAL REPORT

than 80 companies Including off-shore

mutual funds, real estate and insurance

companies and banks. On the Commission's motion for a preliminary injunction, the defendants did not contest the

Commission's allegations but argued

that United States courts lacked jurisdiction of what the defendants claimed

were extraterritonal acts.

The district court found, however,

that the defendants' activities were subject to the provrsions of the Federal secuntres laws since (1) the defendants

had used the tacrhties of interstate

commerce to offer and sell securities to

United States citizens and residents and

to operate their corporate empire from

within the United States, and (2) their

activities, originating in and directed

from the United States, had caused

substantial and irreparable harm both

to domestic and foreign Investors and

creditors and could adversely affect the

ability of American Issuers to raise capital abroad. The court entered preliminary injunctions against each of the de.

fendants. Having found that there was a

real threat of dissipation of valuable

corporate assets by the individual defendants, the court also appointed a receiver for the complex. The orders of

the district court have been appealed by

certain of the defendants to the Court

of Appeals for the Ninth ClrcUlt.26

S.E.C. v. Pig 'N Whistle Corporation.27

The Cornmissrcn obtained consent decrees of permanent Injunction against a

number of defendants alleged to have

participated in violations of the Federal

securities laws in connection with the

distribution of the stock of Pig 'N Whistle. The consenting defendants included

Financial Relations Board, Inc. (FRB), a

Chicago-based public relations firm

which had been engaged by Pig 'N

Whistle. FRB allegedly violated antifraud

and antrtouting provisions by distnbuting press releases which contained false

and misleading Information about the

company, without making an adequate

investigation, and without disclosing the
78 SECURITIES AND EXCHANGE COMMISSION

fact that it was acting on behalf of and

receiving compensation from Pig 'N

Whistle. Under the terms of the decree,

FRS is enjoined from further violations,

provided that It will not be deemed to

have violated the decree In connection

with any statement made or distributed

by it if, after an investigation, it has

reasonable cause to believe that the

statement is accurate. The decree also

required FRS to establish procedures

for screening prospective clients and for

investigating the facts contained in any

release distnbuted on behalf of a client.

S.E.C. v. Manor Nursing Centers,

Inc.28 This action arose out of an "ailor-nothing" public offenng of Manor

common stock on behalf of Manor and

certain of its principal stockholders. The

Court of Appeals for the Second Circuit

affirmed an order of the district court

enjoining various defendants from violating the antifraud and prospectus-delivery provrsions of the Federal securities laws. The court also upheld, with

one minor modification, the district

court's grant of ancillary relief, which

(1) recurred the defendants to disgorge

the proceeds received from the public

offering, (2) ordered the appointment of

a trustee to receive and distribute such

funds to defrauded Investors and (3)

temporarily froze the assets of the defendants pending their transfer of the

proceeds to the trustee.

The Commission had alleged that

Manor and the selling-stockholder defendants had violated provisions of the

secunties laws by retaining the proceeds received from investors in the offering even though all the offered

shares had not been sold and payment

received. It charged that, after the

effective date of the Manor registration

statement, these defendants realized

that the offering would not be successful and, aided and abetted by the underwriter and other defendants, engaged

In a fraudulent scheme to make it appear that the Issue was sold out. Manor

received less from the offering then had

been represented, while the selling

stockholders were paid in full at the

closing.

In affirming the district court's findrng of violations of the antifraud provrsions, the court of appeals held that the

failure to return to the public proceeds

obtamed In an "all-or-nothmg" offering,

where the preconditions for retention of

the funds are not satisfied, IS a misappropnation of the proceeds, which constitutes a fraud on investors. It further

held that the antifraud provisions are VIolated where securities are offered on

the basis of a prospectus which fails to

disclose material developments occur.

nng after the effective date of the regis.

tration statement.

After the decision, the distnct court,

on remand, ordered two of the defend.

ants to pay over to the trustee more

than $700,000. At fiscal year-end appeals from these orders were pending.29

S.E.C. v. Shapiro.30 The Commission

alleged violations of Rule 10b-5 under

the Securities Exchange Act Involving

transactions in the securities of Harvey's Stores, lnc., traded on the American Stock Exchange. The Commission

charged that the defendants had purchased stock without disclosing nonpublic matenal Information of proposed

mergers involving Harvey's, and said

some of them had passed on the information to friends who then purchased

shares. The defendants had obtained

the Information either by virtue of their

positions as directors or controlling

stockholders of Harvey's, or as parties

privy to the merger negotiations, or

through having been "tipped" by persons having direct access to the information. In addition to Injunctive relief

against future violations, the Commission sought an order directing the defendants to disgorge to a court-appointed trustee any profits realized or

accrued from their own transactions or

those of their "tippees". All of the defendants except two-against whom the

case was pending at fiscal year-end-s-
THIRTY-EIGHTH 79

consented to the entry of final judgments of permanent Injunction and

orders of drsgorgernent,

S.E.C. v. International Te/epnone and

Telegraph Corp.31 The Commission's

complaint alleged, among other things,

that lIT and some of its insiders had

violated antifraud provisions by selling

secunties without disclosing significant

developments in settlement negotiations

in an antitrust case Involving lIT. All

defendants consented to injunctions as

requested in the complaint.

S.E.C. v. Advance Growth Capital

Corporation. 32 The Commission had

flied a complaint In 1969 charging,

among other things, that the chairman

of the board and the president of Advance, a registered investment company, each had caused the company to

enter into a series of transactions with

various affiliated persons of the investment company or the board chairman

without obtaining advance Commission

approval as required under the Investment Company Act. In August 1971, the

district court rendered its decision denyIng the Commission's request for injunctive relief and the appointment of a

receiver. It found that, while the

transactions in question had violated

the Investment Company Act, the violations had not been intentional. The

Comrnissron has appealed to the Court

of Appeals for the Seventh CIrCUlt,33

urging that the drstnct court's finding of

lack of intention was clearly erroneous

and that, in any event, the Commission

was not required to prove Intent in

order to obtain injunctive relief and the

appointment of a receiver.

S.E.C. v. Century Investment Transfer

Corp.34 The Commission charged that

some defendants participated In a

scheme, aided and abetted by the other

defendants, to create a public market

for the distribution of unregistered

shares of the common stock of four

shell corporations. One of the defendants had purchased for cash controlling

blocks of stock of these corporations in

ANNUAL REPORT

proceedings under Chapter XI of the

Bankruptcy Act.35 Orders of the bankruptcy court stated that all shares were

issued to this purchaser, which was not

a creditor, under a provrsron of the

Bankruptcy Act which exempts from the

registration provisrons any transaction

In securities Issued pursuant to a Chapter XI arrangement In exchange for

claims against the debtor or partly in

such exchange and partly for cash

and/or property. The Cornrrussron alleged that the exemption was not available, and that an attorney for the debtors In the Chapter XI proceedings as

well as the purchaser who had given

opinion letters to the effect that the

shares Issued for cash could be traded

Without registration should also be enjoined. The District Court for the Southern Distnct of New York agreed With the

Comrrussron's positions and entered an

order prelrrnmanly enjorrung the defendants. The court found that the attorney's misleading opinion letters, which

It said went beyond mere errors in legal

judgment, were crucial to the drstnbunon of unregistered securities and that

he had aided and abetted the scheme.

An appeal was taken by the attorney to

the Court of Appeals for the Second

CircUlt.36

The decision of the distnct court was

consistent with an earlier decrsion In

S.E.C. v. Budin & CO.,37 where it was

held that 200,000 unregistered shares

Issued by one of the Chapter XI debtor

companies could not be Included In

computing the net capital of a brokerdealer, and With the decision of the

bankruptcy court in Sveden House of

Texas, Inc.,38 dismissing an attempt to

enjoin the Commission from Interfering

With any resales WIthout registration of

the securities purchased by the noncreditor.

S.E.C. v. Continental Tobacco Co. of

South Carolina, Inc.39 The United States

Court of Appeals for the Fifth Circuit

held, contrary to the decisron of the drstrict court, that Continental's sale of un-
80 SECURITIESAND EXCHANGECOMMISSION

registered securities to about 40 persons, for a total of' $140,000, was not,

as claimed, an exempt "private offering" under Section 4(2) of the Securities Act, and that the sale therefore violated the registration provisions of that

Act. The court ruled that Continental

failed to sustain its burden of proving

by explicit, exact evidence that each offeree of the unregistered stock had

relationship with Continental giving him

access to the kind of information that

registration would have disclosed. Although Continental had distributed

brochure containing information about

the company and Its secunties, the

court stated that mere disclosure of information does not assure entitlement

to the exemption for nonpublic offerings. Offerees of unregistered securities

should also have the ability, by reason

of their facility for acquiring information

about the issuer, to verify for themselves the accuracy of the disclosure.

Such ability, the court Indicated, was

not possessedby all of Continental's offerees since some of them lacked personal contacts with Continental's management prior to acquiring the

unregisteredsecurities.

S.E.C. v. Computer Statistics, Inc.

The United States District Court for the

District of Columbia40 denied the defendant's motion to dismiss the action

for improper venue, or in the alternative, for a transfer of venue and granted

the Commission's cross-motion for summary judgment enjoining the defendant

to file timely and proper periodic reports. On appeal,41the defendant contends that the district court should have

transferred venue to the Northern District of Texas where the defendant has

its principal place of business and

should not have granted the Commission's motion. It argues that there was

an issue of fact whether a reasonable

likelihood of future violations existed In

light of its assertion that it would attempt to comply with the reporting requirements in the future.

SEC. v. Realty Equities Corporation

of New York.42 A permanent injunction

enjoming the defendant from failing to

comply with reporting requirements

under the Exchange Act was entered,

despite its contentions that ItS past failure to file the required reports on a

timely baSISwas the result of factors

beyond ItS control. The company aca knowledgedthat it had been delinquent

in its reporting over a 5-year period. At

the time the Cornrnissron's action was

instituted on December 31, 1971, the

a company was delinquent in filing its annual report for its fiscal year ended

March 31, 1971, and its quarterly reports for the first two quarters of its

1972 fiscal year. Trading in the company's securities on the American Stock

Exchange had been halted in August

1970 becauseof its failure to file reports

on time.

The district court held that bad faith

and fraud need not be shown to warrant an injunction. It stated that the delinquencies were willful "In the sense

they were not the result of mistake, accident or inadvertence but rather resulted from a series of factors, including financial pressuressome years back,

inadequate staff, lack of necessary

financial records found in acquired companies, broken promises by retained accounting firms and management's failure to place timely reporting in priority

status." The court noted that while assurances had been given that these

matters were now under control, the delinquencies had continued after the suit

was instituted, and that similar assurances had been given to the Commission in the past.

SEC. v, Radio Hill Mines Co. Ltd.43

The United States District Court for the

Southern DIstrict of New York entered

an order which, in addition to preliminarily enjoining the defendants from

further violations of registration and antifraud provisions of the federal securities laws, directed four defendants to

report periodically their securities hold-
THIRTY-EIGHTH 81

ings and transactions to the Commission. The court noted that these defendants had often engaged In securities

transactions through nominees, and that

a reporting requirement of this type was

needed in view of the difficulty the

Commission might encounter in determining whether the defendants were

continumg their violative activities. An

appeal was taken to the Court of Appeals for the Second Circuit.44

Shamrock Fund.45 A temporary restraining order was entered by a district

court, on the Commission's motion, enjoining this open-end investment

company from failing to repurchase or

redeem its shares In accordance with

the terms of such securities, in violation

of Section 22(e) of the Investment

Company Act, and from selling its

shares to the public at other than the

current public offering price described

in the prospectus, in violation of Sec'

tron 22(d) of that Act. Subsequently,

the court appointed a receiver to take

charge of the assets and records of the

investment company to safeguard and

conserve assets. It empowered the receiver to perform the duties of a board

of directors, to suspend the repurchase

and redemption of the outstanding

shares, and to obtain shareholder approval for a new investment adviser or

to merge the Fund into another investment company or liquidate it.

The Technical Fund, Inc.46 The Commission brought an injunctive action

against this registered investment company and some of the principals of the

company or ItS adviser, alleging that the

defendants filed misleading proxy material with the Commission and violated

provisions of the Investment Company

Act prohibiting prlncrpal transactions between an investment company and affiliated persons and requiring a written

contract between an investment company and its adviser and shareholder

approval of such contract. The defendant principals were also charged with

gross misconduct in engaging in pracANNUAL REPORT

tices which constituted a breach of fiduciary duty. After a hearing, the court

preliminary enjoined the defendants

from further vrolations and appointed a

receiver for the investment company.

During the fiscal year, receivers appointed by the courts in SEC v. Fifth

Avenue Coach Lines, Inc. and SEC v.

Gray Line Corp.47 entered Into a settlement agreement which eliminated cross

ownership between the two companies

and disposed of all claims between

them. The settlement provided that

Gray Line turn over all of ItS holdings In

Fifth Avenue (approximately 25 percent

of the outstanding stock) to Fifth Avenue and that Fifth Avenue turn over all

of its holdings in Gray Line (approximately 37 percent of the outstanding

stock) to Gray Line. In addition, Fifth

Avenue was required to return $1.85

million to Gray Line.

An order exempting the settlement

agreement from applicable provisions of

the Investment Company Act was obtained from the Cornrnissron and approval of the terms of the settlement

was obtained from the courts. The settlement has been implemented, Fifth

Avenue's receivership has been terminated, and it is presently engaged in

conducting business as a registered investment company. Gray Line, under

the direction of its receiver. is in the

process of liquidation.

S.E.C. v. Everest Management CorporatlOn.48 The Commission charged

44 defendants with Violations of antifraud provisions of the securities laws.

and some of them with violation of provrsrons of the Investment Company Act

designed to prevent self-dealing and

gross abuse of trust. An investment

company and its adviser which were not

named as defendants moved to intervene as plaintiffs on certain counts of

the Commission's complaint and against

some of the defendants The district

court denied their motion after hearing

the Cornrmssron's arguments that intervention would complicate the action be-
82 SECURITIESAND EXCHANGECOMMISSION

cause of the defendants' right to a jury

trial, would add new Issues, and would

interfere with the expeditious conduct of

the action and the possibility of negotiating settlements with some of the defendants. The Commission pointed out

that the proposed intervenors were free

to assert their claims in a separate lawSUIt. An appeal from the denial of intervention has been taken to the Court of

Appealsfor the SecondCircuit.49

Participation as Amicus Curiae

The Commlssron frequently participates as amicus curiae in litigation between private parties under the securities law where it considers it important

to present its views regarding the interpretation of the provisrons involved. For

the most part, such participation is In

the appellate courts. During fiscal 1972,

the Cornrnlssron filed amicus curiae

briefs In 20 cases and participated as

Intervenor In two cases.

Supermtendent of Insurance v. Bankers LIfe and Casualty Co.50 The Supreme Court. adopting views expressed

by the Commission as amicus curiae,

unanimously reversedthe holding of the

lower courts that the complaint of the

Superintendent of Insurance had failed

to state a claim for relief under Section

10(b) of the Securrties Exchange Act

and Rule 10b-5 thereunder.

The Superintendent had alleged that

Manhattan Casualty Company, a New

York Insurance company, had been defrauded by its' sole shareholder into sellrng nearly $5 million of ItS portfolio securities on the assumption that the

proceedsfrom the sale of the securrtres

would be returned to the company. In

stead, the Superintendent had alleged,

the defendants misappropriated the proceeds of the sale to the detriment of

the company. The defendants had

argued, among other things, that the

fraud, If any, was a self-inflicted wound

and that, accordingly, no claim for relief

had been stated.

The Supreme Court, affirmatively recognizing the existence of a private right

of action under Section 10(b) for the

first time, held that the Securities Ex.

change Act "protects corporations as

well as Individuals who are sellers of a

security." The Court recognized the

broad purpose underlying Section 10(b)

and, In noting that the "crux of the

present case IS that Manhattan suffered

an injury as a result of deceptive practices touching its sale of securities as

an investor", stated:

"Hence we do not read Section

10(b) as narrowly as the Court of

Appeals; it is not 'limited to pre.

serving the integrity of the securities markets' ... , though that purpose is Included. Section 10(b)

must be read flexrbly, not technically and restrictively. Since there

was a 'sale' of a 'security' and

since fraud was used 'in connection with' It, there is redress under

Section lO(b) .... (T)he fact that

creditors of the defrauded corporation buyer or seller of securities

may be ultimate victims does not

warrant disregard of the corporate

entity."

Affiliated Ute Citizens v. United

States.51 The Cornmlssron urged reversal of a decision of the Court of Appeals for the Tenth Circuit concerning

the application of Rule 10b-5 under the

Securities ExchangeAct to the sale of

certain stock by mixed-blood Indians of

the Ute Tribe. The Supreme Court, in

accordance with the positions urged in

the Commission's brief, rejected the

view of the court of appeals that, under

the circumstances of the case, involving

primarily a failure to disclose, proof of

reliance on material misrepresentations

of fact was necessary to recover damages for a Violation of Rule 10b-5. The

Supreme Court stated that the defendants devised a plan and induced the Indians to dispose of their shares without

disclosing to them material facts that
THIRTY-EIGHTH 83

reasonably could have been expected to

influence their decisions to sell.

The Supreme Court also rejected the

court of appeals' view of the measure

of damages. It held that the correct

measure of damages was the difference

between the fair value of all that the

sellers received and the fair value of

what they would have received had

there been no fraudulent conduct, except for the situation where the defendant received more than the seller's actual loss. In the latter case, damages

are the amount of the defendant's

profit.

Cattlemen's Investment Co. v.

Fears.52 The district court, as urged by

the Commission, construed the term

"tender offer" In Section 14(d) of the

Securities Exchange Act (part of the

"Williams Bill") to include acqursition

by the defendant of more than 5 percent of the common stock of an issuer

as a result of active and widespread solicitations of public shareholders on an

mdividual basis, in person, over the telephone and through the mails. The

Court adopted the Commission's view

that, although tender offers were usually

made by newspaper advertisements, the

means employed by the defendant were

even more designed "to force a shareholder into making a hurned investment

decrsion without access to mforrnation,

In circumvention of the statutory purpose." The court further concluded, as

urged by the Comrnissron, that the purposes of the Williams Bill would best be

served by giving the plarntiff target cor.

poration standing to sue for an injunction and by granting an injunction even

though the only showing of Irreparable

harm was the defendant's failure to file

a required report under Section 14(d).

Naftalin & Co., Inc. v, Merrill Lynch,

Pierce, Fenner & Smith, Inc. 53 SIX broker-dealers appealed from an order entered in a proceeding in which they petitioned to have Naftalln & Co., Inc.,

another broker-dealer, adjudicated an involuntary bankrupt.s- The district court

ANNUAL REPORT

disallowed the broker-dealers' claims

against Naftalln to the extent It found

that they arose out of extensions of

credit to Naftalrn m special cash accounts In Violation of the credit extension provrsions of the Federal Reserve

Board's Regulation T. The court found

that Naftalln had purported to sell securities it did not own rn special cash accounts maintained With each of the SIX

broker-dealers and that the latter had

failed to liquidate those accounts until

long after the dates on which Naftalin

had agreed to make delivery of the secuntres.

The Cornrnissron, as amicus CUriae,

agreed With that part of the decrsron

which held that the six broker-dealers

Violated Regulation T by extending credit

to Naftalin when It failed to make

prompt delivery of the secunties sold in

the special cash accounts The Commission disagreed With the decrsion, however, to the extent It determined that

delivery of the securities should have

been made on or before the seventh

day after their sale in order to avoid an

Illegal extension of credit. Instead, the

Commission urged that If a special cash

account customer has a credible explananon for a bnef delay m delivery, a broker-dealer may in good faith rely on this

explanation, but that It cannot in good

faith continue a delay in delivery that

extends, at most, beyond a few weeks.

Feit v, Leasco Data Processing EqUip,

ment Corporation. 55 The district court

found Leasco, its chief executive officer,

president, and general counsel, all also

directors, jointly and severally liable m

money damages to the plamtiff class,

consistmg of persons who had exchanged their secunties of another company for secuntres of Leasco under a

registered exchange offer by Leasco.

liability was based on the court's fmdmg that there were material omissions

In Leasco's registration statement filed

with the Commission. After the court issued its fmdrngs of fact and conclusrons of law but before the entry of a
84 SECURITIES AND EXCHANGE COMMISSION

final judgment, Leasco and the mdivrdual defendants moved the court for an

order declanng that Leasco's Intention

to pay the entire Judgment and not to

seek contribution from the lndividuals

would not contravene public policy as

expressed in the Securrttes Act. This

motion was made pursuant to an under'

taking in Leasco's registranon statement

which paralleled that contained In the

note to Rule 460 under the Securities

Act. That note expresses the Cornrrussion's opinion that such Indemnification

is against public policy and thus unenforceable and generally provides for the

registrant to subrnrt the question to a

court for adjudication should a claim for

indemnification be asserted against it.

In a memorandum filed by the Com.

mission, at the Invitatlon of the court, It

took the posrtion that where Inside

directors of a corporation have been

found to have farled to exercise the de.

gree of care Imposed upon them by

Section 11 of the Securitres Act, It

would be contrary to public poucy as

expressed in the Secunties Act to per.

mit the corporation to indernrufy them

directly against their liability or to do so

lndrrectly by farhng to seek contribution

from them.

After the Commission had filed its

memorandum but before the court

ruled, the defendants' motion was withdrawn. The court entered a final judgment but expressly retained junsdictron

over the issue of contribution.

In June, 1972, the Individual defendants offered to contnbute $5,000 each

to the total judgment of $112,000. The

Cornrnissron advised the court of its posrtion that If under all the circum.

stances the court should find that the

amount the mdividuals proposed to con.

tribute was only a token payment, It

should reject their offer. The Commission took no position as to what might

be an appropnate amount. After having

directed publication of a notice of the

terms of the proposed settlement, and

there apparently be109 no objection, the

court approved the settlement on August 1, 1972.

The Birnbaum Doctrine. As amicus

curiae, the Cornrrussron has continued

to urge rejection of the doctrine established by Birnbaum v, Newport Steel

Corp.56 that permits only a purchaser or

a seller of secunties to recover rnonetary damages In a pnvate action under

Section lO(b) of the Secunties Ex.

change Act and Rule 10b-5 thereunder.

In Mount Clemens Industnes Inc. v.

Bell,57 the plaintiffs alleged that they

had been mduced to refrain from bid.

dmg on and purchasing securities at a

sheriff's sale because of misrepresentation by one of the defendants. The

Commission expressed the view that

neither the legislative history nor the

language of Section lO(b), and Rule

10b-5 thereunder, restrict the ambit of

those provisions to purchasers and sellers of securities. The Court of Appeals

for the Ninth Circuit, however, held that

the purchaser-seller Imutatron was a desrrable method for effecting what it consrdered to be the congressional intent,

and it suggested that this limitation

might be a matter of constitutional

necessity. In Manor Drug Stores v, Blue

Chip Stamps,58 an action presently

pending before another panel of the

Court of Appeals for the Ninth Circuit,

the plaintiffs allege that as a result of

the defendants' misrepresentations they

were induced to refrain from purchasing

secuntres offered in connection with the

settlement of an antitrust action. The

Commission urged this panel to reject

the purchaser-seller limitations. In a

supplemental memorandum requested

by the panel, the Commission explained

its disagreement with the Mount CJemens decision.

In Travis v, Anthes Imperial

Limited,59 the district court, on the

basis of the BIrnbaum doctrine, had dismissed a complamt which alleged that

the plamtiffs In St. Louis had been

fraudulently induced by Canadian defendants to refrain from selling certain
THIRTY-EIGHTH ANNUAL REPORT 85

securities. On appeal to the Court of

Appeals for the Eighth Circuit, the Commission took the position, as amicus

curiae, that there should be a private

right of recovery under Section 10(b)

and Rule 10b-5 whenever an Investor

has been fraudulently Induced to refrain

from buymg or sellmg securities, as well

as when he has been fraudulently induced to purchase or sell. The Commission also took exception to the district

court's determmation that there was no

JUrisdiction under the Federal securities

laws because there were not sufficiently

substantial acts committed within the

United States in connection with the alleged violation. The Commission noted

that the defrauded victims were in the

United States at the time deceptive

statements were made to them by telephone and that the Securities Exchange

Act applied to communications between

any foreign country and any state.

After a rehearing en banc, the Court

of Appeals for the Second Circuit, in

Drachman v. Harvey,60 reversed the dismissal of a share-holders' derivative suit

that sought damages under Section

10(b) and Rule 10b-5 on behalf of the

corporation for losses allegedly suffered

when defendants caused an improvident

redemption of convertible debentures to

prevent dilution of voting controlwhich the defendants had sold at a premium. The court did not, however, find

it necessary to repudiate the Birnbaum

doctnne as urged by the Commission in

ItS brief as amicus curiae.

CRIMINAL PROCEEDINGS

During the past fiscal year the Commission referred 38 cases to the Department of Justice for prosecution, representmg a sharp mcrease over the 22

cases referred in the prior year.61 Twenty-eight mdictrnents were returned

against a total of 67 defendants, in

cases that had been referred in that

and prior years, and 75 defendants

were convicted in 25 cases that were

tried. Convictions were affirmed in 10

488-483 0 - 73 - 8

cases, and appeals were stili pending in

9 crimmal cases at the close of the period. Staff members of the Commission

familiar with a case generally assist in

the prosecution and 10 any appeal from

a conviction.

The cases handled again demonstrated a variety of fraudulent and other

unlawful practices to which the investing public is subjected In U.S. v.

Colasurdo,62 the convictions of LeWIS

Colasurdo and other defendants for conspiracy and other crimes were upheld

by the Court of Appeals for the Second

Ctrcurt. Colasurdo and hrs associates

were able to gam control of Crescent

Corporation, listed on the New York

Stock Exchange, usrng Crescent's own

money. They caused another corporation controlled by them to transfer an

agricultural operation to Crescent

through a series of sham transactions

and used the proceeds of the sale to

pay for their Crescent stock, and they

subsequently concealed their activities

by causing Crescent to file false statements with the Commission. Colasurdo

was sentenced to a two-year prison

term and a $50,000 frne. Other defendants received various prison sentences

and were fined a total of $50,000.

The securrties fraud convictions of

Service Securities, Inc., a New York broker-dealer, and M. Perry Grant, its president, were upheld by the Court of Appeals for the Second ClrcUlt.63 In

connection with an all-or-nothing offer109 of common stock of Data Industries

Corporation of Texas, through Service

Securities as underwriter, these and

other defendants defrauded public

investors by entering fictitious subscription orders to make It appear that the

offering was sold out by the specified

deadline. Thereafter, they generated

purchase orders for the stock to offset

the fictitious subscriptions. Grant received a six-month prison sentence, and

Service Securities was fined.

Recently, the Court of Appeals for the

Tenth Circuit upheld the convictions of
86 SECURITIES AND EXCHANGE COMMISSION

four defendants for fraudulently seiling

certam loan commitments letters (which

the court held to be secuntresj.s- The

defendants promised to provide loans

for prospective borrowers and caused

them to pay them an advance fee in return for a loan commitment letter. In

fact, no loan was ever placed or consummated and with few exceptions the

fees paid were not returned. The court

charactenzed the defendants' acts as a

"carefully designed scheme to defraud

persons seeking equity capital or mortgage money."

In a case involving the first cnrrunal

prosecution for violation of Section

17(e)(1) of the Investment Company

Act, the Court of Appeals for the Second Circurt upheld the conviction of Jerome Deutsch for aiding and abetting

the Violation of that provision by a codefendant.65 Deutsch, an officer of

Realty Equities Corporation, attempted

to place $12 million of Realty's prornissory notes With institutional investors.

His efforts were unsuccessful until he

convinced the co-defendant, Frank D.

Mills, senior officer of the Investment

adviser for 12 mutual funds, to purchase notes for one of those funds.

Thereafter, Deutsch was able to place

the entire Issue. After Realty had contracted to repurchase several notes,

Mills, usrng a nominee account, purchased one of those notes through

Deutsch for $537,000. Three days later

one of the funds, of which Mills was a

vice-president, purchased identical notes

for $928,125 per note. Section 17(e)(1)

forbids affiliated persons of an investment company from accepting, while

acting as agent, any outside compensation for the purchase of any property

for the Investment company. The court,

after ruling that the statute was not unconstitutionally vague, stated that "The

objective of Section 17(e)(1) IS to prevent affiliated persons from having their

judgment and fidelity Impaired by conflicts of interest. It is clear that, as

soon as Mills purchased the Realty note

at a reduced pnce, he was inhibited by

a conflict of interest which could easily

becloud his judgment to the detriment

of the benefrcianes of the funds." The

court held that the JUry was justified in

finding that Deutsch's sale to Mills of

the note at a discount was "compensation in appreciation of past conduct."

In U.S. v. Zlmmerman,66 various defendants pled guuty to securities fraud

charges In connection With transations

mvolvmg State Fire and Casulaty Insurance Co. The defendants obtained control of the company and then exchanged its valuable marketable assets

for restricted unmarketable secunties of

other corporations. The company failed

and was forced into receivership. Defendant S. Mort Zimmerman was fined

$30,000 and placed on five years probation. Other defendants, Including C.

Carey Matthews, an attorney and former

member of the state legislature, were

also fined and placed on probation.

Another public official, former Louisiana Attorney General Jack P. F. Gremillion, was found gurlty of giving false

testimony before a Federal grand jury

mvestigatmg possible Violations of the

Federal securities laws in connection

with the operations of LOUisiana Loan

and Thnft Corporation.e? Gremillion was

sentenced to concurrent three-year

terms on each of five counts of perjury.

Organized Crime Program

The prosecution of securrties cases is

often based on circumstantial evidence

requiring extensive investigation by

highly trained personnel. The difficulties

in such prosecutions are compounded

when elements of organized crime are

involved. Witnesses are usually reluctant

to cooperate because of threats or fear

of physical harm. Books, records, and

other documentary evidence essential

for successful prosecution may be destroyed or nonexistent. The organized

cnrnmal element is prone to disguise

transactions by using nominees and taking advantage of foreign bank secrecy
THIRTY-EIGHTH ANNUAL REPORT 87

laws. It frequently operates through

"fronts" and infiltrates legitimate business concerns. Organized crime has an

extensive network of affiliates throughout this country m all walks of life, and

in many foreign nations.

Despite these difficulties, the Commission, working in cooperation with

other enforcement agencies, has been

able to make major contributions to the

fight against organized crime. Members

of ItS staff, including a special unit in

the headquarters office, assist the Department of Justice and its various organized crime "strike forces" in the investigation and prosecution of securities

cases involving organized crime. For

example, the Commission, m cooperation with the New York Strike Force, as

well as the New York Police Department

and the New York County District Attorney's Office, participated in the investigation and successful prosecution of

certain defendants, including Arthur Tortorello, John Dennett and Frederick

Hesse, for Violating the antifraud and

registration provisions of the securities

acts in connection with the financial affairs of Underwriter Investment Company. The defendants caused the preparation of inflated balance sheets for

that company, which was in fact a corporate shell. They then engaged in a

complex scheme to distribute the overvalued shares to the public. Six defendants pled guilty prior to trial. Tortorello

and Dennett were found guilty after

trial. They have appealed their

convictions.68

In another significant case, the Commission's staff participated With the

New York Strike Force in the trial resulting in the convictions of John Lombardozzi, Hilmer Sandine, Leslie Zacharias,

Samuel Benton and William Hamilton of

securities fraud, mall fraud, and conspiracy to defraud investors m connection with transactions in the stock of

Picture Island Computer Corporation.69

Two other defendants, Peter Crosby and

Dinty Whiting, failed to appear for trial,

and became fugitives from justice.

Evidence produced during the sixweek trial revealed that the defendants

caused more than 23 million unregistered shares of Picture Island stock to

be distributed throughout the United

States, Europe and South America. In

connection with the distribution, they

disseminated fmancial statements and

shareholder reports which falsely stated

that Picture Island had assets rn excess

of $50 million. In fact, the company

was a nearly worthless shell. Among the

assets claimed for Picture Island were

3112 million acres of government-owned

off-shore oil lands in the Arctic, which

were assigned a value of over $31 million. After the trial, Lombardozzi, Sandme, and Zacharias jumped ball and became fugitives from justice. The other

defendants were expected to be sentenced in the fall of 1972.

In addition to providmg direct assistance to the Justice Department and ItS

"strike forces" in the investigation and

prosecution of organized crime cases,

the Commission also participates rn

other ways, both direct and rndirect, in

the fight against organized crime. The

Chairman of the Commission is a member of The National Council on Organized Crime. Quarterly reports concerning organized cnme investigations are

submitted to the Justice Department.

The Cornrnisston also frequently supplies mformation from its extensive files

on publrcly-held companies and brokerdealers to the Justice Department and

other agencies engaged in fighting organized crime. A potential contnbution

of great significance relates to the problem of securities theft. Securities worth

hundreds of millions of dollars are stolen each year from brokerage firms,

banks, insurance companies, and other

institutions. Organized cnme is responsible for much of this theft. Although

the Commission has no direct responsibility in the area of stolen securities, its

current efforts looking toward the immobilization of stock certificates in central
88 SECURITIES AND EXCHANGE COMMISSION

depositories will greatly reduce the opportunities for securities theft.

Proposed Swiss Treaty

The Commission has connnued its

participation WIth other agencies of the

Federal Government in discussions look109 toward a possile Treaty of Mutual

Assistance In Criminal Matters between

the United States and Switzerland.7o It

IS believed that such a treaty would be

of assistance to the Commission in

dealing With problems presented by the

use of SWISS financial institutions in

connection WIth securities transactions

taking place in the United States.

The Comrnlssrcn's representative partrcipated in two further rounds of informal discussions between Swiss and

Amencan representatives which took

place 10 wasnmgton in the fall of 1971.

These meetings resulted in resolution of

the known remaining substantive problems between the two working groups.

The matter now awaits a deterrnmatlon

by the governments concerned as to

what further action they may desire to

take.

COOPERATION WITH OTHER

ENFORCEMENT AGENCIES

In recent years the Cornrrussron has

given increased emphasis to cooperation

and coordination of ItS own activities

WIth the various other enforcement

agencies, including the self-regulatory

organizatrons and enforcement agencies

at the state and local level as well as

certain foreign agencies. Its programs in

this area cover a broad range. For example, the Cornrnissron believes that

certain cases, where the violations,

whrle mvolving the Federal securities

laws, are of a local nature, are more appropnately enforced at the local rather

than the Federal level. In these instances the Commission authorizes referral of the case to the appropriate

state or local agency, and members of

the staff familiar With it are made available for assistance to that agency in its

enforcement action. One recent such

case involved Dempster Investment Co.

and ItS president who were found guilty

by a Michrgan state court of selling unregistered secunties in VIolation of that

state's securities law. The Commission

had previously obtained a Federal court

order enjorning the defendants from violating registration and antifraud provisions of the Federal securities laws. The

case was initially developed through a

JOint mvestigation by the Cornrnissron's

staff and the Michigan Secunties

Bureau,?1

The Commission has also fostered

programs designed to provide a comprehensive exchange of information concerning mutual enforcement problems

and possible securities Violations. Durrng the fiscal year, it continued its program of regional enforcement conferences held once a year within each of

the Cornrrusston's nine regions. These

conferences are attended by personnel

from state securities agencies, the U.S.

Postal Service, Federal, state and local

prosecutors' offices and local offices of

self-regulatory associations such as the

NASD. They provide a forum for the exchange of Information on current enforcement problems and new methods

of enforcement cooperation. One result

of these conferences has been the establishment of programs for joint investigations. Although the conferences were

lrutrally hosted by the Cornrnissron's regional offices, many state agencies are

now serving as sponsors.

The Cornrnisston IS constantly seeking

ways to Improve these conferences. One

innovation that has been tried in some

regions is to open one session to the

brokerage community and to private

practitioners in the securities field. The

resulting exchange of views has so far

proven to be very beneficial to all concerned. It is planned to follow this practice in the future at other regional conferences.

Dunng the past year the Commission
THIRTY-EIGHTH 89

reinstituted its annual enforcement

training program, after a lapse of one

year. The more than 150 persons In attendance included, In addition to Commission personnel, 30 persons from various state agencies, 15 from other

Federal agencies and 7 representatives

from Canada, 2 from Mexico and 1

from Panama. The program seeks to impart an understanding of how the securities markets operate, explain applicable rules, suggest desirable investigative

procedures, Indicate how available

enforcement remedies can best be utilized and provide guidance In connection with the trial of securities cases.

The Commission's Section of Securities Violations provides one of the

means for cooperation on a continuing

baSIS with other agencies having enforcement responsibilities. This Section

acts as a clearinghouse for Information

regarding securities enforcement actions

taken by state and Canadian authorities,

other governmental and self-regulatory

agencies, and the Cornrnissron itself. It

answers requests for specrfic information, and in addition publishes a penodrc SV Bulletin which IS sent to contributing agencies and to other

enforcement and regulatory agencies.

During fiscal year 1972, the Section received 4,212 letters either providing or

requesting information, and sent out

2,457 communications to cooperating

agencies. Records maintained by the

Section reflect a steady Increase In recent years In the number of enforcement actions taken by state and Canadian authorities.

The data In the SV files (which are

cornputerized) is useful in screening applicants for registration as securities or

commodities brokers or dealers, Issuers

and investment advisers, as well as applicants for loans from such agencies

as the Small Business Administration

and the Economic Development Administration of the Department of Commerce.

The Wanted Supplement to the SV

ANNUAL REPORT

Bulletin is a valuable source of data on

fugitives in securities-related criminal

actions. As an example of results attainable through coordination and cooperation between agencies, an individual

listed in the Supplement was discovered

to be in Honolulu using an alias. He

was seized through the [ornt efforts of

the Cornrnlssron's San Francrsco Office,

the Honolulu Police Department, and

the State of California.

FOREIGN RESTRICTED LIST

The Commission maintains and publicizes a Foreign Restricted List designed

to alert broker-dealers, financial institutions, Investors and others to possible

unlawful drstrrbutrons of foreign securities. The list consists of names of foreign companies whose securities the

.Cornrmssron has reason to believe recently have been, or currently are being,

offered for public sale in the United

States in violation of registration requrrernents. Most broker-dealers refuse

to effect transactions In secunties issued by companies on the list. Thrs

does not necessarily prevent promoters

from Illegally offering such secunties directly to investors In the United States.

The number of companies on the list increased from 54 on June 30, 1971, to

60 at the end of the 1972 fiscal year.

The following companies were added to

the list durmg the year:

Trans-American Investments, limited,

Land Sales Corporation, Timberland,

and Vacationland.72 These are all names

under which one Edward Zelsman was

selling Investment contracts which involved Interests In Canadian land, including minerai and timber land leases

and vacation land properties. The contracts were offered in the United States

by mall and extensive advertismg In national magazines. Representations were

made that purchasers of the leases

need do no work and would realize profits. Moreover, many U.S. investors complained to Canadian authorities that

documents they received purporting to
90 SECURITIES AND EXCHANGE COMMISSION

convey leasehold interests were unacceptable to Canadian land record offices

because descriptions were too vague

and the instruments were not properly

executed.

Normandie Trust Company of

Panama.73 The Commission received information that transactions were being

effected in securities purporting to be

"letters of credit" of Normandie Trust

Company, purportedly a Panamanian

corporation, and investigation disclosed

several instances where such "letters of

credit" were sold for cash in the United

States. In connection with these sales,

financial statements of highly questronable origin and content were disseminated to the public.

Santack Mines Limited.74 The Comrnissron received information that

unregistered shares of thrs Canadian

mining corporation had been sold to

residents of the United States.

Strathmore Distillery Company,

Limited.t» This company, located in

Glasgow, Scotland, was publicly advertrsing and mailing solicitations to mvestors 10 the Uruted States in an attempt

to induce them to buy Whiskey warehouse receipts covering kegs of Scotch

Whiskey stored In warehouses in Scotland. The Investments were solicited on

the baSIS that profits would be realized

from the sale of the whiskey after It

had become more valuable through

aging. It appeared that what was being

offered constituted investment contracts

which are securities as defined In the

Securities Act.

NOTES FOR PART 4

1C.A.D.C., No. 71-1963.

2 M.D.L. Docket No. 55.

3 CCH Fed. Sec. L. Rep. !jf93,400

at p, 92,003 (March 1972).

4447 F. 2d 166 (C.A. 10, 1971),

certiorari derued, 404 U.S. 1038 (1972).

5 No. 72-2574 (C.A. 5).

6 See, e.g., the court of appeals decisron 10 S.E.C. v. Texas Gulf Sulphur

Company, 446 F. 2d 1301 (C.A. 2.

1971).

7 Securities Exchange Act Release No.

9708 (August 7, 1972).

8 Securities Exchange Act Release No.

9614 (May 23, 1972).

9 Securities Exchange Act Release Nos.

9247 (July 15, 1971) and 9516 (March

8, 1972).

10Securities Exchange Act Release No.

9327 (September 8, 1971).

11 Securities Exchange Act Release No.

9478 (February 9, 1972).

12Investment Company Act Release

No. 7280 (July 19, 1972).

13 Securities Exchange Act Release No.

9666 (July 10, 1972).

14C.A.D.C., No. 71-1602.

1337th Annual Report, pp. 138-139.

16Securities Act Release No. 5266

(June 27, 1972).

17 Securities Act Release No. 5295

(September 6, 1972).

18Securities Act Release No. 5218

(December 20, 1971).

19See Securities Exchange Act Release No. 9629 (June 6, 1972).

20Securities Exchange Act Release No.

9536 (March 20, 1972)

21452 F. 2d 943 (C.A. 10, 1971),

certiorari denied, 406 U.S. 957 (1972).

22 S.E.C. v. National Bankers Life Insurance Company, et a/., 334 F. Supp.

444 N.D. Tex. 1971).

23C.A. 5, No. 71-3599.

24 D.D.C., No. C.A. 225-72.

25 CCH Fed. Sec. L. Rep. U 93,383

(D. Ore. February 16, 1972), appeal

pending, C.A. 9, No. 72-1334.

26C.A. 9, No. 72-1334.

27 N.D. III., Civ. Action No. 71 C 545.

28458 F.2d 1082 (C.A. 2, 1972).

29 S.E.C. v. Manor Nursing Centers,

Inc.. CCH Fed. Sec. L. Rep. !jf 93,359

(S.D. N.Y., 1972) and U 93,501 (S.D.

N.Y., 1972), appeals pending, C.A. 2,

Nos. 72-1304 and 72-1614.

30 S.D. N.Y., 72 Civ. 269.

31S.D. N.Y., 72 Civ. 2561.

32 N.D. III., No. 69-G-1266.

33 C.A. 7, No. 71-1817.

34 S.D. N.Y., 71 CIV. 3384.

35 In the Matter of Sveden Ho~e of

Texas, Inc., et et., Debtors, S.D. Texas,

No. 69-H-135 (consolidated).

36 C.A. 2, No. 71-2167.

37CCH Fed. Sec. L. Rep. U 93,088

(D. N J., 1971).

38 S.D. Texas, No. 69-H-135, reported

previously in 37th Annual Report. p.

202.

39463 F.2d 137 (C.A. 5, 1972).

40 No. 307-71.
THIRTY.EIGHTHANNUAL REPORT 91

41No. 72-1230 (C.A.D.C.).

42D.D.C., No. 2544-71.

43S.D. N.Y., No. 70-3286 (November

5, 1970).

44C.A. 2, No. 71-1073.

45C.D. Cal., No. 72-569-ALS.

46D.C. Mass., No. 72-1080-M.

47See 37th Annual Report, pp. 163-

165.

48S.D. N.Y., No. 71 Civ. 4932.

49C.A. 2, No. 72-1782.

50300 F. Supp. 1033 (S.D. N.Y.,

1969), affirmed, 430 F.2d 355 (C.A. 2,

1970), reversed and remanded, 404 U.S.

6 (1971). Previously reported in 37th

Annual Report, p. 124. 51406 U.S. 128 (1972).

52W.O. Okla., Civ. No. 72-152 (May

3, 1972).

53C.A. 8, Nos. 71-1634, 71-1672.

54 In the Matter of Naftalin & Co.,

lnc., 333 F. Supp. 136 (D. Minn., 1971).

55332 F. Supp. 544 (E.D. N.Y., 1971). 56193 F.2d 461 (C.A. 2. 1952) certiorari denied, 343 U.S. 956 (1952).

57(Current Binder) CCH Fed. Sec. L.

Rep. U 93,552 (C.A. 9, June 28, 1972).

58No. 71-2223 (C.A. 9).

59No. 71-1587 (C.A. 8). 60453 F.2d 722 (C.A. 2, 1972).

61In addition. five criminal contempt

actions were referred or instituted by the

Commission.

62453 F.2d 585 (C.A. 2, 1971), certiorari denied, U.S. Sup. Ct., Docket No.

71-1267 (May 22, 1972). 63 U.S. v. Grant, (Current Volume)

CCH Fed. Sec.L.Rep., U 93,502 (C.A. 2,

May 25, 1972).

64U S. v. Austin, (Current Volume)

CCH Fed. Sec. L. Rep. U 93,539 (C.A.

10, June 26, 1972).

65U S. v. Deutsch, 451 F. 2d 98 (C.A.

2, 1971), certiorari denied, 404 U.S.

1019 (1972).

66See litigation Release No. 5307

(January 26, 1972).

67See litigation Release No. 5278

(January 5, 1972).

68 See Litigation Release No. 5230

(December 29, 1971).

69See Litigation Release No. 5434

(June 20, 1972).

70See 37th Annual Report. pp. 128-

129.

71 See Litigation Release No. 5294

(January 18, 1972).

72 secunties Act Release No. 5184

(August 31, 1971).

73Securities Act Release No. 5194

(September 22, 1971).

74Securities Act Release No. 5202

(October 14, 1971).

75Securities Act Release No. 5245

(April 19, 1972).



PART 5

INVESTMENT COMPANIES

AND ADVISERS

Under the Investment Company Act

of 1940 and the Investment Advisers

Act of 1940, the Commission is charged

with extensive regulatory and supervisory responsibilities over investment

companies and investment advisers. Un.

like the other federal securities laws

which emphasize disclosure, the Invest.

ment Company Act provides a regula.

tory framework within which investment

companies must operate. Among other

things the Act: (1) prohibits changes in

the nature of an investment company's

business or Its Investment policies without shareholder approval; (2) protects

against management self-dealing, embezzlement or abuse of trust; (3) provides specific controls to elimmate or

mitigate inequitable capital structures;

(4) requires that an investment company disclose its fmancial condition and

Investment policies; (5) provides that

management contracts be submitted to

shareholders for approval, and that provision be made for the safekeeping of

assets; (6) prohibits underwriters, investment bankers, or brokers constituting more than a minority of an investment company's board of directors; and

(7) sets controls to protect against

unfair transactions between an invest.

ment companyand Its affiliates.

Persons advising others on their secunty transactions for compensation

must register with the Commission

under the Investment Advisers Act of

95
96 SECURITIESAND EXCHANGECOMMISSION

1940. This requirement was extended

by the Investment Company Amendments Act of 1970 to include advisers

to registered investment companies. The

Adviser's Act, among other things, prohibits performance fee contracts which

do not meet certain requirements;

fraudulent, deceptive or manipulative

practices; and advertising which does

not meet certain restrictions.

The August, 1972, reorganization of

the Commission for the first time

placed responsibility for both investment companies and investment advisers in one Division, the Division of Investment Company Regulation. This

union should enhance the ability of the

Commission to oversee the activities of

these important elements of the invest.

ment community and enable the Com.

mission to deal comprehensively with

problems involving the economics, distribution methods and services in the

growing money management field complexes.

ECONOMIC, REGULATORY

MATTERS

Investment companies provide an important means for the pooling of the

collective resources of individuals in the

nation's capital markets. Investor confidence is vital to their success in attracting the savings of individuals, and the

safeguards provided by the Investment

Company Act contribute to sustaining

such confidence.

A dramatic example of the importance of investor confidence IS found in

the continued acceleration of the internationalization of the caprtal markets.

Becauseof the degree of investor confidence existent in this country, our securities markets have historically served

as a magnet for foreign investors.

One of the vehicles created to meet

this demand from foreign investors has

been the establishment of offshore

funds-investment companies created

to trade in the United States securities

markets, but which are domiciled in foreign countries in order to avoid regulation by the Commission and to achieve

tax advantages. Becauseof their foreign

domicile. these funds are not registered

under the Act and generally operate

free of regulation. In many cases, however, their sales practices have been too

aggressive, and their disclosures inadequate. Moreover, the managers of these

funds are generally not subject to restrictions against overreaching, on the

extent of their compensation, or on

their use of fund assets.

In response to this problem, the

Commission on August 11, 1971, announced the formation of an Interagency Task Force, consisting of representatives of the Commission,

Department of State, Department of

Treasury and the Board of Governors of

the Federal ReserveSystem in order to

consider the possible development of a

regulated vehicle which would still provide appropriate tax advantages for foreign residents. The Task Force has completed substantially all of its work, and

it is expected that shortly the Commission and the Department of Treasury

will propose legislation to the Congress

which will extend the regulatory policies

of the Act to at least some offshore

funds.

Another business area where the

Commission deems further regulation

necessaryfor investor protection and to

stimulate investor confidence is that of

oil and gas programs. As discussed in

Part 1 of this report, the Commission

has submitted proposed legislation to

the Congress designed to provide such

regulation. Both the Commission and

the oil and gas drilling industry recognized that increasing national demands

for energy require large amounts of

capital for exploration and that such

capital may be more difficult to raise if

in addition to the risk of a drilling venture investors must also bear the risk of

being treated unfairly. The proposed legislation took the Investment Company

Act as its model.
THIRTY-EIGHTHANNUAL REPORT 97

Mutual Fund Distribution

Since the adoption of the Investment

Company Act, perhaps no facet of

open-end investment company activity

has received greater attention than the

distribution process for the shares of

such companies. The past year was no

exception. The Commission's concern

over the cost to investors of participating in mutual funds and over regulatory

problems associated with the distnbution system was manifested in a number of areas.

It has been a widespread practice to

use fund brokerage commissions to reward broker-dealers for sales of fund

shares. This practice, however, creates

a myriad of economic and regulatory

problems. Among other things, there is

a danger that a retailer of fund shares

will base his recommendations not on a

customer's needs but rather on the relative amounts of brokerage he can expect from different funds. In addition,

the need of a mutual fund to allocate

brokerage as a reward for sales of its

shares can create pressures for unnecessary portfolio transactions. And the

practice of allocation can have serious

anti-competitive effects in that larger

funds have more brokerage available for

compensation to fund sellers.

To correct these problems and potential for abuse, the Commission, in its

Statement on the Future Structure of

the Securities Markets, concluded that

the practice of using brokerage from

the portfolio transactions of mutual

funds to reward broker-dealers for sales

of fund shares must be terminated.

Subsequently, the National Assocratlon

of Securities Dealers proposed an

amendment to its Rules of Fair Practice

Which would bar the reciprocal practice

of giving or receiving portfolio brokerage

business as an inducement to or reward

for the sale of fund shares.

The elimination of the cloud caused

by reciprocity will better enable the

Commission to determine the consequences of a repeal of the "retail price

maintenance" provislon of Section

22(d) of the Act.

Section 22(d) precludes the sale to

public investors of redeemable investment company securities which are

being currently offered to the public by

or through an underwriter except at a

current publlc offering price described

in the prospectus. The Committee on

Banking and Currency of the United

States Senate had requested in 1969

that the Commission review the potential consequences of repeal of the section and report its findings to the Committee. The Commission's staff has

been engaged in a study of the potentral economic impact of the repeal of

Section 22(d) on the funds themselves,

principal underwriters, retail sales organizations and their salesmen,the investing public and the stock market. The

staff report is expected to be submitted

to Congressearly in fiscal 1973.

The recent liberalization of the Commission's mutual fund advertising

rules 1 may also have an Impact on the

distribution process. Rule 134 under the

Securities Act was amended to permit

the expansion of mutual fund "tombstone advertisements" in include a general description of an investment company, ItS attributes, method of

operation and services. Rule 434A

under the Securities Act was also

amended to permit mutual funds for

the first time to use an abbreviated

form of prospectus containing all of the

basic information contained in the full

prospectus, but omitting some of the

detailed information. Although this summary prospectus may not be used in

lieu of the statutory prospectus with

sales literature, it can be used alone as

a newspaper advertisement or mailer

prior to the delivery of the full prospectus. The Commission adopted a new

Rule 135A under the Securities Act governing generic advertising of mutual

funds. It provides that generic advertisements may contain general explanatory
98 SECURITIESAND EXCHANGECOMMISSION

information about mutual fund shares,

the nature of investment companies and

services offered by mutual funds. Most

importantly, in contrast with past interpretations of the Securities Act which

effectively limited the use of generic advertising to those securities dealers who

made available a wide range of mutual

funds, under the new rule such advernsing may be used by any mutual fund

underwriter or adviser. Thus, those

members of the securities industry who

have the greatest interest in communicating the mutual fund concept to the

public now have the opportunity to do

so.

The Commission views the changes

made so far as only a modest step in

liberalizing mutual fund advertising

rules, and has invited interested persons to submit additional rule proposals.

The need to develop new markets for

fund shares is a product of increased

competition for investors' savings. One

means adopted by certain funds to attract investors has been to reduce or

eliminate the sales load previously imposedon salesof their shares.

Finally, it can be reasonably expected

that one consequence of the Commission's opinion in United Funds, Inc.2 will

be a reduction in costs to some shareholders of Investment companies. In

that case, the Commission granted an

exemption from Section 22(d} of the

Act to permit shareholders of United

Funds and certain other open-end investment companies who redeem their

shares to use the recemption proceeds

to repurchase shares within 15 days

without the payment of an additional

sales load. The companies and their underwriter requested the exemption on

the basis that it had been their experience that a substantial number of

shareholders redeemed their shares

without being aware that they could

borrow money on the security of those

shares or could exchangeshares of one

of the funds for those of another fund

without paying a sales load.

The Commission held that it would

be equitable to permit shareholderswho

had mistakenly redeemed shares to correct their mistakes without paying another sales load. by the end of the

fiscal year a number of other investment companies had applied for a similar exemption.

NUMBER OF REGISTRANTS

As of June 30, 1972, there were

1,334 investment companies registered

under the Act, with assets having an aggregate market value of nearly $81 billion. Compared with corresponding totals at June 30, 1971, these figures

represent a decline of 17 in the number

of registered companies but an increase

in the market value of assets of nearly

$3 billion, for another new high since

the Act was passed. At June 30, 1972,

3,811 investment advisers were registered with the Commission, representing

an increase of 326 over a year before

and a new record total. Further data is

presented in the statistical section of

the report.

During the fiscal year, the staff of the

Commission conducted 106 investment

company inspections and 148 investment adviser inspections, representing

increases of 10 percent and 22 percent,

respectively, over the prior fiscal year.

SPECIALIZED INVESTMENT

COMPANIES

A number of registration statements

processed by the Division during the

fiscal year indicated the continuing interest of other financial institutions in

the investment company vehicle and the

development of specialized objectives

and investment methods as a means of

competing for investors' interest.

Following the Supreme Court's decision in Investment Company Institute v.

Camp,3which held that the operation of

a mutual fund by a national bank is
THIRTY.EIGHTHANNUAL REPORT 99

prohibited by the Glass-Steagall Act,

First National City Bank (Citibank) deregistered its Commingled Investment Account. However, in January 1972, the

Federal ReserveBoard amended its regulations to permit bank holding companies and their subsidiaries to act as investment advisers to registered

investment companies, subject to certain limitations. Under this amendment,

Citibank, a wholly-owned subsidiary of

First National CIty Corporation, has become the investment adviser to Advance

Investors Corporation, a closed-end investment company. Although it is a

closed-end investment company (l.e., its

shareholders do not have the right to

have the company redeem their shares),

Advance may make purchases of its

shares from time to time in market

transactions as it deems advisable and

has the right to borrow amounts up to

an aggregate of 20 percent of its net

assets for this purpose.

Similarly, Independence Income Securities Company, Inc., a closed-end investment company, entered into an in.

vestment advisory arrangement whereby

Providence National Bank, acting

through its Trust Division, acts as investment adviser for the company and

performs all administrative functions for

It. The Commission's staff was advised

by the Federal Reserve Board and the

Comptroller of the Currency that they

considered this arrangement permissible

under the banking laws notwithstanding

the Supreme Court decision referred to

above.

The Dreyfus Third Century Fund, lnc.,

whose registration became effective duro

ing the fiscal year, invests in companies

which, "in the opinion of the Fund's

Management, not only meet traditional

Investment standards, but also show evidence in the conduct of their business,

relative to other companies in the same

industry or industries, of contributing to

the enhancement of the quality of life

in America as this nation approaches

the Third Century of its existence." The

factors which the Fund considers in

making its investment decisions include

performance In the areas of environment, occupational health and safety,

consumer protection and product purity,

and equal employment opportunity.

Minbanc Capital Corp., a closed-end

non-diversified management investment

company, was created at the instance

of the Urban and Community Affairs

Committee of the American Bankers Assocration for the purpose of making

capital funds available to qualifying

minority-owned banks. During the fiscal

year, it registered shares for an offering

to banks which are members of the Association. According to Minbanc's prospectus, funds may be made available

to any bank "at least 50 percent of

whose voting securities are owned, or

which is managed, by individuals from

minority groups in the United States

which are under-represented in its free

enterprise system, and which has an

operating history of three years or

more."

The Bache-Huntoon Paige Ginny Mae

Fund, Series I, will sell units of beneficial interest in a fund composed of

"mortgage-backed securities" guaranteed as to payment of principal and interest by the Governent National Mort.

gage Association (Ginny Mae).

Mortgage-backed secuntres are issued

against a pool of VA and FHA mortgages which have been collected by

mortgage bankers or other similar institutions. The pooling arrangement permits such institutions to obtain a Ginny

Mae guarantee prior to the issuance of

the securities. The Fund is an open-end

diversified investment company designed to seekhigh income.

First Real Property Securities Fund,

Inc. will invest primarily in securities of

entities engaged in various real estate

activities. The Fund expects that a substantial portion of its assets will be invested in companies in the formative

stages of their development which will

have no public market for their securi-
100 SECURITIESAND EXCHANGECOMMISSION

ties. These portfolio companies generally will be formed by developers who

will supervise construction on and management of real estate properties. Because information about the portfolio

companies will generally not be available from other sources, the Fund will

supply shareholders with such information in its periodic reports.

APPLICATIONS

One of the Commission's principal

activities in its regulation of investment

companies is the consideration of applications for exemptions from various

provisions of the Act or for certain

other relief. Applications may also seek

determinations of the status of persons

or companies under the Act. During the

fiscal year, 326 applications were filed

and final action was taken on 406 applications. As of the end of the year, 141

applications were pending.

An investor in a periodic payment

plan for the gradual acquisition of the

shares of a registered investment company may change his investment objectives before he has completed the plan.

First Investors Corporation applied for

permission to enable an investor in a

Plan sponsored by it for the acquisition

of the shares of Wellington Fund, to exchange his Plan for another, also sponsored by First Investors, to acquire

shares of First Investors Fund for

Growth without losing credit for the

"front-end" load already paid. The Commission approved the proposed exchange offer and granted an exemption

from the retail price mamtenance provision of the Act to permit credit to be

given for past payments on Wellington

Fund Plans when determining the sales

charge to which future payments on

Fund for Growth Plans would be

subject.s

Under the Act, an affiliate of a registered investment company, such as its

investment adviser, cannot participate

in a joint arrangement with the investment company absent Commission approval. Massachusetts Mutual Life Insurance Company, which proposed to

sponsor and act as adviser of MassMutual Corporate Investors, Inc. (Fund),

a closed-end investment company, applied with the Fund for approval of an

arrangementwherebythe insurancecompany would invest concurrently for its

general account in each issue of securities purchased by the Fund at direct

placement an amount equal to that invested by the Fund, and would exercise

warrants, conversion privileges and

other rights at the same time and in

the same amount. In support of the application, it was represented that the insurance company had a nationally recognized position as a source of capital

funds and as a purchaser of investment

securities to be issued at private placement and as a result attracted issuers

in all parts of the country and engaged

in a wide variety of Enterprises. These

investment opportunities were to be

made available to the Fund under the

proposed arrangement. The Commission, finding that the Fund's participation in the proposed arrangement would

not be less advantageous than that of

the insurance company, gave its approval, subject to certain safeguards

which the applicants had proposed.P

In First Multifund of America, Inc.,6

the applicants sought a declaratory

order that it would be lawful for members of the NASDwho are underwriters

of the shares of mutual funds to grant

concessions to other members of the

NASD who act as brokers for purchasers of such shares, not excluding brokers who are affiliated persons of such

purchasers. The Commission determined

that where an investment company's

adviser,which is also a registered brokerdealer, effects purchases for the company's portfolio of shares of other

investment companies on which the adviser receives concessions from the underwriters of the selling companies, the

adviser acts as a "broker" for the affiliated investment company even though
THIRTY-EIGHTHANNUAL REPORT 101

the selling agreements between it and

the underwriters of the selling companies characterize it as a "dealer", and

as such is entitled to receive and retain

concessions which do not exceed 1 percent of the purchaseprice.

RULES AND GUIDELINES

Continued implementation of the Investment Company Amendments Act of

1970 as well as the normal continuing

review of rules in light of changing conditions and administrative experience resulted in the revision of various rules

under the Investment Company and Investment Advisers Acts during the fiscal

year.

Performance Fees

Prior to the 1970 amendments of

Section 205 of the Advisers Act, compensation arrangements between investment companies and their advisers

based on portfolio performance were

often unfair to the companies and their

shareholders. Many such fees were not

symmetrical, in that they did not decrease where performance was poor or,

if they did, decreases were disproportionate to increases for good performance. The 1970 amendments to Section

205 were designed to align, as nearly

as possible, the interests of the adviser

and the investment company by correcting imbalances in incentive fee arrangements.

These amendments prohibit all performance fees unless compensation

increases and decreases proportionately

with investment performance of the

company over a specified period in relation to the investment record of an appropriate index of securities prices. The

point from which increases and decreases in compensation are measured

must be the fee which is paid or earned

when the investment performance of

the company is equivalent to that of the

index.

During the fiscal year, the Commission published for comment a proposed

488-483 0 73 9

Rule 205-1 under the Advisers Act. The

rule, in modified form, was adopted in

August, 1972.7 The rule is designed to

assure that "investment performance"

of an investment company is computed

on the same basis as the "Investment

record" of an index, so as to make the

two comparable. It requires that all incrernents-e-dlstnbutlons of realized capital gains and dividends paid out of investment income, the value of capital

gains taxes paid or payable on undlstributed realized capital gains, and all

cash distributions of the companies

whose stock comprises the index-be

treated as reinvested when computing

both "investment performance" and

"investment record."

Series Companies

Another rule published for comment

in fiscal year 1972 and thereafter

adopted in modified form is Rule 18f-2

under the Investment Company Act.8

Implementing an amendment contained

In the Investment Company Amendments Act of 1970, the rule is designed

to insure fair and equitable treatment of

shareholders of investment companies

of the series type.9 The rule requires series investment companies,as a requisite

for taking action on a matter requiring shareholder authorization, to obtain

the approval of each individual class or

series of its stock which would be affected by such matter. Certain matters,

such as those in which the interests of

the series are substantially identical, are

exempted from the separate voting requirements. The rule also has special

provisions concerning investment advisory contracts and investment policies

which give individualized treatment to

separate series.

Capital Gains Distribution

In its report to Congress proposing

amendments to the Investment Company Act, the Commission proposed an

amendment to limit capital gains distrlbuttons of registered investment cornpa-

• -
102 SECURITIESAND EXCHANGECOMMISSION

nies to not more than once a year. It

stated that such a prohibition would relieve managers from pressure to realize

gains on a frequent and regular basis,

mitigate improper sales practices related to such distributions and eliminate

the administrative expenses attending

quarterly or semiannual capital gains

distributions.

As a result of the Commission's recommendation, Section 19(b) was added

to the Act as part of the 1970 Amendments to give the Commission rulemaking power with respect to distributions

of long-term capital gains. The Commission implemented this provision by

adoptmg Rule 19b-1 which limits registered investment companies to a single

distribution of long-term capital gains

during anyone taxable year, with a limited exception, based on tax considerations, for additional distributions under

certain circumstances for companies

qualifymg as regulated investment companies under SubchapterM of the Internal RevenueCode.IO

Combined Orders

In view of the possibility that a registered investment company could, by

combining its orders for the purchase

or sale of securities with the orders of

other persons, secure the benefits of

volume discounts, negotiated commission rates, and advantageous block

transactions, the Commission announced that It was considering an

amendment to Rule 17d-1 under the

Investment Company Act which now

prohibits such combination without

Commission authorization to the extent

It involves orders of a registered investment company and those of a related

person.u The amendment would permit

such combined orders for the sole purpose of execution in order to achieve

the best overall execution, provided the

arrangement is likely to produce a benefit for the investment company. The

proposed rule would require that the

net unit price paid for securities purchased, or received for securities sold,

be the same for each person whose

order is so combined, and that the securities purchased or sold be allocated

among all participants in proportion to

their respectiveorders.

Fidelity Bonds

The Commission also announced a

proposal to amend Rule 17g-1 under

the Investment Company Act pertaining

to fidelity bonds required of investment

company officers and employees with

access to the company's securities or

funds.I2 The proposed rule would set

forth, for the first time, minimum reo

quired amounts of coverage, based on

the amount of the company'sassets.

Adjournment of Shareholder Meet.

ings

The Commission also has under consideration the adoption of Rule 20a-4

under the Investment Company Act.I3

The proposed rule provides that no

meeting of shareholders of any registered mvestment company relating to a

proposal requiring shareholder approval

shall be adjourned if a quorum is present at such meeting, in person or by

proxy, under state or applicable law or

corporate charter or other instrument

pursuant to such law. The rule is designed to prohibit the practice of repeated adjournments of such meetings

notwithstanding the presence of a quorum, in an effort to gain sufficient additional votes to carry certain proposals.

However, the rule is not intended to

preclude adjournment and additional solicitations in unusual situations, such as

where a material factual change has

rendered proxy soliciting material misleading.

Small Business Investment Compa- nies

Rules 3c-3 and 18c-2 under the Investment CompanyAct were adopted by
THIRTY-EIGHTHANNUAL REPORT 103

the Commission to enable small busi- NOTES FOR PART 5 ness investment companies licensed

under the Small Business Investment

Act of 1958 to issue debentures guaranteed by the Small Busmess Administration without violating certain provisions

of the Act.14 Rule 3c-3 provides, among

other things, that the term "public offering" as used in Section 3(c)(1) is

not deemed to include offers and sales

of SBA-guaranteed debentures. Rule

18c-2 exempts such securities, under

certain conditions, from the provisions

of Section 18(c) which otherwise prohibits a closed-end investment company

from issuing more than one class of

senior debt security.

Registration Guides

On June 9, 1972, the Comrrusslon

published definitive staff guidelines for

the preparation and filing of registration

statements under the Investment Company Act by investment companies.15

These guidelines set forth the policies

and practices followed by the staff in Its

examination of those statements. They

cover such areas as the issuance of

senior securities, the concentration of

investments in particular industries and

indemnification of directors and officers.

1Securities Act Release No. 5248

(May 9. 1972).

2 Investment CompanyAct ReleaseNo.

7189 (May 25, 1972).

3401 U.S. 617 (1971). See 37th An- nual Report, p. 156. 4 Investment CompanyAct ReleaseNo.

6803 (November 2, 1971).

5 Investment CompanyAct ReleaseNo.

6690 (August 19, 1971).

6 Investment CompanyAct ReleaseNo.

6700 (August 26, 1971) 7 Investment Advisers Act ReleaseNo.

327 (August 8, 1972). 8 Investment CompanyAct ReleaseNo.

7276 (August 8, 1972).

9 Series companies are open-end investment companies which issue classes or series of preferred or special stock

each of which is preferred over all other

classes or series in respect of assets

specifically allocated to that class or series. For all practical purposes, rndividual series of a series company are

separate investment companies.

10 Investment Company Act Release

No. 6834 (November 23, 1971).

11 Investment Company Act Release

No. 7035 (March 9, 1972). 12 Investment Company Act Release

No. 7107 (April 5, 1972). 13 Investment Company Act Release

No. 7087 (March 31, 1972). 14 Investment Company Act Release

No. 7127 (April 17, 1972). 15 Investment Company Act Release

No. 7221.



PART 6

PUBLIC-UTILITY

HOLDING COMPANIES

Under the Public Utility Holding Company Act of 1935, the Commission regulates interstate public-utility holdingcompany systems engaged in the

electric utility business and/or retail

distribution of gas. The Commission's

jurisdiction also covers natural gas pipeline companies and other non-utility

companies which are subsidiary companies of registered holding companies.

There are three principal areas of regulation under the Act: (1) physical integration of public-utility companies and

functionally related properties of holding-company systems, and simplification

of intercorporate relationships and financial structures of such systems; (2)

financing operations of registered holding companies and their subsidiary companies, acquisition and disposition of

securities and properties, as well as certain accounting practices, servicing arrangements, and intercompany transactions; (3) exemptive provisions,

provisions relating to the status under

the Act of persons and companies, and

provisions regulating the right of persons affiliated with a public-utility company to become affiliated with another

such company through acquisition of

securities.

COMPOSITION

At fiscal year-end. there were 23

holdrng companies registered under the

Act. Twenty were included in the 17

107
108 SECURITIESAND EXCHANGECOMMISSION

"active" registered holding-company

systems.1 The remaining three regis.

tered holding companies, which are relatively small, are not considered part of

"active" systerns.s In the 17 active systems, there were 91 electric and/or gas

utility subsidiaries, 57 nonutility subsidiaries, and 16 inactive companies, or a

total, including the parent holding companies and the subholding companies,

of 184 system companies. The table on

page 171 lists the active systems and

their aggregateassets.

PROCEEDINGS

Delmarva Power & Light Company.3

The Commission instituted a proceeding

under Section ll(b)(l) of the Act,

which requires the Commission to limit

operations of each registered holding

company system to a single integrated

electric or gas utility system. Retention

6f one or more additional integrated

electric or gas utility systems is permitted only upon showing compliance with

standards contained in that section.

Delmarva, which operates both electric

and retail gas distribution systems in

Delawareand has electric utility subsidiary companies operating in two other

states, has asserted that its properties

are retainable under the standards of

the Act and that its principal integrated

public-utility operation is its electric system. Hearings began in September

1972.

New England Electric System.4 This

proceeding involves the proposed creation of a new holding company system

to include Boston Edison Company and

two registered holding companies, New

England Electric System and Eastern

Utilities Associates. Briefs were filed

with the hearing officer during the fiscal

year. After fiscal year-end, the hearing

officer filed an initial decision approving

the proposal, conditioned upon the

granting of access to future major generating facilities of the proposed system

to all utilities, cooperatives, and rnunicipalities in the area, together with transmission arrangements. The Department

of Justice, the Massachusetts Municipal

ElectriCAssociation and the Division of

Corporate Regulation oppose the pro.

posed affiliation and filed petitions for

review of the initial decision with the

Commission. Their petitions, and a petltion filed by the applicants, were

granted by the Commission on September 15, 1972.

American Electric Power Company,

tnc» This proceeding involves the pro.

posed acquisition by American Electric

Power of the common stock of Columbus and Southern Ohio Electric Com.

pany, a nonassociate electric utility

company, in exchange for AEP's stock.

Hearings were concluded during the

fiscal year. Shortly thereafter, AEP sub.

mitted a settlement proposal conditioned on Commission approval of the

proposed acquisition. The proposal provided in part that AEP would offer to

sell certain generating units to Ohio municipalities distributing power to consumers. The Commission determined to

defer consideration of AEP's proposals

until it could consider the evidence

after the hearing officer had submitted

an initial decision. The Division of Corporate Regulation and the Department

of Justice filed briefs with the hearing

officer opposing the proposed acquisition, urging (among other things) that it

would have anti-cornpetltlve effects, contrary to the standards of the Act.

LouiSiana Power & Light Company.6

The court of appeals affirmed the Commission's decision authorizing Louisiana

Power and Light, an electric utility subsidiary company of Middle South Utilities, Inc., to issue and sell certain

securities in connection with the financing of its construction prograrn,? The

cities of Lafayette and Plaquemine, La.,

which sought intervention in the pro.

ceedings before the Commission, alleged that certain unrelated activities of

the applicant were in violation of the

Federalantitrust laws.

Middle South Utilities, Inc.s In are-
THIRTY-EIGHTHANNUAL REPORT 109

fated proceeding, the Commission had

rejected intervention and a request for

reopening the hearing (filed 15 months

after its close) by the same two cities.

It approved the acquisition by Middle

South of the common and preferred

stocks of Arkansas-Missouri Power Company, an unaffiliated company. The

Commission conditioned its approval

upon Middle South's filing a plan under

Section nee) of the Act to eliminate

any resulting minority interest 9 and

upon the divestment of the gas utility

and ice business of Arkansas-Missouri.10

The cities filed petitions for review of

the Commission decision. At the end of

the fiscal year the matter was under advisement by the court of appeals.!1

Union Electric Company.12 Union, an

exempt holding company and an electric

and gas utility company, applied to acquire (through an invitation for tenders)

the outstanding shares of common

stock of Missouri Utilities Company, a

nonassociate electric and gas utility

company. Hearings were concluded during the fiscal year and briefs were filed

with the hearing officer. The Division of

Corporate Regulation opposed the application. The Division urged, among other

things, that the proposed exchange offer

is not reasonable; that the expansion of

a combined electric and gas utility system is contrary to the Act; and that

Union has failed to make the requisite

showing of economies and efficiencies

to result from the proposed acquisition.

The Division also opposed granting a requested exemption to Union under Section 3(a)(2), except upon the conditions

that (1) the gas properties of Union

and its subsidiary companies, and (2)

the gas and water properties of Missouri Utilities be divested.

Two proceedings pending before the

Commission for decision at year-end

present the question of whether a holding company, whose utility operations

are intrastate but which diversifies into

unrelated non-utility activities, is entitled to an intrastate exemption. The Division has taken the position that such

activities are detrimental to public,

investor and consumer interests, and

that therefore their retention precludes

the grant or continuation of the exemption. In one of the cases, an application

for exemption was filed by National Utilities & Industries Corp., whose utility

subsidlary company, Elizabethtown Gas

Company, distributes natural gas at retail in New Jersey.13 In Pectiic Lighting

Corporation, proceedings were instituted

by the Commission to determine

whether an exemption granted to Pacific

in 1936 should be revoked or modified

because of Pacific's diversification into

non-utility ventures unrelated to the operanons of its utility subsidiary company, Southern California Gas Company.14

FINANCING

During fiscal 1972, a total of 16 active registered holding-company systems

issued and sold 67 issues of long-term

debt and capital stock for cash, aggregating $2.79 billion 15 pursuant to authorizations granted by the Commission

under Sections 6 and 7 of the Act. All

of these issues were sold at competitive

bidding to raise new capital. The public

utility financing table in the statistical

section presents the amount and types

of securities issued and sold by these

holding company systems.

The volume of external financing during fiscal 1972 set a new record, representing an increase of 13 percent over

fiscal 1971, the previous record year.

Preferred stock and common stock issued and sold increased by 101 percent

and 24 percent respectively, while the

amount of debentures issued and sold

in fiscal 1972 decreased by 77 percent

from fiscal 1971.

This unprecedented volume of financing was accompanied by further deterioration in the earnings coverages of interest and preferred dividends. For the

calendar year 1971, the 17 active registered holding-company systems earned
110 SECURITIESAND EXCHANGECOMMISSION

their interest and preferred dividend

requirements an average of 2.04 times

(after taxes) as compared to 2.19 times

in 1970 and 2.93 times in 1966.

LEGISLATION

During the fiscal year, a bill (5. 1991,

92nd Cong.) which would amend the

Act to grant authority to the Commission to permit companies subject to the

Act to invest limited amounts in low

and moderate cost housing projects

under programs subject to certain federal housing statutes was reported favorably by the Senate Committee on

Commerce. On July 21, 1972, the Senate passed an amended version of S.

1991. An identical bill was introduced in

the House (H.R. 6711), but no commit.

tee report has been issued. This legislation was an outgrowth of a Commission

decision 16 holding that such investments

were not permissible under the Act in

its present form.

NOTES FOR PART 6

1Three of the 20 were subholding

utility companies in these systems. They

are The Potomac Edison Company and

Monongahela Power Company, publicutility subsidiary companies of Allegheny

Power System, lne., and Southwestern

Electric Power Company, a publlc-utillty

subsidiary company of Central and South

West Corporation.

2 These holding companies are British

Amencan Utilities Corporation; Kinzua

Oil & Gas Corporation and its subsidiary

company, Northwestern Pennsylvania

Gas Corporation; and Standard Gas &

Electric Company, which has been dissolved and its assets distributed.

3 Holding Company Act Release No.

17530 (April 5, 1972).

4 Previously reported in 37th Annual

Report, p. 170; 36th Annual Report, p.

160; 35th Annual Report, p. 149; 34th

Annual Report, p. 138.

5 Previously reported in 37th Annual

Report, p, 168; 36th Annual Report, p.

160; 35th Annual Report, p. 148; 34th

Annual Report, p. 138.

6 Previously reported in 37th Annual

Report, p. 170.

7 CitIes of Lafayette and Plaquemine,

Louisiana v. SEC, 454, F. 2d 941

(C.A.D.C., 1971).

8 Previously reported in 37th Annual

Report, p. 171.

9 The plan was approved by the Commission (Holding Company Act Release

No. 17446, February I, 1972) and en.

forced by the U.S. District Court for

the District of Missouri by order dated

April 28, 1972 (Civ. Action No. 72C199(2». 10 The Commission subsequently

granted an extension of time within

which to complete such divestment

(Holding Company Act Release No.

17631, June 27, 1972). 11 CitIes of Lafayette and Plaquemine,

Louisiana v. SEC, C.A.D.C.,No. 71-1337.

12 Previously reported in 37th Annual

Report, pp, 172-73.

13 Previously reported in 37th Annual

Report, p. 172.

14 Holding Company Act Release No.

17217 (August 3, 1971).

15 Debt securities are computed at

their price to company, preferred stock

at the offering price, and common stock

at the offering or subscription price.

16 Michigan Consolidated Gas Company, Holding Company Act ReleaseNo.

16763 (June 22, 1970), aff'd 444 F. 2d

913 (C.A.D.C., 1971).


PART 7

CORPORATE

REORGANIZATIONS

The Commission's role under Chapter

X of the Bankruptcy Act, which provides

a procedure for reorganizing corporations in the United States district

courts, differs from that under the various other statutes which it administers.

The Commission does not initiate Chapter X proceedings or hold its own hearings, and it has no authority to

determine any of the issues in such

proceedings. The Commission partrcipates in proceedings under Chapter X to

provide independent, expert assistance

to the courts, participants, and investors in a highly complex area of corporate law and finance. It pays special attention to the interests of public

security holders who may not otherwise

be representedeffectively.

Where the scheduled indebtedness of

a debtor corporation exceeds$3 million,

Section 172 of Chapter X requires the

judge, before approving any plan of reorganization, to submit it to the Commission for ItS examination and report.

If the indebtedness does not exceed $3

million, the judge may, if he deems it

advisable to do so, submit the plan to

the Commission before deciding

whether to approve it. When the Commission files a report, copies or summaries must be sent to all security holders

and creditors when they are asked to

vote on the plan. The Commission has

113
114 SECURITIESAND EXCHANGECOMMISSION

no authority to veto a plan of reorganization or to require its adoption.

The Commission has not considered

it necessary or appropriate to participate In every Chapter X case. Apart

from the excessive administrative burden, many of the cases involve only

trade or bank creditors and few public

investors. The Commission seeks to participate principally in those proceedings

in which a substantial public investor

interest is involved. However, the Commission may also participate because

an unfair plan has been or is about to

be proposed, public security holders are

not represented adequately, the reorganization proceedings are being conducted in violation of important provisions of the Act, the facts indicate that

the Commission can perform a useful

service, or the Judge requests the Commission's participation.

The Commission in its Chapter X activities has divided the country into five

geographic areas. The New York, Chicago and Seattle regional offices and

the San Francisco branch office of the

Commission each have responsibility for

one of these areas. Supervision and review of the regional and branch offices'

Chapter X work is the responsibility of

the Division of Corporate Regulation of

the Commission, which, through its

Branch of Reorganization, also serves

as a field office for the southeastern

United States.

SUMMARY OF ACTIVITIES

In fiscal 1972, the Commission entered 12 new Chapter X proceedings involving companies with aggregatestated

assets of approximately $234.9 million

and aggregate indebtedness of approximately $119.4 million.

Including the new proceedings, the

Commission was a party in a total of

113 reorganization proceedings during

the year.! The stated assets of the companies involved in these proceedingstotaled approximately $1.5 billion and

their indebtednessabout $1.2 billion.

During the year, 14 proceedingswere

closed, leaving 99 proceedings in which

the Commission was a party at fiscal

year-end.

ADMINISTRATIVE MATTERS

In Chapter X proceedings, the Commission seeks to have the courts apply

the procedural and substantive safeguards to which all parties are entitled.

The Commission also attempts to secure judicial uniformity in the construction of Chapter X and the procedures

thereunder.

King Resources Company.2 An involuntary petition was filed in the district

court in Dallas. The petition was approved and a trustee appointed. The

Commission joined in a motion to transfer the proceedings to Denver, the location of the debtor's prmcipal office. This

motion was made by the indenture

trustees for $39.5 million of outstanding debentures, and by banks holding

$13 million of notes. The Commission

pointed out that neither the debtor's

office nor any significant part of the assets were located in the Northern District of Texas and that Denver was the

most convenient forum.

The transfer was recommended by

the special master and was ordered by

the district judge. The case is now proceeding in the district court in Denver.3

In a pending appeal,« petitioning creditors are urging that the judge did not

afford them an opportunity to file exceptions to the special master's recommendations pursuant to Rule 53 of the

Federal Rules. The Commission filed a

brief supporting the transfer, urging

that the order conformed to the standard practice in the Texas district court,

that it did not prejudice appellants' appeal, and that the departure from Rule

53 was permitted by the General Order

37.

Waltham Industries Corporation.5 The

Debtor moved its corporate offices from

New York City to Los Angeles, and filed

a voluntary Chapter X proceeding in
THIRTY-EIGHTHANNUAL REPORT 115

Los Angeles about two months later.

The Commission supported objections

to the venue by a major shareholder

and by substantial eastern creditors.

The debtor had its operating division In

Massachusetts; nine of its 12 subsidiaries were located in the northeastern

United States; and the one California

subsidiary had ceased operations. Most

of the creditors were in the northeast,

and only one employee had moved to

California when the offices had been

moved there.

The district judge overruled the objections. An appeal was taken by a

creditcr.s and In the meantime the administration progressed In the California

court. The appeal was subsequently dismissed by stipulation.

Dextra Corporation.7 The debtor

amended its Chapter XI petition to

transfer the proceedings to Chapter X

when it was unable to work out by

agreement its problems with secured

creditors. The special master found that

the debtor's petition was not filed in

"good faith" Within the meaning of Section 146(3) since no reorganization

under Chapter X was possible. Objections to the speciat master's report

were overruled by the district judge who

dismissed the ChapterX petition.

Transfer to Chapter X pursuant to

Section 328 merely decides that no adequate relief is available in Chapter XI.

The amended Chapter X petition must

also satisfy the "good faith" provision

of Section 146(3). This determination is

made when the amended Chapter X petition is presented to the distrrct judge

for approvat.s

Viatron Computer Systems Corp.9

Trade creditors opposed the trustee's

petition to include trade creditors and

the public holders of the debtor's debentures in the same class. They urged

separate classification on the grounds

that their interests were different and

that classification immediately after approval of a Chapter X petition, before

any plan was contemplated, was prernature.

The district court granted the trustee's petition and the trade creditors appealed. The court of appeals, as urged

by the Commission, affirmed. In a per

curiam opinion, the court, assuming

that the district court's order was appealable, stated that appellants' contentions were "unimpressive." 10

Landmark Inns of Durham, Inc.ll The

court of appeals affirmed the refusal of

the reorganization court to permit the

ground lessor to forfeit the lease and

take possession of a motel constructed

by the debtor, at a cost of $1.5 million,

on land leased for a 52-year term.P Although the lease expressly provided for

termination on the passageof any interest to a trustee or receiver In bankruptcy, the court held that such termination would be highly unconscionable

and inequitable and "a demand for

blood" and that as a court of equity the

bankruptcy court had the discretion to

refuse enforcement of the forfeiture.

A petition for certiorari was denied by

the SupremeCourt.

Bubble Up Delaware, Inc., et a/.13

The trustee proposed to sell outside of

a plan substantially all of the debtor's

properties to a third party. The trustee

relied on Section 116(3) as authority

for such sale.14 At the hearing on the

proposed sale, another potential purchaser of the assets appeared and bid

against the purchaser selected by the

trustee. In accordancewith the Commission's recommendation, the court instructed the parties to submit proposed

plans of sale to the trustee, so that the

sale would be made through a plan,

which requires a vote of security holders affected hereby.

A sale of substantially all of the debtor's assets pursuant to Section 116(3)

must lead to the liquidation of the

debtor without a vote by securrty holders. This, in the Commission's view,

should be authorized only in exceptional
116 SECURITIESAND EXCHANGECOMMISSION

circumstances. No such circumstances

existed in this proceeding.

Beck Industries, Inc.IS The debtor

was engagedin the manufacture, importation and retail sale of shoes and related products. It conducted part of its

business through 82 subsidiaries. The

commlssron did not object to sale of

some major retail outlets since it appeared that the sale would eliminate a

significant part of the debtor's operating

and financial diffIculties. The terms were

satisfactory, and the vrability of the retained operations would not be impaired.

King Resources Company. After the

case had been transferred to Denver,as

discussed supra, the Denver trustee secured authority to borrow $3 million on

trustee's certificates. On appeal, in view

of the critical necessity for the borrowings, the case was placed on the summary calendar and, after argument, the

court of appeals affirmed the district

court's order.16

Among the highly publicized assets of

the debtor were oil and gas exploration

permits covering 35 million acres of

public lands in the Canadian Arctic.

These permits Imposed obligations to

perform exploratory work involving up

to $16 million in costs. The debtor had

sold fractional interests in this property,

subject to the obligation to contribute

to those costs, and then entered into a

contract whereby a Canadian subsidiary

of a demesne major oil company, which

acquired a fractional interest, was to perform the exploratory work. The debtor

undertook to pay 60 percent of the

cost, and forfeit its interest if it failed

to paywithin 30 daysafter notice.

The debtor fell into arrears, due

partly to the refusal of the co-owners

to contribute, and had been served with

the 3D-day notice just before the petition was filed. The Texas court had enJoined enforcement of the forfeiture,

and the domestic oil company moved to

vacate the injunction on the grounds

that (a) the properties were located in

Canada; and (b) the contract in question was with a Canadian company,

which was not subject to personal jurisdiction of the Federalcourts.

The Commission supported the jurisdiction of the reorganization court,

pointing out that Chapter X of the

Bankruptcy Act conferred exclusive [urisdrction over the debtor's property,

wherever located. It also urged that,

since the court had personal jurisdiction

over the domestic parent company, the

court, by injunction against this company, could prevent a forfeiture through

a foreign subsidiary under its control.

The district court in Denver declined

to vacate the Injunction. It did authorize

movants to reapply for relief on the

merits if the trustee should be unable

or unwilling to make equitable provision

for performance of the debtor's contractural obligations. A notice of appeal has

been filed from this ruling, but further

proceedingshave been deferred because

of pending negotiations. The trustee

has applied for appropriate relief

against the co-owners who have failed

to meet their obligations.

In the same case, the Commission

objected to the retention of the trustee

appointed by the Texas court on the

grounds that the law firm of which he

had been a member had represented

the debtor in certain legal matters

within two years prior to the proceeding

and hence was not disinterested under

Section 158(3) of Chapter X. It also objected to the appointment of the debtor's chairman of the board as additional

trustee because of questions as to his

possible liability for alleged mismanagement of the debtor. These objections

were mooted by the transfer of the proceedings to Denver and the resignation

of the Texasappointees.

The Commission also objected to the

retention of the counsel appointed for

the trustee in Denver because his law

firm had also represented the debtor

within the two-year period, although

concededly in a very minor and routine
THIRTY.EIGHTHANNUAL REPORT 117

oil and gas matter, and becausean important client of his firm was a bank

which had made substantial loans to

the debtor's officers and held sigrufrcant

amounts of stock of the debtor and of

a related company as collateral for the

defaulted loans. Counsel's firm had undertaken not to represent their client in

this area, but continued to represent

the bank in its other legal business.

After a hearing, the court ruled that

counselwas not disqualified.

An objection had also been filed to

the retention of the trustee on the

grounds that he was an investor in a

small investment club that owned one

of the debtor's debentures. The trustee

had undertaken to withdraw from the

club and to waive his distributive share

in the debenture--about $15. The Commission declined to join this objection,

which was overruled. The objectors' -appeal was heard simultaneously with the

expedited appeal from the order authorizing certificates of indebtedness, and

the order below was summanly atfirmed.

Imperial '400' National, tnc., et alP

The distnct court was informed by

counsel for the trustee that a client of

his firm had expressed an interest in

proposing a plan of reorganization for

the debtor, and that the client had retained another law firm to represent it

in the Chapter X proceedings should it

decide to file a plan of reorganization.

The district judge notified all inter.

ested parties that in his judgment the

client was not precluded from submitting a plan provided that counsel for

the trustee refrained from participation

In any way with respect to the plan.

The district judge also indicated that

the trustee, himself a lawyer, would

handle this aspect of the proceedings

and invited comments with respect to

the proposed procedure.Counselfor the

trustee would continue to represent the

trustee on all other matters.

In a letter to the district judge the

Commissionsuggestedthat the arrange488-483 0 - 73 - 10

ment should be clarified to state that

counsel for the trustee play no part in

any aspects of the proceeding that relate to plan proposals, so long as his

client is involved in the proceeding.The

attorney for a substantial creditor, who

was also chairman of the creditors'

committee, did not object to the retention of counsel for the trustee subject

to these safeguards. The Commission's

suggestion was accepted by the district

judge.

Subsequently,the Judicial Council of

the Third Circuit adopted a resolution to

the effect that when a client of counsel

for the trustee or of his firm submits a

plan, the restnctions Imposed by the

distnct Judge are not sufficient to provide immunity against "the appearance

of a conflict of Interest." 18 In view of

this resolution, the district Judge dismissed counsel for the trustee, who had

declined to step aside voluntanly. He

has appealed,19 and the Cornrrussron

filed a bnef affirming the views it had

presentedin the district court.

Virginia Island Properties, Inc.2o A

shareholders' committee consisted of

five members, three of whom were

officers and directors. Two of them and

another member were credrtors, The

Commission's staff advised committee

counsel that the committee has a fiducrary relationshrp to shareholders and

hence its members may not Include

creditors, whose interest may conflict

with that of shareholders, or directors

and officers, whose managementof the

debtor's affairs may be subject to investigation by the trustee.

In this case the same committee was

solicrting contributions from shareholders to defray its expenses.The staff advised counsel that such solicitations

were Improper, pointing out that under

Chapter X, if the committee and its

counsel render meritorious service, they

may be compensated and reimbursed

for their expenseson application to the

court at the conclusion of the proceeding. The cornrrutteethereafter offered to
118 SECURITIES AND EXCHANGE COMMISSION

return all the funds it had collected,

and it disbanded.

Farrington Manufacturing CO.21The

indenture trustee for an Issue of Eurodollar debentures proposed to resign to

avoid a possible conflict of Interest and

sought to have the Chapter X court appoint a successorindenture trustee. The

Chapter X trustee, a large bondholder,

and the Commission did not oppose the

resignation but objected to the appointment of a successor indenture trustee.

The Commission urged that a successor was not required when a substantial

individual bondholder, who was participatmg actively in the proceeding, would

be an adequate representative of the

interests of the class. The appointment

of a successor would, therefore, unnecessarily increase the costs of the proceeding. The court allowed the indenture trustee to resign but refused to

appoint a successor.

Four Seasons Nursing Centers of

America, Inc.22 The court, in confirming

the plan of reorganization, appointed

the trustee as a director and as initial

president of the reorganized company.

Although such appointment was only for

a four-month term. expiring at the first

meeting of shareholders, the appointee

will be eligible for re-election. The Com'

mission has consistently opposed this

practice. In view of the importance of

the matter, and the unsettled state of

the law,23 it deems it appropriate to

restate its position on this important

question.

A good trustee, who has successfully

coped WIth a difficult situation and revived a falling business, is a very obvious choice when the search begins for

an executive for the reorganized company. He is likely to have the

confidence of the creditors and the employees. All selfish considerations aside,

he may well feel obligated to carry on

the work he has begun.

The Commission's opposition to such

an appointment is not based on a presumption of corruption or improper patronage, but on a belief that the possibility of the trustee continuing to be

associated with the reorganized company subverts the disinterested role

fixed for him by Chapter X. Much more

than crude bargaining for salary or tenture is involved. The trustee has many

critical decisions to make during the

proceedmg and in preparing a plan of

reorganization: The retention or disposition of property, the accumulation of

liquid funds as opposed to maximum

distribution to creditors, the new capital

structure, with particular attention to

how and to whom voting power would

be distributed, and the choice between

internal reorganization and sale of the

enterprise. If the trustee has even one

eye on subsequent employment, his

judgment on these matters may be affected.

All such decisions can easily be rationalized as in the best interests of the

reorganization. But the court and the

parties are entitled to have wholly disinterested decisions of the trustee, not

decisions that may be subtly shaped by

a tendency to identify himself with the

debtor's future.

TRUSTEE'S INVESTIGATION

A complete accounting for the stewardship of corporate affairs by the prior

management is a requisite under Chapter X. One of the primary duties of the

trustee is to make a thorough study of

the debtor to assure the discovery and

collection of all assets of the estate, in.

eluding claims against officers, directors, or controlling persons who may

have mismanaged the debtor's affairs,

The staff of the Commission often aids

the trustee in his investigation.

Federal Coal Company.24 There was a

substantial identity between the public

holders of the debtor's debt and equity

secunties, since income bonds and

stock had been issued in units in an equity receivership in 1919. During the

proceeding, members of the family

which controlled the debtor made a
THIRTY-EIGHTHANNUAL REPORT 119

tender offer to the investors for both

their debt and equity securities at a

price approximately twice that which the

same investors had accepted under the

debtor's abortive Chapter XI plan of arrangement. The tender offer was successful.

The debtor's controlling persons then

moved to dismiss the Chapter X proceeding on the ground that they owned

more than 88 percent in amount of the

debtor's outstanding debentures, the

debtor's only liabilities, and more than

96 percent of the debentures for which

proofs of claim had been filed. They

argued that they could reach an accord

with the remaining debenture holders

without court assistance, including, If

necessary,payment in full.

The Cornrnissron urged the court to

deny the motion to dismiss and to direct the trustee to conduct a thorough

investigation under Section 167 into the

debtor's affairs and to procure an independent appraisal of its property in

order to determine the fairness of the

price paid the investors. The court denied the motion to dismiss and authorized the investigation and the appraisal.

It stated that, while the Commission

could certainly make the investigation

itself, the Chapter X court, once having

taken jurisdiction, should continue to go

forward in order to render complete

justice.25 Thereafter, the trustee, assisted by the staff of the Commission,

began an active and thorough Section

167 examination and retained independent appraisers. At the close of the fiscal

year, the investigation and appraisal

were contlnuing,

Webb & Knapp, Inc.26 The Supreme

Court held in a 5 to 4 decision, that the

Chapter X trustee did not have standing

to enforce claims on behalf of holders

of the debtor's debentures against the

indenture trustee.27The claims involved

alleged negligent or Willful failure to

prevent the debtor's violation of protective covenants in the indenture. The

majority of the court held that the existing law did not provide for such an action, and that whether it would be wise

to confer such standing on a Chapter X

trustee is a policy decision which must

be left to Congress.

The motion was opposed by the

trustee and the Commission. The Commission urged that (1) the record left

doubt as to the adequacy of the disclosures to the public Investors and the

fairness of the price paid; (2) purchases

under the tender offer might have VIOlated Rule 10b-5 under the Securities

Exchange Act; (3) the persons making

the tender offer had failed to file with

the Commissionthe statements required

by the Williams Act amendments to the

Exchange Act, thus rendering the acquisitions VOidable;and (4) no provision

of Chapter X was available to permit

such dismissal inasmuch as no plan

had been confirmed, creditors had not

received full payment, and no showing

had been made that a plan could not

be formulated.

Westec Corporation.28 The trustee

had brought an action against 92 defendants, based on alleged violations of

the securities laws and other breaches

of fiduciary duty in connection with alleged manipulation of the debtor's

stock. This action combined claims for

various injuries to the estate with

claims on behalf of the class of shareholders allegedly Victimized by the manipulation. Certain defendants applied

to the Court of Appeals for the Fifth

Circuit for a writ of mandamus, challenging the jurisdiction of the district

court and the standing of the trustee to

bring the action. The court of appeals

held that the action might proceed on

condition that a representative of the

shareholder class were [orned With the

trustee as a co-plaintlff.s?

Following this ruling, stipulations for

the settlement of the action against 20

of the defendants for an aggregate of

$1,620,437 were presented to the court.

The action Will continue against the remaining defendants.
120 SECURITIESAND EXCHANGECOMMISSION

American National Trust and Republic

National Trust.3D The trustee has recovered approximately $1.2 million of

assets and effected claim reductions of

an equal amount (excluding interest

savings) by vigorous investigation and

prosecution of causes of action and defenses arising out of prior mismanagement of the debtor. His plan of reorganization, discussed below,31 preserved

an equity for debtors' shareholders,

about half of which is accounted for by

these recoveries.

REPORTS

Generally, the Commission files a formal advisory report only in a case

which involves a substantial public

investor interest and presents significant problems. When no such formal report is filed the Commission may state

its views briefly by letter, or authorize

its counsel to make an oral or written

presentation.

During the fiscal year the Commission published three formal advisory

reports 32 dealing with five plans and a

supplement to one report.33 Its views

on five other plans were transmitted to

the court either orally or by written

rnernoranda.sFour Seasons Nursing Centers of

America, Inc.35 This proceeding involved

a debtor engaged in the construction

and operation of a chain of nursing

homes whose ownership was shared be.

tween two ostensibly independent public

companies, with a maze of subsidiaries,

partnerships and corporations. This arrangement was designed to permit reporting of large construction "profits"

by mtercompany sales which formed the

basis for a stock promotion. At the

peak, the outstanding shares were valued in the market at over $300 million,

but the operating nursing homes had

been seriously neglected and were producing substantial losses.

The trustee successfully brought the

nursing homes business to a profitable

level of operation, settled or tried controversies with creditors and co-owners,

and terminated the construction program. The trustee also faced litigation

against the debtors for alleged violations of the anti-fraud provisions of the

Federal securities laws in the sale of

common stock. There were also pendmg

several class suits against the directors,

the underwriter and accountants, in

some of which suits the debtor companieswere joined as defendants.

The trustee's plan of reorganization

was based on consolidation of the debtors. The assets remaining in the estates

were valued at about $50 million. The

plan provided for payment in cash of

priority obligations and unsecured

claims of under $200, and the assumption of about $15 million of secured

debts by the reorganized company. Unsecured creditors, including $15 million

of Eurodollar debentures, were to receive two-thirds of the new shares at

the rate of one share for each $7 of

claim. The remaining one-third were to

be distributed to the fraud claimants,

mostly former shareholders, in proportion to their losses. Losseswere defined

as the cost of securities purchased prior

to July 22, 1970, the date of the Chapter X proceeding, less any amount realized on resale. Claims for fraud filed in

the proceeding totaled over $110 million.

In its advisory report, the Commission found the plan feasible, and concluded it was fair and equitable in most

respects.After reviewing the history and

interrelation among the various debtors,

subsidiaries and partnerships, the

Commission found that they must be

treated as a single enterprise, as proposed by the plan. It also concluded

that the proposed settlement of the

fraud claims was reasonable.

The plan was amended, as urged by

the Commission, to provide for the first

election of directors in November 1972,

rather than May 1974, but the court did

not adopt the Commission's recommendation for a charter amendment to re-
THIRTY-EIGHTHANNUAL REPORT 121

quire cumulative voting. As amended,

the plan was approved. An order of confirmation was entered July 17, 1972,

about two years after the proceeding

began. Three notices of appeal have

been filed from the order of approval,

directed primarily at the settlement of

the fraud claims. Two complain that the

settlement was excessive, and one that

it was inadequate. As of the close of

the fiscal year these appeals were pending.

Yale Express System, Inc.36 A motor

freight carrier was reorganized in this

proceeding. The trustee's plan provided

for satisfaction of all creditor claims, including post-bankruptcy interest, primarily in common stock of the reorganized

company. Secured creditors would receive partial payment in notes, secured

by a mortgage on the debtor's building

in New York City, and in cash. Since

the value of the assets exceeded liabilities, the debtor's common shareholders

also were to receive a portion of the

new stock. The Commission urged that

the plan be amended to provide for

pre-emptive rights to the new shareholders, to prevent future dilution of their

interests, and to provide for cumulative

voting in the election of directors.

The trustee amended the plan, but

qualified the pre-emptive rights provision by adding, inter alia, a general exception for all convertible securities

which might be issued in the future by

the reorganized company. Without such

exception, pre-emptive rights would bar

the company from issuing convertible

securities unless first offered to the

shareholders. On the Commission's

objection, the plan was further modified

to eliminate this exception.37

The trustee's plan originally provided

for allowance of post-bankruptcy interest at the contract rates to holders of

interest-bearing obligations and at 4%

percent to creditors whose debts did

not specify an interest rate. The trustee

subsequently acknowledged the inadequacy of 4% percent, and proposed to

apply the prime rate of interest. The

Commission found neither rate appropriate, and urged that interest rates fixed

by state law should be applied to debts

for which no contractual rate was specified. The district court held that the

post-bankruptcy interest rate is subject

to [udlcral discretion and allowed 61/2

percent.

A merchandise creditor claimed that

the plan should have granted prionty to

vendors who supplied goods and services necessary to the opration of the

debtor's businessWithin SIX months prior

to the commencementof the proceeding.

The bulk of the trade creditors, With

claims aggregating about $3.3 million,

would have fallen Within this class. The

Commission opposed thrs priority claim.

The priority was based on the "sixmonths rule," an equitable doctrine first

developed in railroad receiverships, and

designed to ensure the contmued operation of public utilities. The Cornrnissron

pointed out that Congress had codified

the six-months rule in ~77 of the Bankruptcy Act (11 U.S.C. ~208), which

deals with railroad reorganization, but

deliberately omitted the rule from Chapter X. Although regulated in some reo

spects, a motor carrier does not enjoy

exclusive rights to serve a geographical

area, so that the continuation of its operations is not a matter of public necessity. The Commission urged that application of the "six-months" rule to

single out one group of general unsecured creditors for favored treatment at

the expense of the other creditors with

the same legal status, such as the public investors who hold the debtor's debentures, was contrary to the basic policy of equality which the Bankruptcy Act

embodied. The court agreed with the

views of the Commission.

Although not all of the recommendations made by the Commission were accepted by the court, it characterized the

Commission's advisory reports at the

last hearing on the plan as .. . . . extremely helpful and, indeed construe-
122 SECURITIESAND EXCHANGECOMMISSION

tive.. After the close of the fiscal

year, the plan was approved by the district court.

Imperial '400' National, Inc.38 The

district court judge referred to the Commission three plans sponsored by outside proponents for the reorganization

of the debtor, a motel chain. Shortly

after the close of the fiscal year, the

Commission issued an Advisory

Report 39 in which it found the total

value of Imperial to be about $20.5 million, including $8.2 million of unaffected

debt. This value gave an equity to the

debtor's former stockholders.

A group wishing to invest in the reorganized enterprise proposed two of the

plans. The original plan called for the

issuance of three classes of stock, two

of which included complex conversion

features; three series of warrants, each

with varying terms; and a secured convertible loan. The alternative plan, containing several options, called for the ISsuance of convertible preferred stock,

or cash at a heavy discount, and a

small issue of warrants. Each plan

would have given the proponent control

for a nominal cash investment, while

the debtor's creditors and stockholders

would have received an inadequate allocation of the value of the reorganized

company in exchange for their claims.

The commission advised the court

that both plans were unfeasible and

patently inequitable, and that the inordinately complex capital structures which

they proposed were contrary to the intent of Chapter X.

The third plan involved the formation

of a holding company which would own

all of the stock of the debtor and of a

construction company whose stock was

owned by the proponents. The Commission advised the court that this plan

was feasible but unfair with respect to

the amount of holding company stock

allocated for creditors and stockholders

of the debtor.

Shortly after the Comrnissronsubmitted its report, several new plans of reorganization were filed with the court, offering substantially better terms.

American National Trust and Republic

National Trust.39a A plan of reorganization has been approved by the district

court. Under the plan, the debtors,

which are real estate investment trusts,

will be combined into a single company

owning rental real estate valued at approximately $15 million. The properties

are encumbered by mortgage indebtedness of about $11 million, which the reorganized company will assume. Other

creditors are to be paid in full. The public investors who own the shares of the

old trusts will become owners of the equity in the new company by exchanging

their old shares on a share-for-share

basis.

The Commission considered the plan

to be feasible and to be fair and equitable in most respects. It took the position that the disputed claims of certain

former shareholders must either be litigated or compromised as a class under

the plan. These former shareholders

had asserted that the debtors were

culpable participants in a scheme

whereby a trustee of the debtors, following his resignation as trustee, obtained from the public some $600,000

of trust shares in exchange for his

worthless notes. About half of the

shares so acqurred were returned to the

debtors in connection with abortive real

estate transactions. The balance were

resold by him and the proceeds squandered. Although the trustee denied liability, the plan was amended to offer

the class Victims, as a compromise, one

new share for each two shares lost by

them in the transaction with this former

trustee. This offer has been accepted by

the necessarymajority of the class.

San Francisco & Oakland Helicopter

Airlines, Inc.40 The plan proposed the

continuation of the debtor's helicopter

operations and the issuance of stock to

its creditors.

In its memorandum the Commission

recommended that consideration of a

"
THIRTY.EIGHTHANNUAL REPORT 123

plan should be deferred because, in

view of the debtor's past and continuing

losses, there was no adequate basis

from which to project future earnings.

Postponement of a plan would give the

trustee time to gain operating experience and to judge the feasibility of are.

organization in light of operating results. The district court deferred

hearings on any plan for at least six

months.

Manufacturers' Credit Corporation.41

The proceedings demonstrated that the

financial condition of the parent and its

25 affiliates and subsidiaries was hopeless and that an internal reorganization

was not possible. However, with financial assistance from the State of New

Jersey, the trustee was able to propose

a plan of liquidation calling for the sale

of all the debtors' assets to another bus

company that serves adjacent routes

and thereby preserve bus transportation

for the communities served by the debtors. But, since the sale would not yield

enough to cover secured claims, public

holders of unsecured notes would not

share in the proceeds of sale. The plan

was submitted to the Commission,

which advised the court that the exclusion of the public investors was in accord with the standards of ChapterX.

Webb & Knapp, Inc.42 The trustee's

plan of reorganization, approved by the

court, provides for an orderly liquidation. The most important feature was a

settlement of disputed Federal tax

claims of some $36 million for

$2,750,000 in cash. The tax dispute

was based on a claim that profits made

in the early years were ordinary income

rather than capital gains. Other priority

claims and administrative expenses are

also to be paid in cash and any balance

remaining distributed pro rata to unsecured creditors, including the debenture

holders. The debtor being insolvent, pre.

ferred and common shareholders are

excluded from participation.

Maryva/e Community Hospital, Inc.43

The court of appeals affirmed the order

approving the plan of reorganization.44

The plan was based on a sale of the

debtor's property and distribution of the

proceeds to the bondholders, the debtor's only creditors. The debtor was a

nonprofrt corporation and the Attorney

Generalof Anzona had intervenedto assert a right to any surplus remaining

after satisfaction of the rights of the

bondholders. The court of appeals

agreed with the trustee and the Commission that the bondholders were entitled to post-bankruptcy interest as well

as interest on interest, as specified in

the indenture. The Commission and the

Attorney General had objected to allowance of a call premium but the court of

appeals did not decide this Issue, since

it found that the other items allowed

would exhaust the fund.

Phoenix Gems, Inc.45 This case in.

volved a debtor engaged in the formulation, production, marketing and sale of

various low toxic insecticides. It had

outstanding about 2.3 million shares of

common stock. In 1969, the company

underwent a Chapter XI arrangement

which was substantially consummated.

However,that arrangement did not cure

the debtor's fmancial ills which continued and led to the filing of a Chapter X

petition. Since its tlabihtres were less

than $250,000, the debtor remained in

possession.

A plan of reorganization was proposed by proponents who owned a

small company in a parallel line of business. It contemplated the acquisition of

that enterprise by the debtor and the issuance of more than 18 million shares

of the reorganizedcompany, 80 percent

for all of the shares of the proponents'

company and 20 percent for the claims

and interest in the debtor.

The staff of the Commission stated

that the number of shares to be issued,

20 percent of which would be publicly

traded, was not justified by the modest

assets of the reorganizedcompany. The

plan was amended to reduce the nurnber of shares to about 1.8 million.
124 SECURITIESAND EXCHANGECOMMISSION

About 1.5 million of these shares would

be received by the proponents and held

as restricted stock.

ALLOWANCES

Every reorganization case ultimately

presents the difficult problem of determining the compensation to be paid to

the various parties for services rendered

and for expenses incurred in the proceeding. The Commission, which under

Section 242 of the Bankruptcy Act may

not receive any allowance for the services it renders, has sought to assist the

courts in assuring economy of administration and in allocating compensation

equitably on the basis of the claimants'

contributions to the administration of

estates and the formulation of plans.

During the fiscal year 275 applications

for compensation totaling about $7 million were reviewed.

TMT Trailer Ferry, Inc.46 Two appellate matters were pending at the close

of the last fiscal year.

In one proceeding, the stockholders'

committee, supported by the Commission, appealed from orders awarding interim compensation to trustee's counsel. The Commission urged that,

because of the lack of progress in the

reorganization, trustee's general counsel

be allowed no interim compensation for

services rendered in 1970 instead of

the $89,020 which the district court had

allowed him and that In the future he

be allowed a maximum of $35,000 interim compensation for services rendered in anyone year.

The other pending matter related to

the district court's award to committee

counsel of $10,000 as interim compensation, and $5,000 as reimbursement of

expensesfor services rendered over the

first 11 years of the proceeding. The

court of appeals, as recommended by

the Comrnlssron, increasedthe award to

$60,000 interim compensation and

$10,000 reimbursement of expenses. It

also granted the committee's request

for protection against harassing depositions proposedby trustee's counsel.s?

Upon remand, the district court

granted the sum directed by the court

of appeals, but in addition prescribed

how the fees were to be divided, excluding one lawyer entirely and ordered

committee counsel to account for their

expenses. It also permitted trustee's

counsel to bring disqualification proceedings against the committee and its

counsel based on essentially the same

charges raised in the prior appeal and

authonzed discovery proceedings in

connection therewith. The committee

and its counsel sought a writ of mandamus, prohibition, and related relief in

the court of appeals to require the district judge to abide by the appellate tribunal's mandate. The Commission supported this position.

As to the fee for trustee's counsel,

the court of appeals, noting the lack of

progress in the proceeding, (1) reduced

the interim compensation to trustee's

counsel for 1970 from $89,020 to

$30,000, and (2) limited any future interim compensation to him to a maximum of $30,000 in anyone year.48 The

court granted the committee's petition

for mandamus, prohibition and related

relief. It removed the restriction imposed by the district court on its previous award and put an end to the disqualification and related discovery

proceedings. Noting that trustee's counsel had assured the court that the reorganization proceeding would be wound

up within a year, it Withheld ruling on

the Commission's suggestion that a

special master be appointed.49

Thereafter, the district judge filed a

single petition for a writ of certiorari in

the Supreme Court, seeking review of

the limitation on fees of trustee's counsel and the grant of the extraordinary

writ.5o The committee and the Commission opposed the petition on the merits.

The Commission also pointed out that

the district judge was not a party to the

fee appeal and therefore had no stand-
THIRTY-EIGHTHANNUAL REPORT 125

ing to seek review. After the close of the

fiscal year, the petition was denied.

Cybern Education, Inc. 51Efforts to reorganize a company engaged in developing specialized educational programs

failed within a few months of the commencement of the proceeding. Small

sums had been accumulated from sales

of miscellaneous assets. Deducting a

trustee's certificate, the estate consisted

of about $46,000 in cash. The trustee

and his counsel applied for interim allowance of $45,000, which the district

court granted after a hearing. No notice

of hearing, pursuant to Section 247,

was given to creditors and stockholders,

including the Internal Revenue Service,

the holder of the principal claim against

the estate and most affected by the allowance.

At the hearing the Commission sought

to develop a proper record With respect to the nature and value of the

services rendered and on the need for

interim allowances, but no testimony

was offered. The Commission also objected to the lack of notice under Section 247.

The United States, as a tax claimant,

petitioned for leaveto appeal, which the

court of appeals granted.52 The Commission filed a brief in support of the

United States. The appeal was pending

at the close of the fiscal year.

Parkwood, Inc.53 The order appointing

trustee's accountants in accordance

with General Order 45 fixed the maximum to be paid for accounting services

at $180,000. The accountant sought

this amount plus an addtional $6,750

for certain special tax services performed by an attorney in the accounting

firm. The Commission agreed that the

accounting firm had earned the

$180,000 authorized by the order of appointment but opposed any additional

allowance on the ground that the requisite authorization had not been obtained. The court denied the additional

compensation on the basis of General

Order 45.

The two co-chairmen of the Secured

Noteholders' Committee sought compensation of $100,000 for services rendered during the proceeding and during

the prior equity receivership. One of the

applicants had acquired a note of the

debtor while acting for the committee in

the receivership. The Commission

urged, and the court agreed, that trading in the receivership was covered by

the bar of Section 249.54

The other applicant had also traded,

but he had done so after substantial

consummation of the plan. The trustee

urged that such trading nevertheless requrred denial of compensation. The

Commission advised the court that

there was no need to reach this issue

since the applicant had failed to show

that he had performed compensable

services,and the court agreed.

Imperial '400' National, Inc.55 The

court of appeals had reversed,as excessive, the third interim allowance to the

trustee and his counsel.56 On remand,

the district court reduced the allowance

to the maximums indicated by the court

of appeals and ordered refund of the

excess payments. The successful appellant urged that payment of interest on

the refunds should be required. The district judge ordered that one applicant,

who had invested and earned interest

on his allowance, pay the earnings to

the estate, but did not require the payment of interest on funds not profitably

invested.An appeal followed.

The Commission had suggested that

decision on this relatively small matter

be deferred until final allowances were

granted and the equities arising from

the overpayment be adjusted in that

context, and it adhered to that position

in the appeal. The court held, however,

that the applicants should pay interest

on the refund. It fixed the rate at that

earned by the estate on its surplus

funds during the period they held the

money.57

Bermec Corp.58 Attorneys for the

trustee filed an application for an in-
126 SECURITIESAND EXCHANGECOMMISSION

terim allowance of $65,000. The application included the time spent on estate matters by lawyers and

para-professionals. The latter are not

lawyers, but render routine services

which junior attorneys of the firm would

otherwise have to perform. The Commission urged that their services be

treated as profesional services, and

recommended $30,000 as adequate interim compensation, since the time

spent was weighted so heavily by the

work of the para-professionals.

The referee as special master recommended $51,265 of which $10,000 was

allotted as overhead expense for the

para-professionals' service. He stated in

his report that he could not allow fees

for these services because such "help

should be included 10 overhead just as

is secretarial assistance or summer law

students." The district judge allowed

the amount recommended by the special master, without discussmg the status of the para-professionals.The Commission continues to adhere to its

reviews on this subject.

INTERVENTION IN CHAPTER XI

Chapter XI of the Bankruptcy Act provides a procedure by which debtors can

effect arrangements with respect to

their unsecured debts under court supervision. Where a proceeding is

brought under that chapter but the

facts indicate that it should have been

brought under Chapter X, Section 328

of Chapter XI authorizes the Commission or any other party in interest to

make application to the court to dismiss the Chapter XI proceeding unless

the debtor's petition is amended to

comply with the requirements of Chapter X, or a creditors' petition under

Chapter X is filed.

Attempts are sometimes made to

misuse Chapter XI so as to deprive

investors of the protections which the

Securities Act of 1933 and the Securities ExchangeAct of 1934 are designed

to provide.59 In such cases the Commission's staff normally attempts to resolve

the problem by informal negotiations. If

this proves fruitless, the Commission intervenes in the Chapter XI proceeding

to develop an adequate record and to

direct the court's attention to the applicable provisions of the Federal securities laws and their bearing on the par.

ticular case.50

Synergistics, Inc.51 The Commission

intervened because of questions regarding the viability of the debtor's business. Its main concern was the proposed issuance of an additional

800,000 shares of common stock, in

addition to over 1 million shares previously issued and outstanding. Very little information about the debtor was

available to the investing public and

there was the possibility that a specula.

tive market in the debtor's shares would

develop.

The Commission's objections to the

arrangement were withdrawn when certain amendments were proposed. These

included voluntary registration of the

debtor's common stock under Section

12(g) of the Securities Exchange Act,

and a commitment that all of the

800,000 shares to be issued to its creditors would be restncted for two years

from confirmation, after which the

debtor would use its best efforts to register such shares under the Securities

Act. The referee confirmed the arrangement. His order of confirmation included the following statement: "The intervention of the Securities and

Exchange Commission in Chapter XI

proceedings... is at one with the duty

of a Chapter XI court ... to make sure

that it does not confirm a Plan that

aids creditors in foisting stock of highly

doubtful value on an unsuspecting public, the members of which may believe

that the order confirming the Plan gives

a validity to the issued stock beyond its

real worth."

Space City, USA, Inc.52 The debtor

filed a Chapter X petition and was subsequently adjudicated a bankrupt when
THIRTY-EIGHTHANNUAL REPORT 127

it proved impossible to reorganize.After

three years in bankruptcy, the debtor

filed a Chapter XI petition. Though a

mere corporate shell, it filed a plan of

arrangement providing for the issuance

of about 2.5 million shares. The Commission intervened in order to prevent

the issuance of a large quantity of

worthless securities, pointing out that

the use of Chapter XI for the purpose

of reactivating trading interest in a dormant shell was improper. The district

court dismissed the Chapter XI proceeding.

A-T Industries, Inc.63 This company

began as a thrift and securities institution which issued approximately $3.2

million of debentures to the public

years ago. In later years it was converted into an operating company, with

several small businesses. Although it

made a modest operating profit, it had

lost a large part of its capital on unsound investments. On default in payment of interest, it filed a Chapter XI

petition.

The proposed arrangement provided

that the debenture holders would receive $1.6 million of new lO-year debentures issued by the debtor's bowling

alley subsidiary, $1.6 million of the

debtor's new preferred stock, and 50

percent of the debtor's common stock.

The debtor would guarantee payment of

the subsidiary debentures at maturity.

Available cash would be used to pay

management its back bonuses. The

debtor could not hope to pay preferred

dividends and coverage of the debenture interest was doubtful.

The Commission indicated that it

would file a motion under Section 328

of Chapter XI to have the proceeding

transferred to Chapter X. Thereafter, the

staff, at the request of the Referee, conferred with other parties. As a result the

proposed arrangement was amended to

create approximately $2 million of new

notes, secured by a pledge of the principal assets of the debtor and subject

to appropriate sinking fund requirements. The preferred stock was eliminated and the debenture holders received 90 percent (instead of 50

percent) of the debtor's common stock.

Management received stock rather than

cash for their back bonuses. In view of

the amendment, the need of the debenture holders for Chapter X seemed less

clear, and the Commission determined

not to proceedunder Section328.

Capital Cities Nursmg Centres, Inc.64

The debtor had made an offering of securities, representing that unless all the

shares were sold, any funds subscribed

would be returned to investors. Although debtor raised only $1.9 million

of the $4.5 million sought, it spent the

funds received and was unable to return

them. The Cornmlssion brought a civil

action under the securities laws, and

the Federal Court in New York appointed a trustee on the Commission's

motion.65 Two weeks later, the debtor

filed its voluntary Chapter XI proceeding

in New Jersey, and asserted that this

proceeding ousted the New York

trustee. The New Jersey court overruled

a motion to dismiss the Chapter XI proceeding as having been filed in bad

faith, but appointed its own receiver.

Subsequently, an understanding was

reached. It allowed the Chapter XI receiver to utilize current cash flow from

the debtor for current operations and

permitted the trustee in the civil action

to seek an accounting from the individual defendants for the funds they had

diverted. The Chapter XI receiver or the

trustee were to retain any funds each

received from the defendants pending a

later determination of the proper disposition.

Posi-Seal International, Inc.66 The

debtor had outstanding about 4.9 million shares held by the public. The arrangement provided, inter alia, that

after a one-for-ten reversesplit, new

shares would be distributed in specified

proportions, including 25 percent to the

present stockholders and a like percentage to the holders of the debtor's de-
128 SECURITIESAND EXCHANGECOMMISSION

bentures, which apparently were not

publicly held. The corporate charter was

also to be amended to decrease the

amount of authorized shares and to

eliminated the authority to issue preferred stock. All of these charter

amendments required consent of stockholders under state law and the arrangement specified that such consent

was a condition precedent to consummation of the plan.

The referee confirmed the plan. A

stockholder filed a petition for review, In

which he objected to the jurisdiction of

the court to confirm the arrangement.

contending that (1) Chapter XI does not

permit a stock recapitalization of the

debtor as provided for in the arrangement, and (2) Chapter X, not Chapter

XI, is the proper avenue of relief if

rights of stockholders are thus adjusted.

The district judge affirmed the referee's

order and the stockholder appealed.

At the request of the court of appeals, the Commission filed a brief amicus curiae, in support of the jurisdiction

of the Chapter XI court. The Commission viewed the plan as a composition

with unsecured creditors, which could

properly be implemented by the recapitalization in accordance with the requirements of state law. The Commission also concluded that the

circumstances in this proceeding did

not indicate the need for the safeguards

of Chapter X. The court of appeals

agreed with the Commission and affirmed the order below.67

NOTES FOR PART 7

1The table on page lists all reorganization proceedings in which the

Commissionwas a party during the year.

2 N.D.Texas,No. 8k-3-2302.

3 D. Colo., No. 71-8-2921. 4 C.A.5, No. 72-1158. 5 C.D. Calif. 94420-.

6 C.A.9, 72-1528.

7 S.D. Fla., No. 72-126-8k-eF.

8 See SEC. v. American Trailer

Rentals ce., 379 U.S. 594, 618 (1965).

See also cases cited in 31st Annual Report, p. 104 (1965). 9 D. Mass.,No. 71-218. 10 No. 71-1264 (C.A.I, 1972).

11 M.D. N.C., No. 8-198-69. Previously reported in 36th Annual Report,

p. 179; 37th Annual Report, p. 181. 12 Weaver v. Hutson, 459 F.2d 741

(C.A. 4, 1972), cert. den. October 24,

1972.

13 C.D. Cal., Nos. 78641-FW, 78950-

FW,79596-FW and 80470-FW. 14 Section 116(3) provides that the

court may authorize the trustee "upon

cause shown, to lease or sell any prop- erty of the debtor . . . upon such terms

and conditions as the judge may approve." 15 S.D. N.Y., No. 71-8-523.

16 No. 72-1114 (C.A. 10, 1972).

17 D. N.J., No. 8-656-65. Previously

reported in 36th Annual Report, p. 176;

35th Annual Report, pp. 161-162; 33rd

Annual Report, pp. 132, 137-138; 32nd

Annual Report, pp. 94-95. 18 The resolution reads:

"RESOLVEDthat in all bankruptcy

proceedings this Council holds as

Incompatible the continued representation as attorney for the trustee

by any lawyer or his firm who

represents a third party who submits a plan for reorganization in

the bankruptcy; and that the recu- sal by the attorney only from commenting on proposedreorganization

plans is not an adequate immunization from the appearance of a

conflict of interest."

19 In re Imperial '400' National, Inc.

(Joseph M. Nolan, Appellant), C.A. 3,

No. 72-1399.

20 D. V.I., Division of St. Croix, No.

8-4-1971.

21 E.D. Va., Nos. 17-71-A, 256-71-A

and 257-71-A.

22 W.O. Okla., 8k. 70-1008, 70-

1008A-D, lOO8-A-D, 1129, 1129A.

23 The principal reported decision is

In re TMT Trailer Ferry, Inc., 334 F. 2d

118 (C.A. 5, 1964), in which it was held

that there was no rule of law precluding

employment of the trustee. The court

noted, however, that proof that the

trustee was offered "emoluments and

security" rather than a mere nomination, would disqualify him. In a later

phase of the TMT proceeding the Su- preme Court granted certiorari on this

issue among others (387 U.S. 929

(1967» but in Protective Committee v.

Anderson, 390 U.S. 414 (1968) it re-
THIRTY-EIGHTHANNUAL REPORT 129

versed the orders appealed from on

other grounds, and stated "finally, there

is no necessity to determine whether it

was improper to contemplate making the

trustee president of the reorganized com.

pany" (p. 453) because of mootness.

Three Justices dissented, saying:

... the only question which could

be thought even remotely to justify

the presence of this case in this

court is whether the trustee, by

virtue of his office, was as a mat.

ter of law disqualified from being

elected as president of the reor- ganized company." (p, 454).

The dissenters felt that failure to decide

that issue required dismissal of the writ

as improvidently granted.

24 S.D. W. v«, No. 69-270. Previously

reported in 34th Annual Report, p. 196;

36th Annual Report, pp. 194-195.

25 In re Federal Coal Company, 335 F.

Supp. 1183, 1185 (S.D. W. Va., 1971).

26 S.D. N.Y., No. 65-B-365.

27 Caplin v. Marine Midland Grace

Trust Company of New York, 406 U.S.

416 (1972).

28 S.D. Tex., 66-H-62. Previously reported in 35th Annual Report, pp, 163-

164.

29 Ernst & Ernst et al. v. U.S. Dist. Ct.,

457 F. 2d 1399 (C.A. 5, 1972).

30 S.D. Indiana, consolidated cases,

Nos. IP-68-B-447 and IP-68-B-609.

Previously reported in 36th Annual Report, pp. 176, 178-179; 34th Annual

Report, pp. 144-145.

31 Infra, p. --.

32 In re Yale Express System, lnc.,

S.D. N.Y., No. 65-8-404, Corporate Reorganization Release No. 309 (January

14, 1972); In re Four Seasons Nursing

Centers of America, lnc., et el., W.O.

Okla., Bk-70-1008, 1008A-O, 1129,

1129A, Corporate Reorganization Release No. 310 (March 16, 1972); In re

Imperial '400' National, Inc. (3 plans),

O. N.J., No. B-656-65, Corporate Reorganization Release No. 312 (July 12,

1972).

33 In re Yale Express System, lnc.,

supra, Corporate Reorganization Release

No. 311 (March 23, 1972).

34 In re American National Trust and

In re Republic National Trust, S.D. Ind.,

Nos. 1P-68-B-447, IP-68-B-609 (cases

consolidated); In re Manufacturers'

Credit Corporation, O. N.J., No. 8-

1084-67; In re Phoenix Gems, Inc., O.

Ariz., No. 8-21072-Phx.; In re San

Francisco & Oakland Helicopter Airlines,

Inc., N.D. Calif., No. 8-70-5175; In re

Webb & Knapp, Inc., S.D. N.Y., No. 65-

18-365.

35 W.O. Okla., Bk 70-1008A-O, 1129,

1129A. Previously reported in 37th Annual Report, pp, 180-181.

36 S.D. N.Y., No. 65-B-404. Previously

reported in 34th Annual Report, pp. 149,

153-154; 33rd Annual Report, p. 133;

32nd Annual Report, pp. 88-89.

37 The Commission said in its Supplemental Report:

"We are not suggesting that the

reorganized company should remain

permanently under this bar. If man- agement believes that pre-emptive

rights should be modified to permit

the issue of convertible securities,

it can secure such modification by

a vote of stockholders specifically

directed to this proposal. We do not

consider such modification a proper

proposal for inclusion in the plan.

Present security holders voting on

the plan do not have the opportunity to address themselves to this

speclfic feature of the plan. Their

only alternatives are to vote for or

against the plan in its entirety." 38 O. N.J., No. B-656-65. Previously

reported in 36th Annual Report, p. 176;

35th Annual Report, pp, 161-162; 33rd

Annual Report, pp. 132, 137-138; 32nd

Annual Report, pp. 94-95. 39 Corporate Reorganization Release

No. 312 (July 12, 1972).

39a S.D. Indiana, consolidated cases,

Nos. IP-68-B-447 and IP-68-B-609.

Previously reported in 36th Annual Report, pp. 176, 178-179; 34th Annual Re.

port, pp. 144-145. 40 N.D. Calif., No. 8-70-5175. 410. N.J., No. B-1 084-67. Previously

reported in 37th Annual Report, p. 182;

36th Annual Report, pp. 177-178; 34th

Annual Report, p. 160. 42 S.D. N.Y., No. 65-365. Previously

reported in 37th Annual Report, pp. 183,

193-194; 36th Annual Report, pp. 193-

194; 35th Annual Report, p. 170; 34th

Annual Report, p, 150; 33rd Annual Report. pp, 131, 134. 43 O. Ariz., No. 8-9352-Phx. Pre.

viously reported in 37th Annual Report,

p.187. 44 In re Maryvale Community Hospital,

Inc. 456 F.2d 410 (C.A. 9, 1972).

45 O. Arlz., No. B-21072-Phx.

46 S.D. Fla., No. 3659-M-Bk-WM.

Previously reported in 37th Annual Report, pp. 191-193; 36th Annual Report,

pp. 179-180, 190-191; 35th Annual Report, p, 160; 34th Annual Report, p.

153; 33rd Annual Report, p. 135; 32nd

"

•
130 SECURITIES AND EXCHANGE COMMISSION

Annual Report, pp, 92-93; 31st Annual

Report, p. 100; 30th Annual Report, p.

105; and 29th Annual Report, pp. 91-92.

47 Protective Cornrnrttee v. Kirkland,

434 F.2d 804 (C.A. 5, 1970), cert. den.

402 U.S. 907 (1971).

48 Protective Cornrmttee v. Wolff, 457

F.2d 100 (C.A. 5, 1972).

49 Protective Committee v. Mehrtens,

457 F.2d 104 (C.A. 5, 1972) cert. den.

October 10, 1972.

50 No. 71-1610.

51 N.D. III., No. 70-8-5299.

52 C.A. 7, No. 72-1131.

53 D. D.C., No. 39-66. Previously reported in 35th Annual Report, pp. 164-

165.

54 In re Cosgrove-Meehan Coal Corp.,

136 F.2d 3 (C.A. 3), cert. den. 320 U.S.

777 (1943).

55 D. N.J., No. 656-65. Previously reported in 36th Annual Report, p. 190.

56 In the Matter of Imperial '400'

National, lnc., 432 F.2d 232 (C.A. 3,

1970).

57456 F.2d 926 (C.A. 3, 1972).

58 S.D. N.Y., No. 71-8-291. Previously

reported in 37th Annual Report, p. 179.

59 See 37th Annual Report, p. 198;

36th Annual Report, p. 197.

60 During the past year, the staff com.

municated with referees around the

country requesting that it be notified of

Chapter XI cases in which the proposed

arrangements may involve this type of

issue.

61 D. Mass., No. 70-1251.

62 N.D. Ala., No. 8568-NE.

63 D. Oregon, No. 8-71-3499.

64 D. N.J., No. 8-1401-71.

65 S.E.C. v. Manor Nursing Centers,

Inc., 340 F. Supp. 913 (S.D. N.Y., 1971),

aff'd 458 F. 2d 1082 (C.A. 2, 1972).

Debtor is the corporate successor to the

original issuer.

66 D. Conn., No. 9038.

67 In re Posi-Ses! International, lnc.,

457 F.2d 237 (C.A. 2, 1972). The court

said it was concerned Whether the proceedmg was properly brought under

Chapter XI and said: "The brief of the

Securities and Exchange Commission,

which is scholarly and most helpful to

the court supports the jurisdiction of

the court below and found no error in

the confirmation of the plan."


PART 8

s. E.C. MANAGEMENT

OPERATIONS

REORGANIZATION

The first major reorganization of the

Commission's structure In thirty years

became effective on August 7, 1972.

The Commission now has five operating

divisions instead of three. The Division

of Trading and Markets was divided into

a Division of Enforcement and a Division of Market Regulation. A new Divrsion of Investment Company Regulation

was spun off from the Division of Corporate Regulation. Investment Company

disclosure activity was transferred to

the Division of Corporation Finance and

all enforcement activities were concentrated in the new Division of Enforcement. Thus, the major elements in the

reorganization were the concentration of

488-483 0 - 73 - 11

all investigative and enforcement activity in a single divrsron, the focusing of

all disclosure activity in a single division, and the creation of two regulatory

divisions, one for broker-dealers and

markets and the other for Investment

companies. Public-utility holding company and bankruptcy and reorganization

functions remain in the Division of Corporate Regulation.

A more detailed description of the reorganization appears In Part 1 of this

report.

OTHER CHANGES

Executive Director

The position of Executive Director

was reestablished by the Commission in

133
134 SECURITIESAND EXCHANGECOMMISSION

a move which had broad impact on the

day-to-day operation of the agency. Increased public financing, intensified

market activity, new responsibilities imposed by Congress,and mounting problems in the securities industry required

the concentration of executive and administrative functions in an executive

position reporting directly to the Chairman.

As the chief operating official of the

Commission, the Executive Director exercises administrative and management

direction over all divisions and offices

except for three units directly assisting

the Commission. The reestablishment of

the position of Executive Director represents the beginning of a management

structure designed to provide executive

direction and control, alternative program approaches to meet policy goals,

and improved operating systems.

During the year, the Office of the Executive Director was strengthened to assist in improving communications and

internal procedures and in the review

and appraisal of internal compliance

with the Commission's policies, plans

and procedures.

The Executive Director's Report was

instituted in February, 1972. The report

is a comprehensive management tool

containing data with respect to major

workload and cost items, significant

events, industry operations and progress

on rules, regulations, and other Commission projects. The report is distributed to the Commissioners and all division and office heads and regional

offices.

In addition, the Executive Director,

along with the Division and Office

Heads, assumed an active role in the

budget process, using the budget as a

key management tool in establishing

priorities and allocating resources.

Office of Public Information

The Office of Public Information was

established with a professional inforrnation staff to fully implement the Commission's role as an agency of disclosure by bringing SECinformation to the

investing public, the securities industry

and the corporations in an active, comprehensive,clear manner.

The Office of Public Information is responsible for seeing that the purpose of

corporate and regulated industry disclosure is fulfilled by devising programs

that effectively bring this information to

the investing public. The Office develops

programs to highlight what is most significant in disclosure and works with the

communications industry to achieve

maximum dissemination of this information through the financial press, commercial reporting services, microfilm facilities, securities industry, corporate

and investor organizations, SEC Public

Reference Rooms and investor education programs.

The Office of Public Information also

shares with operating divisions the responsibility for seeing that the corporations, regulated industries and professions that serve them understand the

alms and requirements of SEC disclosure. As the communications arm of the

Commission, the Public Information

Office also provides professional writing

and other vital communications support.

Others

The Office of Chief Financial Analyst

was established in the Division of Cor.

poration Finance to provide uniformity

of comment and disclosure in comparable situations, as well as to anticipate

trends in the business community which

may present particular disclosure problems that could require Commission action.

The Industry Operations Technical

Staff was established in the Division of

Market Regulation (formerly part of the

Division of Trading and Markets) to prepare for the elimination or immobilization of the stock certificate; to assure

an orderly transition from procedures

that rely heavily upon stock certificates

to one that will rely principally upon
THIRTY-EIGHTHANNUAL REPORT 135

computer records; to recommend new

rules to be promulgated by the Commission and/or the self-regulatory bodies;

and to draft proposed legislation as

appropriate.

The Office of Broker-Dealer Examinations was established in the Division of

Market Regulation (formerly part of the

Division of Trading and Markets) to direct and coordinate an accelerated nationwide program of broker-dealer and

investment adviser examinations. This

intensive approach includes development of examination policies, recommendation of new rules and regulations

relating to the program, training of new

examination personnel and coordination

of multiregional examinations involving

the states and the self-regulatory organizations.

A branch of the Washington, D.C. Regional Office was established to serve

the investing public in Philadelphia, the

Nation's fourth largest city.

OMS STUDY

Early in the fiscal year the Office of

Management and Budget conducted a

management review of the Commission's operations. The OMB report confirmed the Commission's view that the

agency had run down in numbers and

strength and had not kept up with the

Increased workload it had been called

upon to handle. The report pointed out

that increased securities activity had far

outstripped authorized manpower and

money resources. The report also recommended increased oversight of the

self-regulatory agencies and pointed out

that the Commission had fallen behind

in inspections, investigations and enforcement responsibility, and particularly in keeping up with its obligations

under the Public Utility Holding Company Act and the Bankruptcy Act. As a

positive recommendation, OMB urged a

greater effort to take the lead in anticipating problems and to base this endeavor on more extended economic and

policy research. The report also recommended additional management support

and the establishment of a public

inforrnatron faculty. Many of the detailed recommendations already have

been implemented, and the Commission

is giving continuing attention to staffing,

operational methods and policies in its

major areasof responsibility.

FINANCIAL MANAGEMENT

In the 1972 fiscal year, the Congressional appropriation to the Commission

was $26.8 million, of which $19.1 million was offset by fees collected by the

Commission, or 71 percent of appropriation. The net cost of SEC operations

was $7.7 million.

All fees collected by the Commission

are deposited into the Treasury as miscellaneous receipts. The Commission is

required by law to collect fees for (1)

registration of securities issued; (2)

qualiftcation of trust indentures; (3) registration of exchanges; (4) brokers and

dealers who are registered with the

Commission but who are not members

of a registered national securities assocratlon: and (5) certification of documents filed with the Cornrnlssron.

Effective March I, 1972, the Commission adopted a fee schedule under the

Securities Act of 1933, the Securities

ExchangeAct of 1934, the Public Utility

Holding Company Act of 1935, the Investment CompanyAct of 1940 and the

Investment Advisers Act of 1940. Fees

are now charged for certain filings and

services under those Acts where no

charges had previously been made.

Such fees are not refundable.

In fiscal 1972, these charges produced $2.3 million in additional revenues. For fiscal 1973, an estimated $5.3

million will be produced.

PERSONNEL MANAGEMENT

Recruiting

Due to severe budgetary limitations,

the Commission adhered to a general

hiring freeze during the first six months
136 SECURITIESAND EXCHANGECOMMISSION

of fiscal 1972. However, with the approval of a supplemental appropriation

late in December, 1971, funds became

available to permit the Commission to

generally resume hiring and to increase

its ceiling for permanent employees by

146, from 1,416 to 1,562. Since actual

employment at that time was only

1,356, it was necessary to launch an intensive effort to recruit more than 300

people to fill the 60 then existing vacancies, the 146 new jobs, and the approximately 120 positions which became

vacant due to turnover between December, 1971, and June, 1972.

Altogether the Commission filled 163

professional and 152 technical or clerical positions, in all grade levels from

G8-1 through G8-18, and in virtually

every one of its existing job categories.

Appointments were made in a wide

range of grades and occupations, drawing upon persons employed in the private sector as well as in Federal and

State agencies. The Commission was

able to attract to its staff a number of

top-flight people with significant and

substantial experience in the securities

industry, including several from self-regulatory bodies such as the New York

Stock Exchange, the National Association of Securities Dealers, and state

securities commissions. Most of the experienced accountants hired were

CPA's with work experience in prominent national accounting firms. The

Commission also hired a significant

number of recent college graduates, inclUding some With graduate degrees, for

starting level positions of Accountant,

Financial Analyst and Investigator.

In summary, in substantially increasing its permanent staff in fiscal 1972,

the Commission was able to attract a

good mix of recent college and law

school graduates with high academic

achievement, and individuals with diversified and high quality experience in the

field of securities and finance, including

a number of minority group persons

and women.

In order to accommodate the additional staff, about 23,000 square feet of

office space was acquired at 1100 L

Street NW. The Offices of Hearing Examiners, Opinions and Review, and Policy Research, as well as the Branches

of Public Utility Regulation and Reorganization, were moved to that location.

The followlng table shows the permanent personnel strength of the Commission as of June 30, 1972.

June 3D, 1972

Commissioners_______________ 5

Staff

Headquarters Office_______ 986

RegionaIOffices___________ 568

Total Staff_______________ 1,554

-- f

GrandTotaL_________________1,559 ../

Reduction in Average Grade

In launching its recruitment program,

the Commission had to bear in mind

the Office of Management and Budget's

instructions to Federal agencies to reduce their average grades. The Commission's assigned objective was a reduction of 0.15 by June 30, 1972, and

0.30 by June 3D, 1973. Despite the fact

that a significant number of the additions to the staff were experienced persons appointed in the mid-level (G8-9

through G8-12) and senior level (G8-13

through G8-15) grades, the total average grade reduction that was targeted

to be reached at the end of fiscal year

1973 was achieved in fiscal 1972.

Service and Merit Awards

The Commission's Seventeenth Annual Service and Merit Awards Program

was held in November, 1971. Distinguished Service Medals were awarded

by the Commission to Gerald E. Boltz,

then Regional Administrator of the Fort

Worth Regional Office (now Regional Ad-
THIRTY-EIGHTHANNUAL REPORT 137

ministrator in Los Angeles); Arthur A.

Pennekamp, Regional Administrator of

the San Francisco Regional Office (now

retired); Sheldon Rappaport, Associate

Director, Division of Market Regulation;

Charles J. Sheppe, Chief of the Branch

of Forms, Regulations and Legislative

Matters, Division of Corporation Finance

(now retired); and Stanley Sporkin, Associate Director, Division of Enforcement. Eight employees were given 35-

year SEC service awards; 12 employees

received awards for 30 years of SEC

service. Within-grade salary increases in

recognition of high quality performance

were granted to 19 employees; and

cash awards totaling $7,950 were presented to 39 employees for superior

performance, or special service.

Training and Development

The Office of Personnel, with the help

of the various Divisions and Offices, designed and is about to launch a new

professional employee orientation program. The program consists of presentations by each of the major operating

divisions and by other key staff and

service offices. It is intended to reduce

the time it takes a new staff member to

become familiar with the intricacies of

the agency, thus making the new employee more productive at an earlier

date.

A revised Executive Development Program was adopted in April, 1972, and

incorporated into the Agency's Manual

of Administrative Regulations. The purpose of this program is to identify and

develop employees occupying positions

in Grades GS-13, 14, and 15, who are

regarded by their superiors as having

high potential to fill executive positions

in GradesG5-16, 17 and 18.

The Fifth Annual Enforcement School

conducted by the Division of Trading

and Markets was held in June, 1972,

with over 100 participants from both inside and outside the Commission.

In January, 1972, the Division of Corporate Regulation conducted a weeklong training session on the Investment

Company Act in Los Angeles. In attendance were staff members from Los Amgeles, Forth Worth, and Seattle as well

as representatives of the California Department of Corporations and the

NASD. In addition, a training program

covering the amendments to the Investment Company Act was held in Denver.

Development of a series of procedural manuals was begun in fiscal

1972. The Broker-Dealer Inspection

Manual was completed and issued for

staff use in April, 1972. The Investment

Adviser Inspection Manual was completed and Issued for staff use shortly

after the end of the fiscal year. A final

draft of the Enforcement Manual was

under review at the year's end, and an

outline of the Investment Company

Inspection Manual was completed and

work was in progress at the year's end.

New Classification Standard for

Investigator Positions

The Commission received Civil Service Commission approval for the establishment of a single-agency position

classification standard for inspector (investigator) type positions. The government-wide standard issued recently by

the Civrl Service Commission was inappropriate because it placed too much

emphasis on investigators involved with

so-called "street" crimes as opposed to

the "white-collar" violations with which

the SEC must deal. The Commission's

investigative and enforcement program

was identified as being sufficiently

unique to warrant establishment of a

new standard applicable to the SEC

only. With the accompanying title of Securities Compliance Examiner primarily

for those engaged in broker-dealer, investment adviser, and investment company inspections, the special title and

job standard should enhance the prestige and status of those staff members

involved in all inspection programs.
138 SECURITIESAND EXCHANGECOMMISSION

Position Management and Control

A formal position management system was established in November,

1971, resulting in an improved management control in creating new positions

or in filling vacancies in existing jobs.

Also, promotions are now funded and

planned on a selective and priority

basis.

ELECTRONIC DATA

PROCESSING

During the 1972 fiscal year, the Commission increased its efforts to further

apply electronic data processing technology to its information systems.

A new system developed involves the

creation of a data base covering information derived from holdings and transaction reports of corporate insiders. The

system is designed to reduce late reporting and failure to report; utilize

these reports systematically to verify

share balances and detect liabilities for

short-swing trading profits; assist in the

enforcement of antifraud provisions;

permit wider and more detailed public

dissemination of insider trading information; and aid in the compilation of

data for statistical and policy planning

purposes.

Another project developed in fiscal

year 1972 and currently being implemented in a delinquency reporting system involving Forms 1Q-K (Annual Report), 1D-Q (Quarterly Report), and

Forms N-1Q and N-1R (Investment

Company reports). The purposes of the

system are to assist in enforcement of

timely reporting requirements; respond

to inquiries from the public, staff members and other interested persons concerning specrflc reports and issuers; and

end the lengthy manual reviews which

have been necessaryin the past.

The CUSIP numbering system, a

method of identifying and describing securities which was developed by the

Committee on Uniform Security Identification Procedures of the American

Bankers Association, was instituted during the past year. In addition to the

computer programs needed to crossreference CUSIP data with Commission

data files, programs and procedures

were developed to provide for the manual and automated update and maintenance of the basic file.

In addition to these standing systems, the Commission also developed

computer programs and produced specific outputs for several special, onetime projects. One of these involved the

collection and analysis of data concerning certain oil and gas programs for use

in drafting proposed legislation affecting

such programs. Another project involved

the creation of a computer file

consisting of data collected through an

Investment Company Brokerage Commission Questionnaire. Reports generated from this data file assisted the

staff in assessing the effect on registered investment companies of the elimination of minimum commission rates

on portions of orders in excess of

$500,000.

EDP applications currently under development include a system for processing data reported on Form 144, the

form used for notice of proposed sales

pursuant to the recently adopted Rule

144 under the Securities Act of 1933.

Preliminary systems work was also

begun late in fiscal year 1972, to determine the feasibility and probable design

of an automated information and early

warning system pertaining to financial

and operational difficulties of brokerdealer and investment adviser firms.


PART 9

STATISTICS

THE SECURITIES INDUSTRY

Securities Industry Dollar

Of each dollar received by brokerdealers in calendar 1971, a total of 45.6

cents was derived from the securities

commission busmess, 16.2 cents from

trading activities, 14.5 cents from the

underwriting businessand the remaining

23.7 cents from secondary sources of

revenue such as interest income on customers' accounts, sale of investment

company securities and gam or loss

from firm investments.

Total expenses amounted to 82.1

cents. The two largest components of

expenses were registered representatives' compensation, 19 cents per dollar,

and clerical and administrative employee

costs, 24.3 cents per dollar of revenue.

Operating income before partners' compensation and taxes accounted for 17.9

cents of the average secuntres industry

dollar.

141
142 SECURITIES AND EXCHANGE COMMISSION

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THIRTY.EIGHTH ANNUAL REPORT 143 

Income and Ex~enses securities, also recorded increases in 

1971.
 Gross revenue of brokevdealers from Total expenses increased 21 percent all activities rose 34 percent to 56.8bil- to s5.5 billion in 1971,from 54,6billion lion in 1971 from 55 billion in 1970.The in 1970.All expense items, except inter- increase was attributable primarily to a est cost, rose in 1971,with compensain the dollarvalue Of tion of registered representatives and 

shares traded On exchanges and Over- clerical and administrative employees the.counter to nearly the lg6' peak accounting for nearly two.thirds of the levelfand to a Of new 5963 million increase in total expenses. issues. These factors are reflected in an Broker.dealers, operating income before increase of $881 million in securities 

commission income and a $357 million Paenerr' compensation and taxes inrise in underwriting income. AII other creased by nearly 170 percent over 

sources of revenue, except interest in. 1970. to a $1.2 billion level. This com. 

come on customers' accounts and in- Pares with a decline of nearly $230 

come from sales of investment company million from 1969 to 1970. 

* BROKER-DEALER INCOME AND EXPENSES 

($Thousands) 

I 1969 1 1970 1 1971. 

inmme Amount 

Securities Commission Business ... Exchange Commission Business 

Floor Activities ................... Over-the.Counter Business...... 582,476 

In!erest Income on Customers' 

0; Makers........................ 399,928 


Munici a1 and Government 


BonJ~eaiers................. I 209.70;
 /

Trpders in Nan-Exemutad 


jecurities ......................
 u"&erwriting...................... 
 Sale:s of Investment Company Securities........................ pestm?,nt Advisory Fees......... 

Commissions Paid to Other 

Broker6.......................... 
 Floor Brokerage Clearance. Com. 

mission Fees .................... Registered Representatives' Camoensatlon....................... interest............................ Clerical and Administrative 

Employees...................... Communication.. ................. 
 Occupancy and Equipment I ....... 
 Promotional ....................... 
 Other................... .......*... 


Total Expenses ................. >.-


Operating Income or Loss Before 

Taxes a .......................... 
 Number of Firms.................. 


* Broker-dealers with gross securities income of $ZO.OW and aver. 
 I includes depreciation and amortization. 
 3 Before partners' compensation. 
 P Preliminary. 

144 SECURITIES AND EXCHANGE COMMISSION

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146 SECURITIESAND EXCHANGECOMMISSION

Registered Broker-Dealers

During fiscal year 1972, there was a

further net decline of 206 in the number of broker-dealers registered with the

Commission, to 4,734. This decline resulted primarily from the withdrawal of

688 broker-dealer registrations in the

course of the year. Since fiscal 1970,

the net decline has totalled 490. However, the number of registered firms at

the end of the past year was still substantially higher than that at the end of

fiscal 1967, when the number of registered broker-dealerswas only 4,175, the

lowest number since 1954.

About one-fourth of all firms registered at the end of fiscal 1972 had their

principal office in NewYork City. Another

413 firms maintained their principal

office in other locations in New York

State. California, with 483, accounted

for the next highest numbers of firms,

followed by New Jersey, with 234, and

Pennsylvania, with 215. About 70 percent of the registered broker-dealers

were organized as corporations. Of the

remainder, the majority were sole proprietorships, with partnerships the least

common form of organization. By way of

comparison, at the end of fiscal 1968,

only about 54 percent of the registered

broker-dealers were corporations.

Number

5500

REGISTERED BROKER-DEALERS

5000

4500

4000

or

1963

j

64

J

65

I

66

I

67

I

68

I

69

I

70

i

71

L

1972

( Fiscal) 05-5049
THIRTY.EIGHTH ANNUAL REPORT 

LOCATION OF BROKER-DEALERS 
148 SECURITIES AND EXCHANGE COMMISSION

BROKER-DEALERS AND BRANCH OFFICES

o 3000 6000

7479

9000

8434

Breker-Deelers

P Preliminary

Branch Offices

1969

1970

1971

o 100

EMPLOYEES

(Thousands)

200

(178)

300 400

_Registered

Representati ves

P «Pre l im inary

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-
THIRTY.EIGHTH ANNUAL REPORT 149

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THIRTY-EIGHTH ANNUAL REPORT 151

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152 SECURITIESAND EXCHANGECOMMISSION

Investment Companies

As of the end of the 1972 fiscal year,

1,334 investment companies were registered with the Commission, a decline of

17 from the number one year earlier.

Of the registered companies, 90 were

classified as "inactive." Approximately

65 percent of the active companies

were management open-end companies

("mutual funds").

The 1,244 active companies had total

assets having an approximate market

value of $80.8 billion, with mutual funds

accounting for about 80 percent of that

value. The $80.8 billion figure represents the highest fiscal year-end figure

since the Investment Company Act was

passed in 1940. An appreciation of the

tremendous growth of the investment

company industry in the intervening period may be gained by noting that in

1950 there were 366 investment companies with total assets of about $4.7

billion, and that as recently as 1960,

there were only 570 companies with

assets of $23.5 billion.

REGISTERED INVESTMENT COMPANIES

(June 3D, 1972)

Number of re~istered

Approximate

market value

companies of assets

of active

comCianies Active Inactive- Total (mi ions)

Management open-end ("Mutual Funds") ______________________________ 812 29 841 $64,738

Funds havin, no load or load not exceeding per cent of net asset 252 8,483 value _________________________________

Variable annuity-separate accounts _____ 47 848

caPltallevera,e comparues _____________ 2 67 All other load unds _____________________ 511 55,340

Management closed-end _________________ 177 37 214 8,450

Small business investment companies __ 42 217

capital leverage companies _____________ 7 347 All other closed-end companies _________ 128 7,886

Unit Investment trusts ____________________ 250 21 271 6,515b

Varia ble annuity. separate accou nts _____ 37 72 All other Unit investment trusts _________ 213 6,443

Face-amount cernficate companies _______ 5 3 8 1,113

Total. ___________________________________1,244 90 1,334 80,816

"Inactive" refers to registered companies which were in the process of being liquidated or

merged, or have filed an application under Section 8(1) of the Act for deres:istration. or which have

otherwise gone out of existence and remain reglstered only until such time as the Commission

issues orders under Section 8(1) terminating their registration.

b Includes about $4.8 billion of assets of trusts which invest in securities of other investment

companies, substantially all of them mutual funds.

-
THIRTY-EIGHTH ANNUAL REPORT 153

NUMBER AND ASSETS OF

REGISTERED INVESTMENT COMPANIES

No. of Companies

1500 Face Amount

Certificate Companies 1351

Unit Investment Trusts

Management Closed-End 1167

; Management Open-End

"Mutual Funds"

1000

500

o

Dollars Billions

80 Face Amount Certificate Companies 72.5

Unit Investment Trusts

Management Ctosed-End

60 ; Management Open-End --68.2-

"Mutual Funds'

49.8

44.6

41.6

40 36.1

20

o

1963 64 65 66 67 68 69 70 71 1972

(Fiscal) 05-6048
154 SECURITIES AND EXCHANGE COMMISSION

Investment Company Registrations

Since 1969 there has been a steady

decline in registrations of new investment companies, most of it attributable

to a decline in new mutual fund registrations. At the same time more existing

investment companies have terminated

registrations.

NEW INVESTMENT COMPANY REGISTRATIONS

(Fiscal)

1968 1969 1970 1971 1972

--------------- Mana~ement open-end ("mutual funds")

Fun s havrng no load or load not exceeding 3 percent of net asset value __________________________________________ 21 33 42 18 10 Variable annuity-separate accounts _______________________ 14 14 9 4 0 All other load funds _______________________________________ 82 109 82 41 28

Sub-totaL _____________________________________________--- --------- --- 117 156 133 63 38

Mana~ement closed-end --------- --- --,-

Sma I business investment companies ____________________ 3 2 1 5 1 All other closed-end funds ________________________________ 32 42 26 18 23

Sub-total ______________________________________________ --- --- --- --- --- 35 44 27 23 24

--- = --- = --- Unit investment trusts Variable annuity-separate accounts _______________________ 3 6 11 8 7 All other unit investment trusts ___________________________ 11 16 14 27 22

Sub-totaL _____________________________________________--------------- 14 22 25 35 29

Face-amount certificate companies _________________________------ --------- 1 0 2 0 0

TotaL _________________________________________________--- ------------ 167 222 187 121 91

---

INVESTMENT COMPANY REGISTRATIONS TERMINATED

(Fiscal)

1968 1969 1970 1971 1972

--------------- Management Open-end ("mutual funds")

Funds haVing no load or load not exceeding 3 percent of

0 14 net asset value . 1 2 3 ariable annuity-separate accounts _________________________ 0 0 1 2 0 II other load funds _________________________________________ 20 3 9 41 50 --- --- --------- Sub-totaL _____________________________________________ 21 3 12 46 64

--- ------ Mana~ement closed-end Sma I business investment companies ____________________ 6 0 2 3 7 All other closed-end funds ________________________________ 9 16 9 38 27

Su b-total, _____________________________________________--------------- 15 16 11 41 34

---= = ------ nit investment trusts Variable annuity-separate accounts _______________________ 0 0 0 0 1 All other unit Investment trusts ___________________________ 6 2 3 10 8

Sub-total ______________________________________________--- ------------ 6 2 3 10 9

--- ------ --- ace-amount certificate companles _________________________ 0 1 0 1 1

--------------- Total __________________________________________________ 42 22 26 98 108

= ---= ==

F

V

A

U

--- --- --- =

__________• ___ ___________________________

= =
THIRTY-EIGHTH ANNUAL REPORT 155

Private Noninsured Pension Funds:

Market Value

The market value of all private noninsured pension fund assets was $125

billion at the end of 1971. This figure

was 17 percent higher than book value.

At year-end 1970, market value exceeded book value by 8 percent. These

estimates include pension funds of corporations, non-profit institutions, and

multi-employer and union groups; excluded are health, welfare and other

employee benefit plans.

MARKET VALUE OF PRIVATE

NONINSURED PENSION FUNDS

($ millions)

1960 1965 1966 1967 1968 1969 1970 1971

--- ---

Cash and deposits ••• 500 900 900 1,300 1,600 1,600 1,800 1,600

U.S. Government

secuntres., , __••••.• 2,700 2,900 2,700 2,200 2,600 2,600 3,000 2,800

Corporate and other

bonds, 14,600 21,900 22,500 22,600 22,400 21,300 24,900 26,100 Preferred stock. 700 800 800 1,000 1,400 1,600 1,600 2,000

Common stock •.••••. 15,800 40,000 38,700 50,100 60,100 59,800 65,500 84,800

Own company 2,000 4,400 3,500 5,000 5,700 5,700 5,900 7,600

Other comparues , 13,800 35,600 35,200 45,100 54,400 54,200 59,500 77 ,200

Mortgages _. 1,300 3,400 3,800 4,000 3,600 3,500 3,600 3,200

Other assets •••••• _._ 1,400 3,000 3,500 4,200 4,300 4,300 4,300 4,500

Total assets 37,100 72,900 72,800 85,500 96,000 94,600 104,700 125,000

Private Noninsured Pension Funds:

Book Value

Total assets of private noninsured

pension funds were $106.4 billion (book

value) at the end of 1971, almost 10

percent higher than 1970. While this

rate of growth exceeds the 7 percent

rise in 1970, it is less than the average

annual growth rate from 1960 to 1968

(12 percent). A total of $62.8 billion of

pension fund assets were invested in

common stock in 1971. This represents

about three-fifths of all assets versus

only about one-third held in common

stock in 1960.

BOOK VALUE OF PRIVATE NONINSURED PENSION FUNDS

($ millions)

1960 1965 1966 1967 1968 1969 1970 1971

--- --- --- --- Cash and deposits •••• 550 940 900 1,320 1,590 1,620 1,800 1,640

U.S. Government

secuntles •... _._... _ 2,680 2,990 2,750 2,320 2,760 2,790 3,030 2,730

Corporate and other bonds _. _._._. 15,700 23,130 25,230 26,360 27,000 27,610 29,670 29,010 Preferred stock, ._. 780 750 790 980 1,330 1,760 1,740 1,770

Common stock 10,730 25,120 29,070 34,950 41.740 47,860 51,740 62,780

Own company_._. 890 1,830 2,090 2,560 2,800 3,020 3,270 3,500

Other companies. 9,850 23,290 26,980 32,380 38,940 44,840 48,480 59,280

Mortgages_._. ________ 1,300 3,380 3,910 4,080 4,070 4,220 4,300 3,680

Other assets _. 1,400 2,870 3,520 4,230 4,580 4,720 4,730 4,800

Total assets._._ 33,140 59,180 66,170 74,240 83.070 90,580 97,01' 106 ,420

••••••• _•••••

__••• _

••• _

•• ________

•• __

__• ___

__•

•••••• _

_____••
156 SECURITIES AND EXCHANGE COMMISSION

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THIRTf.EIGHTH ANNUAL REPORT 157 

stock Volume by Exchanges; cent of total share and dollar volume. 

NASDAQ Volume Since November 1, 1971,trading volume for a significant portion of the acThe NYSE share of all exchange Val. tive over.theiounter market has been 

ume rose slightly in 1971 to nearly 80 compiled by the NASO's automated 

percent of share volume. AMEX share quotations system (NASDAQ). For the 

volume was 18 percent of the total, first six months of 1972, NASDAQ volwhile AMEX dollar volume accounted for ume was 1.2 billion shares, equivalent to 

10 percent of all exchange volume. For 56 percent of NYSE volume and 183 

both measures, this represented a slight percent of AMEX volume. This trading 

decline from the previous year. Of the volume reflects the number of shares 

regional exchanges, the Midwest and bought and sold by market makers plus 

Pacific Coast Stock Exchanges had the the net inventory changes for market 

biggest volume, each exceeding 3 per- makers. 

SHARE VOLUME BY EXCHANGES 

Year 

DOLLAR VOLUME BY EXCHANGES 

Dollarvolume NYSE ASE MSE PCS PBS BSE DSE CIN Other 

(Ithausands) % % % % % % % % % 

1935........... $15 3% 139 86.64 7.83 1.32 1.39 .88 1.34 .40 .M .16 

1 .......... 8'419'772 85.17 7.58 2.07 1.52 1.11 1.91 .36 .09 .09 


1945........... 15'284'552 82.75 10.81 2.00 1.78 .% 1.16 .35 .06 .13 


1950........... 2118(18'284 85.91 6.85 2.35 2.19 1.03 1.12 .39 .ll .05 


1955........... 38:039:107 86.31 6.98 2.44 1.90 1.03 .78 .39 .09 .M 


1956........... 35 143 115 84.95 7.77 2.75 2.08 1.08 .80 .42 .08 .07 


1957........... 32'214'846 85.51 7.33 2.69 2.02 1.12 .76 .42 .08 .07 


1958........... 38'419'560 85.42 7.45 2.71 2.11 1.10 .71 .37 .08 .05 


1959..........- 52'001'255 83.66 9.53 2.67 1.94 1.09 .66 .33 .07 .05 


1960........... 45'306'603 83.81 9.35 2.73 1.95 1.10 .60 .34 .08 .04 


1461...-....... 44'071'623 82.44 10.71 2.75 2.00 1.10 .50 .37 .07 .06 


1962........... 54:855:894 86.32 6.81 2.76 2.00 1.11 .46 .42 .07 .05 


1953........... 54 438 073 85.19 7.52 2.73 2.39 1.12 .42 .52 .ffi .05 


1964........... 72'461'750 83.49 8.46 3.16 2.48 1.21 .43 .66 .06 .05 


1965........... 89'549'093 81.78 9.91 3.45 2.43 1.18 .43 .70 .08 .04 


1966........... 123:666:443 79.78 11.84 3.14 2.85 1.14 .57 .57 .08 .03 


1967........... 162 189 211 77.29 14.48 3.08 2.80 1.16 .67 .44 .M .M 


196%........... 197'117'957 73.56 18.00 3.12 2.66 1.7 1.04 .35 .02 .08 


1969........... 176:389:759 73.49 17.60 3.39 3.13 1.46 .67 .12 .01 .13 


1970........... 131 710 176 78.45 11.11 3.76 3.81 2.W .68 .ll .03 .05 


1971........... 186:374:651 79.07 9.98 3.99 3.79 2.29 .59 .19 .05 .04 

158 SECURITIESAND EXCHANGECOMMISSION

Third Market Volume shares and $8 billion the previous year.

The increase in dollar volume repreDuring 1971, over-the-counter sales of sented the largest annual increase since

common stocks listed on the New York 1965, when reports to the Commission

Stock Exchange (the so-called "third regarding third market transactions were

market") reached record levels in terms first required. Trading over-the-counter

of both share and dollar volume, Over- in NYSEcommon stocks as a ratio to all

the-counter volume amounted to almost stock trading on the NYSE reached a

298 million shares, valued at $12.4 new high of 7.0 percent on a share

billion, compared with 210 million basis and 8.4 percent on a dollar basis,

ITHIRD MARKET' VOLUME IN NY SE STOCKS

Dollars BiIlion s Percent

12 12

Dollar Volume

8 8

As Percent of

Dollar Volume

on NYSE

4 4

o o

1965 66 67 68 69 70 1971

CS ..!50!52
THIRTY.EIGHTH ANNUAL REPORT 159

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160 SECURITIESAND EXCHANGECOMMISSION

Value and Number of Exchange

Securities

The market value of all securities, including bonds, on United States stock

exchanges was $928 billion at year.end

1971. This represents a gain of $131

billion, or 16 percent, over the value

reported a year earlier.

The value of common and preferred

stock traded on all exchanges was a

record $795.6 billion at the end of

1971. This reflected a 17 percent increase in value during the year and

compares to the previous high of

$759.5 billion at the end of 1968.

The value of stocks on exchangeshas

had an upward trend for the past two

decades, and is now more than double

the 1960 value of $335.3 billion.

The value of stocks listed on exchanges is dominated by NYSE-Iisted

stocks. The NYSEstocks totaled $741.8

billion at the end of 1971, 93 percent

of the value of all listed stocks. The

proportion ten years earlier was 91 percent for NYSE stocks. The value of

stocks listed on the American Stock Exchange totaled $49.1 billion at year-end

1971, sharply higher than the preceding

year, but lower than the record total of

$61.2 billion at the end of 1968. Stocks

totaled $4.7 billion on December 31,

listed exclusively on other exchanges

1971. $100 million less than the precedingyear total.

The number of stock and bond issues

on U.S. exchanges at the end of 1971

was 5.902. This represents an increase

of 447. or 8 percent, from the number

of issues at the end of 1970. The major.

ity of securities on U.S. exchanges are

listed on the New York Stock Exchange

which accounts for 3.915 listed securities. or 66 percent of the total. Data on

the number and value of foreign securities are in a footnote to the first of

the following tables.

VALUE OF SECURITIES ON EXCHANGES

December 31, 1971

American Stock New York Stock Exclusively on All U.S.

T~pe of

Exchange Exchange other Exchanges Exchanges'

ssue Value Value Value Value Number ~$ mil, Number ~, mil. Number ~$ mil- Number ~, mil- ions) Ions) Ions) Ions)

Stocks Common 1,2n $47,751 1,399 $714,358 348 $4,410 2,981 $766,519 Preferred ___ 1,298 528 27,469 125 336 727 29,103 Bonds ________ 182 2,761 1,988 129,445 24 302 2,194 132,508 --- --- --- --- --- --- --- --- TotaL ______ 1,490 $51,810 3,915 $871,272 497 $5.048 5,902 $928,130

1Excludes securities which were suspended from trading at the end of the year and securities

which because of inactivity had no available quotes.

Includes the following foreign stocks:

Number Value ($ millions)

Exchange:

New York_______________ 34

American_______________ 67

AlIOthers_______________ 6

Total____________________ 107

$12.414

9,534

165

$22.113

• ••__

•
THIRTY-EIGHTH ANNUAL REPORT 161


MARKET VALUE OF STOCKS ON EXCHANGES 

VALUE OF JTOCKS ON EXCHANGES 
162 SECURITIES AND EXCHANGE COMMISSION 

Securities on Exchanges Issues were i~sted and registered ... +h. ...-

New York Stock Exchange, accounting 

AS of June 30. 1972, a total of 6.160 for 52.4 percent of the stock issues and 

securities, representing 3.377 issuers. 90 percent of the bond issues. ~~t~be. 

were admitted to trading on securities low on "Securities Traded on E~. 

exchanges in the United Stales. This changes" involves some duplication 

compares with 5.781 issues, involving since it includes both solely and dually 

3,220 issuers, a year earlier. Over 4,000 listed securities. 

UNDUPLICATED COUNT OF SECURITIES ON EXCHANGES 

(June 30, 1972) 

Registered Exchanges Stocks Bonds Total Issuers 

in~lved 

Registered and listed.. ................... Temporarily exempted from registration.. Adm~ttedto unlisted trading prallagss .... 

3.818 

10 

53 

2.226 

2 

4 

6.044 

12 

57 

3,2982 

13 

Exempted Exchanges 

Listed..................................... Admitted to unlisted trading privileges .... 34 

8 

5 

0 

39 

8 

26 

8 

Total.................................. 3.923 2.237 6,160 3.377 

SECURITIES TRADED ON EXCHANGES 

Stocks 

ISSY~~S Temoo. Bonds 1 

empted 

American............. 1.306 1.394 193 

Boston............... 728 15 


Chica o Board of 

~rafe.............. 4 ..... 
 Cincinnati............ 244 9 


Detroit................ 392 340 406 ..... 
 Honolulu 3.. .......... 41 ..... ... 5 


Intermountain*....... 54 ..... 
 Midwest.............. 632 388 329 719 15 


National.............. 131 137 ... 137 7 


New Yark ............. 1.747 1.999 ... 2,003 2,004 
 Pacific Coast ......... 822 793 198 993 60 


Phila..Balt.-Wash ..... 926 254 828 1,082 58 

Spokane.............. 34 31 .. 37 ..... 


I Issues exempted under Sectlan 3(a) (12) of the Act, r~ch or obllgatonr of U S. Government. 

the 618teS. and cat ss are not mnclbded in tho* ta0.e 

'E~ernptedexcnanie had 42 l(,rtco rtoclr and 8 adm'tted to unlfsted tradong. I1ntermo~nta.nStac* Excnange cnangea nr name from Sat Lake Exchange on May 1972. 
THIRTY.EIGHTHANNUAL REPORT 163

1933 ACT REGISTRATIONS

Effective Registrations;

Statements Filed

The Commission declared effective a

record number of 3.712 registration

statements in fiscal 1972. Commission

action cleared the way for the offering

of approximately $62.5 billion of securities. The previous record number of

effective registrations was 3,645, in fiscal 1969. However, the total dollar

amount in 1972 fell far short of the

record $82.5 billion set in 1969.

There were 4.112 registration statements filed during fiscal 1972. This

volume of filings nearly equaled the

record of 4,314 established in 1970. Included in this total were 1.371 statements by companies filing with the

Commission for the first time. 374 more

than in the previous year.

EfFECTIVE REGISTRATIONS

($ millions)

Cash sale for account of issuers

Total

Fiscal year ended Bonds,

June 30 Common deben- Preferred

Number Value stock tures, stock Total

and

notes

193561

__________________________ 284 $913 $168 $490 $28 $686

689 4,835 531 3,153 252 3,936 1937__________________________ 840 4,851 802 2,426 406 3,635 1938__________________________ 412 2,101 474 666 209 1,349 1939__________________________ 344 2,579 318 1,593 109 2,020 1940__________________________ 306 1,787 210 1,112 110 1,433 1941. _________________________ 313 2,611 196 1,721 164 2,081 1942__________________________ 1943

1944____________________________________________________ 123

193 2,003

659 137

263 1,041

316

162

32 I,m

221 1,760 272 732 343 1,347 1945__________________________ 340 3,225 456 1,851 407 2,715 1946__________________________ 661 7,073 1,331 3,102 991 5,424 1947__________________________ 493 6,732 1,150 2,937 787 4,874 1948__________________________ 435 6,405 1,678 2,817 537 5,032 1949__________________________ 429 5,333 1,083 2,795 326 4,204 1950__________________________ 487 5,307 1,786 2,127 468 4,381 1951__________________________ 487 6,459 1,904 2,838 427 5,169 1952__________________________ 635 9,500 3,332 3,346 851 7,529 1953__________________________ 593 7,507 2,808 3,093 424 6,326 1954__________________________ 631 9,174 2,610 4,240 531 7,381 1955__________________________ 179 10,960 3,864 3,951 462 8,217 1956__________________________ 906 13,096 4,544 4,123 539 9,206 1957__________________________ 876 14,624 5,858 5,689 472 12,019 1958__________________________ 813 16,490 5,998 6,857 427 13,281 1959__________________________ 1,070 15,657 6,387 5,265 443 12,095 1960__________________________ 1,426 14,367 7,260 4,224 253 11,738 1961. _________________________ 1,550 19,070 9,850 6,162 248 16,260 1962__________________________ 1,844 19,547 11,521 4,512 253 16,286 1963__________________________ 1,157 14,790 7,227 4,372 270 11,869 1964__________________________ 1,121 16,860 10,006 4,554 224 14,784 1965______________. ___________ 1,266 19,437 10,638 3,710 307 14,656 1966__________________________ 1,523 30,109 18,218 7,061 444 25,723 1967__________________________ 1,649 34,218 15,083 12,309 558 27,950 1968__________________________ '2,417 54,076 22,092 14,036 1,140 37,269 1969__________________________ '3,645 '86,810 39,614 11,674 751 52,039 1970__________________________ '3,389 '59,137 28,939 18,436 823 48,198 1971. _________________________ '2,989 '69,562 27,455 27,637 3,360 58,452 1972 3,712 62,487 26,518 20,127 3,237 49,882

Cumulative TotaL ___________ 41,048 662,111 282,581 207,095 21,175 511,457

1 For 10 months ended June 30, 1935. Includes registered lease obligations related to industrial revenue bonds.

_-- ----- ----------------

_______________________• __

•

•
75

164 SECURITIES AND EXCHANGE COMMISSION

SECURITIES EFFECTIVELY REGISTERED

Dollar. BdlJon.

90

BILLIONS OF DOLLARS

60

45

30

15

30

20

o

1935 40 45 50 55 . 60 65 70

(Fiscal)

10
THIRTY-EIGHTHANNUAL REPORT 165

Purpose of Registration

Securities registered for cash sale for

the account of the issuers aggregated

$49.9 billion in fiscal 1972. This was

$8.6 billion less than the record 1971

amount but $1.7 billion above the 1970

level. The decrease was primarily due

to a reduced volume of debt issues;

only $20.1 billion of bonds, debentures

and notes were registered for the account of the issuer during the year compared with the $27.6 billion in fiscal

1971. Securities registered for the account of the issuer for other than cash

sale, such as stock underlying a convertible issue, also declined in 1972.

However. the registrations of secondary

offerings (for the account of other than

the issuer) jumped 68 percent and

totaled $6.8 billion in 1972.

Registrations of immediate cash offerings amounted to $31.0 billion, down

sharply from the record $38.2 billion in

1971. All of this decline was attributable

to new debt offerings which fell nearly

$9 billion to $18.8 billion in 1972. New

flotations of common stock, however,

rose to a record $10.0 billion for the

year. Preferred stock registrations declined sharply from the record level of

1971. although these issues continue to

attract increasing attention as a means

of raising capital.

Registrations of extended offerings

amounted to $18.8 billion in fiscal 1972,

unchanged from a year earlier. The

larger part of this total consisted of

investment company shares, registrations of which rose slightly to $11.4

billion during the year.

EFFECTIVEREGISTRATIONSBY PURPOSEAND TYPEOF SECURITY:

FISCAL1972

($ thousands)

Type of security

Purpose of registration Total Bonds,

deben- Preferred Common

tures, Stock Stock

and notes

All registrations (estimated value) __________ $62,486 ,640 $20,629 ,059 $3,444.507 $38,413 ,074

For account of issuer for cash sale ______ 49,882,065 20,126,610 3,237,308 26,518,147 Immediate offenng _________________ 31,045,977 18,844,874 2,172,952 10,028,151 Corporate _______________________30,571,865 18,385,762 2,157,952 10,028,151

Offered to: General public __________ 28,599,381 18,341,655 2,121,695 8,136,031 Security holders ________ 1,972,484 44,107 36,257 1,892,128 Fore~n governments ___________ 474,112 459,112 15,000 Extende cash sale and other issues ____________________________ 18,836,088 1,281,736 1,064,356 16,489,996

For account of issuer for other than cash sale _____________________________ 5,758,758 269,105 81,444 5,408,209

Secondary offerings ____________________ Cash 6,845,817 233,344 125,755 6,486,718 sale ___________________________ Other _______________________________ 4,518,232 116,800 25,973 4,375,459

2,327,585 116,544 99,782 2,111,259
166 SECURITIES AND EXCHANGE COMMISSION 

New Corporate Securities for year. 

Immediate Cash Sale Equity issues accounted for 40 per. 

cent of the total. In recent years this 

Securities cleared for cash sale ex- proportion has been significantly higher 

ceeded $30 billion during fiscal 1972, than in preceding Years, as corporations 

considerably below the record of nearly have sought to improve their debt-equity 

$40 billion during the previous fiscal ratios. 

NEW CORPORATE SECURITIES EFFECTIVELY REGISTERED 

GROSS PROCEEDS 


DOLLARS BILLIONS 


40 
 ..... .......


.......
 COMMON ....... 


PREFERRED -

...... STOCK ......... 

Regulation A Offerings under Regulation A. Issues between 

During fiscal year 1972, 1,087 notifi- $400.00 and $500,000 in size predomications were filed for proposed offerings nated. 

1 Fiscal Year 

1960-1969 
 1 (Annuai 1970 1971 1972


Average) 

/ 1 1 


SIZE: 


1W ,000or less......................... 133 90 54 52 
 ........................ 132 92 116 46 
 ........................ 424 922 429 118 
 ........................ 0 0 114 L 182 
 ........................ 0 0 123, 689 


TOTAL................................ 690 1.104 836 1.087 


UNDERWRITERS: I I I 1
 Used................................... 245 370 5W 


Not Used.............................. 444 466 497


TOTAL................................ I 689 1 1,104 1 836 1
 1.087 


OFFERORS: 

IESU~~~ Companies..................... 655 1.101 822 1.052 


Stockholders............................ 24 2 11 28 


Issuers and Stockholders Jointly........ 11 1 3 7 


TOTAL................................ 690 1.104 836 1.087 


I Regulation A ceiling rose from $300,000to $500.&0 on March 26.1971. 
THIRTY.EIGHTH

ENFORCEMENT

Types of Proceedings

As the table below reffects, the securities laws provide for a wide range of

enforcement actions by the Commission.

The most common types of actions are

injunctive proceedings instituted in the

Federal district courts to enjoin conANNUAL REPORT 167

tinued or threatened securities law vlolators, and administrative proceedings

pertaining to broker-dealerfirms and/or

individuals associated with such firms

which may lead to various remedial

sanctions as required in the public in.

terest. When an injunction is entered

by a court, violation of the court's

decree is a basis for criminal contempt

action against the violator.

TYPES OF PROCEEDINGS

I. Administrative Proceedings

Basis for Enforcement Action

Broker-dealer. investment adviser

or associated person

Willful violation of securities acts provision

or rule; aiding or abetting of such violation;

failure reasonably to supervise others; willful

misstatement in filing with Commission; conViction of or injunction against certain securities, or securitles.ralated, violations.

Member of raglstered securitiu

association

Violation of 1934 Act or

willful violation of 1933 Act or

Member of nationa' securities exchange

rule thereunder;

rule thereunder.

Violation of 1934 Act or rule thereunder.

Any person

Same as first item.

Violation of 1934 Act or rule thereunder;

willful violation of 1933 Act or rule thereunder.

Willful Violation of securities acts provision

or rule; aiding or abetting of such violation;

willful misstatement in filing with Commission.

Principal of brolcer-dealer

Appointment of SIPC trustee for broker- dealer.

Registered securities association

Rules do not conform to statutory require- ments.

Violation of 1934 Act or rule thereunder;

failure to enforce compliance with own rules;

engaging in activity tending to defeat purposes

of provision of 1934 Act authorizing national securities associations.

Sanction or Relief

Revocation, suspension or denial of broker.

dealer or mves ment adviser registratIon. or

censure of broker-dealer or investment adviser.

(1934 Act, Sction 15(b)(5); Advisers Act, Section 203(e».

Expulsion or suspension from association (1934

Act, Section 15A(1)(2».

Expulsion or suspension from exchange. (1934

Act, Section 19(a)(3».

Bar or suspension from association with a

broker-dealer or Investment adViser, or censure.

(1934 Act, Section 15(b)(7); Adviser Act, Section 203(f».

Bar or suspension from association WIth

member of re,istered securities association.

(1934 Act, SectIon 15A(1) (2».

Prohrbrtlcn, permanently or temporarily, from

serving in certain capacities for a registered

Investment company. (Investment Co. Act, Sec.

tion 9(b».

Bar or suspension from association with a

broker.dealer. (Securities Investor Protection

Act, Section 10(b».

Suspension of registration (1934 Act, Section

15A(b».

Revocation or suspension of registration (1934

Act, Section 15A(1)(I».
168 SECURITIES AND EXCHANGE COMMISSION

Basis for Enforcement Action

National securlnes exchange

Violation of 1934 Act or rule thereunder; failure to enforce compliance therewith by

member or issuer of registered securities.

Officer or director of registered securities association

Willful failure to enforce association rules

or willful abuse of authonty.

Officer of national securities

exchange

Violation of 1934 Act or rule thereunder.

1933 Act registratIon statement

Statement materially inaccurate or incomplete.

Investment company has not attained

$100,000 net worth 90 days after statement

became effective.

1934 Act reporting requirements

Material noncompliance

Securities issue

Noncompliance by issuer with 1934 Act or

rules thereunder.

Public interest requires trading suspension.

Registered investment company

Failure to file 1940 Act registration statement or required report; filing materially incomplete or misleading statement or report.

Company has not attained $100,000 net

worth 90 days after 1933 Act registration

statement became effective.

Name of company, or of secunty Issued by

it, deceptive or misleading.

Attorney, accountant or other profes. sional or expert

Lack of requisite qualifications to represent

others; lacking in character or integrity; unethical or improper professronal conduct; willful Violation of secunties laws or rules, or

aiding and abetting of such violation.

Attorney suspended or disbarred by Court;

expert's license revoked or suspended; con- viction of felony or misdemeanor involving

moral turpitude.

Permanent injunction or finding of violation

in Commission-instituted actron: finding of Violation by CommiSSIon in administrative proceeding.

Sanction or Relief

WIthdrawal or suspension of registration (1934

Act, Section 19 (a)(1».

Removal from office (1934 Act, Section

15A(1)(3».

Expulsion or suspension from exchange (1934

Act, Section 19(a)(3».

Stop order suspending effectiveness (1933 Act,

Section sre».

Stop order (Investment Co. Act, Section 14(a».

Order directing compliance (1934 Act, Section

15(c)(4».

Denial, suspension of effective date, suspension or withdrawal of registration on national

securities exchange (1934 Act, Section

19(a)(2».

Summary suspension of over-the-counter or exchange trading (1934 Act, Section 15(c)(5) and 19(a)(4».

Revocation or suspension of registration (in.

vestment Co. Act, Section 8(e»,

Revocation or suspension of registration (Investment Co. Act, Section 14(a».

Prohibition of adoption of such name (Investment Co. Act, Section 35(d).

Permanent or temporary denial of privilege

to appear or practice before Commission (Rules

of Practice, Rule 2(e)(1».

Automatic suspension from appearance or

practice before Commission (Rules of Practice,

Rule 2(e)(2».

Temporary suspension from appearance or

practice before Commission (Rules of Practice,

Rule 2(e)(3».
THIRTY-EIGHTH ANNUAL REPORT 169

II. Civil Proceedings in Federal District Courts

Basis for Enforcement Action

Any Person

Person engaging or about to engage in acts

or practices violating securities acts or rules

thereunder.

Noncompliance with provision of law, rule or

regulation under 1935 Act, order issued by

COmmission, or undertaking in a registration

statement.

'ssuer subject to reportlnll

requirements

Failure to file reports required under Sec'

tion 15{d) of 1934 Act.

Rellistered Investment company or

affiliate

Name of company or of security issued by

it deceptive or misleading.

Officer, director, adviser or underwriter engaging or about to engage in act or practice

constituting breach of fiduciary duty involving

personal misconduct.

Breach of fiduciary duty respecting receipt

of compensation from investment company, by

any person haVing such duty.

Sanction or Relief

Injunction against acts or practices which con.

stitute or would constitute violations (plus

ancillary relief under court's general equity

powers). (1933 Act, Section 20{b); 1934 Act.

Section 21{e); 1935 Act, Sectoon 18{f); Invest.

ment Co. Act, Section 42{e); Advisers Act,

Section 209{e».

Writ of mandamus directing compliance (1933

Act, Section 20{c); 1934 Act. seenen 21{f);

1935 Act, Section 18{g).

Forfeiture of $100 per day (1934 Act, Section

32{b».

Injunction against use of name (Investment

Co. Act, Section 35{d».

Injunction against acting in certain capacities

for investment company (Investment Co. Act.

Section 36{a».

Award of damages. (Investment Co. Act, Sec'

tion 36{b».

III. Referral to Attorney General for Criminal Prosecution

Any Person

Willful violation of securities acts or rules

thereunder.

Maximum penalties: $5,000 fine and 5 years'

imprisonment under 1933 and 1939 Acts,

$10,000 fine and 2 years' imprisonment under

other Acts. An exchange may be fined up to

$500,000, a publlc.utility holding company up

to $200,000. (1933 Act. Sections 20{b), 24; 1934 Act, Sections 21{e), 32{a); 1935 Act, Sections 18{f), 29; 1939 Act, Section 325; Investment Co. Act, sections 42{e), 49; Advisers Act,

Sections 209{e). 217).
170 SECURITIES AND EXCHANGE COMMISSION 

Enforcement Proceedings registration statements, directed corn. 

pliance with reporting requirements in 

The tables below show enforcement three cases, and permanently suspended 

proceedings instituted, and, for injunc- 20 Regulation A exemptions. 

tive and criminal matters, developments Major categories of civil litigation, 

in pending cases. other than injunctive actions in Federal 

In administrative enforcement pro. distrlct courts, in which the Commission 

ceedings, the Commission during the was involved during the year included 

fiscal year revoked the registrations of 27 proceedings in the courts of appeals 

51 broker-dealers and four investment upon review of Commission decisions. 

advisers, barred 93 persons from asso- 51 appeals from district court decisions 

ciation with a broker or dealer, and im- in injunction and miscellaneous cases 

posed various suspensions on many and 22 actions between private litigants 

other firms and individuals. The Com. in which the Commission participated as 

mission also issued five stop orders on amicus curiae or intervenor. 

ADMINISTRATIVE PROCEEDINGS 

Stop Order. Re A 

Broker-Dealer investment Adviser Suspennon and kther 

Fiscal Year Cases Disclosure Cases 

I I 

INJUNCTIVE ACTIONS 

Fiscal Year I Cases Instituted 1 Injunctions Ordered 1 Defendants Enjoined 

CRIMINAL CASES 

Number of 

Fiscal Year Cases Referred Number of Defendants ~onwcilonr 

to Justtce Dept. lnd~ctments lndleted 

1963................... 49 10 117 115 


1964................... 50 39 95 93 


1965.................. 52 34 208 106 


1966................... 44 50 193 76 


1967.. ................. 44 53 213 127 


1968................... 411 42 123 84 


1969.. ................. 37 64 213 83 


1970.. ................. 35 36 102 55 


1971................... 22 16 83 89 


1972.. ................. 38 28 67 75 

THIRTY-EIGHTH ANNUAL REPORT 171

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172 SECURITIES AND EXCHANGE COMMISSION 

Financing 1971, the previous record year. Preferred 

The volume of external financing by stock issued and sold increased 101 per. 

these companies set a new record in Cent, common stock 24 percent. The 

fiscal 1972 of $2.79 billion which repre- amount of debentures issued and sold 

sents a 13 percent increase over fiscal decreased 77 percent from fiscal 1971. 

FINANCING OF HOLDING-COMPANY SYSTEMS 

(Fiscal 1972) 

I

1 1 

(In Millions 

1 

of Dollars) 

1 Holdinecompany systems Bands Debentures Preferred Common 

Stock Stock 

Alto heny Power S stem. Inc ............... 
 hononganeta bower Company. ........ 
 Potomac Ed son Company. The.. ..... west Pann Power Company.. .......... Amar~unEleGrls Power Company. Inc...... ADtndL.no. alacnoan 6 ~rh.rn Pawsv Cornpan power &ii*li::::, 


I(.nt~cky Power Company.. ............ 
 Ohlo Power Company. ................. 
 Amaria" Natural Gar Company............ 
 Central Indiana Gar Compsn Inc 


Micnlmn Cons01 aatsd Oar dbmP=%l: 


Micnlnrn Wasconsin PiDe .me Com. 

The.................................... 
 Hartford Electric Light Company The... Western ~~~~ Mas~a~husens ~~~~~ Electnc'~omany.. ............................. 
 Onio &#son company...................... 
 Penna Ivan a Po~erCompany......... 
 Sa~tnern
Ea 

Alsbamqrolvert

Geor fa 

GJ.~tower ~~m~~~~................... 
 MISSISSIDP~Power Company.. ..........I 


Utah Porer and LI ht Combanj............. 
 Vermont Yankee N% :lea, Power coroora- I 

tion 6 .............................:........ 


Total..................................
I= -~-

-TWOissues. 
THIRTY-EIGHTH ANNUAL REPORT 173

CORPORATE REORGANIZATIONS

Commission Participation

During fiscal year 1972, the Commission was a party in a total of 113

reorganization proceedings under Chapter X of the Bankruptcy Act. These were

scattered among district courts in 35

states, the District of Columbia, and one

territory. In 12 proceedings, the Commission first entered its appearanceduring the year; 14 proceedingswere closed.

PROCEEDINGS UNDER CHAPTER X OF BANKRUPTCY ACT IN WHICH THE

COMMISSION PARTICIPATED: FISCAL YEAR 1972

Debtor

S.E.C.

notice of

District Court Petition flied appearance

filed

Alco Industries, Inc

American Associated Systems, Inc American National TrustArizona Lutheran Hospital' Arlington Discount Co.'

Atlanta International Raceway. Inc Bankers TrustBeck Industries, Inc.' Bermec Corp

Bubble Up Delaware. Inc

Burton's In The Round, Inc

Business Finance Corp.'

Canandaigua Enterprises COrp.'

Central States Electric COrp.' Clute Corp.'

Coast Investors, Inc.'

Coffeyville Loan & Investment'

Commonwealth Financial COrp

Computer Services Corp.'

Contmental Vending Machine COrp

Cosmo Capital Inc.'

Creative Merchandising, Inc." Cybern Education. Inc

Dextra Corp.'

Dumont-Airplane & Marine

~!ri~~f:'~~~:;&'~~::: Farrington ManufactUring CO Federal Coal CO

Federal ShOPlling Way, Inc.' First Holding COrp.' First Research Corp

Flying W. Airways. Inc Food Town. Inc.'

Four seasons Nursing Centers of America. Inc General United Corp Inc Gulf Aerospace Corp.'

~~~~~?&::-'ric_ ::: :::::::::::::: ::::::::::::::::: Houston Educational Foundation. Inc Hughes Homes, Inc.'

Human Relations Res. Foundation ,

Imperial-American Resources Fund. Inc.' Imperial '400' NationaL

Indiana Bus. & Investment Trust Investors Associated, Inc.'

Jade Oil & Gas CO.'

King Resources Co.'

Klrchofer & Arnold ,

D. Ariz

E.D. Ky S.D.lnd

D. Ariz

S.D.Ohio

N.D. Ga

S.D.lnd

S.D.N.y

S.D.N.y

C.D. Calif.

N.D. 111.

E.D. Pa W.D.N.Y

S.D.N.y

D. Colo

W.O. Wash D. Kans

E.D. Pa

S.D.lowa

E.D.N.y

N.D. 111. D. Colo

N.D. 111.

S.D. Fla S.D.N.y

N.D. Calif.

E.D. Pa

S.D. Calif.

E.D. Va

S.D. W. Va

W.O. Wash S.D.lnd

S.D. Fla

E.D. Pa D. Md

W.D.Okla

D. Kans

S.D. Tex N.D.Okla

S.D.N.Y

S.D. Tex D. Mont

S.D. Calif. D. COlo

D. N.J

S.D. Ind

W.O. Wash C.D. Calif. D. COlo

E.D.N.C.

Sept. 17, 1969

Dec. 24, 1970

Feb. 13. 1968 May 11,1964

July 3,1967

Jan. 18, 1971

Oct. 7, 1966

May 27.1971

Apr. 16, 1971

Aug. 31, 1970

Mar. 23. 1970

June 1~1970 Dec. 1:>,1964

Feb. 26, 1942

Nov. 5, 1962

Apr. 1. 1964

July 17,1959

Dec. 4, 1967

Feb. 24, 1970

July 10, 1963

Apr. 22, 1963

Jan. 18, 1972

Sept. 11, 1970

Feb. 28, 1972

Oct. 22, 1958

Oct. 11, 1967

Nov. 25, 1958

Mar. 17. 1958

Dec. 22, 1970

Jan. 29, 1971

Nov. 13, 1967

Oct. 7, 1969

Mar. 2, 1970

Sept. 23, 1970 July 28, 1959

June 26, 1970

May 22. 1964

Apr. 23, 1969 Apr. 27. 1972

July 7.1969

Feb. 16. 1971 Sept. 8, 1961

Jan. 31, 1964

Feb. 25, 1972

Feb. 18, 1966

Oct. 10, 1966

Mar. 3, 1965

June 28, 1967

Aug. 16. 1971 Nov. 9. 1959

Jan. 22, 1970

Feb. 26, 1971

Mar. 27, 1968

May 25. 1964

July 10, 1967

Feb. 3, 1971 Nov. I, 1966

July 30, 1971

Apr. 19, 1971

Oct. 19, 1970

Apr. I, 1970 Feb. 3, 1971

Dec. 15, 1964

Mar. 11, 1942

Jan. 29. 1963

June 10, 1964

Aug. 10, 1959

Dec. 13, 1967

Mar. 11, 1970

Aug. 7, 1963

Apr. 26, 1963

Feb. 11, 1972

Sept. 25, 1970

Apr. 10, 1972

Nov. 10, 1958

Oct. 11, 1967 Jan. 16, 1959

Mar. 24, 1958

Jan. 14, 1971

Jan. 29. 1971

Nov. 29. 1967

Dec. 10. 1969

Apr. 14, 1970

Dec. 15. 1970 Aug. 10, 1959

July 13.1970

July 16, 1964

June 20, 1969

June 6, 1972 July 14, 1969

Mar. 2. 1971 Oct. 5, 1961

Feb. 14, 1964

Mar. p! 1972 Feb. ~,1966

Nov. 4 1966

Mar. 17. 1965 Aug. 16, 1967

Oct. 19, 1971

Nov. 12. 1959

_

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_

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_

_

_

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_

_

_

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_

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174 SECURITIES AND EXCHANGE COMMISSION 

PROCEEDINGS UNDER CHAPTER X OF BANKRUPTCY ACT IN WHICH THE 

COMMISSION PARTICIPATED: FISCAL YEAR 1972-Continued 

S.E.C. 

notice of Debtor District Court Petition filed appearance filed 

Ladco Carp., ........................................ N.D. Calif .... Nou.3 1957 Feb.7 1968 
 Lake Winnebago Development Co ..Inc............. W.D. Mo..... Oct.14 1970 Oct. 26 1970
 Landmark lnnsof Durham . Inc..................... M.D. N.C ..... Se t .i 1969 Dec.16 1969
 Lmle Missouri Minerals Association .Inc............ D. N.D. ..... Ju&l8'1%6 Jan .29'1958
 LOS Angeles Land & Investments.Ltd.............. D. Hawaii.... Oct. 24: 1967 Nov.2(i, 1967 


Louisiana Loan &Thrift Inc ......................... E.D. La...... Oct.8.1968 Oct.8 1968 
 Lk Cap ..................................... D A 0 Nov.15 1965 
 Dolly Madison Industries .Inc......................E.D. 

. Pa 

. 

...... June 

28 

2 i.

1 

1970 July 6 1970 
 Magnolia Funds .Ine............................... E.D. La...... Nou.18 1968 ~ay
 2k, 1969 Mammoth Mountain inn Corp ...................... C.D. Calif .... Sept.16. 1969 Feb.6.1970 


Manufacturers Credit Carp ......................... D.N.J.......Aug.1. 1967 July 30 1968
 Maryv.de Community Hospital .................... D.Ariz ....... Aug. 1 1953 Sept.il1963 
 D.Ariz ....... July li. 1965 Jan . 19 is6 
 Ma er Central Ba tiR Buildln churc$lII:I 3 II:1 ........ E.D.La ...... July30. Oct.23.1968
 Morehead &tyshipbuilding3 ....................... E.D. N.C..... Nov.9. 1%; NOV.li. 1959 


Moulded Products Inc.l............................ D.Minn...... July 6 1971 Aug.6 1971 
 Nation i d 0 ............................... N .I .. F b 1969 Mar. 26.1969
 Nevada Industrial uarantya....................... D. Nev.. ..... May 7 1963 Jul 
 Norman Finance Thrift Carp.5 ................... W.D. Okla .... Oct.16 1969 022 1963 

1) 1969 
 Paramount General C0rp.L ......................... C.D. Calif.... Feb.li,1969 Apr.10: 1969 


Pkwd I..................................... D C .. June 13 1 June 17 1966 Peoples ~oan& Investment ~o.2 ................... W.D. ~rk ..... ~ay 13.'1%9 May 21.'1%9 
 Phoenlx Gems .1nc.c ...............................D.Ariz....... Dec.23. 1971 Jan .31 1972 
 Phoenix Mortgage Co .............................. D.Ariz....... Aug.14, 1967 Apr.17'1968
 Polycast Corp.' ..................................... D. Conn..... Sept.6.1966 Sept.2j. 1966 


RiC International Industries .Inc................... N.D. Tex .....Sept. 16.1970 Se t.23 1970 
 John Rich Enter rises lnc D.Utah...... Jan.16, 1970 ~ep.6, f970 ~iker~el~w~~e E)orp._ ... IIx....IIIIIIIIII..IIII 0. N.J ....... Apr .21 1957 May 23 1967 Roberts Compan r; ..... M.D. N.C.... Feb.li1970 Mar.2 i.1970 San Francisco 8. akland Helicopter Airliner .Ins... N.D. Calif .... ~uly31:1970 Aug.11.1970 

Santa's Forest Carp ................................ E.D. Wisc.... May 18 1970 June 15 . 1970 


srato COP ................................... M P . A r. 3 959 Apr .15 1959 


Edw. N.Sieglera C0.C ............................. N.D. Ohio .... hRay 25, 1956 ~une7:1%6
 Sierra Trading Carp ................................. D.Colo...... July 7. 1970 July 22.1970
 Sire Plan . S.D. Feb.16, 1963 Feb. 18 1963 Inc ....................................... N.Y ..... . 
 Sire Plan Management Corp ........................ S.D. N.Y ..... Mar.4. 1963 Apr.5 1963 
 60 Minute Systems .Inc............................. M.D. Fia..... July 17 1970 ~uly29 1970 
 Sound Mortga e co In=.=..........................W.D. Wash... ~uly27: 1965 Aug.3i 1965 


Southern ~anf~i~e'bor f~........................... E.O. La...... Dec.7 1966 Dec.31: 1956 
 Sunset International Pe roleum Corp.8 .............. N.D. Tex..... May 29 . 1970 June 10.1970 


SwawFinch Oil Carp ................................ S.D. N.Y ..... Jan . 2 1958 Jan.23 1958 


Tele-Tronlcs Cor................................... E.D. Pa...... July 26 1962 ~ept .12 1962 


Texas Independent Coffee Organization . Inc.8...... S.D. Tex ..... Jan . 5 '1955 Jan .13.i965 

TMT Trailer Ferry. Inc.............................. S.D. Fla...... June i7 1957 Nav. 22.1957 


Tower Credit Corp.8 ................................. M.D. Fla ..... Apr.13.'1%6 Sept.6. 1966 


Traders Com~resr Co.' ............................. W.D. Dkla .... May 12 1972 June 6 1972 


Trans-International Computer Investment Corp.1 ... N.D. CaliL ... Mar.22' 1971 Jul 26: 1971 T " t COP..................................... cD. i f. . s t 1 1 029 1961 


Twentieth Centur Foods Corp = E.D. Ark..... OC! .M,is1 ~eb.i1952

union ~nvenmanfs .~nc ......:Z~::I:IIIIIIIIII:ID.Hawaii.... ~eb.2.1970 Mar.i 2. 1970 

U i In ................................. D . I d.. D .4 1970 Jan.28 1971 

Viatron Computer Systems Carp .................... D. Mass..... A r Apr .29'1971
 &.. 24, 1971 

i n COP ......................................... ED Mi 2 1 Apr.9 1963 


Virgin Island Properties .inc.2 ....................... D. V.1 ........ Oct.22 1971 Apr .li1972 


Waltham Industries C0rp.l .......................... C.D. Calif.... July 14: 1971 Aug.16 1971 


Webb & Knapp. Ine................................ S.D. N.Y ..... May 7 1965 May 11 1965 


H.R Weibee COP.............................. N I .. a . 18 ~pr
 .3, is8 

Westec C0rp.a ...................................... S.D. Tex ..... Se t $6 1966 Dct.4 1966 


Western Growth Capital Corp .....,................ D . Ariz ....... Fep..lo.i%7 ~ay
 i6 1968 


Western National Investment Corp.8 ...-............D.Utah ...... Jan . 4 . 1968 Mar.li.1958 


Whale.Inc.2........................................ M.D. Tenn ... 
 Wonderbawl. Inc................................... C.D. CaliL ... 
 Yale Express System .Inc........................... S.D. N.Y .....Mav24 


I Commlrr.on loled notoce at appearance in fnscal ear 1972. :Reoryn.ratlon procesdtngr closed aurlng tlscaryear ,972 

'Plan as been sdbstant~a~ly Consummated b~t no tlnol decree nar been enteved because Of

pendong mattsrs . 
THIRTY-EIGHTH

SEC OPERATIONS

Net Cost

Overthe past five years, fees collected

by the Commission have in no year accounted for less than 69% of funds

appropriated by Congress for Commission operations. The Commission is required by law to collect fees for (1)

registration of securities issued; (2)

APPROPRIATED FUNDS

Dollars Millions

30

20

10

ANNUAL REPORT 175

qualification of trust indentures; (3) registration of exchanges; (4) brokers and

dealers who are registered with the

Commission but are not members of the

NASD;and (5) certification of documents

filed with the Commission. In fiscal year

1972, the Commission adopted a fee

schedule, effective March I, 1972, lrnposing fees for certain filings and services such as the filing of annual reports

and proxy material.

vs FEES COLLECTED

o

1968 69 70 71 72 1973*

*Estimated
176 SECURITIES AND EXCHANGE COMMISSION

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0

0

0 0

0

0 ~ 0

~

~

~~~

~