time. The Pacific Coast Stock Exchange facility is currently being used as a pilot regional center. The association has also sought and in large part received the cooperation and participation of the banking industry to incorporate certain banking operations into the national over-the-counter clearance system. We believe such is necessary if an effective and efficient operation is to be achieved. BROKER-DEALERS REFUSAL TO ACCEPT SMALL ORDERS It has been recently disclosed that some broker-dealers have imposed minimum dollar limitations on the size of an order they would accept and on the amount of an initial order they would accept to open a new account. There is presently nothing in the association's rules to prevent a member from doing this and while we do not anticipate imposing any such prohibition we are closely following this development to insure that the small investor is not closed out of the marketplace. Our initial review indicates that the practice is not widespread. As recently as 2 days ago, all of our district offices were interrogated and we find that nationwide only 33 complaints have been received from investors. Some are undoubtedly duplications. We intend to continue to watch this closely in order to insure that all investors are treated fairly and without discrimination. TRANSACTIONS BY INSIDERS Improper insider activity by broker-dealers can take place in several ways. Two of them, free riding and unfair underwriter's compensation, have been discussed above. Another is the use of confidential information to their benefit. The latter is the most difficult to discover and usually also involves insiders of an issuer corporation. Several such cases have recently been prosecuted by the Securities and Exchange Commisison. I think it is fair to state that the association does not condone any such improper activity and I can assure the committee that all cases involving such conduct will be the subject of disciplinary action and appropriate sanctions will be imposed. CONCLUSION We appreciate this opportunity which the committee has provided to review certain problems which presently exist in our industry and to discuss activities of the association of the recent past. I cannot emphasize too greatly the urgency with which we are proceeding in attempting to establish a national over-the-counter clearance system. We have received every degree of assistance and cooperation from all segments of the securities industry and from the Securities and Exchange Commission in developing this system and we hope to report our progress to you at an early date. Thank you, very much. Mr. Moss. Thank you, Mr. Sayre. Mr. Williamson, would you hand a copy of this document to Mr. Sayre? 27-845-69—13 In the meantime, I want to address the first question to page 27 of your statement, where you talk about the fact that there is presently nothing in the association's rules to prevent a member from doing this, this being the imposition of dollar limitations on the size of an order. Leaving aside the question of present rules of the association has to basic authority, has the association the basic authority to impose such rules should it become desirable? Mr. SAYRE. I believe we do. I will defer to Mr. Derrickson and Mr. Walbert for confirmation. Mr. DERRICKSON. The association undoubtedly has the power to impose such a rule should the public interest require it, sir. Mr. Moss. Now I want to talk about the inside case information. I wonder if you will discuss this briefly for us in terms of an illustration such as the Merrill, Lynch, Douglas Underwriters. In this case it appears that as a result of information received during a proposed underwriting certain broker customers of Merrill, Lynch were treated differently because of the information they received. The problem of the use of inside information is admittedly a difficut one. I am sure that we are all troubled as to just how this can be handled and how conflicts of interest can be avoided. I wonder in the specific case what disciplinary action has the association taken. Mr. WALBERT. Mr. Moss, I might address myself to that. The important element here, I believe, is the discovery of such condition. To my knowledge, the SEC is the only one who has effective surveillance of the activity of markets which would cause them to question any undue activity or any undue change in the price of securities. So in the relatively few instances where this has come up, I believe it has been generally through the SEC's daily, constant surveillance of the market activity. The difficulty is in discovering where this does take place. Mr. Moss. But in the specific case of the Merrill, Lynch, Douglas underwriting, you finally did become cognizant of it. My question goes to the nature of the discipline taken by the NASD against its member. Mr. DERRICKSON. The NASD took no formal action against the brokerage firms who were its members who were also involved in the SEC proceedings, if I understand your question correctly. Is that what you asked? Mr. Moss. That is what I asked. Mr. DERRICKSON. I might say that probably to my knowledge none is currently contemplated, although we can check that. As you understand, sir, the SEC proceeding against Merrill, Lynch was settled and the remaining individuals or firms who were cited are still involved with the administrative proceeding. As such, there has been established, so far as we know, no exact finding that all the facts on which that proceeding was based were either illegal or unethical. So in the sense that we do not have possession of the data or facts, we probably would not proceed and duplicate what they are doing. Mr. Moss. Have you sought the facts from the SEC? Mr. DERRICKSON. We have not, to my knowledge, asked for a transcript of that proceeding which is in progress right now. Mr. Moss. Certainly, there is no question of the fact that you have authority to proceed in this matter, is there? Mr. DERRICKSON. To my knowledge, there is absolutely no reason why any conduct which might be found illegal would not also be unethical. The question would be, should we proceed in the event the SEC finds that it is illegal? Mr. Moss. Aren't you in the role, really, of demanding of your members a higher standard of conduct than might be required of them by the SEC, and wasn't that one of the reasons for the creation of the NASD? Mr. DERRICKSON. Yes, sir. There is no question about it. Mr. Moss. Then in this instance you do not feel that the facts which you have not secured would justify examining the case to determine whether or not additional penalties might be desirable in dealing with this type of conduct? Mr. DERRICKSON. No, sir; I wouldn't say that. No; this is a matter which would be handled by our New York office. I have no knowledge as to what they have done. Mr. Moss. Would you normally have knowledge if they were contemplating any action, as general counsel of NASD? Mr. DERRICKSON. Not usually; no. In other words, the investigation and the preliminary work is done in the local district offices. To the extent that it is of an unusual nature, they perhaps would communicate with us. Mr. Moss. Wasn't this rather a major and jolting experience for the market and the public? Therefore, shouldn't it have been a matter of more than just routine concern to NASD? Mr. DERRICKSON. It certainly is of more than routine concern. I think perhaps someone else might prefer to speak to that than me. (The following correspondence was received for the record:) U.S. HOUSE OF REPRESENTATIVES, Mr. RICHARD WALBERT, DEAR MR. WALBERT: It sees to me that it would be helpful if you were to clarify a colloquy appearing on pages 184 to 188 of the transcript of February 27 which I had with you and with Mr. Derrickson relative to the Merrill Lynch underwriting of Douglas Aircraft. I asked you what disciplinary action you had taken against Merrill Lynch as a result of its activities in disseminating information to certain of its broker customers and not to others which it had received in the course of its consideration of the underwriting. Mr. Derrickson's answers seem to me rather evasive and an odd discussion of predicating any contemplated action on the basis of whether the conduct of this member was found to be illegal. It was my assumption from your discussion of the purposes of your association and the discussion during this colloquy that the association took into account the question of ethical conduct which might require a higher standard of conduct than that imposed by the question of legality. It seems to me that you may wish to enlarge upon your answer. Very truly yours, NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC., Hon. JOHN E. Moss, As we indicated at the hearing no action has been taken by the Association against Merrill Lynch in connection with this problem. The Association historically has cooperated and worked closely with the SEC in disciplinary matters involving Association members. In almost all cases the Commission will depend upon the Association to take action where ethical conduct is in question, since such is appropriately within the Association's purview. On the other hand, the Association will rely upon the Commission to proceed in matters of a complex legal nature involving legal standards and burdens of proof which, in large measure, can only be satisfied through the use of legal procedures which are not available to the Association. In some situations the Association and the Commission have jointly proceeded against the same broker/dealer. This was because under the circumstances and facts the proper disciplining of the member could be best obtained. The most obvious example of casees in this category are those in which the Commission seeks an injunction to prevent the further operation of a broker/dealership in violation of stated rules, and after obtaining such, relies upon the Association to discipline the offending member rather than to commence its own more elaborate and necessarily time-consuming administrative procedure. The results of cooperative efforts such as this are prompt cessation of violative conduct through the issuance of a court injunction and prompt proceedings by the Association with penalties deemed appropriate under the circumstances, with review power vested in the Commission. The Association's proceedings, as you are aware, may and often do include charges of violation of law and regulation as well as ethical practices under Association rules. Charges of violation of ethical practices alone would not be the basis for a proceeding by the Commission. Conversely, the Association would not be the appropriate organization to proceed in certain types of violations involving multiple parties, some of which would not be within the jurisdiction of the Association. The Association may proceed only against its members, and not against issuers of securities as may the Commission, and in addition, the Association does not possess subpoena power. It has been our view and, I am sure, that of the SEC, that it is usually unwise for one organization to duplicate the actions of another. I am sure that you will agree that where appropriate sanctions are imposed whether by the SEC, the Association or any Exchange, it would be unfair for another organization or agency to impose the same or additional penalties upon the offender for the same violative conduct. Such duplicate action in most instances would hamper and reduce the effective effort of either organizations' examination and enforcement staff to the detriment of the public. This pattern of cooperative regulation is derived from the provisions of the Securities and Exchange Act of 1934 which provide that previous disciplinary actions by the Commission, the Association or an Exchange may be used as the basis for denial of membership or the continuation thereof. In this regard, the Association may deny or refuse to continue in membership those who have been disciplined by an exchange. While such regulatory provisions obviously eliminate duplication of effort as to misconduct which has been the subject of appropriate sanction they do not prevent institution of separate proceedings by another organization. Where separate proceedings are deemed necessary they are instituted. In respect to the Merrill Lynch matter, we understand that the Commission's proceeding as to it and its employees was concluded with a settlement involving penalties against the firm and certain individuals. The consent to the findings of violation and penalties made by Merrill Lynch was solely for the purpose of concluding the proceeding and was not an admission to the charges against them. Further, it is our understanding that the proceeding as to others has not been concluded. Ordinarily, we would expect the Commission to advise us if it believed that we should institute separate proceedings against a member which the Commission had acted against. This has not been done and our preliminary assessment is that sanctions imposed by the Commission were appropriate and that duplication of disciplinary effort would be fruitless. Nonetheless, we intend to pursue this matter to establish without question that such is the case. Should you desire any further information or an opportunity to confer on this matter we would be pleased to cooperate. Very truly yours, RICHARD B. WALBERT, President. Mr. Moss. I earlier passed down a copy of a column from the June 20, 1968, issue of the Wall Street Journal written by Mr. Wayne Green, commenting upon this very aspect of the activities of NASD, as to how vigorously it is pursuing its role of regulating its members and disciplining its members. I might ask permission that this column be placed into the record at this point. (The Wall Street Journal column referred to follows:) [From the Wall Street Journal, June 20, 1968] TESTING THE NASD-STOCK TRADING SNARLS POSE MAJOR CHALLENGE TO OVERCOUNTER GROUP SOME SAY IT IS ACTING MORE BOLDLY THAN USUAL TO EASE THE PAPER WORK LOGJAM, BUT CRITICS STILL CALL IT TIMID (By Wayne E. Green) WASHINGTON-It's taken a crisis to arouse it, but a long-slumbering watchdog is showing signs of life. So it seems, at least, to Wall Street experts and some Government men eyeing the little-known regulatory group called the National Association of Securities Dealers. This industry organization is struggling to ease a giant paper work logjam in brokerage houses trading in the over-the-counter market, where stocks not listed on exchanges are bought and sold. Many feel the NASD, which polices that market, has acted with uncharacteristic boldness to meet the problem; among other things, it is checking on the finances and records of some member firms, arming for a possible crackdown on delinquents. "For once the NASD is providing some leadership rather than just following the New York Stock Exchange," observes an official of E. F. Hutton & Co., a large New York brokerage concern that belongs to both the NASD and the Big Board. That type of backhanded praise irritates officials of the NASD, but it's an improvement over the past. Those who have observed the organization have generally regarded it as a laggard, not a leader. Few have considered it a tough or effective regulator; usually it has made news only when critics have attacked it as lethargic or weak-kneed. Even now, an official of the Government's Securities and Exchange Commission, which oversees the NASD, says that while there are some areas where the industry group is the first to express concern, "when it come to taking steps it has to be prodded-in some cases it has to be shoved." The NASD's Powers The NASD administers a set of rules on qualification for employment in the securities industry and on fraudulent transactions, advertising, retail markups, commissions and record-keeping in the over-the-counter business. For violations it can impose penalties ranging from fines and censure of its member firms and individual brokers to expulsion of a firm from the NASD and revocation of a broker's NASD registration. Expulsion severely cripples a firm. During the past three years, the NASD's disciplinary actions have dropped off significantly. The number of complaints it filed against member firms or individuals preliminary to imposing penalties-fell to 118 last year from 146 the year before and 127 in 1965. Expulsions from membership fell to seven last year from 16 in 1966 and 23 in 1965. The NASD revoked the registration of only 25 individuals in 1967, down from 56 in 1966 and 54 in 1965. Though this downtrend would seem to support the critics' contention that the NASD hasn't been acting tough enough, the association contends it simply reflects an improvement in members' behavior. NASD officials also argue that their rules aren't designed |