Mr. BUDGE. I would like to say, Mr. Chairman, that we will be more than happy to cooperate with you in every way that these problems may be solved. I very much appreciate your making it possible for us to be with you this morning. Mr. Moss. Le me say, Mr. Chairman, that your statement is excellent and thought-provoking. It fully bears out the statement you made to me yesterday in conversations that you were fully prepared to appear here today as the opening witness. I want to take the opportunity to concur in a bit of conservatism as you outlined on pages 23 and 24 of your statement. I think it is a perfect example of where that conservatism becomes the most prudent type of management and accountability in the final analysis for the investing public. I have two questions I would like to direct to you at this time. In connection with the data which you have presented to us regarding the amount of fails, fails to deliver, do you have, or have you compiled, the situation over the past months regarding the amount of customers' free credit balances held by these same members concerning whom you have data as to the amount of fails to deliver? Mr. BUDGE. We have, Mr. Chairman. I don't have that Mr. Moss. Would you supply it to us for the record at this point? Mr. BUDGE. Yes. I can say that that has increased substantially. I shall supply the figure. (See attachment K to letter dated April 4, 1969, p. 25.) Mr. Moss. The American Stock Exchange earlier this month banned off the floor trading by its members for their own account in 103 of its most volatile stocks. This was done, so it was stated by the press, to focus on unusual speculative activity, and it also presumably has the effect of reducing the amount of trading in these issues and reduces members' paperwork problems. Have you given any thought to a ban not only on members' transactions as floor traders, but also to members' transactions off the floor for their own account until this paperwork and back-office or fails problem is cleaned up? Mr. BUDGE. That has been discussed, Mr. Chairman, but there has been no definitive agreement reached by the Commission. It is something that we are considering. Mr. Moss. Is there any data as to the amount of members trading for their own accounts? Mr. BUDGE. I am sure we do have that. Mr. Moss. Would you supply that for the record at this point? Mr. BUDGE. Yes, sir. (See letter dated April 4, 1969, p. 25.) Mr. Moss. What proportion of the total problem does this represent? Would you give us an estimate of that or prepare it for the record? Mr. BUDGE. Yes, sir. I am advised that it would be around 10 percent. Mr. Moss. Mr. Blanton. Mr. BLANTON. Thank you, Mr. Chairman. I, too, want to commend the Chairman on his excellent statement. I have no questions at this time. Thank you. Mr. Moss. Mr. Watkins. Mr. WATKINS. Thank you, Mr. Chairman. I would like to certainly wish the new Chairman, Chairman Budge, all the success possible. I know of your great experience. I must say that it was my loss that I was not able to serve with you in the Congress of the United States. Your great record in the Congress is well known to this committee concerning things that we will want from you in the future. Mr. BUDGE. Thank you very much. While these surroundings are not new to me, I never before realized just how great is the difference in elevation. Mr. WATKINS. We have great respect for the gentleman you replaced, Mr. Cohen. He was very helpful. I am sure that now that you are an experienced and level headed Republican, we will be able to go on with the work that we have. I wish you well. I compliment you on your very constructive report and assure you that I shall cooperate with you in any way possible, and I hope you will return the same favor. Mr. BUDGE. Thank you, sir. I shall. Mr. Moss. I would just like to observe that I hope as we proceed that we recognize that these are uniquely American and not partisan problems. Mr. WATKINS. I would like to keep it on perhaps a nonpartisan basis, but my experience, Mr. Chairman, in a lifetime of politics, shows that there is a big difference between a Republican and a Democrat. Mr. Moss. Mr. Stuckey. Mr. STUCKEY. Thank you, Mr. Chairman. Let me also wish you well on your new job. I know you will have your work cut out for you. I have several questions that would be part of one big question. If you would like, you can submit the answers later to the committee. Is this a statement that you prepared or is this the one that the former Chairman was going to submit? Mr. BUDGE. The material for this statement, or at least major portions of it were being prepared at the time of my appointment. I don't have a list of the matters which former Chairman Cohen wanted to discuss. In short, material for portions of this statement have been prepared by the staff of the Commission and portions of the statement are my own. Mr. STUCKEY. I noticed on page 29 it looked like we were coming to a recommendation or proposal and we had it cut. I was curious. Mr. BUDGE. Do you want to know what happened there? Mr. STUCKEY. Yes. Mr. BUDGE. It had a statement in it that perhaps the Commission could ban some of the complex securities. I was just afraid that somebody might ask me to describe which ones we were going to ban and which ones we were going to permit. I wasn't in a position to make that distinction. Mr. STUCKEY. This morning you have discussed with our committee the possibility for a review of major problems of the securities industry. Among these were speculation, fails to deliver stock certificates, institutional buying and selling, the tendency of brokers and dealers to execute only the large institutional orders and to refuse the small orders from the general public. You also touched on tender offers which resulted in conglomerates which were discussed, daily volume of trading, commission revenues, and also the workload which is present. I am somewhat concerned that all of these areas are all of a sudden described to us today as major problems. As a member of this subcommittee, I have tried to review the legislative proposals that we have had from the SEC in recent years. Apparently, either these problems were not recognized or the SEC thought it had adequate legislative authority to cope with these problems. As you know, we did spend many days in the 90th Congress reviewing legislative problems for the SEC. During this time, I do not recall that any of these problems dealt with any of the major problems that you are now concerned with except the possibility of institutional buying and selling, and also your Commission rate structure. What I would like to ask and get information from the SEC on, or if you would like you can submit the answers later, is: First, could you supply us with a list of the administrative actions and rule changes that the SEC has propsed in the last year or two to meet these problems which we have discussed? Second, can you draw our attention to any legislative proposals the SEC has made indicating any lack of authority with which to meet these problems? Third, what is the workload arrangement in the SEC that would permit these problems to become major before they are called to the attention of this committee? Can you staff supply us with existing statutory authority that the SEC at this time has to deal with speculation, with fails, institutional buying and selling, broker-dealer refusal to execute any large orders but large institutional orders, tender offers, and comment on revenues to broker-dealers? Fifth, do you think the SEC now has adequate legislative authority to cope with these various problems we have discussed today? What, specifically, is the SEC doing on each of these problems which we have discussed and referred to today? As I said, I am somewhat concerned that we are now told that these problems are major. It makes me wonder if these priorities are in order or that the SEC has put these problems which we have discussed in proper order. Maybe this is just my idea, but it is my conception that the SEC is an agent which Congress created to regulate the securities industry to insure investor protection and to report to us immediately any potential problem before these problems become major problems which you have described them as today. Finally, would be, how can we strengthen the role of the SEC in recognizing these problems before they do reach these dangerous proportions as were described today? Mr. BUDGE. I shall be very happy, Mr. Stuckey, to supply a statement just as comprehensive as we can make it in answer to your inquiry. Mr. STUCKEY. Thank you. Mr. Moss. The record will be held open at this point to receive the information requested by the gentleman. (The following letter and attachments were received for the record:) Hon. JOHN E. Moss, SECURITIES AND EXCHANGE COMMISSION, Washington, D.C., April 4, 1969. Chairman, Subcommittee on Commerce and Finance, House of Representatives, Washington, D.C. DEAR MR. Moss: During my appearance on February 25, 1969 before the Subcommittee on Commerce and Finance of the House Committee on Interstate and Foreign Commerce, Mr. Stuckey requested information respecting the Commission's activities in connection with and actions taken by it to deal with it the problems discussed in my testimony. He specifically referred to such problems as: "... speculation, fails to deliver, stock certificates, institutional buying and selling, the tendency of brokers and dealers to execute only the large institutional orders and to refuse the small orders from the general public." He also referred to my discussion of: .. tenders or offers which result in conglomerates which were discussed, daily volume of trading, commission revenues, and also workload which is present." I am pleased to respond, for the record, to Mr. Stuckey's specific questions concerning these important matters. 1. Administrative Actions and Proposed Rule Changes by the Commission in the Past Year or Two to Meet These Problems a. Proceedings Instituted As part of the Commission's special concern with the growing "back office problem" we instituted, in May 1968, a special broker-dealer inspection program to review the back office operations of the individual brokerage houses. Our staff has in the course of this program inspected 481 broker-dealers. These inspections revealed a number of violations of federal securities laws. These include primarily (1) failure to make and keep current and accurate certain books and records, (2) failure to maintain net capital (net worth less assets not readily convertible into cash and making deduction to provide for fluctuations in the value of certain liquid assets) in the required amount and ratio to aggregate indebtedness, and (3) failure by the firm and its principals to adequately supervise their personnel to prevent these violations. To date in this program the Commission has instituted 24 administrative proceedings (of which 2 are public) and 3 injunctive actions. To date 6 of the administrative proceedings have been completed. In three instances-Lehman Brothers, Rowles, Winston & Co., and Kroeze, McLarty & Duddleston-the Commission's order, issued after the firm had corrected the conditions giving rise to the proceeding, censured the firm and its partners and required the firm to file monthly reports of back office conditions for one year. Should conditions deteriorate, we could immediately impose restrictions on the firm and reinstitute the proceeding. This follow-up procedure provides incentive to the firms to revise their back office operations so that they can handle the increasing volume of market activity on a current basis. In the three other proceedings which have been concluded-Pickard & Co., Inc., Fleming-Jones Securities, Inc., and Transmittal Securities Corp.-violations of other provisions of the federal securities laws were found and additional action was taken. Attached are the Commission releases regarding these six completed proceedings, two injunctive actions-Allied Securities Co. and Dalen Investments and Funds, Inc.'-and the institution of public proceedings against Pickard & Co., Inc. and L. D. Sherman & Co.2 The existence and nature of the Commission's private administrative proceedings are not publicly announced until the Commission issues its final order and opinion. For the Committee's information, we attach a schedule showing the 24 administrative proceedings and the 3 injunctive actions instituted, the parties thereto (where publicly disclosed), date of action, and violations charged. The Commis 1 The third injunctive action, James Anthony & Co., was instituted on February 26, 1968. 2 Attachment A. Attachment B. sion is continuing to review additional situations to determine whether actions should be instituted. b. Rule Changes During the past year, the Commission, as part of its effort to alleviate the back office problem, has worked with the various self-regulatory agencies toward the adoption of rules by these agencies designed to reduce back office problems. The Commission has also proposed amendments to its own rules and issued interpretations of existing rules. On January 30, 1969, the Commission amended its net capital rule by requiring that broker-dealers in the computation of their net capital deduct a percentage of the value of their aged fails to deliver. This amendment was designed to afford greater protection to the investing public by requiring the brokerage community to provide a greater reserve of capital for outstanding aged fails to deliver. Attached is Securities Exchange Act Release No. 8508 announcing this amendment.* The Commission has also proposed a rule which would require issuers whose securities are publicly traded to maintain facilities reasonably designed to effectuate the prompt issuance, registration, and registration of transfers of securities, and delivery of certificates. Comments have been received from members of the public and are being analyzed by the staff. The Commission has also issued interpretations of its various rules regarding the duties of brokers and dealers in the execution and consummation of securities transactions. The attached Securities Exchange Act Release No. 8363° cautioned that it was a violation of the applicable anti-fraud provisions for a broker-dealer to solicit or induce the purchase or sale or to accept or execute any order for the purchase or sale of a security if he did not have the personnel and facilities to enable him to promptly execute and consummate all of his securities transac tions. The release further cautioned that it would be inconsistent with applicable requirements to sell a security as principal for his own account or to purchase as broker for another person if the broker-dealer knew or had reason to believe that it would be difficult to obtain delivery of the particular security. Further, in Securities Exchange Act Release No. 8404, the Commission stated that among the supervisory responsibilities of a brokerage firm were the supervision of the back office operations which included the accuracy and currency of the firms, books and records, the status and causes of "fails to receive" and "fails to deliver," net capital, credit extensions and financial reports. 2. Legislative Proposals That the SEC Has Made, Indicating Any Lack of Authority With Which To Meet These Problems The Commission has not initiated any formal legislative recommendations respecting the areas you have mentioned. The Commission has been studying these matters for some time and, to the extent that they come within the ambit of our concern rather than other Governmental agencies, has been attempting to deal with these matters with our existing powers. It must be recognized that a significant portion of the back office problem stems from the failure of the brokerage firms to adequately provide for the vast increase in volume. The purchase of data processing machines, the training of adequate personnel and the emphasis on back office problems as a major responsibility of management are not the kind of items easily cured by legislation. Should the studies undertaken by the Commission and the industry indicate that existing statutory authority is inadequate to deal with these problems, the Commission will make recommendations for appropriate remedial legislation. I should add that in my March 6, 1969 testimony before the Securities Subcommittee of the Senate Banking and Currency Committe, I did suggest certain amendments to the Exchange Act in connection with tender offer problems. They, together with supporting reasons, are contained in the response, below, to Mr. Stuckey's question on the Commission's authority to deal with problems relating to tender offers. 3. What is the workload arrangement of the SEC that would permit these problems to become major before they are called to the attention of this Committee? The Commission has endeavored to keep the Committee fully informed regarding the development of problems of major importance such as the "fails" and "back office" situations and has provided the Committee with information and responded to inquiries regarding these problems. Thus, on October 19, 1967, 4 Attachment C. 5 Attachment D. Attachment E. |