require all self-regulatory organizations to adopt procedures which will afford constitutionally adequate due process to non-members directly affected by their actions.

Turning from actions affecting individuals to the broad policymaking activities of the self-regulatory organizations, the Subcommittee does not believe that they should be made subject to rigid procedural requirements, either as to the composition of their policymaking bodies or their methods of procedure. There is, however, one important procedural requirement that should be imposed. To insure that proposed rules and rule changes can be properly understood by the public and effectively reviewed by the SEC, each such proposal should be accompanied by a "concise general statement of its basis and purpose" sufficient to satisfy the rule-making requirements of the Administrative Procedure Act. The absence of such a requirement has on occasion created delay in the SEC review process; it has more often left the public record devoid of any statement as to the basis for significant policy decisions.

While the overall jurisdiction of the NASD is spelled out with some particularity in the Exchange Act, securities exchanges are free to adopt rules on any subject so long as they are not inconsistent with the Act or the SEC's rules. In the absence of explicit limitations on their authority, exchanges have undertaken to regulate the activities of their members in areas which essentially require economic determinations rather than decisions as to whether particular activities are inequitable, manipulative, fraudulent or deceptive. The decision-making process in these areas has created serious problems for the self-regulatory system. It would be impossible, and perhaps undesirable, to define the jurisdiction of self-regulatory organizations by statute to include "ethical" and exclude "economic" questions. However, the step-bystep elimination of fixed commission rates, together with the Subcommittee's proposed resolution of the "institutional membership" question and the "Rule 394" question, should go a long way toward eliminating the most serious conflicts of interest that have recently clouded the deliberations of certain self-regulatory organizations.

In addition, the Subcommittee believes that attention should be given to certain redefinitions of self-regulatory jurisdiction, in the hope of alleviating future problems and further improving and rationalizing the process of self-regulation.

First, questions have been raised as to whether some actions taken by self-regulatory organizations, such as the regulation by certain exchanges of their members' sales of life insurance, might be beyond the SEC's power of review. It should be made clear that the the exchanges and the NASD have no self-regulatory duties as to which the SEC does not have oversight responsibility. To achieve this objective, the Exchange Act should be amended to limit the scope of any self-regulatory organization's authority over its members to securities-related activities and to those aspects of their other activities, such as financial arrangements, which may pose dangers to pul lic securities investors or to the public's confidence in the integrity of the securities markets. It should also be amended to give the Commiss on clear and effective authority over all uses of self-regulatory power.

Second, questions have been raised about the present allocation of self-regulatory responsibility among the various exchanges and the

NASD. That allocation, which represents historical rather than functional patterns, results in overlapping and duplicative regulation and different standards of conduct for firms engaged in the same lines of activity. The tying of regulation of retail activities to the operation of a particular marketplace may also impede the development of a central market system. The Subcommittee therefore believes that the time has come to begin planning the framework which will guide the development of the self-regulatory system in the future. In the revised system, a single nationwide entity would be responsible for regulation of the retail end of the securities business, including such matters as financial responsibility and selling practices, while each exchange would concentrate on regulating the use of its own trading facilities. The Subcommittee believes that the SEC should begin work toward this more functional re-ordering of the self-regulatory structure, and will give careful consideration to SEC recommendations for implementing legislation as and when required.

C. THE AUTHORITY AND PROCEDURES OF THE SEC

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In its Study of Unsafe and Unsound Practices of Brokers and Dealers, which it submitted to the Congress in December 1971, the SEC stated that it requires "additional statutory authority to prevent a recurrence of the problems described by [its] Study and furnish needed protection for investors as well as to maintain a strong and viable securities industry." Specifically, the SEC asked for authority (1) to approve or disapprove all new rules and rule changes proposed by all self-regulatory organizations, and to require them to adopt, amend or abrogate rules on any subject; (2) to enforce the rules of self-regulatory organizations directly against their members, and (3) to review all disciplinary actions of all self-regulatory organizations and to modify them in any way, including power to increase the penalty imposed.

Analysis indicates that the differing limitations on the SEC's power to disapprove or require changes in the rules of the exchanges and in the rules of the NASD are based on historical anomalies and do not currently follow any rational pattern. The Subcommittee believes that effective fulfillment of the SEC's role in the regulatory process requires that it have the power which it requests to disapprove or require changes in the rules of all self-regulatory organizations. The procedure to be followed by the SEC in taking such actions, however, should be attended by greater safeguards than those which apply to the Commission's adoption and amendment of its own rules. Specifically, persons affected by the Commission's disapproval or requirement of a self-regulatory rule should be afforded the opportunity for an appropriate adversary hearing and review on the record to assure that the relevant issues are fully presented and explored.

In support of its request for power to enforce the rules of selfregulatory organizations directly against their members, the Commission has argued that the existence of this power "would have encouraged stricter compliance with exchange rules and would have led to more vigorous efforts of self-regulators to enforce their own rules." However, the Commission has not given any specific instances where this authority would have had beneficial effects, and the

Subcommittee's case studies do not indicate that the absence of such power was a significant factor in any of the problem areas studied. In light of these findings, and of respectable opinion that direct SEC involvement in the enforcement of self-regulatory rules would weaken, rather than strengthen, the self-regulatory process, the Subcommittee does not believe a case has yet been made for granting the SEC such authority. The Subcommittee will, however, be pleased to receive additional data from the Commission as to specific "experienced needs" for such authority.

Similarly, the SEC's request for authority to increase the penalties levied by the self-regulatory organizations in disciplinary actions against their members has been supported simply on the ground that it would "round out" the Commission's review powers, without any evidence as tɔ problems resulting from inadequate penalties. While the Subcommittee, as stated above, believes that persons affected by exchange disciplinary actions should have a right of Commission review, it does not believe that a case has been made that Commission authority to increase, on its own initiative, the penalties imposed by the self-regulatory organizations would significantly improve the effectiveness of the regulatory system.

The case studies undertaken by the Subcommittee, to help it to evaluate the Commission's request for additional authority, indicate that the major regulatory problems in the securities industry have not by and large been the result of the SEC's lack of authority but rather of its unwillingness to use the powers it already has. In the areas of net capital requirements and regulation of specialists, for example, where the Commission has had full power to supplant or supplement the rules of the exchanges to whatever extent it deemed necessary, it has failed to exercise this flexible power in a limited way appropriate to the specific defects which it perceived in the self-regulatory pattern. While the Congress cannot legislate a willingness on the Commission's part to take effective action, it can take steps to improve its own ability to oversee the Commission's regulatory performance. For this purpose, the Subcommittee recommends that the Commission be required to include in its annual report to the Congress specific information with respect to its program of inspection of the selfregulatory organizations, its actions with respect to their significant rule changes, and its evaluation of their significant programs and activities.

These requirements for more detailed reporting by the SEC to the Congress should also help to assure more adequate attention to the Commission's responsibility for continuing oversight of the selfregulatory programs and activities of the exchanges and the NASD, through regular inspections and other surveillance techniques.

The procedures followed by the SEC in passing on the rules of the self-regulatory organizations are not subject to the procedural safeguards of the Administrative Procedure Act which apply to the Commission's adoption of its own rules. People with significant interests affected by self-regulatory rules often receive no notice of their pendency, have no opportunity to participate in their consideration, and may even be unable to obtain judicial review of them after they are put into effect. Rather than subjecting the self-regulatory organizations themselves to the procedural requirements applicable to govern

mental rulemaking, the Subcommittee believes the better approach is to require the SEC to give adequate public notice of all new rules and rule changes filed with it by the exchanges and the NASD, to afford an opportunity for comment or argument appropriate to the nature and significance of the proposal, and to provide a statement of the effect and purpose of the proposal adequate for public understanding and possible further review. In addition, the Commission should limit the scope of its private negotiations with the self-regulatory organizations on its and their proposed rules to assure that other interested persons have an opportunity to participate in the rule-making procedures at the points at which the significant decisions are being made.

D. ROLE OF THE COURTS

The Commission, the exchanges and the NASD are vested with broad discretionary powers under the Exchange Act. This flexible structure was conceived by the Congress to accommodate the everchanging nature of the securities markets and in the hope that the expertise of the Commission and of the self-regulatory bodies would provide a superior form of regulation to that which might be expected from a highly complex and specific statute which could rapidly become obsolete.

Hand in hand with the delegation of broad discretionary powers, however, is the need for appropriate judicial review. It has been suggested that "the availability of judicial review is, in our system and under our tradition, the necessary premise of legal validity."

Under present law, formal actions by the Commission are reviewable in the courts of appeals under the Exchange Act or in the district courts under the Administrative Procedure Act and principles of general equity jurisdiction. Activities of the self-regulatory bodies have been held subject to judicial review only after having been passed upon in some way by the Commission.

Because of certain peculiarities in the Exchange Act, not all of the activities of the self-regulatory bodies are subject to Commission review. Consequently, it is sometimes difficult for parties aggrieved by self-regulatory action to obtain direct judicial review. Additionally, in litigation, the Commission has sought to characterize many of its decisions as non-actions, that is, mere abstention from exercise of its existing power. These statutory gaps and the Commission's reliance upon procedural technicalities have combined to limit unduly the availability of judicial review of Commission and self-regulatory action. Having no other alternatives, aggrieved parties have relied increasingly upon collateral attack, often basing such suits on antitrust or due process claims. These collateral attacks have, in turn, led to pressures to limit the applicability of the antitrust laws to the actions taken by members of the industry in the course of "self-regulation." Because the Subcommittee believes that direct judicial review of all significant decisions of the SEC and the self-regulatory agencies will strengthen the regulatory process established by the Exchange Act, it recommends legislation to clarify the availability of direct judicial review of Commission and self-regulatory action. Specifically it recommends that, in reviewing self-regulatory actions, the Commission, where practical, should be required to enter a formal order ap

proving or disapproving of such action. In those areas where the frequency of activity or other practical considerations make it necessary for the statute to permit automatic effectiveness of self-regulatory action, the statute should provide that when the Commission allows an action of a self-regulatory agency to stand or to become automatically effective, such action shall be subject to judicial review, to the same extent as if it had been formally approved by the Commission. In other sections of the report, the Subcommittee addresses itself to the need for more formal Commission review of self-regulatory actions. These recommendations will also go far to facilitate the availability of a convenient means of judicial review.

Meaningful judicial review requires that the Commission make its reasons for acting sufficiently apparent to enable the reviewing court to properly consider the case. The findings of the Study, however, are that the Commission often tends to proceed informally and without articulation of reasons, findings or conclusions. In addition to the other ramifications of this method of procedure on the regulatory process, it tends to impair the effectiveness of judicial review. Accordingly, the Subcommittee recommends that the Commission, when making significant regulatory decisions, be required to state its findings and reasons for its action in a manner which will facilitate effective review.

E. APPLICATION OF THE ANTITRUST LAWS TO THE SECURITIES INDUSTRY

The Securities Exchange Act of 1934 delegates to industry selfregulatory bodies quasi-governmental powers over their members. In so doing, the statute sanctions the concept of a group of competitors agreeing to impose restrictions upon themselves, including restrictions upon how they will compete with one another and restrictions affecting competitors who are not members of the group. This in turn creates the possibility that the group will use its power, intentionally or unintentionally, to limit competition or disadvantage non-member competitors in a way which does not further the purposes of the 1934 Act.

To protect the public and competitors against unjustified anticompetitive restrictions, the rules and actions of the self-regulatory organizations must be subject to review under antitrust standards. In the case of the securities industry, this review can come from two sources: through review by the SEC or through judicial proceedings in the courts.

The Exchange Act does not specifically require the SEC to consider antitrust or anticompetitive consequences in reviewing self-regulatory actions. Nevertheless, the SEC has on certain occasions taken such considerations into account in passing on proposed rules of selfregulatory agencies.

Alleged antitrust violations can be reviewed by the courts either in private suits for damages or injunctions, or in civil or criminal proceedings brought by the government. While the Department of Justice has not yet brought suit against any of the self-regulatory organizations in the securities industry, private litigants have brought a number of suits against them during the last ten years.

One result of these lawsuits has been suggestions by industry representatives that actions taken by self-regulatory organizations should