it, in adapting the requirements of its forms to the particular circumstances of different classes of issuers and, indeed, of the individual registrant. Even the most casual comparison of a registration of the type which was used in the midforties with those which have been in use in recent years will substantiate this point. In this connection, it should be pointed out that the Commission is very conscious of the fact that discriminate treatment of issuers is essential under the provisions of S. 1642. Subsection (h) which would be added to section 12 of the Securities Exchange Act of 1934 provides to the Commission both extensive exemptive power and also power to "classify issuers and prescribe requirements appropriate for each such class." There is no doubt whatever that the Commission proposes to exercise these powers, if S. 1642 becomes law, with this very matter of "burden" as a significant factor to be taken into account. The Commission already exercises similar powers under the Securities Act of 1933. It has no less than 17 different forms prescribed for registrations under that act. There is another distinction which I think can be usefully drawn in the context of this discussion. A registration under the Securities Act of 1933, requiring the preparation of a prospectus which is to be delivered into the hands of each purchaser of the registered security which is being publicly offered, presents a different problem in terms of burden than either a registration of a security for listing on a national securities exchange under the present provisions of the Securities Exchange Act of 1934 or a registration of an equity security for trading in the over-the-counter market as proposed under the provisions of S. 1642. A security which is being publicly offered and registered under the Securities Act of 1933 is the subject of an affirmative, organized selling effort by a group of underwriters and selling group firms. In this context a prospectus is intended to furnish directly to the prospective investor information essential to the exercise of an informed investment decision. The "minimum" information required for this purpose is, therefore, somewhat greater in scope than that required for registration for listing on a national securities exchange or, presumably, for trading in the over-the-counter market. The contrast is evident from a comparison of the information presented in a securities act prospectus with that contained in a registration on form 10 under the Securities Exchange Act of 1934. The comments made above apply in large part to the periodic reporting provisions presently applicable to companies subject to section 13 or section 15 (d) of the exchange act. Again, the principal requirements relate to the accounting statements. If, as Messrs. Ames and Foshay agree, the accounting statements to be furnished to stockholders of companies having less than 1,000 stockholders are to be certified in accordance with generally accepted accounting principles, the major hurdle will already have been surmounted. The items of nonfinancial information called for in an annual report filed with the Commission are substantially identical to those called for in a proxy statement and the Commission's forms and filing requirements are deliberately designed to avoid duplications. To provide this information or as much of it as proves appropriate for smaller companies-should not be a difficult task. The short answer is that a simple factual situation can and should be described simply and succinctly. Where a more important matter is to be disclosed, such as a merger or major acquisition or disposition of assets, it seems to me to be putting the cart before the horse to emphasize the complexities and burdens of disclosure when, in actual fact, it is the transaction itself which is complex, detailed, and consequential to the issuer and its stockholders and, therefore, very demanding of the time and talents of its management, counsel, financial advisers, and accountants. I would never downgrade the care which should be taken in the preparation of a proxy statement by which a corporate management submits a major decision to the vote of its stockholders but at the same time, I believe that document and the burdens of its preparation should be viewed in the context of the entire undertaking. The comments which I have made in this letter should be read in the light of the examples of registration statements, reports, and proxy statements which the Commission is submitting to your subcommittee. Very truly yours, JACK M. WHITNEY II, Commissioner. SECURITIES AND EXCHANGE COMMISSION, Mr. OTTO Lowe, Jr., Senate Committee on Banking and Currency, DEAR MR. LOWE: In the course of Chairman Cary's testimony on S. 1642 on June 18, 1963, we promised to furnish the committee with certain information concerning securities fraud cases involving over-the-counter securities. I attach hereto two copies of a memorandum which is intended to be responsive to this request. It was suggested that we provide figures as to the percentage of cases which involved companies having more than 500 stockholders. As I subsequently indicated to you, this has proved to be impossible, since in the average securities fraud case, we do not determine how many stockholders the issuer has, since this information is not relevant to the case. We have accordingly assembled a representative group of securities fraud cases in which lack of disclosure, such as that which would be provided by the bill, appeared to be a factor, and where the information is available, have identified the companies which had more than 500 shareholders. These proved to be in the minority since a great many securities frauds involve the distribution of securities of promotional ventures. In the course of assembling this material, our attention was directed to the fact that cases involving companies subject to the reporting requirements illustrate very vividly the value of these requirements, both in enabling us to detect fraudulent activities and in broadening the scope of protection against misconduct in the management of publicly held corporations. Such misconduct is commonly accompanied by failure to report or by false reports. We have accordingly included some cases of this character. In the course of the chairman's testimony, there was also some discussion of the problems we have encountered with respect to insurance companies, particularly in response to the questions of Senator Javits. We have accordingly included in this memorandum several cases involving insurance companies. I hope the enclosed material will be of some assistance. Sincerely yours, PHILIP A. LOOMIS, Jr., Director. STATEMENT OF THE SECURITIES AND EXCHANGE COMMISSION WITH RESPECT TO FRAUD IN THE SALE OF OVER-THE-COUNTER SECURITIES The primary justification for the extension of the disclosure requirements of the Securities Exchange Act of 1934 to over-the-counter issuers provided by S. 1162 is the need to make available to investors adequate financial and other material information to permit informed investment decisions. The dissemination of this information on a regular and controlled basis to shareholders also will facilitate intelligent judgments as to the stewardship of management. A secondary, but nevertheless important, benefit of the passage of S. 1642 will be its effect as a deterrent and bulwark against fraud. The availability of reliable sources of current information has been a vital protection to investors in listed securities. It enables responsible broker-dealers and investment advisers to evaluate thoroughly information furnished to them by issuers and other sources. It deprives unscrupulous broker-dealers of the defense, frequently encountered by the Commission in its enforcement efforts, that any false and misleading information disseminated by them was caused by the failure of the issuer and its management to make adequate and accurate disclosures. Members of the investing public also have an opportunity to protect themselves against fradulent sales campaigns by checking representations made with the reservoir of information concerning issuers and their securities contained in reports and other documents filed with the Commission and distributed to shareholders. Fraud thrives best where lack of disclosure is most marked. The overwhelming preponderance of fraud cases before the Commission in past years have involved the securities of companies which have not been subject to the reporting requirements of the exchange act. Appendix A to this memo randum contains digests of a representative sampling of these cases. The typical fraud case involves the distribution of securities which are subject to the antifraud provisions of the Securities Act of 1933. Since the majority of these fradulent distributions involve either new companies or initial public offerings of small companies, the protections afforded by S. 1642 would not have been available. However, in a number of these cases such protection would have been available because of the size of the company involved. There are examples contained in Appendix A where S. 1642 would have applied and served to impede continuation of illegal stock promotions. In some cases, management has been deeply implicated in the fradulent sales of their companies' securities; in other cases, the absence of adequate public disclosure has permitted broker-dealers to perpetrate a fraudulent scheme without the participation by persons associated with the issuer. Although S. 1642 generally would apply to 35 percent of the issuers actively traded in the over-the-counter market, its effect should be felt in the entire market. The initial application of the disclosure philosophy to trading markets on national securities exchanges has created an appreciation of, and an expectation for, regular and continuous information. For this reason, many over-thecounter companies have determined that confidence can best be maintained by voluntarily making adequate disclosures to shareholders. The extension of the disclosure requirements of the Exchange Act to a significant portion of the overthe-counter market undoubtedly will accelerate this trend. The Commission's experience demonstrates that, in common with other industries, particularly those in promotional stages, distributions of insurance company securities have often been accompanied by fraud, and shareholders in these companies have been subjected to various kinds of management overreaching. State regulation of insurance companies, even when supplemented by State blue-sky laws, has not been an adequate substitute for the protections afforded by the disclosure requirements of the investor-oriented Federal securities laws. Investors in insurance companies stocks traded in the over-thecounter market, like investors generally, need and will benefit by the protections afforded by S. 1642. Attached as appendix C is a representative sampling of fraud cases before the Commission involving insurance company securities. American Founders Life Insurance Co. furnishes an example of a fraudulent distribution of stock where the insiders distributed their securities at prices higher than the public offering price, while representing that all the proceeds would go to the company. National Union Life Insurance Co. illustrates corporate looting and a fraudulent stock promotion by insiders. National Reserve Life Insurance Co. demonstrates the ability of corporate insiders, in the absence of adequate disclosure requirements, to use their control of the company to solidify that position by the disenfranchisement of public shareholders at great personal profit to themselves. The requirement of periodic disclosures, in and of itself, often serves as a powerful deterrent against fraud and other abuses. Moreover, the reporting and proxy provisions of the Exchange Act often extend protection to areas which the antifraud provisions of the Federal securities laws do not reach. Among the cases involving frauds in companies with securities listed on a national securities exchange described in appendix B is the case of U.S. v. Pope. The defendants in that case diverted over $400,000 of assets from a publicly owned listed corporation, which they controlled, to one of their privately held corporations. The failure to disclose these transactions in proxy statements, as required by the Commission's proxy rules, resulted in their criminal conviction for violations of these rules and restitiution by the defendants of the entire amount diverted. When, as in this case, the diversion of assets does not relate to securities transactions, the Commission has no jurisdiction to prosecute such abuse under the antifraud provisions of section 17 of the Securities Act and section 10 of the Exchange Act. The Commission's experience demonstrates that the disclosure requirements of the Exchange Act applicable to listed securities have been of considerable assistance in detection, invesigation and prosecution of violations of the Federal securities laws. In some instances, the information disclosed in reports filed with the Commission provides the first suggestion of a possible violation of the Federal securities laws. For example in the Crowell Collier Publishing Co. case described in appendix B periodic reports filed by the company stated that it had sold $4 million of convertible debentures in reliance on the private offering exemption from the registration requirements of the Securities Act. The staff, after the examination of these reports, initiated an investigation to determine whether, in fact, this examination was available. The investigation subsequently revealed that a block of $3 million of debentures, purportedly sold to 27 persons, was actually sold to 89 purchasers and that further distributions of the common stock into which debentures were converted were made by these original purchasers. A public distribution of the common stock also resulted from the subsequent sale of an additional $1 million of debentures. Thus, a flagrant violation of the registration requirements of the Securities Act was uncovered simply by routine analysis of reports required to be filed with the Commission. The disclosure requirements of the Exchange Act are also important when the Commission receives information from a complaint letter or other outside sources as to alleged violations of the securities laws. When this information relates to a reporting company, the ready availability of reports and other required filings with respect to these companies makes evaluation and investigation of the complaint a speedier and more efficient task. Prompt enforcement efforts are essential for the protection of the investing public. In some instances, unscrupulous managements have sought to conceal fraud and other misconduct by simply ignoring the filing requirements. This is a hazardous course, because the failure to file required reports, when supported by proof of illicit motive, has been sufficient to support a criminal conviction. In the F. L. Jacobs case the failure to file reports required under sections 13 and 16 of the Exchange Act led to the downfall of Alexander Guterma, who controlled the company. A Commission investigation initiated because of the delinquency uncovered a large-scale looting of corporate assets, a manipulation of the securities of F. L. Jacobs. This case and Guterma's similar activities in the Bon Ami and United Dye and Chemical Corporations are described in appendix B. Frequently, corporate manipulators and fraudulent stock promoters in companies subject to the Commission's disclosure requirements attempt to conceal their activities by filing false information with the Commission. On many occasions, these discrepancies are detected during initial examination of the materials filed with the Commission. Even when the filing of false information goes undetected during initial examination, further concealment often proves difficult because of the Commission's requirements of continuous disclosure. In some cases significant discrepancies in financial statements filed with the Commission subsequently are discovered by the company's public accountants while engaged in an annual audit for the preparation of reports to be filed with the Commission. Examples of such cases described in appendix B or H. L. Green & Co. and Continental Vending Corp. In other instances, comparison of information filed with the Commission with the reservoir of information contained in previous reports, proxy solicitation materials, and registration statements by the Commission's staff has disclosed suspicious circumstances, leading to further investigation and the uncovering of abuses by corporate management. The effectiveness of the Commission's disclosure requirement is vividly demonstrated by the activities of Lowell Birrell, perhaps the most successful corporate marauder of recent times. To conceal his activities, Birrell deliberately chose as his primary vehicle for fraud the Swan Finch Oil Co. Since Ewan Finch securities were admitted to unlisted trading privileges on the American Stock Exchange, the company was not subject to the disclosure requirements of the Exchange Act. After obtaining control of Swan Finch, Birrell systematically looted the assets of that and other nonreporting companies by a series of complex transactions involving the issuance of Swan Finch and other marketable stocks in exchange for assets of little or no value. He then publicly distributed this stock at great personal profit. The Swan Finch case and Birrell's other activities have received wide publicity. A detailed account of these intricate schemes appears in the November 1959 issue of Fortune magazine. APPENDIX A Representative sampling of fraud cases before the commission concerning companies which are not subject to the disclosure requirements of the Securities Exchange Act of 1934 AMERICAN EQUITIES CORP. (See SEC Lit. Rel. No. 1955 (1961).) American Equities Corp. (formerly Star Midas Mining Corp.) was a corporation dormant for nonpayment of corporate taxes. Reactivated in 1958 to be used as a vehicle for a fraudulent stock promotion. American Equities entered into negotiations to acquire certain properties and businesses. These negotiations never came to fruition. Nevertheless, the properties were treated by the promoters as wholly owned by American Equities. The promoters then had pro forma balance sheets prepared which further reflected these misrepresentations. Public interest was generated by the use of the false financials. The promoters then induced the stockholders of Verdi Development Co., a company of which one of them was president, by mailing the stockholders false and misleading proxy solicitations, including the false financials, to approve the merger of Verdi and American Equities. As a result of such solicitation, a favorable vote was obtained, and the merger was consummated. Forty thousand shares of American Equities stock was distributed to the shareholders of Verdi and thereafter found its way into the hands of the general public. The insiders of American Equities received freely marketable Verdi stock for almost worthless American Equities stock. The insiders continued to make use of the false balance sheets in their stock sales campaign. The fraudulent sale of American Equities stock would have been frustrated by either public reports on a current basis including certified financials, or past annual reports. Uncertified and false financials could not have been used as a part of the proxy materials sent to Verdi shareholders had the Commission's proxy rules been applicable. On March 22, 1961, the Commission obtained a permanent injunction against violations of the registration and antifraud provisions in connection with the above sales campaign, and four of the insiders were convicted of conspiracy and fraudulent activities. They have not been sentenced to date, pending a presentence investigation. BELMONT OIL CORP. (See SEC Lit. Rel. No. 1541 (1959).) Belmont Oil Corp.'s charter had been revoked in 1924 for failure to pay taxes averaging less than $10 per year. It was revived in 1956 solely for the purpose of setting up a stock-selling scheme. The holders of 51,000 shares had defaulted upon an assessment of 5 cents per share on the outstanding stock. The holder of the remaining 299,000 shares undertook to pay the assessment on the total outstanding shares and took title. Subsequently, a promoter acquired the 350,000 shares outstanding and caused to be issued to himself an additional 325,000 shares to be held by himself and his associates. Certificates were issued in various accounts representing the total outstanding shares to nominees. The corporate name was changed, authorized capitalization was increased 10 times and the total number of outstanding shares increased to 6,750,000 shares. The assets of the corporation were virtually worthless and the corporation operated at a loss. Shares were acquired by various broker-dealers from the promoter, his nominees and associates, and sold to the public by means of fraudulent representations concerning, among other things, a merger of Belmont with a major oil company, that Belmont owned productive wells and was producing substantial volumes of oil from its operatings, that it had a substantial net worth, that existing stockholders had options to purchase additional shares and that the shares of Belmont would be listed on a national securities exchange. These shares were sold at varying prices greatly in excess of any possible value. Had Belmont been required to submit various financial and other reports, such disclosure may have rendered impossible the fraudulent distribution of these securities. Upon complaint by the Commission, an injunction was entered in 1959, halting the fraudulent sale of unregistered common stock of Belmont Oil Corp. CONTINENTAL SULPHUR & PHOSPHATE CORP. (See D. F. Bernheimer & Co., Inc., SEA Rel. No. 7000 (1963).) Continental Sulphur & Phosphate Corp. was organized in 1950 to engage in the sulphur mining and refining business. Continental had always operated at a loss. It had a contract for 50 percent of the first year's production of a sulphur mill which had a capacity of 100 tons per day but never actually produced more than 30 or 40 tons per day or operated profitably. During the period 1955-59, mostly during 1955-56, D. F. Bernheimer & Co., Inc., a New York broker-dealer, sold more than 600,000 shares of Continental stock to at least 500 persons at prices ranging from 7/16 to 62. In making these sales, the broker-dealer through its officers and salesmen told customers that Continental owned or would soon own a sulphur-producing plant and that |