These provisions would not apply to foreign companies, unless the Commission finds any such company, or class of companies, should be included because of an active trading market in the United States. Moreover, dealers who make markets in over-the-counter securities would be exempted from the insider-trading sections to the extent of their market-making activities, but subject to terms and conditions to be prescribed by Commission rules. Finally, the Commission would have broad powers to exempt issuers, affected persons, and securities.

The policy supporting this expansion of the basic disclosure philosophy of the Securities Acts into the over-the-counter market has long been recognized; so has the need. Both have been strongly confirmed by the report of the special study. To these I now turn.

B. THE BASIC DISCLOSURE PHILOSOPHY OF THE SECURITIES ACTS

The keystone of the entire structure of Federal securities legislation is disclosure. Making available to investors adequate financial and other information about securities is the best means of enabling them to make intelligent investment decisions and of protecting them against securities frauds. The Senate Committee on Banking and Currency in its 1934 report on stock exchange practices expressed this philosophy as follows:

"It is universally conceded that adequate information as to the financial structure and condition of a corporation is indispensable to an intelligent determination of the quality of its securities. The concept of a free and open market for securities necessarily implies that the buyer and seller are acting in the exercise of enlightened judgment as to what constitutes a fair price. Insofar as the judgment is warped by false, inaccurate, or incomplete information regarding the corporation, the market price fails to reflect the normal operation of supply and demand. One of the prime concerns of the exchanges should be to make available to the public honest, complete, and accurate information regarding the securities listed."

Although, the quoted statement singles out the exchanges, it applies and was intended to apply to all securities, listed or unlisted. Because too little was known about the over-the-counter market in 1934 to enable Congress feasibly to devise provisions as specific as those relating to listed securities, the original section 15 of the Exchange Act granted the Commission rulemaking power in relation to the over-the-counter market. In doing so the expressed purpose of Congress was "to insure" investors in over-the-counter securities "protection comparable" to that provided investors in listed securities. The sanctions made available, however, proved inadequate because of their focus upon brokers and dealers, rather than companies, and the provision was repealed.

There is no convincing reason why the comprehensive scheme of disclosure that benefits the exchange markets should not also apply in the over-the-counter market. Nothing in the nature of the securities traded in that market or in its mechanics make any less necessary the disclosure of basic information about its companies. On the contrary, because the over-the-counter market includes not only widely known and seasoned compaines, but also relatively unknown and insubstantial ones, the need of investors for accurate information is at least as great, if not greater, than in the exchange markets. The overthe-counter market has become a great institution in channeling the flow of investor capital and has undergone a spectacular growth in the last decade. A brief summary of that development will perhaps clearly demonstrate the importance of this market.

C. GROWTH IN THE OVER-THE-COUNTER MARKET

The recognized need for adequate protection in the over-the-counter market has been greatly accentuated by its expansion and increasing importance, as vividly documented by findings of the special study. The average number of stocks quoted in the daily "sheets" of the National Quotation Bureau, circulated among dealers in the over-the-counter market, increased from 5,000 in 1946 to 8,200 as of January 15, 1963. Moreover, during a 10-month period in 1961 and 1962, quotations were entered in over 14,000 different domestic stocks traded exclusively in the over-the-counter market. In addition, over-the-counter sales of corporate stocks, excluding sales of mutual fund shares and syndicated distributions, increased almost 700 percent in 12 years from an estimated $4.9 billion in 1949 to $38.9 billion in 1961. The importance of the over-the

counter market is further reflected in the fact that, considering only public sales, the volume of over-the-counter stock transactions in 1961 amounted to approximately 75 percent of exchange transactions in terms of shares and 35 percent in terms of dollars.

Companies with stocks traded exclusively in the over-the-counter market constitute an important sector of our economy. A special study sample of over 1,600 of these companies showed that 31 percent had assets of over $10 million, 47 percent had assets of over $5 million, and 77 percent had assets of $1 million or more. Approximately one-half had 500 or more record shareholders and 16 percent had 2,000 or more.

Thus it is clear this is not a modest market, nor are these modest companies with which we are dealing. A substantial public interest needs to be served.

D. THE NEED FOR DISCLOSURE IN THE OVER-THE-COUNTER MARKET The lack of basic investor protection in the over-the-counter market has made informed investment judgment difficult, has introduced an artificial factor in the allocation of securities between the exchange and over-the-counter markets, and has created grave difficulties for brokers and dealers who try to fulfill their responsibilities to provide sound investment advice to the public. It has further deprived investors of important bulwarks against fraud.

The entire report of the special study so far submitted to the Congress is a documented analysis of the necessity for disclosure. The report demonstrates that irresponsible selling tactics, reckless investment advice, extravagant financial public relations, and erratic markets for new issues of securities thrive best where lack of information is most marked. One deplorable manifestation of these ill effects is reflected in the fact that the overwhelming preponderance of securities fraud cases in past years have involved over-the-counter securities. Vigorous enforcement efforts by the Commission cannot be a full substitute for preventative measures which would be far less costly to the taxpayer and to the victimized investor. Eloquent testimony of investor needs is provided by investors themselves. The most significant number of public complaints received by the Commission concerns requests for information about over-the-counter companies with respect to which the public has little or no adequate information. The public should not be asked to buy and sell in darkness, nor can professionals in the securities markets advise them properly in the absence of reliable information. An analyst attempting to assess the investment worth of a company which does not file reports may be unable to find adequate or reliable data in the financial manuals and often is relegated to the choice of utilizing that information which management chooses to make public or expending considerable effort and expense in making his own investigation.

Because of the crucial disparity between the exchanges and the over-thecounter market, that market undoubtedly fails to receive the measure of confidence which it might otherwise enjoy. Thus, the public may draw a fairly sharp line in its investments, as it appears to have done after the market break of a year ago. It is well known that the over-the-counter market has not shown the same resiliency since that sharp decline as the exchange markets, both in terms of price and of volume.

Experience under the Federal securities laws has proven that providing basic investor protection encourages a healthy development of the securities markets. If the present double standard is eliminated, investor confidence in the over-thecounter market will be increased, the ability of companies to raise necessary capital will be enhanced, and securities will gravitate to the market best suited to them.

The need of the over-the-counter market for the benefits offered by this legislation is clear. In its report on S. 1168, 85th Congress, a bill similar in purpose to S. 1642, the Senate Committee on Banking and Currency recognized the inadequacies of the present protection afforded investors in the over-the-counter market:

"The principle of equal treatment by the law of listed and unlisted large corporations in requiring them to furnish financial information to investors has received thorough consideration for nearly a quarter of a century. Many of the arguments against S. 1168 are the same as those advanced against the original Securities Exchange Act of 1934. It is significant that many of the groups opposing the original laws have now become its stanch supporters because of its protection to investors and its furthering of the public interest. The committee

believes that the same recognition of the public interest will follow the enactment of S. 1168."

The need has not diminished, nor is it theortical. The over-the-counter market has grown tremendously in securities traded and in number of investors. Only the protections have stood still.

E. EXAMINATION OF REPORTING BY OVER-THE-COUNTER COMPANIES

The disclosure habits of over-the-counter companies confirm the justifiications in logic and policy for a statutory base of responsibility. On three previous occasions, in 1946, 1950, and 1956, Commission surveys have shown that the financial reporting and proxy solicitation practices of these companies were seriously deficient. An even more exhaustive examination made by the special study corroborated these findings.

The study analyzed the reporting practices of 556 industrial companies which were selected on a random basis. Deficiencies ranged from a failure to distribute any reports to shareholders on the part of a significant number of companies to important defects in the disclosures of numerous others. The results of the special study's examination of proxy solicitation practices of these same companies were even more striking. Many did not even solicit proxies. Of those that did, a clear majority omitted such vital information as the names or experience of nominees for directors of the remuneration of the management.

The findings of the special study do indicate that disclosure patterns tend to improve with increased shareholder ownership. This improvement would, of course, be reflected in those companies with $1 million of assets and 500 shareholders that will be covered by S. 1642. Nevertheless, in companies of that category included in the special study survey, significant inadequacies were found in reporting customs. Thirteen percent did not distribute any financial information to shareholders in 1961. Of those that did, in 12 percent of the cases, it was not certified by an independent public accountant. The proxy solicitation practices of these companies showed even greater need of improvement. Seventeen percent did not furnish any material to stockholders during 1961; 62 percent of the companies which solicited proxies involving election of directors did not disclose the name of nominees; and 92 percent made no disclosure of the remuneration of management. Significant deficiencies were found in many other respects.

The study's review of financial reporting habits would indicate to the extent permitted by such an examination-that some companies presently furnish adequate information. A company making such voluntary disclosures should have no objection to continue doing so under a congressionally endorsed policy. Most importantly, investors in over-the-counter securities are entitled to be assured of the adequacy of the information revealed. This can be achieved only by the imposition of legal obligations which would shape the development of appropriate accounting and other disclosure practices. In the absence of statutory requirements, it cannot be expected that in times of corporate stress-when the need for full and accurate information is most acute-managements will necessarily disclose, on a voluntary basis, matters which may tend to reflect adversely on their activities or on their companies.

F. OVER-THE-COUNTER COMPANIES COVERED BY S. 1642

The necessity for disclosure has long been recognized. The extent of coverage of any disclosure requirements, however, has been a more difficult issue from the point of view of both the size and type of company to be covered. The special study made a particular effort to develop appropriate tests and also especially examined the disclosure practices of banks and insurance companies, examples of regulated industries which have raised special questions in the past.

S. 1642 would extend sections 12, 13, 14, and 16 of the Exchange Act initially to those companies having $1 million in assets and 750 stockholders of record. After a 2-year period, or such later date as the Commission may determine, the shareholder test would be reduced to 500. It is estimated that under the 750shareholder standard, approximately 3,100 companies would be covered, of which about 400 would be banks, subject to the appropriate Federal banking regulatory agency. About 1,500 of the remaining 2,700 are already required to file reports with the Commission under section 15(d) of the Exchange Act. Under the 500-shareholder standard, the estimated figures are 3,900 companies covered, 600 banks, and 1,700 companies already reporting.

The size and shareholder interest of these companies alone indicates the extent of the public interest in them. This interest is further underlined by statistics of the special study which reveal that trading activity in the securities of these companies, as measured by record transfers and broker-dealer interest, is significant for a substantial majority of them.

The selection of the recommended standard of coverage, necessarily a matter of judgment, is based on several factors. Most influential among these is investor interest as evidenced by the number of shareholders. At the same time, the number of companies had to be limited in order that the flow of reports and proxy statements would be manageable from the administrative standpoint and not disproportionately burdensome on companies in relation to the needs to be served.

It is primarily because of the anticipated administrative load, particularly in the years immediately following the effectiveness of S. 1642, that section 3 (c) embodies a phasing down in coverage. Moreover, if, for any reason, the Commission could not accommodate the increased number of companies filing under the lower standard, it could defer operation of that standard. Since the pertinent provisions of S. 1642 do not become effective until 1964, companies will generally not register until fiscal year 1965. Costs of the program for that year are estimated at approximately $600,000.

G. DISCLOSURE WITH RESPECT TO BANK SECURITIES TRADED IN THE OVER-THE-COUNTER MARKET

S. 1642 would apply to over-the-counter banks meeting the statutory standards. However, the bill also provides that all the powers, functions, and duties of the Commission with respect to bank securities shall be delegated to the appropriate Federal banking regulatory authority upon its request. This section accordingly extends disclosure protections to investors in bank stocks and at the same time permits integration of these safeguards with those for depositors provided by the Federal banking regulatory structure.

The report of the special study demonstrates the substantial importance of over-the-counter bank stocks both in terms of number of shareholders and amount of dollars invested. Approximately one-fifth of the securities designated in the 3-month period covered by the January 1962 summary of the National Quotation Bureau, Inc., were bank stocks. Further data from the special study indicates that over 600 banks would be covered by S. 1642. Moody's Bank and Finance Manual for 1963 lists over 550 banks meeting the coverage standards. The aggregate number of shareholders of these banks (without adjustment to eliminate duplication) was approximately 1,600,000 and the aggregate market value of the bank stocks held by these investors, as of December 31, 1962, was about $22.5 billion.

These figures vividly illustrate the extremely broad investor interest in overthe-counter bank stocks and the corresponding need for the disclosure requirements now recommended generally for over-the-counter companies. Do investors in bank stocks need this protection any less than other investors? The question frequently raised in connection with the application of these disclosure provisions to banks is whether duplicative and unnecessary regulation would result. This question has been resolved by S. 1642-authorizing their administration by the banking agencies.

The Federal banking regulatory authorities involved in this bill are the Comptroller of the Currency (as to national banks), the Federal Reserve Board (as to members which are not national banks), and the Federal Deposit Insurance Corporation. We are informed that either the Comptroller or the Federal Reserve Board would have jurisdiction over most of the banks covered by this bill. Delegation to these agencies is mandatory upon their request; enforcement power would go with it. There would be no residual control in the Securities and Exchange Commission after this delegation. Moreover, if the Comptroller or the Federal Reserve Board (or the Federal Deposit Insurance Corporation with respect to a minority of banks) did not request such authority, we agree that any functions left with the Commission will be administered for the appropriate banking agencies. If the bill is not crystal clear on these points, we shall be glad to revise it accordingly. In sum, the Commission has no desire, and is indeed reluctant, to take direct responsibility over bank disclosure in any respect. It is only the principle of adequate disclosure which we assert.

Accordingly, the only remaining issue is whether present practices of banks are such that the purposes of S. 1642 have already been satisfied. The great objec

tives of banking regulation are controls over the flow of credit in the monetary system, the maintenance of an effective banking structure, and the protection of depositors. These objectives neither utilize the same tools nor achieve the same ends as investor protection. The purpose of disclosure is to place the investor in a position to make an informed judgment on the merits of a security, and to provide a basis for comparing that security with others issued by companies in the same or different industries. Essentially this purpose is achieved through the furnishing of financial information which provides a uniform pattern of reporting based on understood and generally accepted accounting practices. To say that bank regulation renders this disclosure philosophy unnecessary is to say that bank regulation is an effective substitute for the free exercise of an investor's judgment. Controls which protect against embezzlement and which assure adequate reserves serve important objectives, but not the objective of informed investment. To hold otherwise would be to imply, that, because of such regulation, bank securities are, without more, worthy investments.

We ask whether the investor should evaluate bank stocks himself or should it be done in Washington? We do not believe any bank regulatory agency would, or should undertake to say that X bank stock is a better value than Y bank stock? Such a practice is paternalism-a philosophy wholly at odds with that chosen by Congress to protect investors, as distinguished from depositors.

The emphasis in the objectives of banking regulations is manifested in its financial reporting requirements. A key report in investment analysis, the income statement, is filed on a confidential basis with the banking authorities and, except at the option of a particular bank, is not available to the public. No attention is given to the protection of investors in proxy solicitations with the exception of recent efforts of the Comptroller of the Currency, nor are there any restrictions with respect to insider trading.

The inadequacies of this reporting structure for the investor's purposes have been brought out by the special study. Its analysis revealed that the disclosure practices of banks fall far short of the standards imposed under sections 13, 14, and 16 of the Exchange Act. In the category of banks that would be covered by S. 1642, the study's findings show that 10 percent did not send any financial information to their shareholders. Of those that did, 32 percent failed to include the most important document, a profit-and-loss statement. These findings are illustrative of the fact that uniformity of reporting to provide some basis for comparing bank stocks among themselves or with other stocks has been notably lacking. Significant deficiencies, moreover, were also found in the proxy practices of banks. For example, in 88 percent of the solicitations that involved election of directors, the names of the nominees were not stated and in 95 percent, their experience was not given. In all cases management remuneration was not furnished.

There have been recent efforts on the part of the Comptroller of the Currency to provide by annual reporting and proxy rules some protection for bank investors. These regulations fall considerably below those contemplated by the Exchange Act, although they constitute a welcome recognition by the Comptroller of the need for action in this area. The regulations, for example, do not provide for review of proxy materials prior to their distribution, contain no general prohibition of the use of false or misleading information, and specifically deny the right of shareholders to secure relief against false or misleading solicitations. In addition, the Comptroller has no express authority to seek an injunction against the use of improper proxy material. Thus useful administrative practices, along the lines developed by the Commission, for assisting companies in transmitting properly prepared proxy materials, are not available nor are effective administrative or private sanctions. Other serious shortcomings are the failure to require that annual reports be submitted to shareholders in time for annual meetings when they would be of most service; the failure to require information about the interests of officers or directors in material transactions or matters to be acted upon by shareholders; and the omission of any duty to disclose the experience of nominees for directorships. Of course, the Comptroller's regulations do not provide any protection against insider trading. Furthermore, they are only applicable to some national banks and leave a large number of banks-national, member, insured, and State-in which there is substantial investor interest free from the responsibility to make necessary disclosures.

The regulations of the Comptroller have been adopted pursuant to his general authority to require special reports. There is, of course, no established con