SEC LEGISLATION, 1963

THURSDAY, JUNE 20, 1963

U.S. SENATE,

COMMITTEE ON BANKING AND CURRENCY,

SUBCOMMITTEE ON SECURITIES,

Washington, D.C. The subcommittee met, pursuant to recess, at 10:05 a.m., Senator A. Willis Robertson (chairman of the full committee) presiding. Present: Senators Robertson and Bennett.

The CHAIRMAN. The committee will please come to order. The chairman of this subcommittee, Senator Williams, of New Jersey, has asked me to preside today because he has to be in his own State on important State matters.

He asked me to say that he regretted his inability to hear the witnesses who will be here this morning and to question them, but he will carefully read their statements and consider them before the committee takes any action to mark up the bill.

The first organization that Chairman Williams scheduled to be heard this morning is the National Association of Real Estate Boards, which I understand will be represented by Mr. John C. Williamson, director.

If Mr. Williamson is here, please come forward, and we will be glad to hear you.

STATEMENT OF JOHN C. WILLIAMSON, DIRECTOR OF GOVERNMENTAL RELATIONS, NATIONAL ASSOCIATION OF REAL ESTATE BOARDS

Mr. WILLIAMSON. Mr. Chairman and members of the subcommittee, I appreciate this opportunity to present the views of the National Association of Real Estate Boards in regard to S. 1642, a bill to amend the Securities Act of 1933 and the Securities Exchange Act of 1934.

Our association, consisting of approximately 74,000 realtors in more than 1,450 local real estate boards, is interested in the pending legislation primarily because of its effect on real estate securitiesa relatively new but fast growing segment of both the real estate and securities industries.

The real estate security is a unique security in that shares in real estate investment trusts and limited partnerships convey interests in real estate. There is some reported judicial opinion to the effect that one who sells a certificate of beneficial interest in a trust or syndicate unit is selling real estate and is therefore subject to appropriate State licensing laws.

Be that as it may, our association is concerned with preventing abuses in the sale of real estate securities and improving investor protection.

The first real estate syndicate was filed with the Securities and Exchange Commission on February 11, 1952. Since then, 130 syndicates have been filed representing total public offerings of $272,744,560; 75 real estate "cash flow" corporations representing total offerings of more than $772 million; and 70 real estate investment trusts representing more than $500 million in public offerings.

This, while impressive, is only part of the picture. Real estate syndicates, particularly in New York, rely heavily on the intrastate exemption from SEC requirements. We believe that a major portion of syndicate public offerings have been made within this intrastate exemption. Unofficial estimates of all public offerings in real estate exceed $10 billion. We are therefore talking about a significant segment of the securities markets.

Getting down to the two principal provisions of the bill, one relating to distribution of real estate securities and the other with respect to adequate reporting, a substantial number of the sellers of real estate securities are not licensed to sell real estate and, because of the intrastate exemption, are not subject to the self-policing requirements of the National Association of Securities Dealers.

To quote from the report of the special study of the securities markets:

The salesman of real estate securities is purveying a commodity more intricate than most securities. Even a sophisticated investor may have difficulty in evaluating the tax aspects of an offering, or the factors of risk and promoters' benefits, and the best investment analysts and counsellors have little if any expertise in the real estate securities field.

The report cites an extremely active underwriter of real estate syndicate shares which gives its salesmen total training of from 8 to 10 hours.

The interest of the investing public as well as the real estate industry require, in our opinion, approval by the Congress of the proposal in the pending bill requiring all broker-dealers and registered representatives, who make use of the mails, or an instrumentality of interstate commerce, to register with the Securities and Exchange Commission and belong to a registered securities association which at present means the National Association of Securities Dealers.

We endorse the provision in the bill which would require registered securities associations such as NASD to adopt rules establishing standards of training, experience, and competence for members and their employees.

We have conferred with officials of NASD and have recommended that their testing requirements reflect this need for more information about real estate securities.

We have offered our cooperation in developing adequate professional standards and qualifying examinations, and we are very pleased to advise that the NASD has accepted our offer of cooperation and that in the near future a committee of our department of education will be meeting with some of the NASD people toward accomplishing this objective.

Now I will turn to another aspect of the report of the special study and the pending legislation. This relates to adequate reporting of

information to investors by promoters of syndicates, trusts, and corporations.

Quoting from the report of the special study:

Issuers of real estate securities seem to share a general reluctance to send regular reports to their security holders with information adequate for an informed appraisal of the issuers' operations including distribution policy, although they may be required to submit an annual balance sheet and profit-andloss statement of income to each participant.

However, even these annual balance sheets and profit-and-loss statements sent to investors fall short of our view of adequate reporting because such statements generally are not certified.

In the language of the report:

Holders of real estate securities rank high among those in need of protection that can be provided by legislation extending certain reporting provisions of the Exchange Act of 1934.

Section 4 of the bill (amending sec. 13 (a) of the act) would remedy this deficiency in reporting to investors by providing for the filing of annual reports containing certified financial statements.

We endorse section 5 (c) of the bill (adding sec. 14(c) to the act), which provides that a company not soliciting proxies would nevertheless be required to furnish shareholders with information equivalent to that contained in a proxy statement.

We also endorse the provision requiring an issuer having total gross assets in excess of $1 million to file a registration statement with the Commission for any class of its equity security held of record by 500 or more persons. This requirement would cover issuers whose securities are traded by use of the mails or any means or instrumentality of interstate commerce.

Earlier in my testimony I referred to estimates of approximately $10 billion in real estate public offerings, although only about $1.5 billion represented filings under the Securities Act of 1933. The balance of $8.5 billion represents intrastate exemptions. The proposed section 12(g) would reach a substantial portion of these exempt offerings and result in a measure of disclosure and regulation both necessary and desirable in the public interest.

Another desirable change flowing from section 3(c) of the bill (adding sec. 12 (g) to the act) would require issuers to file information with respect to material contracts not made in the ordinary course of business. With respect to real estate this would include, for example, management contracts, leases, and mortgages not covered in the initial disclosure. We concur in SEC Chairman Cary's statement in his testimony that—

a company which goes to the public for funds should not subsequently be free to seal off its operations from disclosure.

We appreciate the administrative requirements that necessitate limiting the application of section 12(g) to issuers whose shares are held by 500 persons or more (750 or more persons until July 1, 1966). However, we hope that the Congress and the SEC, after further study, will find it practicable to reduce this minimum to perhaps 300 shareholders in order to bring within the requirements of section 12(g) a greater number of real estate syndicates.

In closing, Mr. Chairman, we would like to submit for the record a copy of a resolution entitled "Real Estate Securities" adopted by

the board of directors of the National Association of Real Estate Boards earlier this month.

The CHAIRMAN. Without objection, it will be received.

(The resolution referred to reads as follows:)

REAL ESTATE SECURITIES

STATEMENT OF POLICY ADOPTED BY THE BOARD OF DIRECTORS OF THE NATIONAL ASSOCIATION OF REAL ESTATE BOARDS, CHICAGO, ILL., JUNE 4, 1963

We pledge our cooperation with the Securities and Exchange Commission in the development of adequate regulations, including regulatory power, directed at preventing abuses in the operation of real estate companies engaged in the public offering of real estate securities.

We urge that the National Association of Securities Dealers, a self-policing trade association recognized as such by the Securities and Exchange Commission, develop appropriate qualifying examinations for broker-dealers and salesmen who are engaged in the sale of real estate securities. We pledge to the National Association of Securities Dealers the cooperation and assistance of this association in the development of appropriate professional standards and qualifying criteria for those engaged in the sale of real estate securities. (The prepared statement of Mr. Williamson follows:)

STATEMENT OF JOHN C. WILLIAMSON, DIRECTOR OF GOVERNMENTAL RELATIONS, NATIONAL ASSOCIATION OF REAL ESTATE BOARDS

Mr. Chairman and members of the subcommittee, I appreciate this opportunity to present the views of the National Association of Real Estate Boards in regard to S. 1642, a bill to amend the Securities Act of 1933 and the Securities Exchange Act of 1934.

Our association, consisting of approximately 74,000 realtors in more than 1,450 local real estate boards, is interested in the pending legislation primarily because of its effect on real estate securities—a relatively new but fast growing segment of both the real estate and securities industries.

The real estate security is a unique security in that shares in real estate investment trusts and limited partnerships convey interests in real estate. There is some reported judicial opinion to the effect that one who sells a certificate of beneficial interest in a real estate investment trust or a limited partnership unit in a syndicate is selling real estate and is therefore subject to appropriate State licensing laws.

Be that as it may, our association is concerned with preventing abuses in the sale of real estate securities and in improving investor protection. We are motivated by the same considerations which inspired realtors to bring about enactment of real estate licensing laws in all 50 States.

A portion of the report of the "Special Study of the Securities Market," submitted to the Congress on April 3, 1963, is devoted to real estate securities and refers to this segment of the securities business as a "phenomenon new to the last decade."

The first real estate syndicate was filed with the Securities and Exchange Commission on February 11, 1952. Since then, 130 syndicates1 have been filed representing total public offerings of $272,744,560; 75 real estate "cash flow" corporations 2 representing total offerings of $772,493,874; and 70 real estate investment trusts representing $501,119,806 in public offerings.

3

This, while impressive, is only part of the picture. Real estate syndicates, particularly in New York, rely heavily on the intrastate exemption from SEC requirements. We believe that a major portion of syndicate public offerings have been made within this intrastate exemption. Unofficial estimates of all public offerings in real estate exceed $10 billion. We are therefore talking about a significant segment of the securities market.

Of the three real estate security issuers, the real estate investment trust is subject to a substantial degree of regulation by the Internal Revenue Service as

1 Ten of these, as of June 12, 1963, had been withdrawn; 6 were pending.

2 Thirteen of these, as of June 12, 1963, had been withdrawn; 6 were pending.

8 Twenty-two of these, as of June 12, 1963, had been withdrawn; 6 were pending.

well as State laws governing trusts. This, coupled with the relatively recent revival of the trust as a real estate investment vehicle, has left the real estate investment trust untouched by the recent highly publicized disclosures of irregularities in the operation of real estate syndicates and "cash flow" corporations.

DISTRIBUTION OF REAL ESTATE SECURITIES

A substantial number of the sellers of real estate securities are not licensed to sell real estate and, because of the intrastate exemption, are not subject to the self-policing requirements of the National Association of Securities Dealers. To quote from the report of the special study:

"The salesman of real estate securities is purveying a commodity more intricate than most securities. Even a sophisticated investor may have difficulty in evaluating the tax aspects of an offering, or the factors of risk and promoters' benefits, and the best investment analysts and counselors have little if any expertise in the real estate securities field."

The report cites an extremely active underwriter of real estate syndicate shares which gives its salesmen total training of from 8 to 10 hours.

The interests of the investing public as well as the real estate industry require, in our opinion, approval by the Congress of the proposal in the pending bill requiring all broker-dealers and registered representatives, who make use of the mails, or an instrumentality of interstate commerce, to register with the Securities and Exchange Commission and belong to a registered securities association which at present means the National Association of Securities Dealers.

We endorse the provision in S. 1642 (sec. 7(a)(3)) which would require registered securities associations to adopt rules establishing standards of training, experience, and competence for members and their employees. We also have recommended that the National Association of Securities Dealers revise its testing requirements to require that broker-dealers and salesmen of real estate securities possess adequate knowledge of real estate investment and the real estate busi

ness.

Perhaps NASD members and persons associated with members dealing exclusively or principally in real estate securities could be classified as such and be subject to specialized training and qualifications. This, we believe, is contemplated in the new section 15A (b) (3) which would be added to the Securities Exchange Act of 1934.

We have advised NASD of our views on the subject and have offered our cooperation in developing appropriate professional standards and qualifying examinations for applicants who propose dealing in real estate securities. I am pleased to advise that the officials of NASD have accepted our offer of cooperation in this matter.

ADEQUATE REPORTING TO INVESTORS

I will now turn to another aspect of the report of the special study and the pending legislation. This relates to adequate reporting of information to investors by promoters of syndicates, trusts, and corporations.

Quoting from the report:

"Issuers of real estate securities seem to share a general reluctance to send regular reports to their security holders with information adequate for an informed appraisal of the issuers' operations including distribution policy, although they may be required to submit an annual balance sheet and profit and loss statement of income to each participant."

However, even these annual balance sheets and profit and loss statements sent to investors fall short of our view of "adequate reporting" because such statements as a rule are not certified.

In the language of the report:

"Holders of real estate securities rank high among those in need of protection that can be provided by legislation extending certain reporting provisions of the Exchange Act of 1934."

Section 4 of the bill (amending sec. 13(a) of the act) would remedy this deficiency in reporting to investors by providing for the filing of annual reports containing certified financial statements, semiannual reports of uncertified profit and loss and earned surplus statements, and current reports whenever events of immediate interest to investors occur.

We endorse section 5(c) of the bill (adding sec. 14 (c) to the act), which provides that a company not soliciting proxies would nevertheless be required to furnish shareholders with information equivalent to that contained in a proxy statement.