STUDY OF SECURITIES AND EXCHANGE COMMISSION

WEDNESDAY, JANUARY 9, 1952

HOUSE OF REPRESENTATIVES, SUBCOMMITTEE OF THE COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE, Washington, D. C.

The subcommittee met at 10 a. m., Hon. Louis B. Heller (chairman of the subcommittee) presiding.

Mr. HELLER. The subcommittee will be in order. The Chair desires to make the following statement:

On August 22, 1951, the Interstate and Foreign Commerce Committee by unanimous vote adopted the following resolution:

That the Chair be authorized to appoint a special subcommittee of seven members with authority to investigate the Securities and Exchange Commission and the exercise, by the Commission, of the duties and functions granted to it by law; and that this special subcommittee may report to the committee from time to time the results of its investigation with such recommendations for legislation or otherwise as it deems desirable and shall, before the expiration of the present Congress, submit to the committee a final report.

Pursuant thereto and on August 24, 1951, the Honorable Robert Crosser, the distinguished chairman of the entire committee, appointed the following members to the subcommittee:

Louis B. Heller (New York) chairman; William T. Granahan (Pennsylvania); John A. McGuire (Connecticut); Harley O. Staggers (West Virginia); Leonard W. Hall (New York); Hugh D. Scott, Jr. (Pennsylvania); and John B. Bennett (Michigan).

I should like to point out that pursuant to rule XI of the House entitled "Powers and Duties of Committees," the Committee on Interstate and Foreign Commerce, among its diversified powers and duties, has jurisdiction over securities and exchanges and that in conformity with the intent of section 136 of the Legislative Reorganization Act of 1946, it is the duty of the Interstate and Foreign Commerce Committee to exercise

continuous watchfulness of the execution by the administrative agencies concerned of any laws, the subject matter of which is within the jurisdiction of such committee; and, for that purpose, shall study all pertinent reports and data submitted to the Congress by the agencies in the executive branch of the Government.

Since the House had recessed on August 23, 1951, until September 12, 1951, the organizational meeting of this subcommittee was held on September 20, 1951. This meeting was attended by the chairman of the entire committee, the Honorable Robert Crosser and the members of the Subcommittee. At this meeting it was decided to invite the Commissioners of the Securities and Exchange Commission to meet with the subcommittee in executive session for an informal conference on September 25, 1951. On that day there appeared before this

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subcommittee all the members of the Commission, to wit: Commissioner Harry A. McDonald, Chairman and Commissioners Donald C. Cook, Richard B. McEntire, Paul R. Rowen, and Robert I. Millonzi. The Commission was requested to furnish a comprehensive statement of its duties, functions and operations by September 28. Such statements were submitted September 28 and October 9, 1951.

The subcommittee met again in executive session on October 17, 1951. At this conference the scope of the investigation to be undertaken by the subcommittee was discussed and it was agreed that the Commission should prepare condensed statements for final submission which would fully disclose to the subcommittee (1) the laws administered by the Commission; (2) the ways in which the Commission had administered the various statutes under which it functions; and (3) the operations of the Commission, so that the subcommittee could become thoroughly informed as to the powers, duties, and functions of the Commission, and its procedures, problems, and so forth. It was further agreed that these statements would be made part of the record and that there would appear before the subcommittee at its next meeting certain members of the Securities and Exchange Commission to be designated by the Commission itself, who would submit to interrogation relative to the said prepared statements.

The condensed report of the Securities and Exchange Commission entitled "A Summary of the Functions and Operations of the Securities and Exchange Commission" was submitted on October 29, 1951. In view of the fact that the Congress had adjourned on October 20, a copy of this statement was forwarded to the members of the subcommittee for study. Since the majority of the subcommittee had left the country on a committee assignment shortly thereafter, it was not possible to resume hearings until today.

The procedure of filing statements with the subcommittee in advance of scheduled hearings was agreed upon in the interest of expediting proceedings. It appears relevant at this point to make a few preliminary remarks for the record as to the proposed investigation.

At the informal conference attended by the Commissioners it was pointed out that the intention of the subcommittee was, to use the words of the distinguished chairman of the Interstate and Foreign Commerce Committee, Hon. Robert Crosser:

to conduct an inquiry into the work of the Securities and Exchange Commission, and to consider whether or not the purpose of the law creating the Commission has been fully appreciated and carried out.

In other words, the subcommittee will seek to ascertain whether or not the legislative intent and policy have been understood and carried out by the Commission. The inquiry will be conducted in an objective, fair, judicial, and impartial manner in the interest of the Nation.

In reviewing the Commission's activities we shall aim to do so in a constructive and dignified manner, to give credit and recognition to the Commission's achievements, and to point out any deficiencies and weak spots wherever these may occur, so that proper steps may be taken to correct them.

As heretofore explained at the informal conference, slander and character assassination will be ruled out of order. We will not smear, but we will not whitewash. At all times it shall be the aim of the subcommittee to extend to those involved and to those who want to be heard the privilege and opportunity to present their views. We

shall, however, avoid cluttering the record with irrelevant testimony and baseless defamatory remarks. We shall strive to keep the evidence within reasonable bounds of relevancy.

The record should also disclose that at the executive session of the subcommittee held on October 17, 1951, the subcommittee adopted the following rule:

For the purpose of taking sworn testimony at public or executive hearings two members of the Subcommittee shall constitute a quorum under the provisions of House Resolution 78, Eighty-second Congress, first session. However, if the chairman and the ranking minority member of the subcommittee so agree, one member of the subcommittee shall constitute a quorum for such purpose at any particular hearing.

Testimony given in executive session may be included by the vote of the committee in the printed hearings. Corrections in such testimony will be permitted only if necessary in the interest of clarity, brevity, or accuracy, or to correct any errors in transcription. If any other changes are to be made, application must be made to the chairman.

The several topics discussed in the Securities and Exchange Commission's statement dated October 29, 1951, will be placed in evidence and made part of the record as testimony relating to those topics are presented during the hearings.

Now it is my understanding that Commissioner McDonald, the Chairman, is here to testify on the Securities Act of 1933, which is the first chapter, pages 1 through 16, in the Commission's statement of October 29, 1951. This chapter will be considered as part of his direct testimony and made part of this record at this point. (The data referred to follows:)

THE SECURITIES ACT OF 1933

BACKGROUND OF THE ACT

Prior to the passage of the Securities Act of 1933 it had become clear that lax financial and ethical standards were undermining the integrity of our capital markets, destroying investor confidence, and were leading the business and financial enterprises of this country to the brink of disaster. The orgy of speculation which culminated in the disastrous debacle of 1929 made clear the pressing need for the establishment and preservation of higher standards of business conduct if the American system of private capital and democracy was to survive. Between 1920 and 1933, approximately $50,000,000,000 of new issues were sold to American investors, of which some $25,000,000,000 or 50 percent had become worthless by 1933.

The State "blue sky" laws were inadequate to meet the situation mainly because State authorities were unable to cope with the depredations of unscrupulous promoters operating over State lines. The experience gained in a decade of feverish activity revealed the need for Federal legislation which would curb financial malpractice and require those using and soliciting the use of other people's money to conform to certain minimum standards. Between 1933 and 1940, there were enacted seven statutes specifically designed to protect the American investors, and the administration of those statutes (including important functions under chapter X of the Bankruptcy Act) has been vested in the Securities and Exchange Commission.

The first of these statutes was the Securities Act of 1933. The language of the act and its legislative history indicate four cardinal principles which guided the Congress in enacting this statute. The principal objective of the act was to protect investors by requiring adequate and accurate disclosure regarding securities publicly offered for sale in interstate commerce or by use of the mails. Α second important aim was to create a mechanism for compelling such disclosure, under which, however, neither action nor nonaction of the agency charged with its administration could be interpreted as a guaranty or approval of any par

ticular security issue or the accuracy of any statements made with regard to the security or its issuer. Thus, the functions granted to the Commission under the act are limited to determining whether the information filed is adequate and accurate, and to compelling, insofar as possible, disclosure of relevant information. It is unlawful to represent that the Commission has in any way passed upon the merits of, or given approval to, any security.

The third cardinal principle upon which the act is erected is that all those responsible for statements, upon the basis of which the public is solicited to invest its money, shall be held to minimum standards of care and diligence. To implement this purpose, the act imposes certain liabilities, for failure to exercise such care and diligence, upon issuers, their directors, principal officers, and upon underwriters of securities publicly offered. The fourth was to outlaw fraud in the sale of all securities, whether or not newly issued, and to make such prohibition effective by vesting investigative and enforcement authority in an administrative agency specifically charged with this task.

REGISTRATION

To accomplish the disclosure objective of the act, it is provided that, before nonexempt securities may be offered or sold to the public through the mails or in interstate commerce, a registration statement must be filed with the Commission and must become effective. In general, Government and municipal securities and the issues of banks, railroads, and cooperatives are exempted from those provisions of the act.

As originally enacted, the act required a 20-day waiting period after filing before the registration statement could become effective. The act was amended in 1940 to give to the Commission the power to accelerate so as to permit an earlier effective date. The principal purposes of the waiting period are to give the public an opportunity to absorb the information in the prospectus or registration statement and to obviate the hasty methods and high pressure tactics of distribution, previously in vogue, which practically compelled distributors, dealers, and even their customers in many cases to make commitments blindly. An integral part of the registration statement, which is available for public inspection when filed, is the prospectus which is required to contain the more important information in the registration statement in order to make available to investors in a convenient form the basic material necessary to an appraisal of the security offered and its issuer. Among other things, information is required with regard to the character, size, and profitableness of the issuer's business, its capitalization, the purpose of the issue, outstanding options, remuneration of management, bonus and profit-sharing arrangements, underwriters' commissions, and pending or threatened legal proceedings. In addition, certified financial statements must be included.

Initially, experts were recruited from all classes of issuers, from the financial community and investor groups, and from the legal and accounting profession, to assist in the preparation of forms and rules suitable to the specialized needs of the many different kinds of businesses which would be required to file under the act. It has since been the Commission's established practice to submit proposed registration forms and rules to those persons to whom they would apply and to seek their comments and criticisms. The procedures first developed in 1933 and 1934 for public participation in the formulation of registration and reporting forms, and in the adoption of other rules and regulations, are the techniques which have since been incorporated in the Administrative Procedure Act of 1946 as procedures required to be followed by all agencies subject to that act. An important segment of the Commission's work continues to be concerned with the adoption and continuous revision of forms, rules, and regulations in the light of experience and changing conditions and circumstances in order to improve and simplify the registration process.

For similar reasons, the Commission organized its staff in a fashion which would most expeditiously accomplish the statutory objectives and yet create no undue interference with the process of security flotation. Consideration of registration statements filed by companies engaged in every field of industrial, commercial, and financial activity requires the skills of attorneys, accountants, engineers, corporation and security analysts, and economists. At the inception there were, however, no available precedents or experience upon which to pattern an organization which would effectively perform the various jobs as an integrated operation within the tight statutory time schedule for processing registration statements and the private time schedules of those engaged in the sale of securities.

It was determined that a conventional organization based upon a division of personnel according to professional skills into separate bureaus would be unsuitable because it would tend to impede coordination, cause delay in operations, and create a serious problem as to centralizing responsibility. To bring into play in the most effective manner the varied skills of the different experts who would be required to examine registration statements and to provide for expeditious review of such examination, the Registration Division (now called the Division of Corporation Finance) was organized on a functional basis and has continued essentially in that form until the present time. The Division is divided essentially into 12 examining sections, each headed by a chief and, when fully manned, staffed by 2 attorneys, an accountant, 7 analysts, and clerical and stenographic help. Due to budgetary limitations, these sections are now seriously understaffed. There are also four technical sections--an Engineering Section; an Oil and Gas Section; & Regulation A Section, which is primarily concerned with offerings under the limited exemption afforded by section 3 (b) of the act; and an Ownership Reports Section, which processes ownership reports filed under the Securities Exchange Act, the Public Utility Holding Company Act, and the Investment Company Act. These sections are initially responsible for the processing of registration statements, annual, current, and other reports, proxy statements, applications for exemption, interpretative and general correspondence, the conduct of administrative hearings and proceedings, certain investigatory work, and the processing of correspondence arising from every phase of the Division's work.

There are five assistant directors, of whom four are responsible for reviewing the examining work of the sections and one is responsible for the initial review of interpretative and legal matters; and a chief accountant who is responsible for the review of all accounting questions. In addition, there are specialists who assist the staff with respect to special fields of work. Subject to the supervision of the Commission, the director, with the aid of the associate director, formulates the broad policies and is ultimately responsible for all of the work of the staff. To attain uniformity of policy application, the flow of work is so organized as to require each assistant director to review a portion of the work of each of the examining sections. The director's practice of holding weekly staff meetings with the associate and assistant directors, the chief accountant for the Division, and with other key personnel, at which differences of opinion regarding application of policy, unique problems and suggestions for revision or modification are thoroughly canvassed, has resulted in a high degree of coordination, efficiency, and centralized responsibility of internal operations.

All matters arising under the Division's jurisdiction with respect to a particular company, regardless of the statute involved, are assigned to a particular section and assistant director, which makes for the most effective use of staff as well as a substantial convenience to the persons subject to regulation. The staff is always available to the public for discussion of specific problems which arise prior to formal filing of registration statements, applications, and reports and, thereafter, for general assistance by conference, letter, or telephone.

Commenting generally on the functional type of organization in the regulatory agencies, the Hoover Commission said: "The Securities and Exchange Commission is one example of an agency which has organized its staff primarily in this fashion, and apparently with marked success in administration.” (See Task Force Report on Regulatory Commissions, appendix N (1949), at p. 52.)

It must be reemphasized that the work of the staff is primarily concerned with obtaining adequate and accurate disclosure. Speculative or apparently unsound issues can be registered and sold provided the truth is told. The Commission cannot and does not direct the flow of capital except in the limited sense of preventing the patently fraudulent offering. The basic policy is not to protect the investor by insulating him from the risk but to make available to him the information with which to gage the risk. To accomplish this result with minimum interference with business, it was necessary to devise new administrative techniques and procedures for which there were no adequate precedents or prior experience. The statute sets up no procedure for the processing of registration statements. It seems to offer only a choice between automatic effectiveness upon the lapse of the statutory period or the institution of formal proceedings looking to a public stop order banning the sale of the securities involved. If, in those cases where revision of the registration statement seemed required, resort could only be had to formal proceedings, serious delays would be caused, and securities flotation would otherwise be hampered. Since this appeared to be contrary to the congressional intent, an informal procedure which would permit appropriate revision or modification without a hearing was devised. This technique, which has since been