Similarly, the report of the House Committee on Interstate and Foreign Commerce (H. Rept. No. 1383, 73d Cong., 2d sess.) accompanying the House bill for the regulation of exchanges quotes with approval the following statement from the report of the Twentieth Century Fund on Stock Market Control:

To leave the over-the-counter markets out of a regulatory system would be to destroy the effects of regulating the organized exchanges (p. 16).

These statements remain no less true today.

3. Abuses in the over-the-counter markets.-A single phase of the administrative experience of the Securities and Exchange Commission suffices to illustrate the extent of the problem of policing the submarginal element among over-the-counter brokers and dealers. In 1937, the Commission made investigations in three areas outside the largest financial centers-in Cleveland, Detroit, and the Pacific Northwest. A few attorneys and accountants were sent to these areas to inquire into certain complaints and to make a brief survey. In the space of a few months 13 individuals were criminally convicted, 16 more were placed under indictment, 17 corporations and 41 more individuals were enjoined, and 2 firms were expelled or obliged to withdraw from national securities exchanges, all for elementary violations of the law. These results produced by so limited a staff within three restricted areas in so short a time speak for themselves. We are advised that the Commission has every reason to believe that the problem revealed thereby exists in other regions as well.

4. Nature of the problem of regulation.-The problem of regulation of the over-the-counter markets has three aspects: First, to protect the investor and the honest dealer alike from dishonest and unfair practices by the submarginal element in the industry; second, to cope with those methods of doing business which, while technically outside the area of definite illegality, are nevertheless unfair both to customer and to decent competitor, and are seriously damaging to the mechanism of the free and open market; and, third, to afford to the investor an economic service the efficiency of which will be commensurate with its economic importance, so that the machinery of the Nation's markets will operate to avoid the misdirection of the Nation's savings, which contributes powerfully toward economic depressions and breeds distrust of our financial processes.

The committee believes that there are two alternative programs by which this problem could be met. The first would involve a pronounced expansion of the organization of the Securities and Exchange Commission; the multiplication of branch offices; a large increase in the expenditure of public funds; an increase in the problem of avoiding the evils of bureaucracy; and a minute, detailed, and rigid regulation of business conduct by law. It might very well mean expanding the present process of registration of brokers and dealers with the Commission to include the proscription not only of the dishonest, but also of those unwilling or unable to conform to rigid standards of financial responsibility, professional conduct, and technical proficiency. The second of these alternative programs, which the committee believes distinctly preferable to the first, is embodied in S. 3255. This-program is based upon cooperative regulation, in which the task will be largely performed by representative organizations of investment bankers, dealers, and brokers, with the Government exercising appropriate supervision in the public interest, and exercising supplementary

powers of direct regulation. In the concept of a really well organized and well-conducted stock exchange, under the supervision provided by the Secruities Exchange Act of 1934, one may perceive something of the possibilities of such a program.

C. LEGISLATIVE BACKGROUND

In the Securities Exchange Act of 1934, as originally enacted, the over-the-counter markets were dealt with, in brief outline, in a single section. The brevity and generality of this treatment arose from a realistic recognition of the great difficulties of working out in any detail a suitable plan of regulation at that time, in view of the fact that so little was then known concerning these markets. But, though the Congress did not at that time have before it a sufficient record of data or experience to enable it to determine upon a detailed plan of regulation, it clearly set forth the objectives of and the standards for such regulation. Section 15, in its original form, expressly contemplated the adoption by the Securities and Exchange Commission of rules and regulations concerning the over-the-counter markets "necessary or appropriate in the public interest to insure to investors protection comparable to that provided by and under authority of this title in the case of national securities exchanges". To that end, the Commission was authorized to adopt rules and regulations providing "for the regulation of all transactions by brokers and dealers on any such market, for the registration with the Commission of dealers and/or brokers making or creating such a market, and for the registration of the securities for which they make or create a market."

* * *

After a year and a half of administrative experience under the original section 15, that section was, in May 1936, amended to embody the results of that experience. In consequence, section 15 in its present form is far more specific than in its original form. Since that amendment, another year and a half of administrative experience has been accumulated. This experience has both demonstrated the need and laid the foundation for a further step, which is taken in the bill now under consideration. In the judgment of the committee this bill, like the amendment of section 15 enacted in May 1936, does not enlarge the objectives or the outline of regulatory functions initially set forth in the original section 15. On the contrary, it represents the essential process of filling in and implementing the original outline in order to make possible the realization of the original objectives.

D. GROWTH OF THE IDEA OF COOPERATIVE REGULATION

The plan of cooperative regulation embodied in S. 3255 rests upon 3 years of gradual and orderly growth. Almost from its inception, the Commission conducted extended conferences with representatives of various associations of investment bankers, dealers, and brokers from all parts of the country. About 3 years ago a conference committee was formed, representative of the industry, to obtain the views of investment bankers, dealers, and brokers as to the desirability of perfecting a permanent scheme of organization for the purposes hereinabove discussed. As a result of the activities of the conference committee, there came into existence in 1936 an organization known as the Investment Bankers Conference, Inc. This organization has

enrolled and maintained a membership, the committee is informed, of some 1,700 firms situated in all parts of the United States. There are likewise in existence in the country a number of other associations of brokers and dealers which have for some time exercised a degree of supervision over the conduct of their members.

The committee believes that these years of experiment in organization among members of the industry and in the development of their relations with the Commission provide a sound and practical basis for the program embodied in S. 3255.

II

ANALYSIS OF THE BILL BY SECTIONS

A. SECTION 1

Section 1 would amend the Securities Exchange Act of 1934, as amended, by inserting after section 15 thereof a new section, section 15A.

1. Subsection (a) of section 15A.-This subsection provides that associations of brokers or dealers may register with the Commission as national securities associations pursuant to subsection (b), or as affiliated securities associations pursuant to subsection (d), under stated terms and conditions, upon the filing of certain specified data. This subsection is similar to subsection (a) of section 6 of the Securities Exchange Act of 1934, as amended, which provides for the registration of national securities exchanges, except that associations which do not register are not denied the use of the mails or instrumentalities of interstate commerce. Thus, the formation of associations and application for registration by them are matters of voluntary choice. It should be noted that membership by a broker or dealer in such a registered securities association does not supersede the obligation of individual brokers or dealers to register under section 15 of the Exchange Act.

2. Subsection (b) of section 15A.-This subsection sets forth requirements which an association of brokers or dealers must satisfy to qualify for the registration as a national securities association. The requirements are enumerated in 10 paragraphs, a discussion of which follows: (a) Paragraph (1) of subsection (b): This paragraph limits eligibility for registration as a national securities association to such associations as are a proper subject of national concern. It is contemplated that associations, to qualify under this paragraph, should either be actually Nation-wide in scope or should represent a substantial and economically cohesive region. Without suggesting that such regions should necessarily be identical with the districts under the Federal Reserve System, such districts may perhaps be cited as an illustration of the type of region which would be appropriate.

(b) Paragraph (2) of subsection (b): This paragraph limits eligibility for regisration as a national securities association to associations ofe which thte general pattern of organization and general character ar such as to satisfy the Commission that they will be able effectually to discharge their function of carrying out the purposes of the new section 15A within the framework of the Exchange Act.

(c) Paragraph (3) of subsection (b): The broad purpose of this paragraph is to make sure that all brokers and dealers who conduct

an honest and responsible business shall be eligible for membership in some association. Particular associations may, however, by their rules restrict membership therein on such specified geographical basis, such specified basis relating to the type of business done by their members, or on such other specified and appropriate basis as appears to the Commission to be necessary or appropriate in the public interest or for the protection of investors and to carry out the purposes of the new section 15A. Thus, an association, membership in which is limited to brokers and dealers from some designated geographical region, or to brokers and dealers transacting business exclusively in a particular class of securities, may be eligible for registration. Any geographical restrictions upon membership, however, must be broad enough to satisfy the requirements of paragraph (1).

(d) Paragraph (4) of subsection (b): The broad purpose of this paragraph is to exclude from membership in any registered securities association any broker or dealer who has disqualified himself by improper conduct. Thus, a broker or dealer may not be admitted to or continued in membership in a registered securities association (except with the approval or at the direction of the Commission in cases in which the Commission finds it appropriate in the public interest so to approve or direct) if he has been and is expelled or suspended from another registered securities association for a serious infraction of its rules; or if he has been and is expelled or suspended from a national securities exchange for a serious infraction of its rules; or if an order of the Commission is in effect denying or revoking his registration pursuant to section 15 of the Exchange Act; or if an order of the Commission is in effect expelling or suspending him from membership in a registered securities association or a national securities exchange; or, finally, if his conduct while employed by, acting for, or directly or indirectly controlling or controlled by a broker or dealer, was a cause which contributed to any suspension, expulsion, or order of the character described above which is in effect with respect to such broker or dealer. To prevent the evasion of these requirements, this paragraph also provides that a broker or dealer shall be ineligible for membership in a registered securities association if any person who is currently a partner, officer, director, or branch manager of such broker or dealer (or who currently occupies a similar status or performs similar functions) or who currently controls or is controlled by such broker or dealer, is subject to any suspension, expulsion, or order of the kind described above, or was a cause of any such suspension, expulsion, or order which is currently in effect.

(e) Paragraph (5) of subsection (b): This paragraph is designed to assure to each member of a registered securities association reasonable representation in all phases of its operations.

(f) Paragraph (6) of subsection (b): This paragraph has a dual purpose: First, to provide that the total of dues assessed against the members of an association shall not exceed an amount necessary to defray reasonable expenses of administration; second, to provide that such dues shall be fairly allocated among the members of the association.

(g) Paragraph (7) of subsection (b): This paragraph outlines the functions for the accomplishment of which registered securities associations are expected to accept responsibility. To be eligible for registration, the rules of an association must be designed to prevent fraudulent and manipulative acts and practices, to provide safeguards

II. Repts., 75-3, vol. 2-60

against unreasonable profits or unreasonable rates of commissions or other charges, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest, and to remove impediments to and perfect the mechanism of a free and open market. As safeguards against abuse, and to make clear that activities of associations under this paragraph are to be consistent with the operation of free and open markets, this paragraph provides that the rules of an association may not be designed to permit unfair discrimination between customers, or issuers, or brokers or dealers, nor to fix minimum profits, nor to impose any schedule of prices, nor to fix minimum rates or impose any schedule of commissions, allowances, discounts, or other charges. Thus, to provide safeguards against unreasonable profits, it is contemplated that associations may adopt rules designed to prevent each member thereof from exacting in any particular transaction a profit which reasonable men would agree was unconscionable in the light of all of the concrete facts and circumstances of that transaction; but an association, whether in a bona fide attempt to prevent or under the pretext of preventing unreasonable profits, may not impose any schedule of prices or commissions.

(h) Paragraph (8) of subsection (b): This paragraph limits eligibility for registration to associations, the rules of which provide that members shall be appropriately disciplined for violations of its rules. Disciplining may be in the form of expulsion, suspension, fine, censure, or any other fitting penalty. The form of discipline in any case must be appropriate to the particular violation.

(i) Paragraph (9) of subsection (b): This paragraph outlines the essential elements of a fair and orderly procedure to which associations must adhere in proceedings to discipline members or to deny membership to applicants. It is contemplated that the exact procedure will be defined by the rules of the association, within the framework set forth in this paragraph.

(j) Paragraph (10) of subsection (b): This paragraph provides simply that the requirements of subsection (c), to the extent that these may be applicable, must be satisfied.

3. Subsection (c) of section 15A.-Under this subsection, an association registered as a national securities association pursuant to subsection (b) may be required or permitted to provide for the admission of an association registered as an affiliated securities association pursuant to subsection (d) to participation in such national securities association as an affiliate, upon certain terms and conditions. The purpose of this paragraph is to enable soundly organized associations of brokers and dealers which are local in character, and hence not eligible for registration as national securities associations pursuant to subsection (b), to retain their identity as registered associations, if, by affiliation with a national securities association, they bring themselves within a sphere which is a proper subject of national concern and make possible coordinated administration.

4. Subsection (d) of section 15A.-This subsection sets forth requirements which must be satisfied by a local association which is seeking registration as an affiliated securities association. In general, these requirements are parallel to those set forth in subsection (b); but there are in addition certain requirements which are applicable only to this kind of association.