if in the Commission's opinion such action is necessary or appropriate for the protection of investors and the public interest so requires. The proposed amendment would codify the Commission's interpretation that it has the power to renew temporary suspensions for one or more additional periods not exceeding 10 days each.

The power under section 19(a) (4) is of an emergency nature and has been exercised whenever developments in respect of the affairs of an issuer made it impossible for trading to be conducted on a fair and informed basis. It is a summary power intended to protect investors, both sellers and buyers, who because of sudden developments (e.g., where there are large defalcations resulting in uncertainty as to the financial condition of the company) are unable to make informed judgments whether to buy or sell the security or at what price. The temporary suspension of trading allows time to obtain and make public the information necessary to reach such informed judgments. In some cases where the Securities Exchange Act has been violated by the issuer this informaton will be obtained and made public in the course of a proceeding under section 19(a)(2). Such a proceeding, however, is not necessary before the section 19(a) (4) power can be used; nor will it always be possible to institute such a proceeding, because the circumstances which give rise to the need to exercise this power may not involve any violation of the Securities Exchange Act, a condition precedent to the institution of a proceeding under section 19(a) (2).

The imposition of any time limitation at the end of which it would be unlawful to issue any further temporary suspensions may be contrary to the public interest because, if, by the end of such period, it has been impossible to obtain and make public the information necessary for buyers and sellers to reach informed judgments, there would be just as much need for suspending trading at that time as there was when the first order was entered, and if the Commission is powerless to enter further orders to suspend trading investors may be harmed.

There seems to be some tendency in certain of the testimony to think of a summary suspension of trading under section 19(a) (4) as in the nature of a disciplinary proceeding against someone, in which, at some point of time, there should be a hearing followed by a Commission decision on the issues (see transcript, p. 190). In fact, as pointed out above, this is an emergency power to be invoked where conditions with respect to a security are such that trading cannot proceed on an informed and orderly basis. Such an order is in no sense a quasi-judicial proceeding at which issues are to be adjudicated between parties; indeed, such orders are not directed at any adversary parties. The time during which a suspension needs to be continued is not at all within the Commission's control, but depends upon the duration of the conditions in the affairs of the issuer which gave rise to the suspension, a matter often not subject to anyone's control. These factors are recognized in the constitutions of the major stock exchanges which authorize the board of governors to "suspend dealings in securities" without specifying either the reasons for, or the duration of, such suspensions, or providing for any hearings.3

It is difficult to see how section 19 (a) (4) could be revised to provide "standards more specific" than "that the public interest so requires" and that "such action is necessary or appropriate for the protection of investors," or what standards would be more appropriate. The standards of "the public interest" and "the protection of investors" are the standards used generally throughout the act as a condition precedent to Commission action. (For example, many provisions authorizing the Commission to adopt rules and regulations as to various matters are conditioned on the requirement that such rules and regulations are necessary or appropriate in the public interest or for the protection of investors.) The section 19(a) (4) power is an emergency power which may have to be used in a variety of situations and any attempt to spell out the circumstances under which the Commission may exercise such power may so restrict the Commission's authority as to make it impossible for the Commission to act in a situation where such action is necessary.

* Constitution of the New York Stock Exchange, art. III, sec. 7: constitution of the American Stock Exchange, art. II, sec. 1; constitution of the Midwest Stock Exchange, art. III, sec. 1.

MEMORANDUM OF THE SECURITIES AND EXCHANGE COMMISSION ON AMENDMENT PROPOSED IN SECTION 30 OF S. 1179

FORFEITURE FOR FAILURE TO FILE REQUIRED INFORMATION, DOCUMENTS, OR REPORTS Various objections have been made to the proposal in section 30 of S. 1179 to add a new section 32(c), which would impose a forfeiture of $100 a day for the failure to file information, documents, or reports pursuant to the Securities Exchange Act or any rule thereunder. The proposal in section 30 of the bill would supplement the existing forfeiture provision now contained in section 32(b) of the act which is limited to reports required by virtue of the undertaking specified in section 15(d) of the act.

On the basis of a reexamination, made in the light of the comments expressed at the hearings on section 30 of the bill, the Commission would have no objection to modification along the following lines:

(1) The forfeiture provision be limited to the reports required under sections 13 and 16 of the act, i.e., periodic reports of issuers and ownership reports of "insiders", respectively.

(2) Recovery of the forfeiture would bar a criminal prosecution for the failure to file the report, with the option in the Commission to determine whether to proceed civilly for the forfeiture or criminally under section 32(a) of the act.

(3) In the case of ownership reports required under section 16 the forfeiture would be a sum not to exceed $50 per day, as determined in the discretion of the court.

The suggestion at the hearing that provision be made for notice of failure to file prior to the imposition of a forfeiture is not, in the Commission's opinion, appropriate. The statute and the Commission's order, in the case of section 16 reports, and the Commission's rules, in the case of section 13 reports, already specify the time within which the reports must be filed. The Commission's rules provide for seeking additional time within which to file reports required under section 13. Furthermore, the section 16 reports and certain of the section 13 reports must be filed upon the happening of certain events, the knowledge of which is usually not available to the Commission although known to the persons who are required to report. In these circumstances, it is particularly questionable whether a notice requirement would even be feasible.

The suggestion that there be a limitation on the amount of the forfeiture is met indirectly in connection with section 16 reports insofar as discretion is vested with the court to determine the amount of the assessment. In the area of the section 13 reports the Commission adheres to the policy of no limitation in the amount of the forfeiture which is now embodied in section 32(b) of the act in dealing with reports pursuant to a section 15(d) undertaking.

The Commission also suggests that the statute be modified so that it would be authorized to bring the civil forfeiture actions in connection with section 15(d) undertakings as well as sections 13 and 16 reports. Section 32(b) now in effect authorizes the Department of Justice to bring the actions resulting from section 15(d) undertakings.

Appropriate statutory language will be submitted after consultation with the Department of Justice.

MEMORANDUM OF THE SECURITIES AND EXCHANGE COMMISSION REGARDING ITS NET CAPITAL RULE

THE STATUTE

The Securities Exchange Act of 1934 contains two provisions which relate to the capital and financial position of brokers and dealers. The first of these is section 8(b) which makes it unlawful for a member of a national securities exchange or any broker or dealer who transacts a business in securities through the medium of any member:

"To permit in the ordinary course of business as a broker his aggregate indebtedness to all other persons, including customers' credit balances (but excluding indebtedness secured by exempted securities), to exceed such percentage of the net capital (exclusive of fixed assets and value of exchange membership) employed in the business, but not exceeding in any case 2.000 percent, as the Commission may by rules and regulations prescribe as necessary or appropriate in the public interest or for the protection of investors.”

The second provision relevant to this subject is section 15(c) (3) of the Securities Exchange Act, which was added by Public Law No. 719, 75th Congress (1938), and reads as follows:

"No broker or dealer shall make use of the mails or of any means or instrumentality of interstate commerce to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any security (other than an exempted security or commercial paper, bankers' acceptances, or commercial bills) otherwise than on a national securities exchange, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors to provide safeguards with respect to the financial responsibility of brokers and dealers."

It will be noted that section 8(b) is self-operating and does not require the exercise of any rulemaking power by the Commission. This section, however, has not been effective for the following principal reasons:

1. It is not applicable to over-the-counter broker-dealers other than those who transact a business in securities through the medium of an exchange member. 2. Its limitations are applicable only "in the ordinary course of business as a broker," thus apparently excluding indebtedness not incurred in the "ordinary course of business" and indebtedness incurred in the course of business as a dealer. Indebtedness in these excluded categories presents a hazard to customers equal to that presented by indebtedness incurred "in the ordinary course of business as a broker."

For these reasons the Commission relies primarily on section 15(c)(3) and its rule thereunder (rule 15c3-1) for the establishment of capital requirements.

HISTORY OF THE RULE

Although section 15(c) (3) of the act became effective in 1938, the Commission did not immediately exercise the rulemaking power therein granted. In 1942 the National Association of Securities Dealers, Inc., which is registered as a national securities association pursuant to the provisions of section 15A of the Securities Exchange Act and includes in its membership most of the overthe-counter broker-dealers in the United States, proposed the adoption of an amendment to its bylaws which would require that all members dealing directly with customers have a minimum net capital of $5,000, and that all other members have a minimum net capital of $2,500. When this bylaw was submitted to the Commission, in accordance with the provisions of section 15A, the Commission, after hearing, disapproved the proposed bylaw, finding it inconsistent with the purposes of section 15A upon the ground that it would discriminate against small broker-dealers. In that connection it was conceded by the association that the adoption even of the relatively modest capital requirements provided in the proposed bylaw might result in expulsion of over a quarter of the membership of the association who apparently did not have sufficient capital to satisfy the proposed requirements.

In its opinion (12 SEC 322, 326 (1942)) the Commission announced that it would adopt its own capital rule and that in doing so it proposed to utilize the ratio method employed in section 8(b), both in deference to the congressional policy there expressed and in order to provide a rule which would impose adequate safeguards in the case of broker-dealers having a substantial indebtedness without unnecessarily penalizing small broker-dealers. In that connection the Commission pointed out that any minimum dollar figure which would be reasonable as applied to the business of a small broker-dealer might be totally inadequate for a larger firm which had substantial indebtedness to customers. Thereafter, following extensive studies for the purpose of developing appropriate definitions of the terms "aggregate indebtedness" and "net capital" the Commission adopted its own rule 15c3-1 in 1944 (Securities Exchange Act Release No. 3602, Aug. 11, 1944; Securities Exchange Act Release No. 3617, Nov. 8, 1944). The rule was substantially revised in 1955 to clarify its provisions and to strengthen the safeguards which it provides for customers (Securities Exchange Act Release No. 5156, Apr. 11, 1955). A copy of this release is attached. The principal change made by this revision was to increase the deduction from the market value of securities owned by the broker-dealer described below, thus increasing the margin of safety provided.

ANALYSIS OF THE RULE

There is attached hereto a copy of the rule as presently in effect. As will be noted, paragraph (a) provides that no broker-dealer shall permit his aggregate indebtedness to all other persons to exceed 2,000 percent of his net capital.

That is, his aggregate liquid assets, computed in accordance with the rule, must be 105 percent of his aggregate indebtedness. For example, if a brokerdealer has liabilities of $1,000, he must have assets computed in accordance with the rule of not less than $1,050. Thus the aggregate indebtedness ($1,000) is 2,000 percent of his net worth ($50), which figure is arrived at by subtracting his total liabilities from his total assets.

A major portion of the rule consists of definitions of "aggregate indebtedness" (par. (c)(1) of the rule) and "net capital" (par. (c) (2) of the rule). The definition of net capital is particularly significant, since it defines net capital to mean the net worth of the broker-dealer, subject to seven specified adjustments.

Subparagraph (c) (2) (B) of the rule requires that net capital be adjusted by deducting fixed assets and assets which cannot be readily converted into cash, including, among other things, real estate, furniture and fixtures, exchange memberships, prepaid rent, insurance and expenses, goodwill, organization expenses, unsecured advances and loans, and customers' unsecured notes and accounts.

Subparagraph (c) (2) (C) requires the deduction of specified percentages of the market value of securities long and short in the accounts of the brokerdealer, and in the accounts of partners. Except in the case of certain debt securities and prior preferred stock, this deduction is 30 percent of the market value. Smaller deductions are provided for such debt securities and prior preferred stock in view of the fact that the market for these securities does not fluctuate to the same degree as that for common stock. These deductions provide a substantial margin of safety for customers against losses incurred by a broker-dealer as a result of market fluctuations.

Similar deductions are provided for in the case of commodity futures contracts and securities which are the subject of open contractual commitments, that is, executory contracts to purchase or sell securities not yet performed.

In addition to providing a margin of safety, these deductions tend to prevent a broker-dealer from overextending himself. Thus, if a broker-dealer invested $100,000 in cash from his capital in the purchase of stock for his own account, he would need to provide an additional $30,000 in cash capital in order to retain the same net capital position under the rule as he had before the purchase. Similarly, if he contracted to purchase $100,000 worth of stock, he would have to enter the full purchase price as a liability, but would value the stock to be acquired at only $70,000, so that $30,000 in cash would be required to carry the commitment.

The purpose of all of these adjustments is to include among assets in the computation of net capital only liquid assets which can be immediately realized in cash for the satisfaction of indebtedness, so that the broker-dealer will be in an entirely liquid position at all times and able to discharge his obligations to his customers immediately. It is to be noted that this standard of liquidity is higher than that required of banks, which may invest a substantial portion of their deposits in loans upon which they may not be able to realize immediately.

The operation of the rule may be illustrated by the following simplified example, representing the financial position of a relatively small broker-dealer. Assume the balance sheet of broker A is as follows:

Cash____.

ASSETS

$10,000

Stocks owned by firm.--

15, 000

Amounts due from customers secured by adequate collateral.
Accounts receivable from customers unsecured_.

1,000

2,500

Applying the adjustments specified in the rule to this firm, the unsecured accounts receivable from customers, the furniture and fixtures and the prepaid expenses would be eliminated under the provisions of paragraph (c)(2) (B) of the rule reducing admissible assets by $5,000. From the market value of the stocks owned by the firm, which aggregate $15,000, there would be deducted 30 percent of this amount, or $4,500. Thus for purposes of the rule, the assets would be reduced by $9,500, thus leaving a balance of $21,500. Since the firm has liabilities of $20,000, its net capital computed under the rule would be $1,500. Its aggregate indebtedness is $20,000 and it is required by paragraph (a) of the rule to have a net capital not less than 5 percent of this sum, or $1,000. The firm, therefore, is in compliance with the rule, but only by a margin of $500. It could not assume additional commitments for the purchase of stock exceeding $1,667 without obtaining additional capital by reason of the 30 percent deduction in the rule.

The Commission enforces the net capital rule vigorously. Compliance with this rule is checked on each broker-dealer inspection. If a broker-dealer is not in compliance, he is given a few days to put up the additional capital, and if he fails to do so, administrative or court action is ordinarily taken against him. If he again violates the rule, immediate action may be taken. During fiscal 1957 violations of the net capital rule were alleged in 34 injunctive actions and 20 revocation proceedings. During fiscal 1958 it was necessary to charge such violations in only 15 injunctive actions and 12 revocation proceedings, indicating the deterrent effect of the enforcement policy pursued.

STAFF MEMORANDUM ON AMENDMENTS TO S. 1179, THE SECURITIES EXCHANGE ACT OF 1934

The Securities Exchange Act of 1934 deals with post-distribution trading. It has three basic purposes: to afford a measure of disclosure to people who buy and sell securities; to regulate the securities markets; and to control the amount of the Nation's credit which goes into these markets.

All stock exchanges must register unless exempted by the SEC, which has certain supervisory functions with respect to their rules and has authority to suspend or expel exhange members who violate the act. The Commission also has certain authority with respect to various exchange practices such as short selling, the specialist system, floor trading and hypothecation by brokers of customers' securities.

No security may be listed on an exchange unless its issuer files an application for registration with both the exchange and the SEC containing much the same information as is required for new issues by the 1933 act. This information must be kept current by the filing of annual and other reports with the exchange and the SEC. The solicitation of proxies in respect of listed and registered securities is subject to SEC control, and there are certain provisions governing the trading in such securities by the issuer's officers, directors, and principal stockholders.

Securities which are not listed on an exchange are not subject to the registration, reporting, proxy, or insider trader provisions. However, over-thecounter brokers and dealers must themselves register with the SEC; they must maintain appropriate records and file statements of financial condition; they are subject to inspection at any time by the SEC, and to denial or revocation of registration in certain contingencies; and there is also provision, under a 1938 amendment of the act, for the registration with the SEC of “national securities associations" of over-the-counter brokers and dealers who thus regulate their own business practices under the general supervision of the Commission.

There are general provisions outlawing fraud and manipulation in both the exchange and over-the-counter markets, and the SEC has a considerable amount of rulemaking authority. The credit provisions of the act give the Board of Governors of the Federal Reserve System authority to promulgate margin rules and the SEC the task of enforcing them.

AMENDMENTS TO THE SECURITIES EXCHANGE ACT OF 1934, S. 1179

The amendments in S. 1179 are recommended by SEC. A substantial number of the amendments were designed to make SEC's enforcement activities more effective by providing additional remedies and eliminating or minimizing various