undertaken it would usually be necessary to duplicate the conduct of hearings and the taking of evidence on both the postponement question and the denial question.

Under the proposed amendment to section 203 (e) the commencement of a proceeding to deny registration would postpone effectiveness of an application for registration for a period of 90 days, or until final determination in the denial proceeding if that occurs sooner; and if the proceeding extends beyond 90 days the Commission could postpone effectiveness beyond the 90-day period only after a hearing on the question of further postponement.

The amendment is in conformity with the Administrative Procedure Act, the SEC points out. Written in 1946, the act provides many of the SEC procedures, such as reasonable notice and opportunity for hearing, proposed findings and recommended decision, exceptions and briefs, argument before the Commission and an opinion. These safeguards take time.

A question may be raised as to administrative delay, though the Investment Counsel Association of America does not object. An adviser may wish to commence his business rapidly. As written, the amendment will give the agency a total of 120 days in which to delay the effectiveness of the registration without the necessity of a hearing or a finding of delay necessary in the public interest. The SEC argues that the time spent is time dedicated to due process for the benefit of the applicant. In practice, the applicant demands additional time to prepare himself adequately for argument.

The report (H Rep. 2711) of the Special Subcommittee on Legislative Oversight recommended that each Commission should be required to grant or deny any motion in 60 days. Extension to 120 days for a decision would be only after hearing and a showing of good cause (at p. 10). The Commission points out that this proposal refers only to a motion, whereas its procedure takes into account time for an investigation as well as hearing and decision.

Section 5. Creation of power to deny withdrawal of application for adviser registration

The Securities Act of 1933 prescribes the procedure for filing registration statements covering securities, and the Exchange Act of 1934 and the Investment Advisers Act of 1940 govern applications for registration as a broker-dealer and an investment adviser, respectively. Registration becomes effective within 20 and 30 days after filing, respectively. None of these acts contains provisions governing withdrawal of applications before they become effective. (However, once effective, sec. 203 (g) of the Advisers Act conditions withdrawal upon terms which the SEC finds in the public interest or the protection of investors.)

To cover this gap section 5 would amend subsection (g) of section 203. Where the SEC had begun a proceeding to deny registration, withdrawal of an application for an investment adviser's license would require its consent. (The same power is also requested under the Exchange Act of 1934, sec. 13 of S. 1179.) Analogy to the Securities Act of 1933 is necessary to present the leading Supreme Court case on withdrawal of applications. In Jones v. SEC (298 U.S. 1 (1935)), the Commission sought to stop the registration statement of securities before it became effective. When the petitioner was denied permission to withdraw his application the Supreme Court held that his right to do so was unqualified unless clear legal prejudice would result to the defendant, other than the threat of future litigation or a renewed application. (See pp. 19, 21.) Because there was no adversary proceeding nor a sale of unregistered stock, no harm could result to investors. The Court compared the retraction to the right to withdraw application for any ungranted license or privilege (to use the mails).

Though the Court did not say so, it could have added that criminal penalties may be invoked for a misstatement willfully made in the application (sec. 24 of the 1933 act; sec. 32 (a) of the 1934 act; sec. 207 of the Advisers Act). Although registration of investment advisers is not the same as registration of stock, yet the rationale of Jones v. SEC is applicable as a matter of general administrative law. If SEC applied this principle it would mean that notwithstanding a proceeding to deny registration, an adviser would have an unqualified right to withdraw his application. The proposed amendment would require permission of SEC in that situation.

As a matter of practice, however, SEC distinguishes the situation of adviser withdrawal of application from the Jones rationale. That case allowed withdrawal in the absence of clear legal prejudice and SEC finds that adviser withdrawal offers harm to investors. That is, it finds the denial proceeding should continue in order to discover whether the applicant has willfully vio

lated the act of 1933. If this fact is found, it would be a reason for denying a later grant of the license (see proposed sec. 3 of S. 1182). And a person who was a "cause" of a broker's expulsion or revocation from an association or an exchange may not be hired by a registered broker-dealer (sec. 15A(b)(4)). If he may withdraw, he may be hired by an association, thus being in a position to harm the public.

To summarize, then, an adviser is not like an offering of stock-the latter may be withdrawn forever or rewritten, but the former has committed certain acts which can never be expunged. These facts should be determined when he first presents his application.

The philosophy of the SEC laws is not to pass on the merits of an application, but merely to disclose the facts. SEC should be allowed to investigate those facts, then; it adds that witnesses and evidence may have disappeared if a new application is made later. The right to withdraw it freely means wasted administrative effort when a new application may only be changed in minor respects, ad infinitum. Later courts have emphasized such protection of investors and have distinguished Jones in every possible way to accentuate possible harm. See particularly Columbia General Investment Corp. v. SEC (Č.A. 5, Apr. 6, 1959, 6-11).

The SEC also argues that criminal penalties are extraordinary remedies requiring resort to the courts. It points out that under State blue sky laws many cases have upheld denial of application withdrawal while proceedings were pending.

Industry counters by saying that it is the very use of publicity by the agency which is arbitrary, because the application is withdrawn, thus preventing harm to investors. And the rule of equity stated in the Jones case eliminates consideration of fear of successive applications (repeated litigation) as a detriment to the defendant (at pp. 19, 21).

As illustrated, industry objection is strong to the amendment. The administrative law section of the American Bar Association, also in opposition, has suggested a compromise. Its proposed legislation would recognize authority in SEC, in appropriate cases, to restrain withdrawal after proceeding to deny has begun. However, SEC would be required to set forth promptly in findings its reasons for considering that the interests of investors or the public would be prejudiced by withdrawal. The requirement that SEC state its posi tion would provide protection against arbitrary action and afford the registrant a basis for determing whether to seek court review.

Procedural defects make this suggestion unworkable, SEC answers. If after setting forth its reasons for refusing withdrawal, the registrant appealed to a court, there would be no final order of denial for the court to reviewmerely a decision that it intended to start denial proceedings. The Administrative Procedure Act requires a final agency order before appropriate court review may be invoked (sec. 6(d)).

Moreover, the present practice of SEC, an announcement of a refusal to permit withdrawal reciting the general reasons for believing prejudice to the public will result, should have the same effect.

Section 6. Addition of power to compel keeping of books; expansion of power to inspect

The present act does not authorize the Commission to require an investment adviser to keep any books and records nor does it authorize the Commission to examine such books and records as he may have kept, unless there is evidence of a violation sufficient to invoke the SEC's power to investigate under section 209.

Section 6 of the bill would authorize the Commission to require investment advisers to keep such books and records as the Commission may prescribe by rule and would provide that these books and records are subject to reasonable inspection by the SEC. Only registered advisers would be included, and certain advisers exempt from registration under 203(b) are excluded. This power is modeled after that presently found in section 17(a) of the Exchange Act of 1934 treating brokers and dealers. In the opinion of the SEC, this power has been indispensable in enforcing the requirements of financial responsibility, etc.. of such persons.

The importance of records and inspections is illustrated by one situation. A registered adviser interviewed by the staff stated that he did not have custody of customers' securities or funds, did not execute orders, and with the exception of a checkbook, kept no books or records. Following complaints, an investigation

revealed that he held some $600,000 of clients' securities. Without adequate records the SEC never appraised his financial condition; and it appears that some $1,700,000 in cash and securities may have been left with him by clients who perhaps sustained a loss of as much as $600,000.

The nature of the business of an investment adviser differs from that of a broker on account of the personal details of a client's life which the adviser keeps on file to assist management of a portfolio. The industry has always feared that an investigation or examination might leave it prey to gossipmongering.

Therefore, when the act was written in 1934, section 210 (c) was written to prevent the Commission from requiring investment advisers who supervise individual accounts of clients to disclose the affairs of such clients except insofar as this may be determined to be necessary in an investigation or proceeding, as distinct from an inspection. Under the proposed section 6 of S. 1182, if the inspection which will now be possible of the adviser's records should indicate possible fraudulent or other improper practices with respect to the affairs of any client, the Commission could order a formal investigation to obtain information concerning the adviser's handling of clients' accounts.

A further safeguard of these relationships is provided in section 210(b) as proposed to be amended by section 13 of the bill which will make it unlawful for the Commission to make public information obtained in an examination or investigation except in the case of public hearings or upon request of either House of Congress. The exceptions only previously applied to the investigation. That change was made at the behest of the industry which hopes it will place the examiners under a duty of nondisclosure similar to that of a bank examiner. Section 13. Power to make public certain matters after investigation and inspection

Section 210(b) now provides, subject to certain exceptions, that the Commission shall not make public the fact that any investigation under the act is being conducted, or the results of such investigation, or any facts ascertained. As this section now reads, it is not clear that the Commission could disclose to appropriate State officials facts ascertained in an investigation which tend to indicate a violation of State law.

The proposed amendment would make it clear that the information gathered in an inspection or investigation could be disclosed in certain circumstances, but only with the approval of the Commission itself. The amendment would also make it clear that the prohibitions against disclosure apply not only to the Commission, but also to members, officers, and employees as well.

See also section 6 of S. 1182.

Section 9. Creation of rulemaking power over antifraud provisions

The substantive prohibitions of the Investment Advisers Act are very limited. They are in essence contained in section 205 and 206, which outlaw certain types of unfair investment advisory contracts, and prohibit an investment adviser from perpetrating fraud or from selling securities directly to clients without disclosing the capacity in which he is acting and obtaining the client's consent. Because of the general language of the statutory antifraud provision and the absence of any express rulemaking power in connection with them, the SEC has always had doubt as to the scope of the fraudulent and deceptive activities that are prohibited and as to how far it is limited in this area by common law concepts of fraud and deceit. These include proof of a (1) false representation of; (2) a material; (3) fact; (4) the defendant must make it to induce reliance: (5) the plaintiff must rely on the false representation; (6) and suffer damage as a consequence.

In order to overcome this difficulty, section 9 of the bill would amend section 206 to add a prohibition against engaging in conduct which is fraudulent, deceptive or manipulative and to authorize the Commission by rules and regulations to define, and prescribe means reasonably designed to prevent, such acts and practices are as fraudulent, deceptive, or manipulative. This is almost the identical wording of section 15(c) (2) of the Securities Exchange Act in regard to brokers and dealers.

In the SEC's estimation, such a provision would enable it to deal adequately with such problems as a material adverse interest in securities which the adviser is recommending to his clients.

It may be pointed out that the language of section 206, making it unlawful to employ any device to defraud a client, or to engage in any transaction which operates as a deceit upon a client, are modeled on clauses (1) and (3) of sec

tion 17(a) of the Securities Act of 1933. Under that section the common law deceit concepts no longer acted as a bar to the defrauded buyer, for it was designed to avoid them. (See Loss, Securities Regulation (1954, pp. 812-821).) Moreover, a defendant who is believed to be about to violate the act may be enjoined. Therefore, a question arises as to the SEC's claim that it has been limited by these concepts under section 206.

Moreover, there is no rulemaking power provided under section 17(a), and the provision has been used effectively to counteract fraud. A question then arises as to the Commission's need for rulemaking power to define fraudulent concepts under the Advisers Act, or if needed, whether general standards of the prohibited activities cannot be delineated. Cited as a model for the language of the proposed section is section 15(c) (2) of the Exchange Act of 1934, which also grants rulemaking power. Only two rules have been effected under

that power.

Under 15(c) (1), a similar rulemaking power over manipulative practices, nine detailed rules have been promulgated with respect to brokers and dealers. The SEC has not, despite 19 years of experience with investment advisers, attempted to define specific standards of fraud in the proposed legislation, if only patterned after concepts of the nine rules applicable to brokers and dealers.

It should be understood that the Investment Counsel Association of America does not object to this general grant, fearing that any attempt to write specific standards will risk inflexibility.

Section 8. Extension of antifraud provisions to unregistered advisers

Section 203 (b) of the act exempts from registration certain investment advisers, primarily those whose business is wholly intrastate or whose only clients are investment companies and insurance companies, or those who have fewer than 15 clients and do not hold themselves out generally to the public as investment advisers. While it is reasonable to the SEC to exempt this group from registration, the reasons for exemption from registration do not, in the view of SEC, support a corresponding exemption from the prohibitions against fraud. Moreover, under the present wording of the statute, an investment adviser not exempt from registration may escape liability for fraud simply by neglecting to register, so that the Commission can only proceed against him for having failed to register.

Section 8 of the bill would make the fraud provisions applicable to all investment advisers, whether or not registered. This change follows the pattern now existing in the Securities Act and the Securities Exchange Act. In both of these statutes there are securities or persons who are exempted, for reasons of policy, from registration, and thus from the regulatory jurisdiction of the Commission, but the fraud provisions of the Securities Act and the Securities Exchange Act are nevertheless applicable to them (section 17, Securities Act of 1933, 10(b) and 15, Exchange Act of 1934).

Section 7. Prohibition against certain advisory contracts extended to unregistered advisers

Section 205 of the act now prohibits registered investment advisers from entering into, extending, renewing, or performing certain types of investment advisory contracts. These include profit-sharing or unilateral assignment of the contract.

Section 205 is not specifically applicable to investment advisers subject to registration who have not registered; the only sanction is for failure to register. The amendment makes section 205 applicable to investment advisers subject to registration, whether or not they have registered, unless exempt from 203 (b).

In 1945 the SEC recommended that the section also be amended to require that the advisory contracts of registered advisers be in writing (H.R. 3691, 79th Cong., 1st sess. (1945)). This recommendation is not renewed in S. 1182. Section 11. Addition of prohibition against aiders and abettors

Section 11 of S. 1182 would add a new section to the Investment Advisers Act making it unlawful for persons to do indirectly, acts which they are forbidden to do directly. In addition, the section makes it unlawful for any person to aid, abet, or induce another person to violate the act. A similar provision, section 11 of S. 1178, would add the same liability to the Securities Act of 1933. The aider and abettor addition is also requested in section 22 of S. 1179 for the Exchange Act of 1934, which already has the "direct-indirect" prohibition.

The new section does not limit the application of the criminal aiding and abetting statute of the United States Judicial Code. Rather the amendment borrows the concept of aiding and abetting from the criminal law and seeks to insure that persons will be liable in civil administrative actions by the SEC, as well as in criminal actions.

It may be inquired if this provision should be limited under sections of the Advisers Act which treat the problem in part. As an instance, the power could be inserted in section 209 (e), allowing the agency to seek an injunction against a person aiding and abetting a violator.

But the SEC insists that placing it under the injunction section, for example, would be unnecessarily restrictive. This power is sought in order to penalize abettors of all violations.

In addition, is it possible that private litigants, not only the SEC, may find in this section a vehicle by which to sue aiders and abettors? For the statute does not say who can sue-it merely says: "It shall be unlawful" (to aid or abet). The courts have extended from the SEC to private plaintiffs a right of suit under a comparably general antifraud provision of the 1934 Securities Exchange Act (sec. 10(b)).

A suggestion agreeable to SEC.-Make it clear that no civil liability to private individuals is intended. The Investment Counsel Association of America does not object to this amendment.

Section 15. Penalty for willful violation of rules

Section 217 now provides penalties for willful violations of the act, but no provision is made for penalties for violations of rules, regulations, or orders promulgated by the Commission.

Section 15 of S. 1182 would make the penalty provisions also applicable to willful violations of any rule, regulation, or order promulgated by the Commission under the authority of the statute. Such an amendment would conform the Advisers Act to the other SEC statutes.

If the amendment is passed, section 211(d) of the act will still be applicable, providing that there will be no liability for a good faith failure to act in conformity with an SEC rule.

Section 16. Effect on State law

No section of the act deals specifically with the effect of the provisions of the act on State laws. The Securities Act of 1933 and the Securities Exchange Act of 1934 now contain provisions making it clear that the jurisdiction of a State securities commissioner or similar officers is not affected by provisions of those acts, so long as there is no conflict with their provisions. There were very few State statutes over investment advisers in 1940.

The amendment would add a new section which would provide that the jurisdiction of a State securities commissioner or similar officer would not be affected by provisions of the Investment Advisers Act so long as there was no conflict with its provisions. The middle road of concurrent jurisdiction would thus be reemphasized in the area of investment advisers, rather than an exclusive jurisdiction as in the ICC.

(The following was ordered inserted in the appendix. See p. 246 for reference.)

SECURITIES AND EXCHANGE COMMISSION,
Washington, D.C., August 4, 1959.

Hon. HARRISON A. WILLIAMS, Jr.,
Chairman, Subcommittee on Securities, Committee on Banking and Currency,
U.S. Senate, Washington, D.C.

DEAR SENATOR WILLIAMS: In my statement before the Subcommittee on Securities on June 25, 1959, I stated that, pursuant to a suggestion made earlier in the hearings, conferences had been begun between staff members of this Commission and of the Interstate Commerce Commission for the purpose of drafting a modification of our proposed amendment to section 3(c) (9) of the Investment Company Act to delineate, in the statute itself, the areas of jurisdiction of this Commission and of the Interstate Commerce Commission. These conferences have been completed, having resulted in a satisfactory solution to the problem, which is reflected in the enclosed proposed modification of section 7 of S. 1181 and proposed new section 6(f) of the Investment Company Act. I understand that the Interstate Commerce Commission has informed you of its endorsement of the amended proposal.