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cases included vote fraud, manipulation for profit, manipulation for theft of services, theft of confidential information and vandalism. The perpetrators or suspects were a policeman, claims and welfare employees, private citizen, elected official and Electronic Data Processing employees. Interestingly-not one computer abuse was discovered through routine audits or checkups. Every time, the guilty party was uncovered through some chance event-like the teller for a sav. ings bank in New York charged with embezzling $1,500,000. He, was discovered when police raided a bookmaking operation and found his name as a $30,000 a day bettor.
(3) In our previous appearance here, we pointed out that the Depository concept as well as the proposed certificateless society poses serious problems. One involves "street name" layering superimposed on the present nominee practice. This will further remove and alienate the investor from the corporation (or corporations) in which he owns stock, and make a mockery of shareholder democracy. This problem, acknowledged in your proposed legislation requiring a study by the SEC, makes the retention of the stock certificate increasingly important.
(4) In 1971 we proposed, as a feasible and sensible intermediate paperwork system, the adoption of a man and machine readable stock certificate-readable by means of optical scanning—together with standardization of supplementary forms involved in the stock processing procedure. It is interesting to note that the New York Depository now is using the optical scanning technique for the control and movement of stock certificates in its possession.
As we emphasized before and our viewpoint applies more so today-in any of the studies relating to the securities industry problems there has been little, if any, representation by corporations or the average shareholder. Recently, at the initiative of the American Stock Exchange Listed Company Advisory Committee, corporations have organized to make known their concern about the withdrawal of the small investor from the marketplace, the ever shrinking number of stockholders, the liquidity of the stock market, and the drying up of the new issue market.
The fact is that in this intervening period the market has been inactive-small investors have looked elsewhere and the new issue market is at its lowest ebb for many years.
The small investor unfortunately has no organized representation and while many reasons are given for his absence from the market the fact remains that he has deserted it. The Exchanges and some member firms are developing public relations programs to bring him back.
In this connection, let me quote a few pertinent excerpts from a recent study on small investors conducted for the New York Stock Exchange. The study points out-among other facts—that: Small investors tend to view the securities industry with an air of caution, particularly in regard to the industry's financial stability-Two thirds feel that their stock certificates are safer in their own hands than in their brokers' custody-(emphasis added).
We strongly suggest that one way to bring the small investor back is to assure him that he will receive his evidence of proprietary ownership, the stock certificate, and not be at the mercy of irresponsible brokers and computers. Computers have yet to convince us that they are fraud proof.
Speaking directly to your proposed legislation—(1) You direct the SEC to bring about the elimination of the stock certificate as a means of settlement in brokers or dealers transactions. Your introductory statement to the legislation says that this provision would in no way preclude the individual shareholders from demanding and receiving certificates as proof of ownership of the shares. This legislation, in our opinion, falls short in one important aspect. The legislation must spell out the automatic right of the investor to receive his stock certificate. I respectfully submit that such language must be a part of any legislation that is ultimately developed. The reasons are real. Under the provision related to the · elimination of certificates in broker or dealer transactions, the investor will be "induced" not to take his stock certificate, particularly by those broker-dealers who become members of depositories. If this be so then this legislation will be misused to accomplish the immediate transition to a certificateless society. In reality the selling investor will give up his certificate for cancellation and the buying investor will be "induced” to leave his stock with his broker. So the -"street" will be able, unless specifically regulated, to effect by indirection what
obviously is not intended by your proposed legislation. This is similar to the use of tax loophole laws for benefits beyond which they were intended at the time of passage.
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Our other objection is to the word “demand”. It doesn't clearly identify the mechanics by which the investor makes his "demand". Why does he have to demand? Certainly much legislation has been passed to protect the consumereven against himself.
Our position is clear—the investor must be protected like any other consumer in his inherent right to receive, promptly, whatever he purchases.
Failure to provide this protection to the public will cause the same relative chaos that occurred in the 1969–70 era when the SEC was inundated with complaints of individuals "demanding" their stock certificates.
2) Your proposed legislation authorizes the SEC to make a study of "street name" registrations. This important study should be completed before a final decision-relative to the elimination of certificates in broker-dealer transactions—is made. We make this suggestion because the study will delve into the very heart of corporate-stockholder communications, which is seriously affected because of "street name” registrations.
3) Another provision of your proposed registration requires that securities be in "a form or with a format" as prescribed by the SEC. In our opinion the SEO 'has long had the right to develop the form or format of the stock certificate. The history over recent years has indicated their all-too-ready acceptance of the punch cards, which proved unworkable. Later, under Commissioner Casey, the SEC readily endorsed the total certificateless society.
A very current development is the use of single denomination certificate which today is actually being used, on a pilot basis, despite a critical, objective report that it is extremely vulnerable to alteration by fraud artists. Therefore, we suggest that any further development in the form or format of the stock certificate be required to be reported by the SEC to your Committee, prior to adoptionin the public interest. We, of course, will make our proposals directly to the SEC at the proper time.
We feel that your proposed legislation is an honest attempt to attain your
However, we feel very strongly that in planning for the future you cannot ignore what will happen tomorrow.
Many significant contributions could be made now for over thirty million *constituents who will be affected by your legislation. We urge the adoption of
our proposal that investors be given the legislative right to receive their stock (certificates without demanding them.
Your bill authorizes the SEC to straighten out the securities industry. But while this is going on, the Commission should be subject to another mandateprotecting the rights of investors, particularly the small investors. Increased concern for them should ultimately result in decreased apathy they now manifest towards the “Street”
In essence, we are requesting that you insure your concern for the individual investor by guaranteeing him protection in the legislation.
Thank you very much for your kind attention.
COMMENTS OF THE LEGAL AND LEGISLATIVE COMMITTEE OF THE WESTERN STOCK
TRANSFER ASSOCIATION, INC. REGARDING H.R. 5050
The Western Stock Transfer Association is concerned principally with the process of effecting the transfer of securities, therefore, the following comments relate only to the provisions concerning transfer agents in Title IV of H.R. :5050 entitled “Securities Processing”. The failure to comment on the other sections of the Bill does not indicate endorsement thereof.
The Committee believes that the stated objective of the Bill as it applies to Title IV “to provide for the development of an integrated national system for the prompt and accurate processing and settlement of securities transactions" is commendable. However, the substantial strides taken by the stock transfer industry in recent years to facilitate transfers through computerization, improvements in internal operating procedures, and the reduction of transfer volume attributable to the widespread use of jumbo certificates, dual capacities, and depositories makes doubtful whether the possible benefits to the investing public
rnal operatin facilitate trans strides
issuers, and ultimately their shareholders.
A) The Bill would designate the SEC as regulatory agent with jurisdiction over bank transfer agents. This responsibility should remain with the bank regulatory bodies presently exercising jurisdiction. Subjecting bank transfer agents to the rules and review of two (2) separate regulatory groups will almost certainly result in bank transfer agents preparing and maintaining similar but non-identical records, will cause uncertainty as to the precise nature of the records to be maintained, and will increase the bank's expense of doing transfer agent business. This increase, of course, would ultimately be borne by the shareholders. In addition to the foregoing drawbacks, this dual regulation appears to be diametrically opposed to the spirit of the rest of the Bill in that it will only serve to increase paperwork and record keeping difficulties.
B) The Bill provides that “every issuer whose securities are registered on a national securities exchange shall consolidate under a single person the function of transfer agent and register and otherwise comply with such rules and regulations as the commission shall promulgate to assure the prompt and accurate processing and settlement of securing transactions". The Committee approves in principle of this provision as an effort to expedite the processing of securities:
only outline the mechanics of a “dual capacity” operation but will provide safeguards for the investing public with respect to the financial responsibility of the transfer agent.
C) The SEC would be granted the expressed mission to do all in its power to minimize the use of stock certificates. It is not clear whether this refers to stock certificates generally or only with respect to settlement among brokers or dealers.
D) The Committee appreciates the obvious importance that Congress has attached to the problem of shareholder relations in connection with street name registration. It is the Committee's recommendation that representatives of the industry and corporate officials be given every opportunity to offer testimony prior to any further legislation or preparation of rules and regulations on the subject with the specific objective of preventing an overemphasis of ease of transfer and immobilization at the expense of communication between issuers and their shareholders.
E) Since the definition of the term "securities” apparently includes debt as well as equity issues, the definition of "transfer agent" appears insufficient.
F) It is not clear whether the definition “transfer agent” is intended to include such functions as dividend disbursement and dividend reinvestment services.
G) Title IV of the Bill as it relates to transfer agents is questionably vague. Congress would grant to the SEC excessively broad powers to implement objectives of doubtful value. Some specific examples of the powers that would be granted to the SEC are these :
1) Establish requirements for registration and the information in support of application for registration for transfer agents.
2) Establish exemptions from registration.
3) The power to refuse registration and to impose disciplinary action for noncompliance.
4) Determine the nature of supplemental information necessary to keep registration current.
5) Establish record retention and report requirements.
6) Determine confidential status of applications, reports, and information submitted by transfer agents.
7) Determine format of certificates.
Title IV of H.R. 5050 treats transfer agents as an appendage of the brokerage industry. This interpretation is incorrect. As transfer agents, we are solely the agent of the issuing entity which entity is already regulated by the Securities Act of 1934. Subjecting transfer agents to separate regulation and control appears to us to unduly increase the number of reporting channels, volume of paperwork, and the cost to all parties involved and would not serve the public interest.
AMERICAN LIFE INSURANCE ASSOCIATION,
Washington, D.C., April 23, 1973. Hon. JOHN E. Moss, Chairman, Subcommittee on Commerce and Finance, Committee on Interstate
and Foreign Commerce, U.S. House of Representatives, Washington, D.C. DEAR MR. Moss: This letter of comment on H.R. 5050 is being submitted by the ALIA in response to an invitation of the Subcommittee on Commerce and Finance to comment on the bill prior to legislative hearings. Our comments are confined to Title II* of H.R. 5050 with respect to competitive commission rates and institutional membership, and to Title IV concerning securities processing. We request the opportunity to appear before the Subcommittee to present these views at the hearings on the bill. We appreciate this opportunity to comment on H.R. 5050.
C. SECURITIES PROCESSING-TITLE IV
As the ALC-LIAA (predecessor associations to the ALIA) previously indicated in their statement of September 1, 1972 to the Subcommittee on H.R. 14567 and H.R. 14826, the life insurance industry supports the principal objective of the legislation being considered-to establish a national system for the efficient handling and processing of securities transactions.
We believe that H.R. 5050 resolves many of the technical problems that concerned our member companies in connection with the previous bills. However, there are several issues that have not been resolved by H.R. 5050, and we take this opportunity to discuss them. 1. Life companies as broker-dealers-section 403
Section 403 of H.R. 5050 would subject life companies or their affiliated .broker-dealers to SEC regulation in connection with their handling and settlement of variable annuity transactions. We believe that this is totally inconsistent with the Congressional intent as expressed in the Securities Investors Protection Act of 1970 (“Act”). Section 3(a) (2) of this Act provides that all persons who are registered as brokers or dealers under the 1934 Act or are members of a national securities exchange shall be members of SIPC, except for persons whose business as a broker or dealer consists exclusively of, among other things, the sale of variable annuities. Moreover, Section 11(b) of the Act provides that the SEC "shall compile a list of unsafe and unsound practices by members of SPIC" (emphasis added), and report to Congress as to, among other things, its recommendations for additional legislation. It is most significant that the Congressional concern for unsafe and unsound practices of brokerdealers, including the processing of securities transactions, was limited to members of SIPC. Consequently, we believe that any legislation which emanates from the SIPC legislation, 10 should be consistent with that legislation and its intent, particularly with respect to variable annuities which, as the SEC indicates, are not processed in the national securities markets.
In the case of variable annuities, we believe that the broker-dealer exemption under the Act was granted by Congress principally because of the limited nature of the securities transactions, which do not give rise to the risks and abuses at which the Act was directed. Variable annuity contracts are not negotiable or fungible and contractholders' checks are frequently made out directly to the life company, so that the broker-dealer affiliate may not be involved. Life companies and their broker-dealer subsidiaries promptly transmit all funds and deliver all securities in connection with these transactions. The Commission has recognized these factors in granting life company broker-dealers certain exemption from three rules (under the Securities Exchange Act of 1934) emanating from the SIPC legislation–Rule 17a-13, Rule 17a-5, and Rule 15c3–3. "These exemptions also apply to broker-dealers of registered open-end investment companies or unit investment trusts.11
In the case of variable life insurance, the 1970 Act and the related SEC rules preceded the issuance of the product and, therefore, do not contain a specific reference to such contracts. The SEC ruled on January 31, 1973 that, among .other things, variable life insurance contracts are securities which must be registered under the Securities Act of 1933.12 We believe that the basis for exempting broker-dealers who limit their transactions to variable annuities and certain redeemable investment company securities from SIPC and the related SEC regulation applies with equal force to variable life contracts.
Consequently, we recommend (see Attachment A) that Section 403 be amended to provide limited exemption for broker-dealers whose business as broker or dealer is restricted to the sale of variable contracts (including variable life in-surance) or redeemable securities of registered investment companies, similar to the exemption provided in Section 402 with respect to clearing agencies and depositories. The exemption would not constitute a full exemption for such brokerdealers from proposed paragraph (6) of Section 15(c) of the 1934 Act, but merely an exemption from the provision with respect to the regulation of such brokerdealers in their processing of variable contracts and certain investment company securities.
*The full text of the letter pertaining to titles II and IV. may be found at p. 767, this hearing. This excerpt pertains only to title IV.
10 See Statement of SEC Chairman William J. Casey before the Subcommittee on Securities of the Senate Committee on Banking, Housing and Urban Affairs on s. 2551, :S. 3297 and S. 3412, May 9, 1972, at 1.
11 See Securities Exchange Act Release Nos. 9376, 9658, and 9775, respectively. 12 See Securities Act Release No. 5360, at 2.
In any event, we urge the Subcommittee to include in its Report on the bill that the additional regulatory authority granted the SEC under Section 403 is not intended to nullify the exemptions granted broker-dealers that limit their transactions to variable annuities and other specified securities, or to preclude further exemptions for such broker-dealers under this provision. 2. Definition of terms-Section 402
Generally, Section 402 of Title IV contains express exclusions from the defini-tions of “clearing agency", "securities depository' and "transfer agent" for those. life companies that may technically fall within the definitions solely by reason of their administering variable annuities. The exclusory provisions raise two problems.
First, we believe that Section 402 should be amended so that the exclusory: language encompasses insurance companies processing variable life contracts.. Our position is based on the fact that the rationale for excluding life companies, in connection with the processing of variable annuities, from the terms of Section: 402 is equally relevant to variable life insurance. Transactions in variable life contracts will not be effected on national securities exchanges or in the over-the-.. counter markets. Rather, such contracts will be exclusively between the life. company (or its affiliated broker-dealer) and the contractholder. The contracts, based on the longevity of a particular individual, will not possess the character.. istics of negotiability and fungibility necessary for trading in a public, secondary market, although in certain cases the contracts may be assignable. As the SEC indicated, in its testimony before this Subcommittee, the legislation is not intended to reach securities such as “annuity contracts issued by insurance companies" which do not "get into the securities processing area, although through a series of definitions” they may be encompassed in the bill.13
Therefore, we recommend (see Attachment B) that the exclusion from the terms “clearing agency”, “securities depository”, and “transfer agent” be ex-. panded to encompass persons who may fall within the scope of the definitions by reason of functions commonly performed by them in connection with "variable contracts or policies issued by insurance companies”.
Second, while the exclusory language of Section 402 would provide relief for many life companies, it does not clearly encompass a subsidiary of a life company performing the processing functions with respect to variable contracts... We recommend (see Attachment B) that the exclusory language in paragraph (22) (D) for insurance companies be simliar to that contained in paragraph (25) with respect to the definition of “transfer agent”. Thus, the exclusion would apply to "any person” who performs the functions of a clearing agency or depository with respect to variable contracts issued by insurance companies. In this man- . ner, subsidiary companies could qualify under the exclusion. 3. Participation of life companies in the clearing agency or securities depository
Section 404 Life companies purchased and sold approximately $8 billion of common stock in 1971. Therefore, it is anticipated that such companies will be major participants in clearing agencies or depositories established for the purpose of facilitating securities transactions. A number of major life companies already have under consideration the formation of a regional depository.
Section 404 in effect would require-in Section 17A (d) (2) under the 1934 Act—that the rules of clearing agencies or securities depositories provide that registered investment companies and banks, among others, are eligible to become participants in such entities. Furthermore, paragraph (3) of Section 17A (d)
While these teel does not cleactions with crespect langua
13 See testimony of Mr. Pickard of the SEC staff, Transcript of Hearing on Clearance and Settlement of Securities Transactions, August 14, 1972, before this Subcommittee, at 36.