who was employed by a broker-dealer to prepare a brochure relating to certain securities, which brochure was misleading as to the issuer's financial condition. In this connection, the Commission has consistently held that predictions, projections, and optimistic forecasts made without a reasonable basis may constitute fraud," and in discussing printed advisory material which contains false statements, has referred to "the duty owed to investors to make adequate representations" and "diligent inquiry.""

C. Civil Actions

10

Section 214 of the Advisers Act authorizes the Commission to proceed civilly in federal district courts to enjoin willful violations of the Act. From 1960 to the beginning of 1967, the Commission had litigated nine such injunctive actions, described in the Litigation Release labelled Exhibit E. One of these injunctive actions, the Capital Gain Research case, culminated in a United States Supreme Court decision, one of the most important judicial decisions rendered under the federal securities statutes. Although both lower courts held against the Commission, in 1963 the Supreme Court finally sustained the Commission's view that it was fraudulent and deceptive for an investment adviser to fail to disclose to his clients a practice known in the trade as "scalping"; that is, purchasing shares of a security for his own account shortly before recommending that security for long-term investment to advisory clients and then immediately selling his own shares at a profit upon the rise in the market price following the recommendation. The court pointed out the conflict of interest present in such a situation by noting that:

"An adviser who, like respondents, secretly trades on the market effect of his own recommendations, may be motivated-consciously or unconsciously-to recommend a given security not because of its potential for long-run price increase (which would profit the client), but because of its potential for short-run price increase in response to anticipated activity from the recommendation (which would profit the adviser)."

The court rejected the interpretations of both lower courts which would have required the Commission to establish intent to injure and actual injury to the adviser's clients in order to obtain a preliminary injunction requiring disclosure of such practices. It pointed out that "Congress intended the Investment Advisers Act of 1940 to be construed like other securities legislation enacted for the purpose of avoiding frauds, not technically and restrictively, but rather flexibly to effectuate its remedial purpose."

When a person is not subject to the provisions of the Advisers Act, the Commission sometimes finds it necessary to proceed civilly under one of the other federal securities statutes in order to prevent the fraudulent dissemination of investment advice. As an example, in S.E.C. v. Chamberlain Associates, et al (S.D.N.Y., May 16, 1963), the Commission obtained an injunction under the Securities Act of 1933 against a public relations official who had distributed false and misleading information to various brokers.

D. Criminal Cases

The Advisers Act provides that the Commission may recommend criminal prosecution by the Department of Justice based upon fraudulent misconduct or willful violation of the Act or the rules promulgated thereunder. The only criminal case prosecuted specifically under the Advisers Act was United States v. Seybold (U.S.D.C. E.D. Mich. 1962). The press release concerning that case is attached as Exhibit F.

In addition, a number of investment advisers have been convicted in Commission developed prosecutions concerning violations of provisions of other federal securities statutes, usually the anti-fraud provisions of the Securities Act of 1933 or the Exchange Act of 1934. After the Commission obtained an injunction in 1961 against Frank Payson Todd, d/b/a The New England Counselor, and after it later revoked his investment adviser registration, Todd was convicted in the Commission developed case of United States v. Todd (D. Mass., 1961), for violating the provisions of Section 17(b) of the Securities Act of 1933. The fraudulent course of conduct underlying his conviction was his practice of being paid to "tout" stocks to investors without disclosing that he was receiving compensation to recommend the stocks.

In another case, Harold Schreiber, whose willful violations of the Advisers Act were one of the grounds for the revocation of the investment adviser regis

MacRobbins & Co., Inc., Exchange Act Release No. 6846 (July 11, 1962).

10 Investment Service Co., Exchange Act Release No. 6884 (August 15, 1962). 77-336 0-67-31

tration of Marketlines, Inc., Investment Adviser Act Release No. 206 (January 20, 1967), was subsequently convicted in United States v. Hayutin, et al, (S.D.N.Y. 1965) 65 Cr. 198, for violations of the registration and anti-fraud provisions of the Securities Act of 1933. In that case, among other things, Schreiber had written a fraudulent market letter recommending the purchase by investors of a worthless security, and the market letter was utilized in distributing large amounts of unregistered stock to the public.

VI. FUTURE APPROACHES

As part of its Mutual Fund study, the Commission is sponsoring several amendments to the Investment Advisers Act. Moreover, the Commission presently has under active consideration certain important rule changes.

A. Suggested Legislation

In the Commission's recently submitted Mutual Fund Report it is recommended that the Advisers Act be amended to eliminate the exemption from registration with the Commission for investment advisers to investment companies and to require that their advisory contracts be subject to the same proscriptions as other advisory contracts. One effect of eliminating the exemption from registration will be to subject investment advisers of investment companies to the bookkeeping, recordkeeping and other provisions of the Act.

The Mutual Fund Report also recommends a change in the Advisers Act to allow the Commission to proceed administratively against a person associated with an investment adviser without naming the registered entity as a respondent. This procedure will bring the Advisers Act in line with the procedures presently applicable to broker-dealers under the Exchange Act.

The Commission also has recommended that the Investment Advisers Act be amended to include a section, similar to Section 15(b) (4), of the Exchange Act, providing that violations of provisions of the Investment Advisers Act by a reg istered investment adviser, or any person acting on his behalf, may be established without the necessity of proving a use of the mails or any means or instrumentality of interstate commerce. Such a provision would recognize, as did the Congress in the 1964 Amendments to the Securities Acts in adding Section 15(b)(4) to the Exchange Act, that registration alone furnishes a sufficient constitutional basis for federal regulation.

B. Rule Proposals

Our staff is presently considering a proposed detailed rule relating to the content of investment advisory communications. It is contemplated such a rule would set specific standards for the actual content of such communications. Consideration is also being given to a companion rule under Section 15(b) (10) of the Exchange Act which would set similar standards for broker-dealers who are not NASD members, and would apply to the content of their broker advertising and sales literature as well as to investment advisory communications. The Commission is presently revising its application forms that broker-dealers and investment advisers must file to become registered with the Commission. The new forms will serve several important purposes. First, the revisions were developed with the aid of State securities administrators and the Committee on State Regulation of Securities of the American Bar Association in order to coordinate the enforcement and regulatory efforts of the Commission with the State regulatory bodies. The new forms will provide for attachment and incorporation by reference of new uniform State forms that are now filed by broker-dealers and investment advisers with most State securities administrators. Second, the new forms will facilitate an expeditious transfer of information into the Commission's new automated data processing system which is being continually adapted to assist the Commission in its regulatory and enforcement programs. Third, they will provide additional information that will be useful in determining whether reasons exist to conduct an inquiry into the affairs of an applicant. In a similar vein, we have under consideration the adoption of a withdrawal form to be utilized by investment advisers to withdraw from registration when they terminate their business. This procedure will be patterned after the existing broker-dealer withdrawal procedure which is designed to assure that obligations to customers are properly disposed of prior to allowing a registrant's withdrawal to become effective.

The CHAIRMAN. Mr. Brown.

Mr. BROWN. I have one question that relates to advertising, Mr. Cohen.

Do you have formalized rules or limitations in some published form on advertising by the organizations over which the SEC has jurisdiction?

Mr. COHEN. We do in some areas and we do not in others. I have to explain that. For example, in the case of the offering of shares by an investment company, back around 1951 and 1952, I think it was, after 3 years of joint effort between the Commission and NASD, we developed one of the most elaborate statements with regard to the statements, omissions and things of that sort that created problem with respect to the offering and sale of mutual fund shares.

In addition, there are antifraud provisions in the statutes and we conduct many proceedings out of which have grown, as in the development of the common law, rules with respect to proper and improper conduct.

Apart from that we have some 20 odd rules under the 1934 act and a lesser number under the Investment Advisers Act, all of which were designed to deal generally with the area of fraudulent activity. This again is a continuous effort on our part. As we write a rule there are those ingenious enough to find a way around the rule. It is a constant struggle. This takes up a considerable part of our time. I think I should mention that the NASD and the New York Stock Exchange have rules in both of these areas which you have raised, Mr. Brown, and they have supplemented our own and assisted in the overall policing in this area.

This is a job that will never end.

Mr. BROWN. My question went not to overall fraudulent practices but rather to any published regulations or limitations with reference to advertising or general rules that you have agreed on. If possible, I would like to get a copy of that as well as the NASD report.

Mr. COHEN. We will make a packet for you. I am afraid it will be a fairly large packet but we will get it together for you. (The information requested follows:)

SECURITIES AND EXCHANGE COMMISSION MEMORANDUM CONCERNING RULES GOVERNING ADVERTISING

Pursuant to Congressman Brown's request to Chairman Cohen during his testimony before the House Interstate and Foreign Commerce Committee on March 9, 1967, the following is a list of the Commission's rules and interpretative releases concerning advertising. Copies of these rules and releases, together with a booklet published by the National Association of Securities Dealers on this subject, are attached to this memorandum. (Attachments referred to may be found in the committee files.)

SECURITIES ACT OF 1933

Definition of Terms: Rule No. 134, 135, 156.

Rules Under Regulation E: Rule 605 (b), 606 (b), 607.

Rules Under Regulation A: Rule No. 256 (c), 257 (b), 258.

Rules Under Regulation F: Rule 653, 656.

Rules Under Regulation B: Rule No. 320.

Rules Under Regulation C: Rule No. 424 (d), 494.

Releases: No. 3844 (Oct. 8, 1957), 4697 (May 28, 1964), 4709 (July 14, 1964).

Rule 206 (4)-1.

INVESTMENT ADVISERS ACT OF 1940

Mr. BROWN. Thank you.

The CHAIRMAN. Mr. Rogers.

Mr. ROGERS. Thank you, Mr. Chairman.

It is good to see you and members of the Commission and our distinguished colleague, Mr. Budge.

Do you think there is a sufficient policing by NASD in the stock exchange of securities' dealers in the country or do you have to do much of the policing?

Mr. COHEN. We do a great deal, Mr. Rogers. It is hard for me to answer the question in terms of sufficiency. I think each of those organizations has been very busy and much more active in recent years than they have before.

We have encouraged them to move into a number of areas and, at the same time, we are also trying to avoid overlapping situations. Mr. ROGERS. Let me just ask you a few quick questions on some of the things I would like to know.

How many have had sanctions imposed upon them?

Mr. COHEN. You mean in which group, the NASD group?

Mr. ROGERS. Yes.

Mr. COHEN. Oh, there are quite a few. I could not give you the exact number.

Mr. ROGERS. Do you have these records?

Mr. COHEN. Yes, we review them and we use them as a basis for discussion with the NASD. I would be glad to give you the exact numbers for the record.

Mr. ROGERS. I would like to have a rundown on how that is done. As soon as the NASD takes action they report this to you, or do they? Mr. COHEN. Yes, we do receive a report and we have available to us in one way or another a transcript of the proceedings conducted by the district committees and the board of directors of the NASD. Mr. ROGERS. Suppose you do not agree.

Mr. COHEN. The situation is this: If someone receives a sanction from the NASD and is not satisfied, he can appeal to the SEC and we review it. We act as an appellate body. But if he is satisfied with it, we have no right to pick the case up and review it for the the purpose of increasing the sanction. The statute precludes us from doing anything of that kind.

However, we do on a regular basis review these sanctions. In fact each member of the Commission receives periodically an exact statement of what has been going on. We use this information as a basis for discussion with the NASD and on occasion with the stock exchange as well if a situation develops which we think warrants some further explanation or perhaps further action.

I might go further, Mr. Rogers. Where we learn of the situation that the NASD has dealt with and we feel that the NASD has not done a complete job, then we can move in and in fact we have. Mr. ROGERS. And you have that authority?

Mr. COHEN. Yes, when it involves a violation of the statutes or the rules adopted under them.

Mr. ROGERS. And you can move in and take the necessary action? Mr. COHEN. Yes, and we have done so.

Mr. ROGERS. I would like a rundown on some of those figures. Mr. COHEN. All right.

(The information requested follows:)

SECURITIES AND EXCHANGE COMMISSION DIVISION OF TRADING AND MARKETS

MEMORANDUM CONCERNING DISCIPLINARY ACTIONS OF THE NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.

This memorandum deals with the disciplinary activities of the National Association of Securities Dealers, Inc. (NASD). Actions of registered securities exchanges are the subject of a separate memorandum.

The NASD's complaint and inspection statistics for the last three calendar years are summarized in the following table:

It should be noted that in 1964 many complaints arose out of misconduct which occurred during the "hot issue"-"boiler room" era of the early 1960's referred to in Chairman Cohen's testimony of Mar. 9, 1967 before the House Interstate and Foreign Commerce Committee (at p. 489).

The inspection statistics include both regular examinations, which are comprehensive in scope, and special examinations, which usually take place when the association becomes aware of a particular problem involving the member of 1 or more of its employees and cover only the specific problem. However, the large majority (about 90 percent) of examinations in each of the years shown were regular examinations.

The statistics do not include the nearly 1,000 sales offices of New York Stock Exchange ("NYSE”) members examined by the NYSE in 1966. The large majority of NYSE branch offices are affiliated with NASD members.

A summary of the more serious disciplinary sanctions, such as expulsion or suspension from membership and revocation or suspenion of registered representative registration, imposed by the NASD during the last three calendar years is shown in the following table:

In addition, in each of these years a large number of firms and individuals received lesser penalties such as fines and/or censures.

THE COMMISSION'S FORMAL REVIEW POWER

Under Section 15A (g) of the Securities Exchange Act of 1934 the Commission is empowered to review NASD disciplinary actions upon application of an aggrieved party, or upon its own motion in appropriate cases. Under the statute, however, the Commission has no authority to increase the NASD's sanctions, to make findings in areas not covered by the NASD complaint, or to find violations where the NASD has dismissed allegations contained in its complaint. If a disciplinary action is applied, the Commission generally considers the matter, often after hearing oral arguments from the NASD and the respondent. upon the basis of the record before the NASD. Through the process of appellate review, the Commission determines not only whether the evidence in individual cases supports the NASD's findings and whether the severity of the penalty imposed is appropriate, but observes generally the workings of the disciplinary processes of the NASD.

Of the 69 NASD disciplinary actions brought before the Commission for review during the five fiscal years July 1, 1961-June 30, 1966, the Commission