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U.S. Securities and Exchange Commission

1997 Conference on Federal-State Securities Regulation:
Final Report

North American Securities Administrators Association, Inc.

One Massachusetts Avenue, N.W.
Suite 310
Washington, D.C. 20001

U.S. Securities and Exchange Commission

450 Fifth Street, N.W.
Washington, D.C. 20549

August 1997





Reports of the Working Groups

  A. Corporation Finance
  B. Investment Management
  C. Market Regulation
  D. Enforcement



  A. Commenters
  B. NASAA and SEC Representatives

I. Summary

The United States Securities and Exchange Commission ("SEC" or "Commission") and the North American Securities Administrators Association, Inc. ("NASAA") held their annual meeting in Washington, D.C. on April 28, 1997. This year's meeting was the fourteenth meeting held pursuant to Section 19(c) of the Securities Act of 1933. That section requires the SEC to hold an annual meeting to maximize uniformity in federal and state securities regulation and effectiveness of regulation while, at the same time, reducing costs and paperwork for issuers and minimizing interference with capital formation.

The 1997 meeting was the first meeting following passage of The National Securities Markets Improvement Act of 1996 ("NSMIA"), which was signed by President Clinton on October 11, 1996. NSMIA contains significant provisions that realign the regulatory partnership between federal and state regulators. The law reallocates responsibility for regulation of the nation's securities markets between the federal government and the states in order to eliminate duplicative costs and burdens and improve efficiency, while preserving investor protections.

Prior to the meeting, the SEC and NASAA solicited the views and comments of interested parties for consideration by conference participants. Six parties provided written comments. These comments provided useful information for discussion at the meeting. 1

Approximately 70 NASAA representatives and 65 SEC representatives attended the 1997 meeting. 2 Participants divided into four working groups in the following subject areas: corporation finance; investment management; market regulation and enforcement. SEC and NASAA representatives discussed matters of common interest and concern in the working groups. A description of the discussions of each group is set forth in the following section. During the working groups, participants outlined current state and federal regulatory efforts and initiatives, identified areas in which joint cooperation would be beneficial and discussed ideas and plans for more effective cooperation, coordination and communication.

II. Reports of the Working Groups

A. Corporation Finance

1. Uniformity of Regulation

NSMIA amended Section 18 of the Securities Act of 1933 ("Securities Act") to preempt state blue-sky registration and review of securities offerings of "covered securities." Securities which do not fall within the definition of covered securities remain subject to state registration and review requirements. Also, the states retain the authority to require specified fee payments and notice filings for several types of covered securities. The states' continuing authority to regulate certain offerings and to require filings and fees for certain covered securities continues the need for uniformity between the federal and state registration systems where consistent with investor protection.

NSMIA requires the SEC to conduct a study as to the extent to which uniformity of state regulatory requirements for securities and securities transactions that are not covered securities has been achieved. The SEC is instructed to consult with the states as well as issuers, brokers and dealers in conducting this study. The results of the study are to be reported to Congress within a year following the enactment of the 1996 Act. The SEC staff urged the states to adopt a single source from which issuers could obtain information with respect to state fees and notice filing requirements applicable to covered securities.

The conferees discussed the degree of uniformity at present and recent steps to increase uniformity going forward. In this regard, the state representatives reported that NASAA had passed on April 27, 1997 a Model Accredited Investor Exemption which is similar, but not identical, to California's Rule 25102(n) exemption. The SEC has adopted Rule 1001 under the Securities Act which provides for a federal exemption which coordinates with the California exemption. The states requested that the SEC consider adopting a federal exemption that would coordinate with the Model Accredited Investor Exemption. The NASAA representatives also summarized the status of the states' regional review and coordinated equity review programs.

2. Sales to Qualified Purchasers

Section 18 of the Securities Act, as amended by NSMIA, excludes from state regulation and review securities offerings to purchasers who are defined by SEC rules to be "qualified purchasers." A security sold to a qualified purchaser is a "covered security" subject to the same new regulatory approach as other covered securities as described above. The SEC personnel summarized the ideas under consideration for the definition of qualified purchaser, including tests based on investments, income and net worth. The staff indicated that the SEC is considering how the definition of qualified purchaser should relate to the definition of "accredited investor" under the Securities Act and whether the definition of accredited investor should be revised. The staff indicated that the qualified purchaser definition would likely include certain natural persons in addition to institutional investors.

3. SEC Exemptive Authority

NSMIA added new Section 28 to the Securities Act granting the SEC extensive general authority to craft exemptions from the Securities Act to the extent that such exemptions are necessary or appropriate in the public interest and consistent with the protection of investors. This new authority permits the SEC to adopt rules which exempt any person, security or transaction, or any classes thereof, from one or more of the provisions of the Securities Act. The SEC and NASAA generally discussed the nature and extent of appropriate exemptions that may be adopted under the SEC's new authority, including possible changes to existing federal exemptions based on other sections of the Securities Act.

4. Small Business Initiatives

On February 20, 1997, the SEC adopted amendments to the holding period requirements contained in Rule 144 under the Securities Act. The amendments permit the resale of limited amounts of restricted securities after a one-year, rather than the previous two-year, holding period. In addition, the amendments permit unlimited resales of restricted securities by non-affiliates after a holding period of two years, rather than the previous three-year period. In a companion release, the SEC proposed certain changes to Rule 144 to simplify the rule's operation and solicited comments on additional changes to Rule 144. The working group discussions primarily focused on whether the Rule 144 manner of sale requirements that relate to brokers' transactions should be retained and the appropriate treatment of hedging transactions under the rule.

The participants also discussed the SEC's recent proposed amendments to Rule 430A to permit certain smaller or less seasoned reporting companies to price securities on a delayed basis after effectiveness of a registration statement, if they meet specified conditions. The working group discussed concerns that the identity of the managing underwriter may not be known at the time of effectiveness of the registration statement and that an underwriter may not have sufficient time to conduct due diligence prior to the offering.

During the fall of 1996, the SEC began meeting with small businesses in town hall meetings conducted throughout the United States. These town hall meetings are intended to provide basic information to small businesses about fundamental requirements that must be addressed when they wish to raise capital through the public sale of securities. In addition, the SEC has learned and will continue to learn more about the concerns and problems facing small businesses in raising capital so that initiatives and programs can be designed to meet their needs, consistent with the protection of investors. The SEC staff provided a brief discussion of the eight town hall meetings held to date, including the most recent meeting in Richmond, Virginia. The staff indicated that future meetings are scheduled for Tulsa, Oklahoma and Philadelphia, Pennsylvania.

5. Disclosure Simplification

On March 5, 1996, the Commission published the Report of the Task Force on Disclosure Simplification (the "Task Force Report"). The Task Force Report includes several recommendations intended to reduce the costs of raising capital by both smaller and seasoned companies. In addition, the Task Force Report includes a discussion of the ongoing debate regarding the need to adapt existing Securities Act requirements and related concepts to current market conditions.

The conference participants generally discussed the findings and recommendations of the Task Force Report. The working group considered the Commission's proposal to eliminate the Form D filing requirement under Regulation D. The staff indicated that the SEC is considering retaining the form so that issuers could continue to file the form with the states under state limited offering exemptions which coordinate with Regulation D.

6. Report of the Advisory Committee on the Capital Formation and Regulatory Processes;Securities Act Concept Release

The SEC has been engaged in a broad reexamination of the regulatory framework for the offer and sale of securities under the Securities Act. The SEC issued a concept release during 1996 to solicit comment on the best means of improving the regulation of the capital formation process while maintaining or enhancing investor protection. The SEC staff reported that approximately 50 comment letters had been received on the concept release as of the date of the conference. The staff indicated that the SEC is considering a wide variety of ideas to improve the capital formation process. Among the ideas under consideration are the following: changing the nature and timing of permissible communications before and during a securities offering; changing the existing prospectus delivery procedures to ensure that investors receive disclosure in advance of an investment decision; and permitting issuers to switch between a public offering and a private offering under certain circumstances. The staff also indicated that improvements to the reporting requirements under the Securities Exchange Act of 1934 ("Exchange Act") also are under consideration, including, for example, expanding the events required to be reported on Form 8-K and requiring reports to be filed on a more timely basis.

7. Plain English

The Task Force Report criticized prospectuses for their dense writing, legal boilerplate and repetitive disclosures and recommended using plain English disclosure to improve the readability of prospectuses. The SEC in January 1997 proposed several rule amendments that would be a first step in implementing the Task Force's recommendation. The proposals require the use of plain English writing principles when drafting the front part of prospectuses -- the cover page, summary and risk factors sections of these documents.

The SEC staff informed the working group that approximately 42 comment letters had been received to date on the plain English release. The staff noted that issuers generally favor the proposal while comment letters from the securities bar and underwriters generally oppose the initiative. Certain commenters have requested a safe harbor from liability if the plain English proposals are adopted.

The Division of Corporation Finance is operating a pilot program for companies that want to draft their documents in plain English. The Division's staff works with volunteers on the techniques for designing and writing plain English documents filed under either the Securities Act or the Exchange Act. The company participants can draft plain English documents and submit them to the staff for suggestions and comments in a nonpublic forum. The staff advised the working group that the program includes approximately 45 participants at the time of the conference.

8. Electronic Delivery of Disclosure Documents

The SEC has issued interpretive releases and rules addressing the use of electronic media to deliver or transmit information under the federal securities laws. These initiatives reflect the SEC's continuing recognition of the benefits that electronic technology provides to the financial markets. These releases are premised on the belief that the use of electronic media should be at least an equal alternative to the use of paper delivery.

The working group participants discussed recent developments in the use of electronic media in the capital formation process and in providing reports under the Exchange Act. The SEC staff indicated that issuers tend to use paper prospectuses rather than electronic prospectuses. The staff summarized a recent position taken by the Division of Corporation Finance that, generally speaking, the reference in a prospectus to the company's web site containing Exchange Act reports would not attach Section 11 liability to the statements made in those reports. The staff also reported an increase in proxy voting over the Internet and indicated that proxy statements should contain a description of the procedures for such voting. The state representatives indicated that NASAA's Model Accredited Investor Exemption permits the posting of an advertisement on an Internet system that is limited to accredited investors.

9. Internationalization of the Securities Markets

The Commission has provided a separate integrated disclosure system for foreign private issuers that provides a number of accommodations to foreign practices and policies. Foreign companies conducting securities offerings in the U.S. continue to be subject to state regulation and review unless the securities being offered are covered securities within the meaning of NSMIA. The working group discussed recent experiences with the "Multijurisdictional Disclosure System" which generally permits U.S. and Canadian issuers to provide disclosure documents based upon the disclosure requirements of their respective jurisdictions.The Commission issued a release on February 20, 1997 proposing revisions to Regulation S to prevent certain abusive practices. The proposals include lengthening the restricted period during which persons relying on the Regulation S safe harbor may not sell equity securities into the United States from 40 days to two years (absent registration or a valid exemption) and classifying equity securities placed offshore pursuant to Regulation S as "restricted securities" under Rule 144. The proposals would apply to offshore sales of equity securities of domestic issuers and of foreign issuers where the principal market for those securities is the United States. The working group discussed the proposed changes to Regulation S. The discussions primarily focused on the treatment of promissory notes received in exchange for Regulation S securities and hedging transactions under the safe harbor.

B. Investment Management

1. Status of Proposed Rules Implementing the Investment Advisers Supervision Coordination Act

Representatives of the Division of Investment Management (the "Division") briefed participants on the status of proposed rules implementing the Investment Advisers Supervision Coordination Act ("Coordination Act"), a part of NSMIA. The Coordination Act amended the Investment Advisers Act of 1940 ("Advisers Act") to, among other things, reallocate the responsibilities for regulating investment advisers between the Commission and the securities regulatory authorities of the states.

Conferees discussed the extension of the effective date of the Coordination Act from April 8, 1997 to July 9, 1997. Division representatives described the logistical problems involved in adopting rules within the six month period in light of the need to give investment advisers adequate time to familiarize themselves with the rules and consult with counsel before reporting their status to the Commission.

The Office of Compliance Inspections and Examinations ("OCIE") representatives discussed the coordination of ongoing enforcement proceedings and examinations between the Commission and the state securities regulators, noting that the extension of the effective date of the Coordination Act provided additional time to conduct joint examinations.

Conferees discussed the two-year "sunset" provision added by the Coordination Act to the definition of "investment manager" in the Employee Retirement Income Security Act of 1974.

2. Coordination of Transition

Representatives of the Division briefed participants on the transition process by which investment advisers would file Form ADV-T with the Commission to indicate their eligibility to remain registered with the Commission as investment advisers.

Division representatives stated that they anticipated that approximately two-thirds of all currently-registered investment advisers would not be eligible for Commission registration after July 8, 1997. Investment advisers that would not be eligible for Commission registration after July 8, 1997, but that do not withdraw from registration on Form ADV-T, would be identified during Commission inspections and examinations. The Commission expects to cancel the registrations of such persons. The Division will notify NASAA and the state securities commissions as to which investment advisers have withdrawn from Commission registration on Form ADV-T. Representatives of the Division discussed the possibility of providing this information in an electronic format (i.e., a database on diskette), as well as on paper (i.e., copies of all Form ADV-Ts filed with the Commission). Division representatives noted that Form ADV-T requires advisers to indicate the states in which they have current and pending registrations, and that the Commission included a request for this information on the form to assist the states. Representatives of NASAA and the Division agreed that they would continue to advise each other of developments with respect to the transition process.

Conferees discussed the use of the Commission's web site to keep investment advisers informed of the changes in investment adviser regulation. Division representatives suggested that the Commission's investment adviser web site contain a hyperlink to NASAA's web site.

Division representatives described the exemptive authority granted to the Commission by the Coordination Act, and discussed the possibility of exempting multi-state advisers (e.g. those advisers that would be required to register in a large number of states) from the prohibition on Commission registration.

3. Long-range Plans Regarding Form ADV and One-Stop Filing

Conferees agreed that a single one-stop filing system for investment adviser registration used by both the states and the Commission would be advantageous, and that the development of a one-stop filing system and the revision of Form ADV for use on that system are the highest priorities for state securities regulators and the Commission after July 8, 1997. Conferees discussed the potential use of the World Wide Web in developing a one-stop filing system.

Conferees discussed the Commission's obligation, under the Coordination Act, to establish a telephonic inquiry system that could be used by clients and prospective clients of investment advisers to obtain information about the advisers. Division representatives explained that after July 8, 1997 the Commission would no longer have current information about smaller, state registered advisers. Accordingly, for such a system to provide a useful service to investors, the system would need to operate in conjunction with a data base maintained jointly with the states, such as the data base that would be created by operation of the one-stop filing system. The conferees agreed that it would be most useful, therefore, for the operator of the one-stop filing system to also operate the telephonic inquiry system.

4. New Task Force on Investment Adviser Regulation

Representatives of the Division described the role of the new Task Force on Investment Adviser Regulation. Division representatives stated that in addition to implementing the July 8, 1997 transition, the Task Force will undertake a comprehensive review of investment adviser forms and regulations.

5. Training and Technical Assistance

Conferees participated in a lengthy discussion with OCIE representatives regarding the needs of the states with respect to training and technical assistance by Commission staff. It was noted that state needs differ based upon state resources, investment adviser population, and staffing levels, and that the Commission intends to tailor its assistance to the particular needs of each individual state. OCIE representatives described the Commission's response to state requests for technical assistance, such as the development of case studies and classroom training exercises, review of state inspection modules, and OCIE internship programs.

OCIE representatives stated that, in response to state regulators' requests for subjective information regarding specific investment advisers, one person in each Commission regional and district office has been designated as a contact person for states to obtain such information.

C. Market Regulation

1. National Securities Markets Improvement Act

a. State Licensing Requirements

NSMIA directed the Commission to conduct a study of the impact of disparate state licensing requirements on associated persons of registered broker-dealers and the methods for states to attain uniform licensing requirements for such persons. The Commission is required to consult with the self-regulatory organizations ("SROs") and the states, and to prepare and submit a report to Congress by October 11, 1997. The participants discussed the status of the study, including discussions with NASAA and the Securities Industry Association ("SIA"), and the Commission's licensing survey. They also discussed the need for and feasibility of requiring uniform state requirements (through legislation or other means).

b. Study Regarding State Requirements for Exchange-ListedSecurities

NSMIA amended Section 18 of the Securities Act to provide an exemption from state blue sky laws and regulations for securities that are listed on the New York Stock Exchange, Inc. ("NYSE"), the American Stock Exchange, Inc. ("AMEX") and Nasdaq National Market System ("Nasdaq/NMS"). The amendments to Section 18 also allow the Commission by rule to designate securities listed on other national securities exchanges as exempt from state blue sky laws and regulations if the applicable listing standards are substantially similar to those of the NYSE, AMEX, or Nasdaq/NMS. Section 18 allows the Commission to adopt such a rule on its own initiative or in response to a rulemaking petition. The Commission has received rulemaking petitions from the Pacific Stock Exchange, Inc., the Chicago Board Options Exchange, Inc., and the Chicago Stock Exchange, Inc. The participants briefly discussed these proposals.

c. Broker-Dealer Books and Records

Section 103 of NSMIA prohibits any state from imposing broker-dealer books and records requirements that are different from or in addition to the Commission's requirements. In addition, the same section directs the Commission to consult periodically with state securities authorities concerning the adequacy of the Commission's requirements. The Commission's current proposal to amend Rules 17a-3 and 17a-4 originated in discussions between NASAA representatives and the Commission about the adequacy of the existing broker-dealer books and records requirements. 3 The proposed amendments clarify, modify and expand the Commission's record-keeping requirements with respect to purchase and sale documents, customer records, associated person records, customer complaints, and certain other matters. In addition, the proposed amendments specify certain types of books and records that broker-dealers must make available in their local offices. The participants at the Conference discussed the proposed amendments and the comments received.

d. State Suitability Rules

The participants briefly discussed NASAA's proposed suitability rule. The proposal is still out for comment.

2. Bank Securities Activities

Last year, the National Association of Securities Dealers, Inc. ("NASD") submitted a rule proposal to the Commission that would govern the conduct of member broker-dealers operating on the premises of financial institutions. The NASD has since substantially revised its rule proposal to address a number of issues raised by the commenters. The participants discussed the proposed rule revisions, as well as other developments in this area, including a proposal by the federal banking regulators to require bank employees that sell securities directly to take certain qualification examinations currently required of broker-dealer employees.

3. Central Registration Depository ("CRD") Redesign

The CRD system is a computer system operated by the NASD that is used by the Commission, the states and the SROs primarily as a means to facilitate registration of broker-dealers and their associated persons. The NASD is in the process of implementing a comprehensive plan to redesign the CRD and to expand its use by federal and state securities regulators as a tool for broker-dealer registration. As a result of the NASD's efforts, the redesigned CRD system ultimately is expected to provide the Commission, SROs, and state securities regulators with: (i) streamlined capture and display of data; (ii) better access to registration and disciplinary information through the use of standardized and specialized computer searches; and (iii) electronic filing of uniform registration and licensing forms, including Forms U-4, U-5, BD and BDW.

After an initial testing period, the NASD discovered that the software used to redesign the CRD was not workable. The participants discussed the delay in the implementation of the redesigned CRD, including the effect on state and SEC registration programs.

4. Arbitration

The NASD and other members of the Securities Industry Conference on Arbitration have been developing new approaches to important issues affecting the administration of securities arbitration over the past year. Much of their work was prompted by the 1996 report of the NASD's Arbitration Policy Task Force. The participants discussed the status of some of the important developments in this area. For example, proposed changes related to the variations in administering claims of different dollar amounts, the administration of older claims, and punitive damages were discussed.

5. Regulation M

On December 18, 1996, the Commission approved Regulation M, representing the most sweeping changes in the way the Commission seeks to prevent the manipulation of securities offerings since the Commission adopted Rules 10b-6, 10b-7 and 10b-8 (also known as the "trading practices rules") over 40 years ago. 4 Regulation M which became effective March 4, 1997 differs from the former trading practices rules by focusing the restrictions on securities that are more susceptible to manipulation; using better measures for manipulative potential; recognizing the global nature of securities markets; assimilating the changes in market transparency and surveillance; and codifying a variety of earlier actions by the Commission to adapt the former rules to current market conditions. Regulation M addresses the concern that persons with a stake in a securities offering, such as issuers, selling securityholders and underwriters, might artificially influence the market price of the security in distribution, thereby boosting its offering price. The regulation seeks to prevent this result by restricting the activities of these persons. In particular, Regulation M requires offering participants to cease their market activities, such as proprietary trading, during a restricted period that begins 1 or 5 business days prior to the offering's pricing and ends when the offering is over. A notable change from the trading practices rules, and one which reflects the more focused approach of Regulation M, is that underwriters of an actively-traded security of a larger issuer would not be subject to these restrictions. The Commission staff summarized the new regulation.

6. Broker-Dealer Examinations

The OCIE representatives discussed a number of significant issues related to the examination program. Information was exchanged on coordination of examinations and follow-up to the Memorandum of Understanding ("MOU") signed in 1995 by all regulators responsible for conducting examinations of broker-dealers. Regional summits involving the SEC offices, NASD offices and state regulators are being held all over the country pursuant to this MOU to discuss coordination of examination schedules and examination priorities, broker-dealers' examination histories, and other areas of related interest. The goal is to encourage information-sharing and avoid unnecessary duplication of examinations.

OCIE also discussed its recent efforts to assist state regulators in drafting examination modules for use in the examination of broker-dealers. OCIE sent to the state regulators a proposed module to be used to review for abusive cold calling practices. In addition, OCIE agreed to provide comments and suggestions on the states' "Module X" that is used for the examination of broker-dealer branches.

OCIE also discussed SEC priorities for examinations of broker-dealers which include:

  • Fraudulent sales practices: manipulations, misrepresentations, unauthorized trading and excessive markups (particularly in sales of low-priced and high risk securities) and adequacy of supervision by broker-dealers;
  • Selective internal control reviews of large broker-dealers;
  • Five of the twenty largest broker-dealers that carry public customer accounts;
  • Hiring, retention and supervisory practices of broker-dealers that employ problem registered representatives;
  • Municipal securities underwriting practices and MSRB Rule G-37;
  • Supervision of registered representatives acting as "independent contractors" and "investment advisers;"
  • Compliance with new order handling rules and best execution;
  • Variable annuity and insurance product sales practices;
  • Branch office sales practice examinations;
  • Broker-dealer soft dollar practices; and
  • Cold calling practices.

D. Enforcement

The Enforcement Working Group had an agenda of nine items. The session was attended by 41 enforcement officials, including representatives from 15 states and the District of Columbia, the SEC Division of Enforcement and the SEC Regional/District Offices. Also attending were representatives from the National Association of Securities Dealers-Regulation ("NASDR"), the NYSE, the U.S. Department of Justice, the Federal Trade Commission and the National White Collar Crime Center. By prearrangement, at 11:15 a.m., the Market Regulation and Enforcement Working Groups conducted a joint session to discuss surveillance of securities related activities on the Internet.

As introductory remarks, the co-moderators of the Enforcement Working Group noted the following recent significant developments in securities regulation and enforcement: federal legislation providing the states with exclusive regulatory jurisdiction over two-thirds of the 22,500 investment advisers registered with the SEC; structural reorganization of the NASD resulting in a bifurcation of listing/trading and regulation/enforcement operations; U.S. Supreme Court proceedings concerning the legal viability of the inside information misappropriation theory; and the mounting number of securities related activities on the Internet.

1. SEC Trends and Priorities

The Director of the SEC Division of Enforcement briefly described major enforcement trends and priorities of the SEC. Last year, the SEC brought 453 cases and has 500-600 cases in litigation. Investor complaints are increasing, a large number of which concern suitability issues and cold-calling by broker-dealers.

a. Securities Offerings

In the past year, there were $1.2 trillion in securities offerings, of which $165 billion were initial public offerings - record amounts in each instance. Also, the phenomenal growth of mutual fund sales has continued.

With respect to exotic securities offerings, the adverse decision in Life Partners is troublesome. 5 However, the SEC has decided not to seek certiorari. The case involved investments in viatical settlements involving AIDS patients.

The Internet continues to present a unique challenge to SEC surveillance efforts. The SEC has brought more than a dozen cases related to Internet activities, more can be expected. State efforts to harness this new investment medium are important to investor protection.

b. Financial Fraud

Approximately 20% of last year's enforcement cases involved financial fraud. Accounting and corporate disclosure issues may increase. There is an ascendancy of non-audit groups (e.g., management advisers) within accounting firms, which is prompting a concern with respect to the independence of auditors, both in fact and in appearance.

c. Broker-Dealers and Investment Advisers

The percent of cases involving broker-dealer matters has remained roughly the same at about 20%. The Commission is continuing its focus upon the adequacy of supervision and it is anticipated that it will levy strong sanctions for failures to supervise violators.

Since its reorganization, relations with the NASD have significantly improved. The concern now is to attempt to coordinate and divide the respective enforcement workloads.

Due in large part to the dramatic increase in the number of investment advisers, there has been a concomitant increase in the number of cases in this area. 6 The increase is expected to continue. Small firms tend to be involved in the more egregious frauds. It was noted that the SROs have provisions concerning ethical duties and fiduciary responsibilities which do not require scienter. The SEC and the states may bring coordinated enforcement actions against 4-5 advisory firms in order to enhance deterrence.

d. Insider Trading

One of the major enforcement programs of the SEC is insider trading. There appears to be a resurgence of merger-and-acquisition type cases and related opportunities for enormous profits through options trading. The SEC has increasingly resorted to temporary restraining orders and asset freezes to preclude disposition of unlawful profits.

Of significant concern to the SEC enforcement program is the outcome of the O'Hagan appeal pending before the Supreme Court. 7 One of the major enforcement weapons of the SEC program against insider trading is the misappropriation theory. In the O'Hagan case, the Eighth Circuit joined the Fourth Circuit in rejecting the misappropriation theory as a basis for Rule 10b-5 liability. 8

e. Foreign Bribery

The SEC recently brought its first foreign bribery case in ten years. 9 The SEC staff is investigating a number of other foreign bribery situations in which middlemen and agents were used.

2. State Trends and Priorities

The Chair of NASAA's Enforcement Section (Securities Commissioner of Maryland) briefly described major trends and priorities of state securities law enforcement.

a. Enforcement Actions

State enforcement activity has increased approximately 25%. [See the appended statistical schedule entitled: "State Securities Enforcement Activity".] There has been a comparable increase in the number of state criminal actions. The states have obtained over $85 million in restitution and over $7 million in fines.

So-called affinity frauds perpetrated on religious, racial and ethnic groups have been a major problem in the past year. Also, prime bank and advance fee schemes still appear to be prevalent.

b. Investigation and Litigation Assistance

In anticipation of exclusive regulatory jurisdiction over small investment advisers, the states and Canadian provinces entered into a Memorandum of Understanding to facilitate and coordinate investigations and enforcement actions. [See the appended Media Release entitled: "States Approve Plan to Regulate Small Investment Advisers", dated April 28, 1997.]

On May 1,1997, the states, with the cooperation of the National White Collar Crime Center, will commence an investigation database designed to provide status of cases to subscribing states. Search notification via E-mail will be an integral part of the system. Also, the Internet Committee of NASAA's Enforcement Section is working on a plan to coordinate surveillance efforts of the respective states.

In July 1997, NASAA will sponsor a training program in Washington, D.C. for new state investigators and in September, a training program in Quebec for civil and criminal litigators.

3. Joint Projects/Cases of Mutual Interest

The Chair of NASAA's Enforcement Policy Committee (Enforcement Director, California Department of Corporations) briefly described specific cases and projects of interest to the SEC and the states.

a. Broker-Dealer Examination Sweep

During the week of February 26, 1997, 24 examiners from 12 states conducted joint regulatory examinations of five broker-dealer firms in New York City to uncover violations of the new cold-call restrictions; and suitability, market manipulation and sales-practice violations and unauthorized trading. Employment of individuals as consultants that were barred from the securities industry was another objective of the broker-dealer sweep.

The states are considering a coordinated effort to detect conversion of customer funds and securities by securities sales personnel and to bring more cases in this area. Other areas of cooperation with NASDR are being sought in NASAA Zone meetings scheduled for the next few months. The inadequacies of the CRD system in generating special reports is a significant impediment to the development of joint state projects involving the activities of broker-dealers and registered representatives.

b. Viatical Schemes

Through the joint efforts of Arizona, California, Minnesota, Nevada, Oregon and South Dakota, a receiver was appointed on April 23, 1997 for $80-$100 million in investor funds in a viatical scheme marketed by a company called Personal Choice Opportunities. The scheme involved promissory notes allegedly secured by interests in life insurance policies of AIDS and cancer victims.

c. Municipal Bond Offerings

California and the SEC are working together to investigate municipal securities offerings in which revenue bond offerings are being marketed as if they were guaranteed by the municipality whose governing body authorized the revenue bond issuance.

4. NASD-Regulation Trends and Priorities

The new Executive Vice President for Enforcement of NASDR briefly described the major enforcement trends and priorities of his self-regulatory organization.

a. Organizational Restructuring

This is the first anniversary of the reorganization of the NASD, which was prompted by an SEC enforcement proceeding. NASDR's enforcement program is now centralized. By the end of 1997, the enforcement staff will have been increased 50%. On April 21, 1997, an advertising review unit was formed. It is developing a computer program of so-called "red flag" phrases.

b. Enforcement Actions

Last year, the number of cases increased 12% to some 1,200 enforcement proceedings. The number of fines has increased 20% and proceedings are instituted more quickly. Closer coordination with federal agencies is taking place, e.g., in Sterling Foster (a seven month investigation involving market manipulation and three IPOs) the SEC got an asset freeze and the Federal Bureau of Investigation ("FBI") seized documents. 10

c. New Enforcement Proceeding Procedures

A dramatic change in NASDR's enforcement hearing procedures has been effected. Moreover, enforcement proceedings will receive more publicity. The disciplinary hearing process has been more formalized and is more lawyer oriented. Hearing panels will have a full-time hearing officer. The new procedures seek to levy stricter deadlines, expedite the process and restrict ex parte communications. As before, appeals will go to the National Business Conduct Committee, for the first time, the staff will have authority to appeal or cross-appeal. Under consideration is the adoption of emergency cease-and-desist authority for appropriate cases.

d. Priorities

Areas of enforcement priority include the small capitalization companies, mutual fund advisers, variable annuity sales and municipal securities practices (Rules G-37 and 38 of the Municipal Securities Rulemaking Board). A major focus will be to seek to avoid duplicative enforcement efforts concerning matters in which there is an SEC and/or state interest.

e. Criminal Referrals

An internal coordinating unit has been formed to refer organized crime matters to the appropriate U.S. Attorney offices.

5. Trends and Priorities of the New York Stock Exchange

The Senior Vice President in charge of enforcement at the NYSE (or "Exchange") briefly described the major enforcement trends and priorities of the Exchange.

The enforcement organization of the NASD has been restructured somewhat along the lines of the NYSE model. The Exchange has 500 people devoted to regulation, of which 250 are examiners, 120 are in enforcement and 100 are investigators. Furthermore, about half of the members of the Exchange's board of directors are independent, i.e., have no affiliation with any member firm of the Exchange.

Litigation has increased due to several factors, including the increased sanctions trend and the practical reality of staying in business pending the outcome of enforcement proceedings. At the NYSE, a regular feature of enforcement settlements has been an undertaking to hire outside consultants to review the compliance procedures of the respondent firm. A somewhat related concern of broker-dealer firms is potential liability for disclosure on Forms U-5 with respect to past problems of a departing registered representative. In Brenner, a New York court enjoined the filing of a Form U-5 and later ordered that the filing be made under seal. The Exchange intervened and was successful in getting that decision reversed on appeal. 11

One of the focuses of the NYSE's examination and enforcement programs is order tickets. Inaccurate and incomplete order tickets make investigations of trading activities more difficult. The Exchange has brought cases based solely on faulty order tickets. Also, broker-dealer late filings continue to generate many cases and supervision charges in sales practice cases continue to be a focus.

6. Department of Justice's Securities Fraud Program

The Deputy Chief of the Fraud Section of the Criminal Division of the Department of Justice briefly presented an update of the Department's securities fraud enforcement activities.

Balancing budgetary limitations and enforcement priorities continues to be a challenge. Although the bank/thrift crisis is over, the FBI case file still contains many cases that will require attention as the Department continues to enhance its securities fraud enforcement program.

Increased litigation has heightened the sensitivity of criminal prosecutors in the instance of parallel enforcement proceedings, e.g., with respect to the Halper issue of double jeopardy. 12 Accordingly, coordination with the respective securities enforcement agencies and the 94 U.S. Attorney Offices is a major focus of the Fraud Section.

The Justice Department has a varied mix of securities fraud cases, with no particular concentration in any one area; however, mob infiltration of the securities industry is a concern that is being examined. Despite press reports to the contrary, no resurgence of insider trading is evident in the caseload of the Justice Department.

7. Surveillance of NASDAQ's Small-Cap and Bulletin Board

The Deputy Director for Regulation of NASDR described the surveillance program of trading on Nasdaq's Small-Cap and Bulletin Board markets.

NASDR has an electronic surveillance group devoted to detecting possible insider trading violations. A program has been specifically developed for uncovering insider trading in the mergers and acquisitions area ("RADAR"). Last year, 118 cases were referred to the SEC. Since January, over 50 cases have already been referred.

Short selling is another surveillance focus.

"Drive-by manipulations" is also a focus, i.e., an issuer hires a research reporter as a consultant, who in turn pumps-up the stock of the company. Small technology companies and Bulletin Board issuers are particularly susceptible to such schemes. Also, a surveillance program is being developed to track options trading.

NASDR is willing to provide stock trading experts to support enforcement investigations and litigation.

As of May 15, 1997, full Rule 15c2-11 applications will be needed for market making in limited partnership interests on the Bulletin Board.

8. Economic Crime Summit Meeting

The Director of the National White Collar Crime Center ("NWCCC" or "Center") stated that his organization is sponsoring its first Economic Crime Summit conference to be held in Providence, May 18-21, 1997. [Next year, the conference will be held April 26th through 29th in St. Louis.] Issues and options (vs. solutions) is the orientation of the conference. The annual summits are designed to provide a platform of public-private cooperation in the prevention, investigation and prosecution of economic crime.

NWCCC is available to provide computer and technological assistance to securities agencies investigating fraud. The Center has become a major resource for state and local investor surveys in connection with investigations.

9. Surveillance of the Internet

The Market Regulation and Enforcement working groups combined to discuss this item of mutual interest.

a. The SEC Program

The SEC enforcement special counsel for Internet projects described the SEC surveillance program.

The SEC has formed a "cyberforce" of 60-70 attorneys/accountants/analysts to scan the Internet. In conducting searches on the Internet, securities investigators should be aware of the provisions of the Electronic Communications Privacy Act [18 U.S.C. 2510-2521, 2701-2711 and 3121-3127]. As of June 1996, the SEC established a web site to receive investor complaints. The SEC receives 30-40 complaints a day concerning Internet communications. The SEC seeks to share its surveillance efforts with state and SRO officials.

The SEC has brought 13 cases related in varying degrees to the Internet and has instituted five trading suspensions precipitated by Internet "chatter."

b. State activities

The securities administrator of New York described his office's participation in "Surf Day" (December 9, 1996).

"Surf Day" was a surveillance project designed to scan Internet transmissions for the purpose of detecting pyramid schemes. The project was organized by the Federal Trade Commission ("FTC"). In addition to the FTC and New York's Bureau of Investor Protection, other participating agencies included the SEC, the Federal Communications Commission and New York's Attorney General Office. The FTC sent notices to suspicious Web sites (over 500) which pointed-out potential violations. New York brought enforcement actions against two of the sites. 13

c. Federal Trade Commission Program

The special counsel for Internet matters at the FTC described his agency's activities in the area.

Enforcement strategy of the FTC is to educate first and prosecute second. For example, the agency established a teaser page on the Internet, which appeared to be an investment opportunity but rather was a public service message warning potential victims of such Internet schemes. Private organizations are also used to educate and inform Web browsers.

FTC's surveillance efforts include a telemarketing complaint system, a consumer Web site ("www.ftc.gov") and a chat session on the Internet. Also, undercover activities are used by the FTC. The Department of Justice is developing a protocol for undercover operations.

The FTC has brought 17 cases involving Internet communications, mostly concerning pyramid schemes, entrepreneurial business opportunities, and international schemes. High technology products are often the focus of the business opportunity scams.

d. The National White Collar Crime Center

The Internet specialist of the NWCCC described the activities of his organization concerning Internet surveillance.

In addition to providing expertise to securities law enforcement agencies, the Center is developing a pilot program with NASAA with respect to the sharing of surveillance information.

Ponzi schemes have seemingly become pervasive on the Internet. Of mounting concern, are the international scams and the resultant flight of money to foreign con artists. Enforcement jurisdiction is a major concern with respect to such schemes.

Appendices to Enforcement Working Group Report

Note: These appendices are not available in electronic format.

  • State Securities Enforcement Activity
  • Media Release - States Approve Plan to Regulate Small Investment Advisers
  • Report on Operation "Surf Day"

III. Exhibits

A. Commenters

  • Investment Company Institute (Paul Schott Stevens, Senior Vice President, General Counsel)
  • Investment Counsel Association of America, Inc. (Karen L. Barr, General Counsel)
  • The Surety Association of America (William L. Kelly)
  • Clarence Manning
  • Small Business Capital Access Association (John R. Perkins, Chairman)
  • Sullivan & Cromwell

B. NASAA and SEC Representatives

NASAA Corporate Office

    • Neal Sullivan, Executive Director
    • Karen O'Brien, General Counsel
    • Jeffery Himstreet, Associate Counsel
    • Dan Kahl, Associate Counsel

SEC Executive Office

    • Commissioner Isaac C. Hunt, Jr.
    • Robert Robertson, Counsel to Commissioner Hunt
    • Vincent Mathis, Counsel to Commissioner Johnson

Corporation Finance Working Group

    • Deborah Bortner
    • Blake Campbell
    • Timothy Cox
    • Catherine Foehrkolb
    • Barry Guthary
    • James Harlan
    • Jack Herstein
    • William Hess
    • Ronald Jones
    • Stephen Maxey
    • Michael Miglets
    • Philip Rutledge
    • William Slattery
    • Adrienne Wanstall
    • Franklin Widmann
  • SEC
    • Jennifer Bethel
    • Meredith Cross
    • Paul Dudek
    • Martin Dunn
    • Barbara Jacobs
    • Anita Klein
    • Brian Lane
    • William Morley
    • John Reynolds
    • Penelope Saltzman
    • Ann Wallace
    • Richard Wulff

Investment Management Working Group

    • Dennis Britson
    • Richard Cortese
    • Jack Herstein
    • Kent Hollen
    • David Hunter
    • Melanie Lubin
    • Daphne Smith
    • Patricia Struck
    • Robert Terry
    • Ronald Thomas
    • Michael Vargon
    • Diane Young-Spitzer
  • SEC
    • Barry Barbash
    • Dan Hirsch
    • Mary Keefe
    • Robert Plaze
    • Cynthia Pugh
    • Lori Richards
    • Catherine Saadeh

Market Regulation Working Group

    • Debra Bollinger
    • Christine Bruenn
    • Marcel de la Gorgendiere
    • Craig Goettsch
    • Dean Heller
    • Robert Lam
    • Ralph Lambiase
    • Guy Lemoine
    • John Lynch
    • Robert Newtson
    • Donald Reis
    • Don Saxon
    • William Schneider
    • Bradley Skolnik
    • Douglas Wilburn
    • Russell Yamashita
  • SEC
    • Paul Andrews
    • Beth Badawy
    • Doris Bamford
    • Belinda Blaine
    • Larry Bergmann
    • Robert Colby
    • Elaine Darroch
    • Kathy England
    • Mary Ann Gadziala
    • Kristen Geyer
    • Lourdes Gonzales
    • Mike Greene
    • Yvonne Fraticelli
    • Robert Love
    • Mike Macchiaroli
    • Caite McGuire
    • Lou Randazzo
    • Pete Smith
    • Ann Vlcek

Enforcement Working Group

    • Joseph Borg
    • David Brant
    • Mac Dodson
    • Philip Feigin
    • Mark Griffin
    • Andrew Kandel
    • Carl Kunasek
    • Marion Lewis
    • Bill McDonald
    • Robert McDonald
    • Tracy Meyers
    • Matt Nestor
    • Victor Rodarte
    • Marilyn Scanlan
    • Veda Shamsid-Deen
    • Jocelyn Smith-Whittey
    • Charles Walker
  • SEC
    • Jim Clarkson
    • Colleen Mahoney
    • Roy McDonald
    • Joan McKown
    • William McLucas
    • Chris Mixter
    • Tom Newkirk
    • Al Rusch
    • Nancy Smith
    • Gary Sundick
  • SEC Regional/District Offices
    • David Bayless, San Francisco District Office
    • Elaine Cacheris, Pacific Regional Office
    • Carmen Lawrence, Northeast Regional Office
    • Charles Senatore, Southeast Regional Office
    • Dan Shea, Central Regional Office
    • Richard Wessel, Atlanta District Office
  • Self-Regulatory Organizations
    • Dave Doherty, NYSE
    • Cameron Funkhouser, NASD
    • Barry Goldsmith, NASD
    • Katherine Malfa, NASD
  • Other Organizations
    • John Arterberry, Fraud Section, U.S. Dept. of Justice
    • Paul Luehr, Federal Trade Commission
    • Richard Johnston, National White Collar Crime Center
    • Ben Lewis, National White Collar Crime Center

1 The commenters are listed in Exhibit A. The comment letters are publicly available for inspection in File No. S7-15-97.
2 Conference participants are listed in Exhibit B.
3 Securities Exchange Act Release No. 37850 (October 22, 1996) 61 FR 55593.
4 Securities Exchange Act Release No. 38067 (December 20, 1996) 62 FR 520.
5 SEC v. Life Partners, Inc., 87 F.3d 536 (D.C. Cir. 1996).
6 Pursuant to NSMIA, as of July 8, 1997, approximately 16,000 (i.e., those with $25 million or less under management) of the some 22,500 investment advisers registered with the Commission will become deregistered. The remaining investment advisers will no longer be subject to state regulatory requirements. However, the SEC and the respective states retain antifraud enforcement jurisdiction over all advisers.
7 U.S. v. O'Hagan, Docket No. 96-842. On June 25, 1997, the Supreme Court reversed the Eighth Circuit in determining that the misappropriation theory of insider trading states a violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. 1997 WL 345229 (U.S.).
8 92 F.3d 612 (1996). In its decision, the Eight Circuit also struck down the legality of Rule 14e-3(a) under the Exchange Act, which deals with antifraud proscriptions against inside information trading related to tender offers. However, in the aforementioned June 25th decision the Supreme Court also reversed the Eighth Circuit's ruling on the Rule 14e issue.
9 SEC v. Triton Energy Corp., D.D.C. Docket No. 1:97CV401 (February 27, 1997); In Re Gore, et al., SEC Docket No. 3-9262 (February 27, 1997); and SEC Litig. Rel. No. 15266 (Feb. 27, 1997
10 See Sterling Foster & Co., Inc. (ENF-0251, 9/18/96).
11 Brenner v. Nomura, et al., 652 N.Y.S. 2d 249, Appellate Division, First Department, Index No. 607244/96.
12 U.S. v. Halper, 490 US 435 (1989). Cf. U.S. v. Ursery, 116 S. Ct. 2135 (1996). Also see Hudson v. U.S., cert. granted April 14, 1997, Docket No. 96-976.
13 See appended "Report on Operation Surf Day" of New York's Investor Protection and Securities Bureau.