==========================================START OF PAGE 1====== United States Securities and Exchange Commission SUMMARY OF COMMENTS AND DISCUSSION REGARDING PROTECTIONS FOR SENIOR CITIZENS AND QUALIFIED RETIREMENT PLANS July 8, 1996 I. Introduction The Private Securities Litigation Reform Act of 1995 (the "Act") directs the Securities and Exchange Commission (the "Commission") to determine whether investors that are senior citizens or qualified retirement plans require greater protection against securities fraud than is provided under the Act and the amendments made by the Act; and whether investors that are senior citizens or qualified retirement plans have been adversely impacted by abusive or unnecessary securities fraud litigation, and whether the provisions of the Act or the amendments made by the Act are sufficient to protect them from such litigation.-[1]- To help answer these questions, the ---------FOOTNOTES---------- -[1]-Section 106 of the Act states: (a) IN GENERAL. -- Not later than 180 days after the date of enactment of this Act, the Securities and Exchange Commission shall -- (1) determine whether investors that are senior citizens or qualified retirement plans require greater protection against securities fraud than is provided in this Act and the amendments made by this Act; (2) determine whether investors that are senior citizens or qualified retirement plans have been adversely impacted by abusive or unnecessary securities fraud litigation, and whether the provisions in this Act or amendments made by this Act are sufficient to protect their investments from such litigation; and (3) if so, submit to the Congress a report containing recommendations on protections from securities fraud and abusive or unnecessary securities fraud litigation that the Commission determines to be appropriate to thoroughly protect (continued...) ==========================================START OF PAGE 2====== Commission published a Request for Comments-[2]- to solicit comments from the public on these questions and on the more general question of the role of senior citizens and qualified retirement plans in our securities markets. In response, the Commission received more than 600 comment letters. The vast majority of comments came from individual senior citizens discussing their own stories of securities fraud and abusive practices. This summary examines generally the role of senior citizens and qualified retirement plans as investors and their importance to our markets and to capital formation, and considers more specifically the concerns of senior citizens and participants in qualified retirement plans as investors. This summary also reviews many of the comment letters the Commission received from various public interest groups, industry associations, academics and individuals who responded to the Commission's request for public comment. Finally, the summary reviews the Commission's various initiatives that relate to certain of the issues raised by the commenters. While this summary discusses the evidence that senior citizens may be more susceptible to fraud and abusive sales practices than other investors, it should be emphasized that the Commission has not determined at this time that these investors require greater protection against securities fraud than is provided under the Act. The Commission is of the view that it is too soon after adoption of the Act to make a meaningful evaluation of the Act's effects. It also should be noted that the Commission has not undertaken a study at this time in response to Section 106(a)(3) of the Act because the Commission ---------FOOTNOTES---------- -[1]-(...continued) such investors. (b) DEFINITIONS. -- For purposes of this section - - (1) the term "qualified retirement plan" has the same meaning as in section 4974(c) of the Internal Revenue Code of 1986; and (2) the term "senior citizen" means an individual who is 62 years of age or older as of the date of the securities transaction at issue. -[2]-Release No. 34-37009 (March 21, 1996). ==========================================START OF PAGE 3====== has not determined at this time that special protection is necessary. II. The Important Role of Senior Citizens and Qualified Retirement Plans in the U.S. Securities Markets Although many of the comments received by the Commission differed as to whether additional protections were needed for senior citizens or for participants in qualified retirement plans, there was widespread agreement that these two groups play a vital and growing role in the U.S. securities markets. Senior citizens and, to an even greater extent, qualified retirement plans account for a substantial amount of the investment capital that finances America's commerce and industry, provides jobs, and keeps our financial markets the strongest and safest in the world. The importance of these sources of capital will continue to grow as our population ages. Although the Commission is not taking the view at this time that any additional protections are necessary, this summary provides background information describing the roles of senior citizens and participants in qualified retirement plans as investors and their experiences with securities fraud and abusive practices. A. The Increasing Importance of Seniors. The Washington Post recently reported that a study by the U.S. Census Bureau predicted that there will be 20 million new seniors in the United States by 2020.-[3]- Senior citizens will comprise one in every six Americans, as compared to one in eight today. The "graying of America" will begin as the first baby boomers retire in only 15 years, starting what has been referred to as a "gerontological explosion."-[4]- Seniors often rely on investment income rather than income from employment to support themselves.-[5]- Since they may hold more investments than other groups, the increase in the sheer number of older Americans may have an accelerated effect on their ---------FOOTNOTES---------- -[3]-Susan Levine, Aging Baby Boomers Pose Challenge, The Washington Post, May 21, 1996, at A9. -[4]-Id. -[5]-In a comment letter dated May 1, 1996, received from the American Association of Retired Persons, the Consumer Federation of America, and the National Council of Individual Investors (the "AARP/CFA/NCII Letter"), it was estimated that three-quarters of American over the age of 65 rely on some form of investment income to help fund their retirements. ==========================================START OF PAGE 4====== importance to our financial markets. A study on share ownership conducted by the New York Stock Exchange found that the probability of owning corporate stock rises with age and income,-[6]- with the result that, although investors over the age of 65 account for only roughly one-sixth of all shareholders, they directly or indirectly hold nearly one-third of all shares.-[7]- Commenters have noted that many seniors appear to devote a larger portion of their investments to stocks and mutual funds in recent years as a result of declining interest rates. The returns from traditional bank or insurance products are perceived by many older Americans as too low to continue to support their standard of living. For many, stocks and mutual funds have provided an attractive alternative.-[8]- B. The Rise of Qualified Retirement Plans. As the population ages, more and more Americans are participating in qualified retirement plans. As one study reported by the Employee Benefit Research Institute found, with the aging of the baby boom generation,-[9]- more workers are moving into ages where there is generally higher job stability, higher pension participation, and higher rates of savings. For example, the study found that when offered a 401(k) plan in 1993, 48 percent of private-sector workers under age 30 elected participation, compared with 72 percent of workers over age 30. The overall 401(k) participation rate among those offered a plan grew from 60 percent in 1988 to 67 percent in 1993.-[10]- The effect on U.S. financial markets of this increased rate of investment through qualified retirement plans has been dramatic. The percentage of all stocks held by public pension plans ---------FOOTNOTES---------- -[6]-Shareownership 1995, New York Stock Exchange, Inc. (1995), at 11 (the "NYSE Study"). -[7]-Id. at 18 (citing 1992 figures). -[8]-See AARP/CFA/NCII Letter ("As a result, many older people who never viewed themselves as investors suddenly became `reluctant investors.'") -[9]-The term baby boom generation is used to refer to people born between 1946 and 1964. -[10]-Employee Benefit Research Institute, Retirement in the 21st Century: Ready or Not? (1994), edited by Dallas L. Salisbury and Nora Super Jones, at 4 (the "EBRI Study"). ==========================================START OF PAGE 5====== increased from 2.8% in 1980 to 9.1% in 1992, while the percentage held by private pension plans rose from 14.2% to 20.5%.-[11]- From 1975 to 1992, the amount of U.S. equity securities held by private and public pension plans grew from $132 billion to $1.3 trillion.-[12]- This substantial investment in equity securities is not limited to publicly traded companies; investments made through qualified retirement plans also play an important role in funding privately financed emerging companies, companies that are vital to America's continued economic growth.-[13]- ---------FOOTNOTES---------- -[11]-Market 2000: An Examination of Current Equity Market Developments, Division of Market Regulation, United States Securities and Exchange Commission (January 1994), at AI-1 (the "Market 2000 Report"). The Market 2000 Report noted at AI-1: Public investors have remained active participants in the U.S. equity markets. Indeed, from 1975 to 1990, the number of shareholder accounts increased from 25 million to 51 million. The public participates in the equity markets in two forms: directly, through individuals purchasing stocks for their own accounts; and indirectly, through institutions such as mutual and pension funds. Over the past decade, investors increasingly have used institutions to represent their interests in the equity markets. These institutions include, most prominently, mutual funds and pension plans. -[12]-Market 2000 Report at 6. -[13]-As noted in a comment letter dated April 30, 1996, received from the National Venture Capital Association (the "Venture Capital Letter"): A significant amount of money venture capitalists receive from investors to invest in emerging growth companies comes from public and private pension funds. In 1995 38% of the $4.4 billion raised by venture capital partnerships came from pension funds. Individuals and families invested another 17% of the $4.4 billion raised by venture capitalists. Money raised goes directly into emerging growth businesses where it nurtures these young companies until they are ready to advance to the public market. ==========================================START OF PAGE 6====== The importance to America's securities markets of qualified retirement plans is likely to grow, at least until the baby boomers have retired.-[14]- As noted in the NYSE Study, the rapid growth in indirect stock ownership through retirement plans seems likely to continue: "The trend toward reliance on defined contribution rather than defined benefit pension plans and the rapid growth of 401(k) plans and related employee saving programs are likely to draw increasing numbers of households into stock ownership."-[15]- In one of the comment letters received by the Commission, it was estimated that half the money currently flowing into mutual funds is being invested through 401(k) plans.-[16]- III. The Impact of Securities Fraud and Abusive Practices on Seniors Securities fraud and abusive practices harm all investors, as well as the stability of our securities markets, and many have noted that the impact on senior investors can often be devastating. As one group of commenters noted: "The effects of investment fraud are felt most severely by older Americans who cannot make up their financial losses through future earnings."-[17]- ---------FOOTNOTES---------- -[14]-The AARP/CFA/NCII Letter states: Though already on the rise, the sheer size of retirement planning investment promises to grow significantly as the baby boomers -- the 76 million Americans born between 1946 and 1964 -- start to save money in earnest for retirement. -[15]-NYSE Study at 11. -[16]-AARP/CFA/NCII Letter. -[17]-Comment letter dated April 30, 1996, received from Citizen Action, Consumer Federation of America, Gray Panthers, National Council of Senior Citizens, Public Citizen's Congress Watch, and U.S. Public Interest Research Group (the "Consumer/Seniors Letter"). These groups went on to state: Although investment swindles plague all age groups, there is widespread agreement among securities law experts that older investors are disproportionately represented among the victims of investment fraud and abuse. ==========================================START OF PAGE 7====== The threat to seniors posed by securities fraud and abuse was the subject of a hearing held by the Senate Special Committee on Aging on May 25, 1993. In his opening statement, Committee Chairman Pryor stated the problem succinctly: Financial fraud and/or abuse that targets the elderly or disproportionately affects them is a serious threat to obtaining a secure retirement. Low or declining interest rates cause seniors to look for new investments to increase their rate of return, which in turn makes them much more susceptible to fraud. This type of fraud or abuse may exist in many forms, whether it is outright misrepresentation of the facts or investments that are unsuitable for older investors. * * * Whatever form we find it, investment fraud is devastating especially to our older citizens, many of whom are at moderate- to low-income levels with limited knowledge of financial or investment matters.-[18]- In his written testimony delivered at the hearing, the president of the North American Securities Administrators Association ("NASAA") called the problem of elderly citizens being defrauded in illicit investment schemes "pervasive."-[19]- He cited ---------FOOTNOTES---------- -[18]-How Secure Is Your Retirement: Investments, Planning, and Fraud?, Hearing Before the Special Committee on Aging, United States Senate, Serial No. 103-8 at 2 (May 25, 1993) (Opening Statement of Senator David Pryor, Chairman). Following Chairman Pryor's remarks, Senator Cohen explained: With lump sum retirement benefits and other assets to invest from a lifetime of work and savings, older persons are especially attractive targets for fraudulent and abusive advisers or salespeople. While investors of all ages can be seriously harmed by the unethical or illegal practices of unscrupulous financial advisers, older persons tend to be particularly at risk, since they live on fixed incomes and their savings may have to last them for ten or twenty or more years of retirement. Id. at 4 (Prepared Statement of Senator William S. Cohen). -[19]-How Secure Is Your Retirement: Investments, Planning, and Fraud?, Hearing Before the Special Committee on Aging, supra note 18, at 56 (Statement of Barry C. Guthary, President, NASAA). ==========================================START OF PAGE 8====== estimates that, although people over the age of 65 represent only 12 or 13 percent of the population, they account for approximately 30 percent of all fraud victims.-[20]- Several of the comment letters received by the Commission from organizations argued that older Americans are more vulnerable to aggressive sales pitches; like many investors, they generally lack an understanding of complex financial matters; they are often specifically targeted by con artists; and, unlike many victims of fraud, they are usually unable to recover their losses through future earnings. Many of the letters received from individuals echoed these arguments. A. Surveys Contend, and Commenters Argue, That Many Seniors Are Vulnerable to Fraud and Abuse. Surveys suggest that most American investors, including the elderly, lack a basic knowledge and understanding of financial matters and, therefore, may be easy targets for investment fraud and abuse.-[21]- Although seniors are the most risk averse of the various age groups of persons owning stocks,-[22]- many commenters noted that they are also the most vulnerable to fraud and abuse. A 1995 report issued by the American Association of Retired Persons, the Consumer Federation of America, and NASAA found that older Americans often lack the education or experience to deal with complex financial matters. The report also found them to be more trusting of salespeople and to have relatively weak sales resistance.-[23]- As a ---------FOOTNOTES---------- -[20]-Id. -[21]-Humberto Cruz, A survey of American investors finds most are financial illiterates, Philadelphia Inquirer, D1 (May 16, 1996). A January 1996 survey commissioned by the Investor Protection Trust and conducted by Princeton Research Associates found that fewer than one-fifth of all individual investors (in stocks, bonds, funds, and other securities) could be considered "financially literate" based on responses to a quiz. -[22]-NYSE Study at 30. -[23]-AARP/CFA/NASAA Background Report, The Five Biggest Problems "Legitimate" Investing Poses for Older Americans, March 1995 (the "AARP/CFA/NASAA Background Report") ("Not only are many older Americans without education or experience to deal with the increasing complexity of the investment world, but they also tend to be more trusting of salespeople. Research released in 1993 by (continued...) ==========================================START OF PAGE 9====== result, seniors may appear to be easy marks for con artists. Even in the case of legitimate investments, in the view of some commenters older Americans may be especially vulnerable to being sold high risk offerings that are inappropriate for their retirement needs.-[24]- Likewise, a recent survey of mutual fund investors, jointly sponsored by the Commission and the Office of the Comptroller of the Currency,-[25]- raised significant questions about the financial knowledge of some mutual fund investors, although it did not find senior citizens to be considerably less financially literate than other age groups. Although they may rely on their investments to maintain a decent quality of life, many seniors are said to be basically middle-income consumers who have never had to develop any degree of financial sophistication.-[26]- Forced to make investment decisions, often for the first time in their lives, many of these older Americans may find themselves completely dependent upon the advice of others. According to some ---------FOOTNOTES---------- -[23]-(...continued) AARP and CFA showed that the elderly have relatively weak sales resistance and rely excessively on the oral assurances of salespeople.") -[24]-One article made the following observation: [M]illions of older Americans know what it is to be hounded by marketers -- some legitimate, some not -- who consider the elderly easy marks. With plenty of assets, ranging from life-insurance payouts to mortgage-free homes, they are seen as lonely and more trusting than cynical baby boomers. * * * Even when the product is legitimate, many elderly people can be victimized simply by being led into making the wrong investment. Constance L. Hays, If the Hair Is Gray, Con Artists See Green, The New York Times (May 21, 1995). -[25]-The survey, released on June 26, 1996, analyzes the responses from a nationwide telephone survey of 2,000 randomly selected mutual fund investors. See Report on the OCC/SEC Survey of Mutual Fund Investors. -[26]-See AARP/CFA/NCII Letter. ==========================================START OF PAGE 10====== commenters, this makes them particularly susceptible to high pressure salespersons and scam artists.-[27]- In some cases, seniors and their retirement savings have been specially targeted by fraudulent investment schemes. Americans who are nearing retirement age and already retired are the population group most likely to have accumulated savings, lump-sum pension payouts, and life insurance proceeds -- ready sources of cash.-[28]- According to testimony delivered at the Senate hearing, many con artists now "narrowcast" their appeals to specific segments of the investing public, including seniors. Their pitches are tailored to have the greatest impact on the group being targeted. Modern technology has also made it relatively easy for the swindlers to single out older Americans through computerized data sources.-[29]- Of course, legitimate securities offerings are also targeted at seniors. Many financial institutions and professionals are directing their marketing efforts toward older Americans because of their financial resources and the need to invest those resources, as well as their need for professional financial advice. While most of these efforts are completely reputable, there have been cases of inappropriately risky financial products being sold to seniors, often with oral assurances that the products are "safe." It has been suggested that the elderly ---------FOOTNOTES---------- -[27]-A comment letter dated April 30, 1996, received from Irwin G. Stein, Adjunct Assistant Professor, Golden Gate University, discussing his study of investments made by those who retired during the period 1981-1990 (the "Stein Letter"), reports: The generation that retired in the 1980's was especially vulnerable to investment fraud because they were especially trusting. Many sought the safety of recognizable institutions or firms or investment professionals of local repute or recommendation. An insignificant few report knowing how [to] evaluate competing investment firms or salespeople. Few victims knew how to evaluate investments on their own. A great many of the victims relied upon a trusted financial professional. -[28]-How Secure Is Your Retirement: Investments, Planning, and Fraud?, Hearing Before the Special Committee on Aging, supra note 18, at 56 (Statement of Barry C. Guthary, President, NASAA). -[29]-Id. ==========================================START OF PAGE 11====== actually lose more money from this type of abuse committed by licensed persons selling lawful products than from con artists engaged in criminal fraud.-[30]- The AARP/CFA/NASAA Background Report identified a number of specific areas of concern: [The] key problem areas in the "legitimate" investment industry that are of greatest concern to older investors: misleading titles designed to portray commissioned salespeople as impartial advisors; bank sales of uninsured investment products; the poor quality of oral and written disclosure; hidden derivatives in investment products touted as "safe;" and unclear account statements. See also, AARP/CFA/NCII Letter; Consumer/Seniors Letter. There have been numerous Commission enforcement actions directed at securities frauds involving large numbers of senior citizens. A summary of a number of recent cases is attached as ---------FOOTNOTES---------- -[30]-As one report noted: While a graying population, the pursuit of higher returns, and the decline of traditional defined benefit pension plans explain much of what is behind the surge of older investors into riskier investments, other factors also explain why so many of the elderly have gone down this path. Foremost among them is the intense and sustained marketing effort waged by financial institutions and individual investment professionals to lure older investors away from federally insured bank products. * * * Most financial institutions and individual financial professionals (including brokers and investment advisers) are reputable. Most customers who deal with such institutions and individuals are not defrauded. But, the truth remains that many aspects of this "legitimate" investment marketplace are particularly ill-suited to the needs of the growing number of older investors who are turning to it. AARP/CFA/NASAA Background Report. ==========================================START OF PAGE 12====== Annex I. Nonetheless, the Commission does not believe that additional legislation is needed at this time. B. Seniors May Be Unable to Recover From Financial Losses. Many of the commenters pointed to the particularly severe impact of securities fraud and abuse on seniors resulting from their inability in most cases to recover from the financial damage through future earnings.-[31]- The money a senior citizen has to invest often represents a lifetime of savings, the proceeds from the sale of a home or business, an inheritance, insurance policy proceeds, or a lump sum pension payment. If this money is lost because of a fraudulent or abusive securities transaction, the older investor is often unable to recapture any losses that may occur. As pointed out in the AARP/CFA/NCII Letter, "[b]ecause their prime earning years have passed and the sources of extraordinary income may be one-time life events, older Americans are less able to repair the damage when they are victims of fraud or abuse." IV. Changes in the Nature of Qualified Retirement Plans. Most qualified retirement plans are subject to regulation under the Employee Retirement Income Security Act, which provides an extensive scheme for regulation of the establishment and administration of such plans under the oversight of the United States Department of Labor. The federal securities laws come into play when an established qualified retirement plan invests in, or disposes of, securities. In recent years, there has been a dramatic shift from defined benefit plans, in which benefits are guaranteed and investment decisions are made by the employer, to defined contribution plans, in which workers are required to make their own investment decisions and take the risk of any losses.-[32]- ---------FOOTNOTES---------- -[31]-See, e.g., Consumer/Seniors Letter ("[N]ot only are seniors the primary targets of investment con artists, but also . . . once their financial assets are lost, they cannot be recaptured through future earnings.") -[32]-The U.S. Department of Labor, Bureau of Labor Statistics, has explained the difference between defined benefit and defined contribution plans as follows: A defined benefit pension plan obligates an employer to provide retirement benefits calculated by a formula specified in the plan. Benefits (continued...) ==========================================START OF PAGE 13====== A. Change in the Nature of Plans from Defined Benefit to Defined Contribution (and particularly 401(k)) Plans. Since the mid-1980s the private pension system has undergone a profound change from a system dominated by defined benefit and profit sharing plans to a system where defined contribution plans, including 401(k) plans, are rapidly becoming the most common type of plan.-[33]- The growth of defined contribution pension plans, and in particular 401(k) plans and other thrift plans, is partly due to tax policies that make these plans attractive ways to save for retirement, and partly due to regulatory policies that have shifted many pension arrangements from a defined benefit to a defined contribution structure.-[34]- 401(k)-type plans now make up 20% of all private plans, cover 35% of all active participants, and hold 26% of all plan assets.-[35]- The number of 401(k) plan participants increased from 4.4 million in 1983 to 20.4 million ---------FOOTNOTES---------- -[32]-(...continued) generally are based on salary, years of service, or both. An employer, however, ordinarily has considerable latitude in financing these benefits. * * * Defined contribution plans generally specify the level of employer contributions to a plan, but not the formula for determining eventual benefits as in a defined benefit plan. Instead, individual accounts are set up for participants, and benefits depend on amounts credited to these accounts, plus investment earnings. Although employers normally guarantee they will make contributions, the employee bears the risk of fluctuation in investment earnings. U.S. Department of Labor, Bureau of Labor Statistics, Employee Benefits in Medium and Large Private Establishment, 1993, Bulletin 2456 (November 1994), at 112, 131. -[33]-U.S. Department of Labor, Private Pension Plan Bulletin, Number 5, Winter 1996 ((Abstract of 1992 Form 5500 Annual Reports). -[34]-NYSE Study at 32. -[35]-U.S. Department of Labor, Private Pension Plan Bulletin, Number 5, Winter 1996 ((Abstract of 1992 Form 5500 Annual Reports), at 2. ==========================================START OF PAGE 14====== in 1993.-[36]- Although the final figures are not in, it has been estimated that in 1995, defined contribution pension plans accounted for $1,400 billion of the $3,740 billion total assets of private pension plans in the United States. Of this, $648 billion was estimated to be held in 401(k) plans.-[37]- In its comment letter to the Commission, the Investment Company Institute reported that: Since the Commission staff documented the shift to participant-directed contribution plans [in its 1992 report Protecting Investors: A Half Century of Investment Company Regulation], it has, in fact, continued to accelerate.-[38]- This sudden shift from defined benefit to defined contribution plans has raised concerns that many defined contribution plan participants may be ill-prepared to make the necessary investment decisions. Noting that the growth of 401(k) plans has helped to expand the defined contribution plan as a savings vehicle for retirement, the Department of Labor observed that, "the participant must determine where to invest the aggregated funds, including matching employer contributions, to enhance retirement income."-[39]- As a result, more and more workers are being called upon to structure their own financial futures, often through securities investments.-[40]- This has raised concerns about the ability of these investors to adequately ---------FOOTNOTES---------- -[36]-NYSE Study at 32. -[37]-Bernstein Research, The Future of Money Management in America, 1995 edition at 37. -[38]-Comment letter dated April 29, 1996, received from the Investment Company Institute (the "ICI Letter"). -[39]-U.S. Department of Labor, Bureau of Labor Statistics, Employee Benefits in Medium and Large Private Establishment, 1993, Bulletin 2456 (November 1994), at 134. -[40]-See AARP/CFA/NCII Letter. ==========================================START OF PAGE 15====== manage their investments and provide for a secure retirement.-[41]- As stated in the ICI Letter, plan participants are just like individual retail investors: "[They] often may make investment decisions and buy and sell on a daily basis -- with no ERISA fiduciary intervention, knowledge or assistance." B. Participants in Qualified Retirement Plans Need to Be Better Informed About Investment Issues. It has been said that the average member of the baby boom generation does not have sufficient knowledge of financial issues to understand his or her vulnerabilities and to distinguish between appropriate and inappropriate financial decisions.-[42]- This lack of financial sophistication, coupled with the need to direct the investment of precious retirement funds held in defined contribution plans, makes participants in qualified retirement plans particularly susceptible to poor investment planning.-[43]- As one ---------FOOTNOTES---------- -[41]-"It is often argued that such trends jeopardize retirement income security because defined contribution plans, which typically involve explicit worker decision making, are replacing defined benefit plans. There is concern about workers' ability to make wise decisions regarding their participation in such plans." EBRI Study at 6. -[42]-"Study after study has demonstrated that the level of economic and financial literacy in this country is appallingly low." EBRI Study at 80. One article described the problem as follows: American workers have an "understanding gap" when it comes to their pensions. This shortfall of wisdom, according to a new survey by Towers Perrin, the New York-based benefits consulting firm, is a major potential problem as more and more employees are being forced to decide how to invest the retirement money their employers provide. Frank Swoboda, The Unforeseen Peril in Retirement Planning, The Washington Post (May 14, 1995), at H9. -[43]-Some employers are actively working to provide assistance to employees in making the necessary retirement planning decisions. Discussing measures used by Xerox Corporation to help employees determine their retirement income (continued...) ==========================================START OF PAGE 16====== group of commenters observed: "[B]illions of dollars in investment capital now lies with the discretion of individuals who may be extremely ill-equipped to make decisions about how to invest wisely for their retirement years."-[44]- However, it should be noted that most commenters did not indicate that participants in qualified retirement plans are more susceptible to securities fraud than other investors.-[45]- V. Comments Relating to the Need for Greater Protections Against Securities Fraud for Senior Citizens and Qualified Retirement Plans. The Commission received many letters in response to its request for public comments. In addition to the hundreds of letters the Commission received from individual investors (most of which gave details of specific instances of fraud and abuse rather than comments on the need for additional protections for seniors and qualified retirement plans under the federal securities laws), the Commission also received a number of comment letters from public interest groups, industry associations, academics and individuals. A. Letters Advocating No Change. ---------FOOTNOTES---------- -[43]-(...continued) needs, Paul A. Rivera asserted: The key role that employers can play is that of a collaborator with employees in their retirement income planning. In basic terms, collaboration is a process of introducing a problem or making employees aware of a problem and then engaging employees and facilitating the problem-solving process. Effective collaboration includes providing tools for employees to identify and determine an appropriate set of solutions and the corresponding implementation procedures. EBRI Study at 150. -[44]-Consumer/Seniors Letter. -[45]-A contrary view was expressed in the Consumer/Seniors Letter, which states that the shift from "employer-controlled pensions in favor of self-directed retirement savings also has created a major opening for unscrupulous promoters of illicit investment schemes," and that workers changing jobs who are forced to make a decision about rolling over their plans "are reported to be prime targets for investment schemers." ==========================================START OF PAGE 17====== Since the specific questions posed by Congress referred to the protections provided by the new Act, several letters maintained that it was too soon to evaluate the impact of the Act on seniors and qualified retirement plans, or anyone else. As stated in one letter, it is simply too early to determine whether all of the Act's particular provisions are having their intended effect.-[46]- "Typically, several years must pass before it is possible to evaluate the effectiveness of reforms to the litigation system."-[47]- This position was echoed in the Venture Capital Letter: "The new law has only been in existence for four months, and thus ironclad statements as to whether senior citizens and retirement plans have been affected in a manner differently than the rest of the investing populous cannot be made."-[48]- There was also a concern expressed in several of the comment letters that the "careful balance" struck by Congress in adopting the Act should not be upset.-[49]- Other letters, while recognizing the importance of seniors and retirement plans, argued that senior citizens and qualified retirement plans are no different than other types of investors and, therefore, did not warrant special consideration. As expressed by one commenter, for example: [E]ven though senior citizens and qualified retirement plans are substantial participants in ---------FOOTNOTES---------- -[46]-Comment letter dated April 30, 1996, received from the American Business Conference, the American Electronics Association, the American Institute of Certified Public Accountants, the Association of Publicly Traded Companies, the National Venture Capital Association, and the Securities Industry Association (the "Industry Letter"). -[47]-Id. -[48]-See also comment letter dated April 29, 1996, received from the New York State Teachers' Retirement System (the "New York State Teachers' Retirement System Letter") ("[I]t is, in all likelihood, too early to tell whether the stated goals of the 1995 Act will be achieved. * * * We would urge extreme caution at this early date before recommending any further changes."); and comment letter dated June 13, 1996, received from the Corporate Governance Task Force of The Business Roundtable (the "Business Roundtable Letter") ("Initial experience under the Reform Act appears consistent with the expectations of the Act's sponsors, although the five-month interval since enactment is too short to permit solid conclusions.") -[49]-See Industry Letter. ==========================================START OF PAGE 18====== our financial markets and play a vital role in capital formation, sections of the Act and the other federal securities regulations are sufficient to protect these investors. * * * We do not believe that these investors have special needs that require additional rules and regulations or changes to the federal securities laws.-[50]- The Industry Letter concurred: "There simply is no evidence that senior citizens or qualified retirement plans are situated differently from investors at large in any way that justifies the creation of unique legal rules."-[51]- Whether or not seniors and qualified retirement plans have special needs, several letters cautioned against establishing different rules for any particular class of investors. The comment letter received from the New York State Teachers' Retirement System ("System") made the following argument: The System would have substantial concerns with any proposal to accord special rights to some investors but not to other investors. That would ultimately only serve to "balkanize" investors into competing interest groups locked in a struggle for special rights and privileges. Such a struggle would, in the long run, be highly detrimental to the proper and efficient operation of the capital markets. * * * [W]e would urge the Commission exercise extreme caution before recommending any kind of measure which would confer special privileges or rights on some investors, even pension plans, but not on investors generally. While this might appear to be contrary to the interests of pension plans as a ---------FOOTNOTES---------- -[50]-Comment letter dated April 30, 1996, received from Banc One Corporation (the "Banc One Letter"). -[51]-See also Venture Capital Letter ("At this time, NVCA believes it is unlikely that senior citizens and qualified retirement plans have been unintentionally and negatively affected by the Act so as to warrant added `protections'."); comment letter dated April 12, 1996, received from Brad Sutherland ("Sutherland Letter") ("The senior citizens and retirement plans do not have any special needs, they, like every group, will demand the highest returns possible and will cry foul if they suffer any major losses.") ==========================================START OF PAGE 19====== distinct class of investors, it is our view that the long run interests of pension plans are best served by assuring all investors have an equivalent stake in the capital markets and in the enforcement of the laws designed to maintain their integrity and efficiency. This concern about creating different classes of investors, with different rights, was also reflected in the Industry Letter. Those commenters recognized that senior citizens have been victims of fraud and that some have argued that they should be afforded additional remedies. However, the commenters stated that "absent some evidence showing that the current legal regime is inadequate because of some peculiarity of seniors' situation - - that fact does not justify creation of a separate legal standard."-[52]- B. Letters Advocating Specific Changes. On the other hand, many of the comment letters advocated specific changes to the securities laws to provide greater protections to senior citizens and qualified retirement plans, and, in some letters, to other investors as well. These changes include: (i) extending the statute of limitations for private actions,-[53]- ---------FOOTNOTES---------- -[52]-See Industry Letter. See also Business Roundtable Letter ("As a general matter, we believe it would be unwise policy for the Commission to seek to create specially protected categories of investors rather than to continue its practice of establishing protections generally applicable to all investors."); comment letter dated April 29, 1996, received from Jonathan C. Dickey, partner, Gibson, Dunn & Crutcher ("[O]ne must question whether `senior citizens and qualified retirement plans' merit the kind of distinction Congress appears to be drawing. This author wonders why persons investing in mutual funds . . . should be afforded any less protection from securities fraud than retirement plans.") -[53]-See the New York State Teachers' Retirement System Letter; comment letter dated April 30, 1996, received from the National League of Cities and the Government Finance Officers Association (the "NLC/GFOA Letter"); comment letter dated April 30, 1996, received from the International Brotherhood of Teamsters (the "Teamsters Letter"); the AARP/CFA/NCII Letter; and the Consumer/ Seniors Letter. ==========================================START OF PAGE 20====== (ii) restoring the private cause of action for aiding and abetting,-[54]- (iii) restoring joint and several liability for those who assist securities fraud,-[55]- and (iv) codifying the fraud-on-the-market theory of liability.-[56]- The Consumer/Seniors group also called for enhanced penalties for investment frauds that target seniors. The letter received from the Investment Company Institute made two specific proposals for legislative changes to amend section 3(a)(2) of the Securities Act of 1933 to remove the exemption from registration and prospectus delivery for interests in bank collective funds and insurance company separate accounts sold to retirement plans, and to amend section 3(c)(11) of the Investment Company Act of 1940 to treat these pooled investments as investment companies subject to that Act. The AARP/CFA/NCII Letter suggested a number of legislative and administrative changes, including: (i) banning the use of misleading titles that imply that a salesperson is a financial professional paid to give financial advice, (ii) prohibiting banks from sharing confidential customer data with their securities affiliates, (iii) reforming written disclosures, including changes to improve the delivery of information, (iv) requiring that disclosure of high-risk investments within a product should be prominently and plainly disclosed prior to its sale, and (v) requiring additional disclosures in account statements. ---------FOOTNOTES---------- -[54]-See the NLC/GFOA Letter; the Teamsters Letter; the AARP/CFA/NCII Letter; and the Consumer/ Seniors Letter. -[55]-See the NLC/GFOA Letter; the Teamsters Letter; and the Consumer/ Seniors Letter. -[56]-See the Consumer/ Seniors Letter. ==========================================START OF PAGE 21====== The letter also advocated strengthening the Investment Advisers Act of 1940 to better regulate the activities of investment advisers and financial planners. Finally, the letter suggested changes in the regulation of broker compensation practices. Although the Commission has determined not to recommend legislation at this time, the Commission and its staff will consider these suggestions as they continue to monitor the effects of the Act. VI. Comments Relating to the Effect on Seniors and Qualified Retirement Plans of Abusive Securities Litigation. Like other investors, senior citizens and participants in qualified retirement plans can be harmed by abusive securities litigation. Although some of the comment letters received by the Commission argued that abusive securities litigation does not have any significant impact on older investors,-[57]- most of the commenters who addressed the issue maintained that senior citizens and participants in qualified retirement plans, like all investors, suffered from the effects of meritless litigation.-[58]- However, none of the commenters suggested that there should be special, additional protections against such litigation for senior citizens or qualified retirement plans. The Industry Letter states that "while many of us believe that stronger protections are justified to deter abusive litigation, we believe they are justified for all investors. * * * We do not find any basis in logic or in evidence for creating special rules for seniors and retirement plans." Similarly , the Venture Capital Letter notes that the Act "is intended to right this mistake [of abusive securities fraud suits], and thus this group [of seniors and qualified retirement plans] will benefit as a result of the new Act." However, the association "believes that no particular ---------FOOTNOTES---------- -[57]-See AARP/CFA/NCII Letter. -[58]-See the Industry Letter ("All agree that abusive securities lawsuits harm investors."); and the Venture Capital Letter ("[A] review of this subject requires an examination into whether senior citizens and qualified retirement plans, as the SEC Release states, `have been adversely impacted by abusive or unnecessary securities fraud litigation?' The answer to this is clearly yes."). ==========================================START OF PAGE 22====== investor in a venture capital partnership should warrant greater protection over any of its other investors."-[59]- VII. Other Comments. A. Letters Discussing the Need For Better Disclosure and Education to Make the Disclosure Meaningful. Several of the comment letters focused on the need for better, more understandable disclosures to allow senior citizens and participants in qualified retirement plans to make more informed investment decisions. More Understandable Disclosure. As noted in the AARP/CFA/NCII Letter, written disclosures provided with investment products often use arcane, complex language that is extremely difficult to understand. Further, the information presented is often in very small type size, making it difficult for older investors to read. The AARP/CFA/NASAA Background Report, which was quoted extensively in the Consumer/Seniors Letter, posed the problem in the following way: To be effective, investment disclosure must provide key information at a time when it is useful and in a form that can be understood. Investors get major product disclosures at two points: what a financial professional says about the product when it is sold (oral disclosure) and a prospectus (written disclosure), which usually arrives after the sale. * * * The notion that there is "full disclosure" to Americans about their investments is, by and large, a myth. One problem is that oral disclosures at the time of a sale often are incomplete, confusing, and sometimes misleading. * * * To make matters worse, most written disclosures are too long and too complicated to be of any practical use to someone other than a securities lawyer or expert investor. As one industry observer has noted: "People don't read ---------FOOTNOTES---------- -[59]-See also the Banc One Letter ("We do not believe, however, that these investors have special needs that require additional rules and regulations or changes to the federal securities laws.") ==========================================START OF PAGE 23====== prospectuses because prospectuses are unreadable." * * * The failure of full disclosure poses a problem for all investors, but is a particular danger for older Americans. As discussed above, 1993 data from AARP and CFA on the habits of older Americans show them to have below average resistance to sales pitches. It stands to reason that the danger of this tendency on the part of older Americans is gravest when misleading oral disclosure is combined with untimely and unintelligible written disclosure. In addition to issues of clarity and readability, some have advocated the use of warning labels such as: WARNING: THIS INVESTMENT INCLUDES HIGH RISKS. IT MAY NOT BE SUITABLE FOR SENIORS, RETIREES AND OTHERS WHO SEEK SAFETY OF THEIR PRINCIPAL.-[60]- Another letter suggested a requirement that all Securities Act offering documents contain "a graphic, front-page illustration of the risk/reward ratio of a particular investment -- something akin to the performance graph now required to be disclosed by Item 402(k) of Regulation S- K."-[61]- Importance of Education. Better disclosure alone may not be enough. Several comment letters emphasized the importance of educating investors so that they would be better equipped to make investment decisions.-[62]- "[E]very effort must be made to inform potential investors about the risks, costs and goals of specific investment opportunities."-[63]- As one letter bluntly put it: "If the SEC wants to help these groups, it should work to educate them. The brokerage industry, regulators and senior citizen groups all have a real interest here to teach these clients about the potential risks and returns they should ---------FOOTNOTES---------- -[60]-Stein Letter. -[61]-Comment letter dated April 30, 1996, received from Douglas Siddoway, Randall & Danskin. -[62]-See AARP/CFA/NCII Letter ("It is critical . . . that financial markets be structured to inform investors -- particularly older investors -- about the risks, costs, suitability, and goals of investments.") -[63]-Consumer/Seniors Letter. ==========================================START OF PAGE 24====== expect when they invest."-[64]- Another letter stated: "Seniors and retirees need help identifying investments that are too risky or otherwise inappropriate for them. The Commission can give them that help."-[65]- B. Proposals for Increased Enforcement. Some of the letters have stressed the need for vigilance in enforcing the securities laws, particularly in cases involving older Americans and qualified retirement plans. As stated in the AARP/CFA/NCII Letter: "While disclosures, education, and information can be helpful, it is also important that the financial marketplace protect investors by ferreting out incompetence, self-dealing, and abuse." The letter received from the Consumer/Seniors group expressed the need for adequate funding of securities law enforcement and oversight efforts: Although we are pleased that Congress is moving toward stabilizing the funding mechanism for Commission oversight and enforcement activities, we nevertheless question whether the resources devoted to securities regulation are adequate. Our markets have grown exponentially in the last decade, as has the number of Americans participating in the marketplace. Many of the newer investors have little understanding of the intricacies of the marketplace beyond an implicit faith that the money they invested will be there in the future when they need it. We must ensure that the Commission's oversight program has the resources necessary for such an important job. C. Letters From Individual Investors. The SEC had received 628 letters from senior citizen investors as of June 18, 1996. Many of these investors believed that they had suffered from fraud and abuse and described these events in detail. Generally, the seniors complained about the following types of fraud and abuse (in the order most often cited): - Misrepresentation of the quality or performance of an investment product. ---------FOOTNOTES---------- -[64]-Sutherland Letter. -[65]-Stein Letter. ==========================================START OF PAGE 25====== - Unsuitable investments were recommended considering an investor's investment objectives, risk tolerance, age, experience, income, and net worth. - Undisclosed fees and charges. In several letters, investors expressed confusion about the load structures within families of mutual funds. - Rudeness in business dealings. - Cold-calling. Investors expressed a general dislike of cold-calling, as well as citing specific instances of abuse. Investors also complained about a variety of other kinds of mistreatment by stockbrokers and other representatives. Among other things, investors claimed that brokers failed to follow their instructions, executed trades without their approval, or churned their accounts. Some investors also expressed frustration at being unable to resolve their problems through the current means of redress available to them: arbitration or the courts. For example, one investor stated that he could not find a lawyer to represent him because his losses were too small. Some investors believe their losses are significant, but not large enough to merit spending the additional funds and time to seek a legal remedy. Complaints about the lack of redress included: - Arbitration -- Among other things, investors complained that arbitration panels are biased and that arbitrators should explain why a decision was rendered. - Statutes of Limitations -- These investors believed that the statute of limitation should be lengthened or tolled. - Legal Representation -- Investors wrote that they could not afford legal representation. Some investors believed that they lacked the resources to "fight" the firms. - Inadequate Remedies -- Some investors submitted comments stating their belief that, in general, remedies were unavailable. - Other Redress Problems -- The Commission also received comments from investors highlighting other problems. For example, two investors commented that investment professionals easily evade liability by filing for bankruptcy. ==========================================START OF PAGE 26====== Many investors offered suggestions and other thoughts.-[66]- Although these comments vary, investors made similar observations: - The need for plain-English in disclosure documents, such as prospectuses. ---------FOOTNOTES---------- -[66]-Following is a sampling of comments received from investors: "I think the SEC needs to take a closer look at broker conduct and put tighter safeguards in place to protect all investors -- especially older adults." "Because we are old they think of us as stupid. I am 83." "Our complaint is that the arbitration process favors the brokerage firms in that they can continually stall the process . . . the appointed arbitrators and . . . officials seem to have very little power to get things going . . . there [sic] object in doing this [is] obviously to get the complainant so mad and frustrated that they are willing to settle just to get the process over." "Several of us were victimized by this broker and although we knew something was wrong, we were not familiar with the securities business and did not know where to turn for help. We had no idea what terms such as `opt out' meant when referring to class action suits or `statutes of limitation.'" "First, they sweet talk you into a good deal with, `Don't worry, I'll watch over your investment' . . . Then . . . they tell you in a round about way that you are `stupid' and `you didn't read your statements properly.'" "As a small investor, there seems to be little recourse in the existing system to obtain a truly fair settlement. The vast amounts of confusing documents and `legalese' shield and protect both broker and brokerage firm." "It is my recommendation that strict disclosure rules be enforced where depositors are referred to investment brokers within a bank or S & L setting. This disclosure should be both verbal and written. Any documents given to prospective investors should contain language, written in simple English and or in the language commonly spoken by the customer, in large print, that notifies the customer that the investments are not guaranteed and that both principal and return are not insured by the bank or any federal agency." ==========================================START OF PAGE 27====== - On-going problems with limited partnership investments. - Delays in transferring pension assets from an employer to an IRA rollover account. - The interests of the investor and the broker should be aligned. - Better regulations are needed when bank customers are referred to investment professionals inside the bank. - Confusion about the relationship between interest rates and bonds. The Commission's Office of Investor Education and Assistance has reviewed the letters received from individual investors and will offer assistance where appropriate. IX. Commission Initiatives Addressing Concerns of Senior Citizens and Participants in Qualified Retirement Plans. Many of the concerns faced by senior citizens and participants in qualified retirement plans are being addressed by the Commission under its current authority and through efforts by the securities industry. In addition to its enforcement program, the various divisions and offices of the Commission are engaged in activities and initiatives that directly affect senior citizens and participants in qualified retirement plans. A. Investor Education and Assistance. Many of the comment letters received by the Commission argued that senior citizens and participants in qualified retirement plans would benefit from education and assistance to better understand how to make sound investment decisions. The Commission established the Office of Investor Education and Assistance ("OIEA"), formerly the Office of Consumer Affairs, specifically to educate investors and to assist them with investment-related problems.-[67]- Over the last two years, OIEA pursued a number of new educational initiatives at Chairman Levitt's request in recognition of the substantial investments many senior citizens have made in securities. Since an educated investor provides the best defense against securities fraud and often the first warning of wrongdoing, the Office ---------FOOTNOTES---------- -[67]-Of course, other offices and divisions of the Commission also provide assistance to investors. ==========================================START OF PAGE 28====== educates investors on how to identify securities fraud, to report suspicious activity to securities regulators, and to invest wisely. Following are descriptions of some of the major educational initiatives: - Toll-Free Investor Information Line, SEC Available On- line -- Since its inception in October 1994, the SEC's toll-free information line, (800) SEC-0330, has received more than 132,000 calls. The information line allows investors to order free brochures on how to avoid securities fraud and abuse, how to invest wisely, and how to obtain updates on fast breaking cases. SEC investor information is also available 24 hours a day on the SEC's World Wide Web home page: http://www.sec.gov. The home page includes all electronic filings by companies registered with the SEC, investor brochures, SEC rule proposals, comment letters, the SEC News Digest, and speeches. - Investor Town Meetings and Seminars -- To educate investors and to hear what is on the minds of the investing public, Chairman Levitt has led 14 investor meetings in New Jersey, Florida, California, Illinois, Massachusetts, New Mexico, Ohio, Tennessee, Texas, Washington, D.C., New York, and Pennsylvania. These town meetings now regularly attract nearly 1000 people at each meeting. The Commission has also begun a seminar series for investors on a wide variety of topics in coordination with the securities industry and others. - Involving Investors in SEC Rulemaking -- Since many investors do not read the Federal Register where rules impacting investors are published for comment, OIEA initiated a new approach to publicizing and increasing individual investor participation in fashioning rules. A plain English summary of selected rule proposals, a "Request For Investor Suggestions On..." has now accompanied three major rule proposals. These user friendly documents have been widely distributed to senior citizens and are available on-line and from the Commission's toll-free information line. - Plain English Advocate -- The Commission has instituted a goal that all communications with the public should be easy to understand and to the point. OIEA is currently drafting a handbook for lawyers, ==========================================START OF PAGE 29====== investment bankers and companies on how to write prospectuses and other disclosure documents in plain English. OIEA will be holding workshops for everyone involved in writing and designing these documents so that plain English becomes the norm rather than the exception. - Consumer Affairs Advisory Committee -- This committee was created by the SEC to provide advice on how to better serve the investing public. The 19 members of the committee include representatives of investor organizations, national consumer advocacy groups, corporations, financial services firms, state securities regulators, senior citizens, and shareholder relations specialists. OIEA also provides explanations and information to investors who inquire about how the securities markets work, the disclosure and other obligations placed on companies subject to the Commission's jurisdiction, whether companies or persons offering investments are registered with the Commission, and whether such companies or persons have a history of violations. OIEA receives nearly 42,000 complaints and inquiries a year from investors. The most common problems identified by seniors who contact OIEA are: - Unsuitable investment recommendations -- some brokers and investment advisers recommend risky investments that do not match the investor s stated investment objectives or risk tolerance levels. - Failure to disclose fees -- some brokers and investment advisers fail to disclose all the costs and fees involved with buying and selling an investment. - Intimidation and rude behavior -- a disturbing number of senior citizens complain that brokers bully, intimidate and refuse to carry out their orders, especially when the investor wants to sell low-priced stocks or get information about why such stocks have not performed as promised by the broker. B. Plain English Initiative. The Commission's plain English initiative, while not directed specifically at senior citizens, may greatly facilitate their understanding of the risks and rewards of various ==========================================START OF PAGE 30====== investment alternatives. In 1995, the Commission staff, at the direction of Chairman Levitt, undertook a review of rules and forms affecting capital formation, with a view toward streamlining, simplifying and modernizing the overall regulatory scheme without compromising or diminishing important investor protection. The Task Force on Disclosure Simplification undertook this review and in March 1996 issued its report which included several recommendations. One of the Task Force's most important recommendations was the simplification of the disclosure format and language in public offering documents. A cornerstone of the securities laws is the requirement to provide full and fair disclosure to investors. The prospectus - the traditional offering document - sets forth business and financial information about the company and the offering. Stylistic and formatting habits developed over the years have resulted in a disclosure document that is written in a manner often described as "turgid," "opaque," and "unreadable." Dense writing with legal boilerplate and repetitive descriptions of the company has become the standard. The Task Force cited similar readability issues with the dense and overwhelming amount of information included in cash tender offer documents. The Commission has established a plain English initiative to formulate new and more effective ways to communicate with investors. The Commission staff is working with companies, their lawyers and underwriters, to enhance the readability of the prospectus by individual investors. Included in this initiative is a proposal for prospectuses to contain an introduction that would facilitate investor understanding by eliminating boilerplate "legalese" and by summarizing key information important to an investment decision. The Commission is considering another of the Task Force's recommendations for a plain English summary sheet in tender offer statements that would function as a "road map" for shareholders by providing answers to commonly asked questions about the cash tender offer. Making the disclosure understandable to the market place is fundamental to the federal securities laws' goal of full disclosure. Efforts to effect the plain English initiative are being undertaken throughout the Commission. The offices and divisions primarily engaged in this initiative are the Division of Corporation Finance, OIEA, and, as more fully discussed below in the case of mutual funds, the Division of Investment Management. C. Mutual Fund Regulation. ==========================================START OF PAGE 31====== In recent years, the Commission and its Division of Investment Management have taken a number of actions regarding mutual funds and other types of investment companies that may be particularly helpful to senior citizens and qualified retirement plans. As discussed below, the Commission and the Division have undertaken a number of initiatives designed to educate investors about mutual fund investing and to provide investors with less complex and more "investor friendly" disclosure documents. The Division also has issued letters that should have the effect of encouraging sponsors of defined contribution plans to disseminate investment information to plan participants. These letters were precipitated in part by a concern that participants may not always receive sufficient information about the plan's features and investment alternatives to enable them to make informed investment decisions. Investor Education. In the last decade, investors have increasingly turned to mutual funds and other types of investment companies as a means to increase their rate of return. The Commission is concerned that many of these investors, particularly those who have never before invested in the securities markets, may not understand what these investment vehicles are, how they operate, and the risks inherent in investing in them. In October 1994, the Commission published the consumer brochure, "Invest Wisely: An Introduction to Mutual Funds." The brochure explains what mutual funds are, the differences among the types of funds, and the various fees that may be incurred by mutual fund investors. The brochure may be obtained by calling a toll-free number or by downloading it from the Commission's home page on the World Wide Web. In addition, the AARP, among other organizations, was given numerous copies for distribution to its members. Disclosure. The Commission also has attempted to improve the disclosure that investors receive regarding investment products. The Commission is aware that many disclosure documents are lengthy, overly complex, and written in a manner that makes it impossible for many investors to understand. The following are just a few of the initiatives the Commission currently is working on to make mutual fund and insurance products' disclosure documents more meaningful and less confusing. - Risk Disclosure -- In March 1995, the Commission issued for public comment a concept release discussing how mutual fund risk disclosure can be improved to communicate more effectively the risks presented by mutual funds. Many of the approximately 3,700 comment letters the Commission ==========================================START OF PAGE 32====== received were sent by senior citizens who are mutual fund investors. - Fund Profiles -- In August 1995, the Commission, together with the Investment Company Institute and NASAA, began a pilot program permitting mutual funds to deliver a "fund profile" with the fund's full prospectus. The profile consists of a brief summary in a standard format of key fund features described in the full prospectus. Fund profiles provide a "road map" of important information about each fund and may help investors compare the investment options and other features offered by various funds. The Division also recently issued a letter approving guidelines for the use of profile prospectuses by variable annuities. - Prospectus Simplification -- The Division has encouraged all mutual funds and issuers of variable insurance contracts to write prospectuses in simpler, more concise formats that are easier for investors to understand. - Amendments to Mutual Fund Prospectus Requirements -- The Division is conducting a "top to bottom" review of the current registration form for mutual funds with the goal of revising the form to elicit clear and more "investor friendly" disclosure. The revised form will reflect comments the Division has received with respect to the profile and prototype prospectuses and the risk disclosure concept release. Providing Information to Participants in Defined Contribution Plans. Acknowledging the need of participants in defined contribution plans for additional information about their mutual fund investment options, the Division issued the following letters. - Summary Brochures -- In April 1995, the Division issued a no-action letter providing relief that enabled fund sponsors and their affiliates to prepare summary brochures and distribute them to participants in defined contribution plans that invest in mutual funds. The summary brochures contain information about the investment objectives, policies and risks of the various funds that are investment options under a particular plan.-[68]- ---------FOOTNOTES---------- -[68]-Fidelity Institutional Retirement Services Company, Inc. (pub. avail. Apr. 5, 1995). ==========================================START OF PAGE 33====== - Employer Not an Investment Adviser -- In two letters to the Department of Labor, the Division has taken the position that an employer that provides investment-related information to participants in the employer's defined contribution plan generally would not be an "investment adviser" as defined in the Investment Advisers Act, because the employer would not meet the "in the business" element of the definition. Thus, the employer would not be subject to registration or regulation under that Act. Clarifying the status of these employers may encourage them to provide information to their employees about the investment options available through their retirement plans.-[69]- D. Regulation of Securities Markets and Professionals. Senior citizens and participants in qualified retirement plans, like other investors, benefit from strong and transparent markets and from initiatives to simplify securities transactions. In addition, they may be particularly vulnerable to cunning or abusive selling practices. The Commission and its Division of Market Regulation have undertaken a number of initiatives to address these issues. Cold-Calling. The Commission's Division of Market Regulation is engaged in an initiative regarding limits on cold- calling by brokers that may be of particular importance to senior citizens. The Division staff is working with self-regulatory organizations ("SROs") to encourage the prompt development of rules that protect investors against certain deceptive and abusive telemarketing practices in connection with the sale of securities. The Commission would evaluate SRO rules to determine whether, together with existing securities laws and regulations, they provide protection substantially similar to the rule adopted by the Federal Trade Commission ("FTC"). The FTC rule requires disclosures and prohibits misrepresentations by telemarketers, imposes time-of-day restrictions, requires the maintenance of a do-not-call list, limits the use of demand drafts, prohibits specified abusive or deceptive conduct, and imposes certain recordkeeping. Bank Sales Practices -- Pending NASD Rule Proposal, Division No-Action Letter, and Federal Banking Agency Statement. Many ---------FOOTNOTES---------- -[69]-Letters from Jack W. Murphy, Associate Director (Chief Counsel), Division of Investment Management, SEC to Olena Berg, Assistant Secretary, Pension and Welfare Benefits Administration, U.S. Dept. of Labor (Dec. 5, 1995; Feb. 22, 1996). ==========================================START OF PAGE 34====== older persons tend to keep substantial retirement assets at depository institutions because of concerns about volatility and safety that are met by fixed returns and deposit insurance. As securities activities at depository institutions such as banks, savings and loan associations, credit unions, and similar financial institutions have expanded, and securities sales facilities have been placed in retail deposit taking areas, customers of these institutions, including senior citizens, may be confused about the distinction between the insured deposit products of the financial institutions and the uninsured securities products of the broker-dealer operations in the same location. A series of regulatory actions have been and are being taken by the securities and banking regulators to improve investor protection and to provide investors with clearer information about the securities services offered on bank premises. The Division of Market Regulation issued a no-action letter in 1993 stating the requirements for networking broker-dealers as related to customer disclosure, compensation of employees of financial institutions, promotional materials, location of the broker- dealer and its securities activities, and inspection of books and records.-[70]- In 1994, the federal banking regulators issued their own guidelines regarding depository institutions that sell securities products to their customers either directly or through networking arrangements or through affiliated broker- dealers.-[71]- The National Association of Securities Dealers, Inc. ("NASD") has submitted a rule proposal regarding its members' securities activities on the premises of a financial institution where retail deposits are taken. The Division is working closely with the NASD to develop appropriate protections.-[72]- ---------FOOTNOTES---------- -[70]-See Letter regarding Chubb Securities Corporation (November 24, 1993). -[71]-See Interagency Statement on Retail Sales of Nondeposit Investment Products (February 17, 1994). -[72]-The NASD also has issued a number of Notices to Members regarding their obligations under the federal securities laws and NASD rules when selling securities products to customers who may have little or no experience with uninsured, non- depository products. See Notice to Members 91-74 (November 1991), Notice to Members 93-87 (December 1993), Notice to Members 94-16 (March 1994), Notice to Members 94-47 (June 1994), and Notice to Members 95-80 (September 1995). ==========================================START OF PAGE 35====== Employee compensation, training, and other important issues are addressed in the rule proposal. Implementation of an NASD rule should strengthen protection for older investors, both by allowing them to make better grounded investment decisions and by improving the NASD's ability to sanction overreaching broker- dealers who engage in abusive or misleading conduct. Dividend Reinvestment and Stock Purchase Programs. Initiatives undertaken by the Commission's Division of Market Regulation have extended low-cost investment opportunities to small investors, including senior citizens. Transaction costs to small investors, including senior citizens, for purchases or sales of securities may be significant. Through a series of no- action and exemption letters, the Division, together with the Division of Corporation Finance, has provided relief applicable to broker-dealer registration, trading practices rules, securities registration, and tender offer provisions regarding programs that have enabled shareholders of an issuer to reinvest dividends or to make additional purchases of that issuer's shares, and enabled new investors to make first purchases of an issuer's shares without the services of a broker- dealer.-[73]- By enabling investors to maintain and add to their securities holdings at more modest costs, the dividend and stock purchase plans enable small investors, including senior citizens, to participate more fully in the stock markets. E. Municipal Securities. Over the past decade, the municipal securities market has grown dramatically and undergone a fundamental change. In the past, the municipal securities market was dominated by institutional investors. Today the market relies mainly on individual investors, including many senior citizens who seek the income and safety that municipal securities have historically provided. Municipal securities outstanding now exceed $1.3 trillion. Individual investors, including those holding through mutual funds and money market funds, held approximately 74% of municipal debt outstanding in 1995, compared with 51% in 1985. As a result, the Commission, working primarily through its Office of Municipal Securities-[74]- and its Divisions of Market ---------FOOTNOTES---------- -[73]-See Letter regarding Securities Transfer Association (September 14, 1995). -[74]-The Office of Municipal Securities was established in 1995 as part of the Commission's overall effort to provide a core (continued...) ==========================================START OF PAGE 36====== Regulation and Corporation Finance, has embarked on a comprehensive municipal securities initiative aimed at improving the transparency and integrity of the municipal securities markets. The initiative will provide lasting benefits to all investors in the municipal securities markets, including senior citizens. The Commission has undertaken its initiative through the use of its rulemaking and enforcement powers. Principal among the Commission's actions have been the following: - Issuance in March of 1994 of an interpretive release addressing the application of the antifraud provisions of the federal securities laws to the disclosure obligations of participants in the municipal securities markets. - Adoption of extensive revisions to existing municipal broker-dealer rules that will facilitate improved annual disclosure of financial information and timely disclosure by municipal securities issuers of material events that affect the value of municipal securities. - Approval of rules to improve transparency for the municipal securities and other debt markets. - Approval of MSRB rule G-37 eliminating "pay to play" practices from the municipal securities markets and MSRB rule G-38 which requires dealers to enter into written agreements with "consultants" and to disclose such arrangements to issuers and the investing public. The Commission continues to encourage of other municipal market participants, including lawyers, financial advisors and others, to embrace similar standards. - Interaction with state and local finance officials who are charged with managing public funds to stress the basics of risk management and to outline the various approaches available to protect public funds. F. Compliance Inspections and Examinations. The Office of Compliance Inspections and Examinations ("OCIE") and the Commission's regional office examination staff actively oversee investment advisers, many of whom advise senior citizens on the management of their retirement savings. Many ---------FOOTNOTES---------- -[74]-(...continued) of expertise and coordination on urgent and ongoing municipal securities issues. ==========================================START OF PAGE 37====== advisers also provide retirement planning services for individuals and qualified plans. A central purpose of every examination is to search for fraud and abuse of trust. Recent examinations have detected and stopped a variety of fraudulent and abusive practices. One examination discovered that an adviser was moving his elderly and retired clients' investments to an off-shore bank. As a result of the examination, the Commission filed an emergency enforcement action and recovered 90% of the clients' funds. In another examination, the staff found that an adviser obtained clients, including many retirees, by offering free services. Once he had access to their financial affairs, the adviser stole three quarters of a million dollars. In a third, the staff discovered that an adviser was using inflated performance figures while soliciting business from unions and a public employees' retirement association. Finally, the examination staff has uncovered a variety of abusive practices by broker-dealers affiliated with pension administrators. OCIE also coordinated the Joint Regulatory Sales Practice Sweep. The sweep was directed at the type of sharp selling practices to which senior citizens may be particularly vulnerable. This joint regulatory initiative of the Commission, NASD, NYSE, and NASAA (collectively the "Working Group") reviewed the sales practice activities of selected registered representatives, and the hiring, retention, and supervisory practices of the brokerage firms employing them. The Working Group made referrals in one fifth of its 179 examinations for further enforcement investigation, and highlighted the need for firms to devote additional resources to the prevention and detection of sales practices abuses by their employees. The Working Group recommended improvements in hiring and supervisory practices, and improved compliance with cold-calling requirements. This examination sweep, in a keenly focussed way, continued the routine regulatory, examination, and enforcement programs of the Working Group members to identify and stop persons and practices harmful to small investors, including the elderly. X. Conclusion. It is clear that senior citizens and qualified retirement plans are substantial participants in our financial markets and play a vital role in capital formation. As the population ages, the importance of seniors and qualified retirement plans to our markets will increase. Many employers are moving away from traditional pension plans in which the plan participants have ==========================================START OF PAGE 38====== little, if any, investment discretion, to defined contribution plans in which the participants have significant investment discretion. Likewise, growing numbers of senior citizens are participating in the securities markets and making important investment decisions. Often inexperienced as investors, seniors and many participants in qualified retirement plans may be susceptible to bad investment decisions and seniors may be particularly vulnerable to the effects of securities fraud. The Commission believes that it is too early to assess the effects of the Act, and the Commission does not recommend legislation at this time to provide greater protections to senior citizens or to participants in qualified retirement plans than is currently provided in the federal securities laws. However, the Commission is actively pursuing administrative activities and initiatives that it believes will have a significant effect on the issues of concern to senior citizens and participants in qualified retirement plans.