SECURITIES AND EXCHANGE COMMISSION
[Release No. 33-7664, File No. S7-12-99]
Securities Uniformity; Annual Conference on
Uniformity of Securities Laws
AGENCY: Securities and Exchange Commission.
ACTION: Notice of Conference; Request for Comments.
SUMMARY: The Commission and the North American Securities
Administrators Association, Inc. today announced a request for
comments on the proposed agenda for their annual conference to be
held on April 19, 1999. This meeting seeks to carry out the
policies and purposes of section 19(c) of the Securities Act of
1933, which are to increase cooperation between the Commission
and state securities regulatory authorities in order to maximize
the effectiveness and efficiency of securities regulation.
DATES: The conference will be held on April 19, 1999. We must
receive your written comments by April 14, 1999 in order to be
considered by conference participants.
ADDRESSES: Please send three copies of written comments to
Jonathan G. Katz, Secretary, Securities and Exchange Commission,
450 5th Street, N.W., Washington, D.C. 20549-0609. Comments
also can be sent electronically to the following E-mail address:
rule-comments@sec.gov. Comment letters should refer to File No.
S7-12-99; if E-mail is used, please include this file number on
the subject line. Anyone can inspect and copy the comment
letters at our Public Reference Room, 450 5th Street, N.W.,
Washington, D.C. 20549. All electronic comment letters will be
posted on the Commission's internet web site
(http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: John D. Reynolds, Office of
Small Business Review, Division of Corporation Finance,
Securities and Exchange Commission, 450 5th Street, N.W.,
Washington, D.C. 20549, Stop 3-4, (202) 942-2950.
SUPPLEMENTARY INFORMATION:
I. Discussion
The federal government and the states have jointly regulated
securities offerings since the adoption of the federal regulatory
structure in the Securities Act of 1933 (the "Securities
Act").[1] Issuers trying to raise capital through securities
offerings, as well as participants in the secondary trading
markets, must comply with the federal securities laws as well as
all applicable state laws and regulations. Parties involved in
this process have long recognized the need to increase uniformity
and cooperation between the federal and state regulatory systems
so that capital formation can be made easier while investor
protections are retained.
Congress endorsed greater uniformity in securities
regulation with the enactment of section 19(c) of the Securities
Act in the Small Business Investment Incentive Act of 1980.[2]
Section 19(c) authorizes the Commission to cooperate with any
association of state securities regulators which can assist in
carrying out that section’s policy and purpose. Section 19(c)
mandates greater federal and state cooperation in securities
matters in order to:
* maximize effectiveness of regulation;
*
* maximize uniformity in federal and state standards;
*
* minimize interference with the business of capital
* formation; and
*
* reduce the costs, paperwork and burdens of raising
investment capital, particularly by small business, and
also reduce the costs of the government programs
involved.
The Commission is required to conduct an annual conference to
establish ways to achieve these goals. The 1999 meeting will be
the sixteenth conference.
During 1996, Congress again examined the system of dual
federal and state securities regulation. It considered the need
for regulatory changes to promote capital formation, eliminate
duplicative regulation, decrease the cost of capital and
encourage competition, while at the same time promoting investor
protection. Congress passed The National Securities Markets
Improvement Act of 1996[3] (the "1996 Act") as a result of this
reexamination. The 1996 Act contains significant provisions that
realign the partnership between federal and state regulators.
The legislation 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.
II. 1999 Conference
The Commission and the North American Securities
Administrators Association, Inc. ("NASAA")[4] are planning the
1999 Conference on Federal-State Securities Regulation to be held
April 19, 1999 in Washington, D.C. At the conference, Commission
and NASAA representatives will divide into working groups in the
areas of corporation finance, market regulation and oversight,
investment management, investor education, and enforcement. Each
group will discuss methods to enhance cooperation in securities
matters and improve the efficiency and effectiveness of federal
and state securities regulation. Generally, only Commission and
NASAA representatives may attend the conference to encourage open
and frank discussion. However, each working group in its
discretion may invite certain self-regulatory organizations to
attend and participate in certain sessions.
The Commission and NASAA are preparing the conference
agenda. We invite the public, securities associations, self-
regulatory organizations, agencies, and private organizations to
participate by submitting written comments on the issues set
forth below. In addition, we request comment on other
appropriate subjects. Conference attendees will consider all
comments.
III. Tentative Agenda and Request for Comments
The tentative agenda for the conference consists of the
following topics in the areas of corporation finance, investment
management, market regulation and oversight, investor education,
and enforcement.
(1) CORPORATION FINANCE ISSUES
The 1996 Act amended section 18 of the Securities Act[5] to
preempt state blue-sky registration and review of offerings of
"covered securities."[6] "Covered securities" are defined by
section 18 and include several types of securities, including
securities traded on the New York Stock Exchange, Inc. ("NYSE"),
American Stock Exchange ("Amex") and the Nasdaq National Market
System ("Nasdaq/NMS") (these securities as a group are called
"nationally-traded" securities). Covered securities also include
registered investment company securities and certain exempt
securities and offerings.
The states retain some authority in connection with
offerings of covered securities despite this preemption. Except
for covered securities that are classified as nationally-traded
securities, the states have the right to require fee payments and
notice filings. The states also retain anti-fraud authority over
all securities offerings, including offerings of covered
securities.
Securities that are not "covered securities" remain subject
to state registration requirements. These securities generally
include the securities of smaller companies, such as those quoted
on the Nasdaq SmallCap market or the NASD’s over-the-counter
Bulletin Board, or in the "pink sheets." Securities issued in a
private offering under section 4(2) of the Securities Act are not
covered securities if the offering does not meet the safe harbor
requirements of Rule 506 of Regulation D. [7] Also, securities
issued under Regulation A[8] and Rules 504 and 505 of Regulation
D are not covered securities.[9]
The states’ authority over securities offerings,
particularly their ability to register and review offerings of
non-covered securities, continues the need for uniformity between
the federal and state registration systems, where consistent with
investor protection. The group will discuss ways to increase
uniformity between the systems. Conferees will focus primarily
on the following topics:
A. Reform of the Securities Offering Process
For many years, the Commission has been actively reexamining
the regulatory framework for the offer and sale of securities
under the federal securities laws. As a result of this work,
the Commission issued a release in November 1998 proposing
significant changes in the regulation of securities offerings and
the disclosure system that applies to publicly reporting
companies.[10] The proposals relate to five areas:
* registration system reform;
* communications around the time of a securities offering;
* prospectus delivery requirements;
* integration of private and public offerings; and
* periodic reporting under the Securities Exchange Act of
1934 (the "Exchange Act").
The Commission’s staff will summarize these proposals and
describe the responses from the public received to date. While
the group may consider various aspects of the proposals, the
representatives will discuss primarily how the proposals would
affect state regulation of offerings of non-covered securities.
The group will focus on some or all of the following matters:
1. Registration system reforms
\ The Commission proposed new Form B for large issuers that
meet certain reporting and annual report requirements and had
registered previously an offering of securities under the
Securities Act which was declared effective by the Commission’s
staff. Form B also would be available to smaller issuers which
meet the same requirements, but only when they offer securities
to relatively sophisticated investors or knowledgeable investors.
These smaller issuers could use Form B for offerings to qualified
institutional buyers as defined in Rule 144A[11] and for
offerings to certain existing security holders, such as: rights
offerings; securities offered under dividend or interest
reinvestment plans; and offerings to holders of common stock,
options, warrants and convertible securities.
Form B would replace Form S-3, the current abbreviated
registration statement form, and provide issuers with more
flexibility than under the current system. The issuer would be
able to delay filing the Form B registration statement until
shortly before the first sale of securities and would be able to
determine when its registration statement becomes effective.
The Commission proposed new Form A for medium-sized
issuers.[12] It would replace Form S-1, the current registration
statement form used by most issuers. Form A would be used by
issuers that do not meet the requirements to use Form B. Some
Form A issuers would be able to specify the time of effectiveness
of their registration statements. Form A issuers that are able
to incorporate company information into their prospectuses would
be able to control the timing of effectiveness if either:
* they have a public float equal to or greater than $75
* million; or
*
* the Exchange Act annual report that is incorporated into
* the Form A registration statement was reviewed by the
* Commission’s staff and amended to comply with any staff
* comments.
The group will discuss these proposed registration statement
reforms and consider how they would operate with state
registration procedures for offerings of non-covered securities.
2. Communications around the time of an offering
Under current federal regulation, an issuer’s communications
to investors and the market are strictly limited around the time
of an offering. The Commission’s proposals in this area would
loosen these restrictions while preserving the legal remedies to
investors for inadequate disclosures.
The approach would depend upon the type of offering. For
Form B offerings, issuers would be able to make oral and written
communications in any format at any time regardless of whether
the offering is imminent or ongoing. Those communciations of
course would be subject to the liability provisions of the
federal securities laws and would need to be filed with the
Commission.
For non-Form B offerings, the Commission has proposed a
bright-line safe harbor for all communications made before the
30-day period before the date of filing the registration
statement. Communications within 30 days of filing would remain
restricted although the Commission has proposed safe harbors for
factual business communications and regularly released, forward-
looking information. After the registration statement is filed,
the Commission proposes to lift restrictions on communications.
These post-filing communications would be subject to the
liability provisions and would have to be filed with the
Commission.
The group will discuss the proposed federal approach to
communications. The conferees also will consider how the
Commission’s proposals would coordinate with state regulations
applicable to communications.
3. Integration of offerings
An issuer of securities that has commenced a private
offering may decide to switch to a registered public offering.
Similarly, an issuer may decide to end a registered offering and
offer securities under a private exemption. The current federal
rules prevent most companies from switching from registration to
a private offering, and vice versa, in a timely fashion. The
Commission has proposed changes to remove most of these
impediments.
The Commission has proposed a safe harbor for issuers that
have started a registered offering and wish to switch to a
private offering. Under the safe harbor, the issuer may withdraw
its registration statement and either wait 30 days to sell
privately or sell privately sooner if it accepts a higher
liability standard for written disclosures provided to
purchasers.
Another safe harbor would apply to an issuer that has
started a private offering and later decides to abandon it and
file a registration statement. Under this proposal, the issuer
could file a registration statement for a public offering
immediately after abandonment of the private offering, unless it
had offered the securities to persons ineligible to buy in a
private offering. In that case, the issuer would need to wait 30
days before filing its registration statement.
The group will discuss the proposed integration safe harbors
and consider how they would coordinate with state rules that
apply in these situations.
B. Small Business Initiatives
1. Registration system reform - effects on small business
issuers
Certain Commission registration reform proposals are
tailored to benefit smaller issuers. One important proposal
would modify the definition of "small business issuer." In 1992
and 1993, the Commission adopted special forms for small issuers
to use in registering under the Securities Act and Exchange Act
and in reporting under the Exchange Act. The disclosure
requirements of these forms are less extensive than those
applicable to larger issuers. The Commission adopted the
definition of "small business issuer" to distinguish the class of
smaller issuers that would be permitted to use these special
forms. A small business issuer generally is a company with
revenues of less than $25 million and a public float of less than
$25 million.[13]
The Commission proposed to change the definition by
increasing the revenue level to $50 million and removing the
public float limitation. This proposal would update the
definition for the significant economic and market changes that
have occurred since the definition was adopted in 1992. The
proposal would significantly increase the number of public
companies that would qualify as small business issuers.
Another important reform proposal would allow small business
issuers to use Form B when offering securities to relatively
sophisticated or knowledgeable investors. Small business issuers
would be able to enjoy the various benefits of Form B in these
offerings.[14]
Other reform proposals also would benefit smaller issuers.
Under one proposal, a small business issuer whose registration
statement has become effective would be allowed to increase the
size of its offering by up to 50% of the maximum offering price
of the earlier effective registration statement. The second
registration statement for the additional offering amount would
become effective automatically under certain circumstances.
Another proposal would permit incorporation by reference of
Exchange Act reports into Form SB-2, the basic registration
statement for small business issuers. This change would permit
earlier incorporation by reference than allowed currently.[15]
Also, the Commission proposed a new Form SB-3, a registration
statement form designed especially for small business issuers to
use in business combinations.
The Commission’s integration proposal, although applicable
to all issuers, may benefit small business issuers in particular.
Because small business issuers often have no market or only a
limited market for their securities before a securities offering,
they may be unable to predict investors’ interest in their
offerings. Once a smaller issuer begins an offering, it may wish
to switch between a registered offering and an exempt offering
depending upon the amount of investor interest in its securities.
The integration proposal would permit an issuer to switch between
registration and an exemption in a timely manner if certain
conditions are met.[16]
The group will discuss the impact of these proposed changes,
if adopted, and the need for any additional rulemaking in the
small business area.
2. Rule 504
Rule 504 of Regulation D provides an exemption from the
Securities Act registration requirements for offerings up to $1
million in any 12-month period, if certain conditions are met.
Generally, Rule 504 is available only to the smallest companies
that do not report under the Exchange Act. Under prior Rule 504,
issuers were permitted to generally solicit and advertise in Rule
504 offerings, and the securities issued in those offerings were
freely tradeable. The Commission recently amended Rule 504 to
address concerns with the previous approach.[17] The revised
rule limits the circumstances where general solicitation is
permitted and freely tradeable securities are issued under the
rule. Specifically, issuers may generally solicit and advertise
and issue freely tradeable securities only in transactions that
are either:
* registered under state law requiring public filing and
delivery of a substantive disclosure document to
investors before sale; or
*
* exempted under state law permitting general solicitation
and general advertising so long as sales are made only to
"accredited investors." [18]
Only companies that do not report under the Exchange Act may
use Rule 504. Where an issuer becomes a reporting company during
an ongoing Rule 504 offering, the issuer may not continue to rely
on the rule after it becomes a reporting company. To address
this case, one of the Commission’s reform proposals would amend
Rule 504 to permit an issuer that becomes a reporting company
during an ongoing Rule 504 offering to continue to rely on the
rule in that offering, if certain conditions are met.
The group will discuss the revisions and proposed amendment
to Rule 504. Conferees will consider whether other changes are
needed in the rule while at the same time preserving the ability
of small companies to raise capital.
3. State initiatives
The group will discuss several state initiatives designed to
facilitate offerings by smaller issuers. These include:
* the Coordinated Equity Review ("CER") program;
*
* the Small Company Offering Registration ("SCOR") form; and
*
* the state regional review program for SCOR and Regulation
* A filings (the "Regional Review Program").
The CER program provides for a coordinated state review
process for offerings of equity securities registered at the
federal level. Under CER, the participating states coordinate
with each other to produce one comment letter to an issuer which
addresses both substantive and disclosure matters. To date, 38
states (out of 42 states that require registration of these
offerings) have agreed to participate in the program. The
states have reviewed approximately 32 registration statements
under this program.
Many states use a similar coordinated program to review
state registrations using the SCOR form, the "Regional Review
Program." The SCOR form is a simplified question and answer
format used for the registration of securities offerings with
approximately 47 states. This form is used to register securities
offerings exempt from federal registration under Rule 504 of
Regulation D or Regulation A. Under the Regional Review Program,
states in certain regions of the country elect one state to lead
the review and issue comments on the filing. Three regional
programs have been started to date and include about 22 of the
states requiring registration of these offerings.[19] About 37
SCOR filings have been reviewed under the Regional Review
Program. The SCOR form was adopted by NASAA in 1989. NASAA’s
Small Business Capital Formation and Regional Review Committee is
considering certain revisions to update and modernize the form.
NASAA’s representatives will discuss their experiences with
the SCOR form and the state coordinated review programs,
including issues which have arisen in their use. Participants
will consider how these programs may be improved to increase
uniformity between the federal and state levels.
C. Definition of Qualified Purchaser and Accredited
Investor; NASAA’s Model Accredited Investor Exemption
Section 18 of the Securities Act, after the 1996 Act,
excludes from state regulation and review securities offerings to
purchasers who are defined by Commission’s rules to be "qualified
purchasers."[20] A security sold to a "qualified purchaser" is a
"covered security" subject to the same regulatory approach as
other covered securities. The Commission is planning to propose
a definition of "qualified purchaser" for this purpose. In this
process, the Commission is considering whether changes should be
made to the definition of "accredited investor" under the
Securities Act, and whether the definitions of "qualified
purchaser" and "accredited investor" should be similar or
different. The Commission and state representatives will discuss
the appropriate criteria for these two definitions.
The group also will discuss NASAA’s Model Accredited
Investor Exemption which was adopted in 1997. Generally, the
model rule exempts offers and sales of securities from state
registration requirements if, among other things, the securities
are sold only to persons who are, or are reasonably believed to
be, accredited investors. To date, 16 states have adopted the
exemption and other states indicate that they intend to adopt the
exemption in the near future. State representatives will share
their experiences with the exemption, including any issues that
have arisen.
D. Plain English Disclosure
Beginning October 1, 1998, issuers filing Securities Act
registration statements must use plain English writing principles
when drafting the front part of prospectuses, i.e., the cover
page and the summary and risk factors sections.[21] These plain
English principles include: active voice; short sentences;
everyday language; tabular presentation or "bullet lists" for
complex material, if possible; no legal jargon or highly
technical business terms; and, no multiple negatives.
The Division of Corporation Finance, in its full review of a
registration statement, examines the prospectus for compliance
with the plain English requirements. If appropriate, the
Division staff will issue comments to obtain improved plain
English disclosures. The Division representatives will discuss
their experiences with the plain English system. The group will
consider any issues that have arisen and federal and state
coordination needed to facilitate success of the system.
E. Year 2000 Disclosure Issues
The Commission and its staff have published several
statements which provide guidance about the disclosure
requirements of public companies facing year 2000 technology
problems. The Commission recently provided guidance in a July
1998 release.[22] That release provides advice to public
companies so they can determine whether their year 2000 issues
should be disclosed in the Management’s Discussion and Analysis
of Financial Condition and Results of Operations section of their
disclosure documents. The release also advises public companies
to consider Year 2000 issues when preparing their financial
statements and drafting other disclosures, such as risk factors
and business description disclosures. The working group will
consider this issue and discuss how to require and review
disclosures on this matter in a consistent manner.
(2) MARKET REGULATION ISSUES
A. Books and Records
Section 103 of the 1996 Act prohibits any state from
imposing broker-dealer books and records requirements that differ
from, or are in addition to, the Commission’s requirements. In
addition, the same section directs the Commission to consult
periodically with the state securities authorities concerning the
adequacy of the Commission’s books and records requirements.
On October 2, 1998, the Commission reproposed amendments to the
books and records rules to clarify and expand recordkeeping
requirements with respect to purchase and sale documents,
customer records, associated person records, customer complaints,
and certain other matters. The reproposed amendments also
specified the books and records that broker-dealers would make
available at their local offices. The Commission modified the
reproposed amendments to reduce the burden on broker-dealers
without substantially detracting from the original objective of
establishing rules that would facilitate examinations and
enforcement activities of the Commission, self regulatory
organizations ("SROs"), and state securities regulators.[23]
Among other changes in the reproposed amendments, the Commission
redefined the term "local office" to include a place where two or
more associated persons regularly conduct a securities business.
The original proposal[24] defined the term local office to
include a place where one associated person conducted a
securities business. Furthermore, as reproposed, a broker-dealer
would be required to update its customer account records at least
once every three years. The original proposal required broker-
dealers to update the customer account records annually.
The comment period closed December 9, 1998. The Commission
received approximately 120 comment letters in response to the
release re-proposing the amendments. The Commission’s staff has
been reviewing the comments that have been submitted. The
working group will discuss these efforts to amend Rules 17a-3 and
17a-4.
B. Central Registration Depository
The CRD system is a computer system operated by the National
Association of Securities Dealers, Inc. ("NASD") and 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 modernize the CRD and to expand its use by
federal and state securities regulators as a tool for
broker-dealer regulation. As a result of the NASD's efforts, the
modernized CRD system ultimately is expected to provide the
Commission, the SROs, and state securities regulators with: (1)
streamlined capture and display of data; (2) better access to
registration and disciplinary information through the use of
standardized and specialized computer searches; and (3)
electronic filing of uniform registration and licensing forms,
including Forms U-4, U-5, BD and BDW.
The NASD is preparing to implement the web-based form filing
component of the modernized CRD system in the third quarter of
1999. In the past year, NASAA, the NASD, the Commission and
others have worked together to modify Forms U-4, U-5 and BD in
order to accommodate the electronic filing environment that will
exist in the modernized CRD. At NASAA’s Annual Fall conference
held in October 1998, NASAA adopted new versions of Forms U-4 and
U-5. The NASD has submitted, and the Commission is reviewing, a
rule proposal to modify Forms U-4 and U-5. The NASD rule
proposes additional formatting and technical changes to the forms
in order to fully implement the web-based CRD system. Also, the
Commission is considering revisions to the Form BD to accommodate
web-based form filing.
In anticipation of the conversion to the web-based CRD
system, the NASD is planning a two week transition period during
which time registration activities will not be processed. This
two week period is currently scheduled for the beginning of
August 1999.
The conference participants will discuss the CRD
modernization process, including the proposed changes to the
forms and the transition period.
C. Micro-cap Fraud Rules
Rule 15c2-11 under the Exchange Act requires a broker-dealer
to review current information about an issuer before it publishes
a quotation for the issuer's security in the non-Nasdaq over-the-
counter markets. Because of the rule's "piggyback" provision,
generally only the first broker-dealer has to review this
information. Once the security is quoted regularly for 30 days,
other broker-dealers can "piggyback" off those quotes without
reviewing any information about the issuer.
On February 17, 1998, the Commission proposed amendments to
Rule 15c2-11 that would strengthen the rule in a number of
ways.[25] The Commission received approximately 199 written
comments from 193 commenters, including 68 identical letters from
OTC Bulletin Board issuers in response to the release proposing
amendments. Broker-dealers, trade associations, and law firms
representing broker-dealers submitted 45% of the comment letters.
OTC Bulletin Board issuers submitted 30% of the comment letters.
State securities regulators and NASAA accounted for 5% of the
comment letters. The majority of the comment letters opposed the
proposed amendments. Because of the significant comments
received, the Commission decided to modify some of these
amendments and repropose them for public comment.[26] The
reproposal acknowledges commenters’ concerns about the initial
proposal by limiting the scope of the rule principally to priced
quotations and to those securities that are more likely to be the
subject of improper activities. The provisions relating to the
broker-dealer’s obligations under the rule and the specified
issuer information that the broker-dealer must obtain and review
are essentially unchanged from the initial proposal. The
reproposed amendments would:
* eliminate the rule's piggyback provision and require all
broker-dealers to review current issuer information before
publishing priced quotations for a security;
* limit the rule’s applicability to priced quotations only
(except in the case of the first broker-dealer to quote the
security);
* require broker-dealers publishing priced quotations for a
security to review current information about the issuer at
least annually;
* require documentation of the broker-dealer’s compliance with
the rule; and
* require broker-dealers publishing quotes in compliance with
the rule to make the issuer information available at the
request of customers, prospective customers, information
repositories, and other broker-dealers to the extent that
such information is not available through EDGAR, any other
federal or state electronic information system, or an
information repository.
However, the new amendments would narrow the scope of the
rule to those kinds of securities most frequently involved in
micro-cap fraud schemes by excluding the following securities:
* securities with a worldwide average daily trading volume
value of at least $100,000 during each of the six full
calendar months immediately preceding the date of
publication of a quotation, and convertible securities where
the underlying security satisfies this threshold;
* securities with a bid price of at least $50 per share;
* securities of issuers with net tangible assets in excess of
$10,000,000, based on audited financial statements; and
* non-convertible debt, non-participatory preferred stock, and
investment grade asset-backed securities.
The amendments also reorganize and simplify the rule’s provisions
consistent with the Commission’s plain English program. The
goals of the amendments are to deter fraudulent or manipulative
quotations for OTC securities, improve the integrity of
quotations for OTC securities, enhance broker-dealer
responsibility for quotations for OTC securities, and provide
market professionals, investors, and others with greater access
to issuer information. The participants will discuss the recent
reproposal and the effects of such reproposal, if adopted, and
other ways to promote investor protection in the OTC market
arena.
D. NASD Proposals
The NASD has undertaken several regulatory initiatives in
the past two years. A new rule change limited the securities
that a member can quote on the OTC Bulletin Board to the
securities of issuers that are registered under section 12 of the
Exchange Act, certain insurance companies, and registered closed-
end investment companies, but only if they are current in their
reporting obligations.
A proposed rule amendment would require clearing firms to
(1) forward customer complaints about an introducing firm to the
introducing firm and the introducing firm’s designated examining
authority ("DEA"), (2) notify complaining customers that the
complaint has been forwarded to the introducing member and the
introducing member’s DEA, (3) provide introducing firms with a
list of exception reports available to help the introducing firms
supervise their activities, and (4) permit introducing firms to
issue checks drawn on the clearing firm’s account only after the
introducing firm has notified the clearing firm, in writing, that
it has established and will maintain and enforce appropriate
supervisory procedures.
The NASD submitted a proposed rule that would provide
guidelines that apply to the employment and supervision of
unregistered persons who contact prospective and existing
customers, and provide for heightened supervision of cold
callers. This proposal is currently out for comment.
Finally, a new rule proposed by the NASD in 1998 would
require a member to review current financial statements of an
issuer prior to recommending a transaction in the issuer’s OTC
securities to a customer, and to deliver a disclosure statement
to its customer prior to making an initial purchase of an OTC
security for the customer, and annually thereafter.
These four initiatives are still being reviewed by the
Commission. The working group will discuss the impact of the new
rules, the status of the proposals, the comments received to
date, and their implications for small businesses and NASAA
members.
E. Arbitration
The NASD submitted to the Commission rule filings that focus
on and deal with the eligibility rule, the contract rule, the
creation of a discovery guide for arbitrators, whether punitive
damages should be capped in arbitration, and the use of interim
injunctive relief in arbitration. On June 22, 1998, the
Commission approved an NASD rule filing which eliminated the
NASD’s regulatory requirement that securities industry employees
arbitrate statutory employment discrimination claims.[27]
Additionally, on December 29, 1998, the Commission approved by
delegated authority the NYSE’s proposal to exclude statutory
employment discrimination claims from its arbitration forum
unless all parties agreed to the arbitration after the claim
arose.[28] On October 14, 1998, the Commission approved the
NASD’s rule change altering the system for selecting arbitrators
by substituting for the current system of administrative
appointment of arbitrators by NASD staff a new system whereby
parties are provided with lists of arbitrators that they may rank
by preference.[29] Recently, the Commission approved an NASD
rule proposal to increase NASD Regulation’s arbitration fees and
the honoraria it pays its arbitrators.[30]
The NASD filings resulted in part from its work with the
Securities Industry Conference on Arbitration ("SICA"). The
participants are likely to address some or all of the above
proposed changes in the securities arbitration process.
F. Day Trading
"Day trading" has been in the news a great deal recently. A
"day trader" can be loosely defined as someone who buys and sells
stocks during the day, often within minutes, hoping to take
profitable advantage of intraday swings in share prices. What
particularly distinguishes a day trader from a more typical
retail investor is that he or she, generally, will (1) not carry
a position overnight; (2) try to make money on the "spreads"
between the bids and offers; (3) trade through automatic order
execution systems, and not on-line through the Internet, in order
to obtain nearly instantaneous order execution; (4) look at
historical buying patterns in order to determine if the stock is
most actively sought during certain hours of the day, times of
the year, etc., rather than looking at a company’s fundamentals
or growth prospects; (5) have the mind set of a "trader" rather
than a long term investor; and (6) focus on trading in volatile
stocks.
The Commission is looking carefully at the activity of firms
that facilitate day trading. Areas that the Commission is
looking into include: (1) activities that may require broker-
dealer or investment adviser registration with the Commission, or
that may require registration with the Commission of sales of
shares of day trading accounts or firms; (2) compliance by day
trading firms with margin and short sale rules, including loans
made to customers; (3) capital requirements; (4) the manner in
which client funds are used; and (5) suitability requirements.
In early 1998, NASAA formed a task force to examine day
trading. The work of the task force is ongoing. The participants
are likely to address the task force’s work.
G. Migration of Rogue Brokers
The federal securities laws do not currently prevent persons
subject to disciplinary findings by state securities and
insurance commissions, and federal banking agencies,[31] from
entering the securities industry (and vice-versa). A 1994
General Accounting Office ("GAO") study raised similar concerns
about the migration of unscrupulous brokers into the financial
services industry, such as banking and insurance.[32] The GAO
recommended that the Department of Treasury work with the
Commission and other financial regulators to (1) increase
disclosure of CRD information so that regulators can consider a
broker’s disciplinary history in allocating examination resources
and employers can use the information in making hiring decisions
and (2) determine whether legislation or additional reciprocal
agreements between the Commission and other financial regulators
are necessary to prevent the migration of unscrupulous brokers to
other financial services industries.
In 1996, the Commission’s staff met with representatives
from the NASD, NASAA, and the National Association of Insurance
Commissioners ("NAIC"), to discuss steps that could be taken to
stem the migration of unscrupulous brokers. At that meeting, it
was agreed that an important first step would be to complete the
ongoing CRD modernization project. The participants also
discussed ways for additional regulatory authorities to obtain
access to the insurance industry’s Producer Information Network
("PIN").[33]
The participants are likely to discuss the CRD modernization
program and other avenues of information sharing between federal
and state securities, insurance and banking regulators in order
to address the possible migration of unscrupulous brokers.
Similarly, the group also expects to discuss whether it would be
appropriate to amend the Exchange Act, to make persons subject to
a "statutory disqualification"[34] if they have been found by a
state securities or insurance commission, or state or federal
banking agency, to have committed certain fraudulent acts or
violated the statutes enforced by these agencies.
H. Year 2000
The Commission has been very active in addressing the
potential problems for securities industry computer systems as a
consequence of the date change on January 1, 2000 ("Year 2000").
In particular, the Commission adopted rules that require broker-
dealers, non-bank transfer agents, and investment advisers to
file with the Commission (and, in the case of broker-dealers,
with their designated examining authority) reports regarding
their Year 2000 efforts.[35] The first reports for broker-
dealers and transfer agents were due August 31, 1998; the first
reports for investment advisers were due December 7, 1998. The
Commission brought enforcement actions against 37 broker-dealers
and 9 transfer agents who failed to file the first report or
filed it late, while the NASD brought 59 similar actions against
broker-dealers.[36]
Broker-dealers and non-bank transfer agents are required to
file a second report on April 30, 1999; larger broker-dealers and
non-bank transfer agents are also required to file a report
prepared by an independent public accountant regarding the
broker-dealers’ and the non-bank transfer agents’ processes for
preparing for the Year 2000. Investment advisers are required to
file a second report on June 7, 1999.[37]
Also during the past year, the Commission has supported the
industry’s efforts to conduct an industry wide test for Year 2000
problems in March 1999. Commission staff has worked with test
organizers and the SROs to identify key test participants. In
particular, the Commission has approved new SRO rules that allow
the SROs to mandate their member firms conduct Year 2000 testing.
Commission staff also meets regularly with the SROs to discuss
member readiness for Year 2000 and contingency planning.
Other Commission efforts regarding Year 2000 efforts include
a moratorium on the implementation of new Commission rules that
require major reprogramming of computer systems by Commission-
regulated entities between June 1, 1999 and March 31, 2000[38]
and surveys of Year 2000 remediation efforts at the exchanges,
Nasdaq and clearing agencies.
I. Examination Issues
State and federal regulators also will discuss various
examination-related issues of mutual interest, including:
summits and examination coordination; branch office examinations;
micro-cap issues; and day trading.
(3) INVESTMENT MANAGEMENT ISSUES
A. Division of Regulatory Authority
Title III of the 1996 Act amended the Investment Advisers
Act of 1940 ("Advisers Act")[39] to divide regulatory
responsibility for investment advisers between the Commission and
state securities regulators. The law generally requires advisers
that have assets under management of $25 million or more, or that
advise registered investment companies, to register with the
Commission.[40] Advisers that have assets under management of
less than $25 million must register with the appropriate state
securities authorities.
On May 15, 1997, the Commission adopted rules to implement
this division of regulatory authority,[41] including a
requirement that each Commission-registered adviser indicate
whether it was eligible for continued registration with the
Commission and, if not, withdraw from Commission registration.
Approximately 11,800 advisers withdrew from Commission
registration and the Commission canceled the registrations of
4,200 advisers that failed to indicate whether they were eligible
for continued registration with the Commission.[42]
Approximately 8,500 investment advisers are currently registered
with the Commission.
The conferees will discuss cooperation between Commission
and state adviser programs, including sharing information about
past examinations and monitoring advisers switching between
federal and state registration.
B. Electronic Filing System
The 1996 Act requires the Commission to establish and
maintain a "readily accessible telephonic or other electronic
process" to receive public inquiries about the disciplinary
histories of investment advisers and persons associated with
investment advisers.[43] In October 1998, Commission staff
announced that they would recommend that the Commission designate
NASD Regulation, Inc. ("NASDR") to operate an electronic
investment adviser registration system.[44] This decision was
made jointly with a NASAA committee.
The Commission has been working with NASAA, the state
securities authorities, and NASDR to develop a one-stop
electronic filing system that investment advisers will use to
apply for registration with the Commission or the appropriate
state securities authorities, and to update their registration.
The Commission and state authorities will have access to the
resulting database to review adviser registration materials and
the database will be available to the public on an Internet web
site. Clients and prospective clients of investment advisers
will be able to quickly obtain disciplinary and other information
about investment advisers and persons associated with investment
advisers.
The conferees will discuss the progress to date in creating
this new electronic filing system.
C. Revised Registration and Disclosure Forms
The Commission and NASAA are revising the investment adviser
registration and disclosure forms. The revised registration form
would provide more useful information to the Commission and the
state securities regulators. The new disclosure form would
require advisers to provide clear and complete disclosures in
plain English to clients and prospective clients.
The conferees will consider and discuss ways in which the
forms can be made most useful to the Commission and state
securities authorities, and clients and prospective clients of
investment advisers.
(4) INVESTOR EDUCATION AND ASSISTANCE
The Commission currently pursues a number of programs to
educate investors on how to invest wisely and to protect
themselves from fraud and abuse. The states and NASAA have a
longstanding commitment to investor education, and the Commission
intends to complement those efforts to the greatest extent
possible. The working group will discuss the following investor
education initiatives and potential joint projects:
A. Financial Literacy 2001
In the spring of 1998, NASAA, the NASD, and the Investor
Protection Trust ("IPT") joined forces to launch "Financial
Literacy 2001" ("FL2001"), an unprecedented $1 million campaign
targeting 25,000 high school teachers across America. The goal
of FL2001 is to encourage - and make it easier for - teachers in
every state to teach the basics on saving and investing. Working
together, NASAA, the NASD, and the IPT have developed a state-by-
state customized classroom guide and have begun to provide
aggressive distribution and teacher training. During the working
group session, the states will brief the Commission’s staff on
the progress of FL2001 and plans for dissemination of the FL2001
program in the coming year.
B. Plain English Update
In January 1998, the Commission approved new rules that
require issuers to write the cover page, summary, and risk
factors section of prospectuses in plain English. These rules
apply to all registration statements filed with the Commission on
or after October 1, 1998, and to all mutual fund disclosure
statements filed on or after December 1, 1998. During the
working group session, the participants will discuss the status
of the Commission’s plain English initiative.
C. Facts on Saving and Investing Campaign
In the spring of 1998, NASAA and the Commission, in
conjunction with the Council of Securities Regulators of the
Americas, launched the "Facts on Saving and Investing Campaign."
The campaign is an ongoing, grassroots effort to educate
individuals about saving, investing, and avoiding financial
fraud. Twenty-one countries throughout the Western Hemisphere
participated in the campaign’s enormously successful kick-off
week. In the U.S., campaign partners - including more than
thirty government agencies, consumer organizations, and financial
industry associations - held educational events and distributed
information on saving and investing throughout the country. In
the coming year, the campaign plans to target two key audiences -
schools and the workplace. During the working group session,
participants will discuss the campaign and future campaign
initiatives. The group also will discuss other initiatives for
international investor education.
D. New Investor Education Programs
Participants in the working group session will brainstorm
ideas for new investor education programs, including joint NASAA
and Commission initiatives.
E. Investor Education Resources
Participants in the working group session will assess
existing resources for investor education - including brochures,
videotapes, online materials, and other media - and identify
gaps. Conferees also will discuss the most efficient and
effective ways to provide educational resources to individuals at
the grassroots level.
(5) ENFORCEMENT ISSUES
In addition to the above topics, state and federal
regulators will discuss various enforcement-related issues which
are of mutual interest.
(6) GENERAL
There are a number of matters which are applicable to all,
or a number, of the areas noted above. These include EDGAR, the
Commission’s electronic disclosure system, rulemaking procedures,
training and education of staff examiners and analysts and
sharing of information.
The Commission and NASAA request specific public comments
and recommendations on the above-mentioned topics. Commenters
should focus on the agenda but may also discuss or comment on
other proposals which would enhance uniformity in the existing
scheme of state and federal regulation, while helping to maintain
high standards of investor protection.
By the Commission.
Jonathan G. Katz
Secretary
March 31, 1999
**FOOTNOTES**
[1]: 15 U.S.C. 77a et seq.
[2]: Pub. L. 96-477, 94 Stat. 2275 (October 21, 1980).
[3]: Pub. L. 104-290, 110 Stat. 3416 (October 11, 1996).
[4]: NASAA is an association of securities administrators from
each of the 50 states, the District of Columbia, Puerto Rico,
Mexico and twelve Canadian Provinces and Territories.
[5]: 15 U.S.C. 77r.
[6]: 15 U.S.C. 77r(a) and (b).
[7]: 17 CFR 230.501 through 230.508.
[8]: 17 CFR 230.251 through 230.263.
[9]: Other securities also are not considered covered securities.
These include securities traded on regional exchanges and asset-
backed and mortgage-backed securities.
[10]: Securities Act Release No. 7606 (November 3, 1998) [63 FR
67174].
[11]: 17 CFR 230.144A.
[12]: The effects of the reform proposals on small business
issuers are discussed under (1) B.1. below.
[13]: 17 CFR 228.10. Other requirements also must be met.
[14]: See discussion under (1) A.1. above.
[15]: Existing Form S-2 permits incorporation by reference if the
issuer has been reporting for a three year period and meets other
requirements. Proposed Form SB-2 would reduce the three year
period to two years.
[16]: See the discussion under (1) A. 3. above.
[17]: Securities Act Release No. 7644 (February 25, 1999) [64 FR
11090].
[18]: 17 CFR 230.501(a). The term "accredited investor," as
defined by the Securities Act and the Commission’s rules, is
intended to encompass those persons whose financial
sophistication render the protections of the Securities Act
registration process unnecessary. Offers and sales to these
investors are afforded special treatment under the federal
securities laws.
[19]: A fourth regional program is forming now. It will consist
of six states in the mid-Atlantic region and expects to accept
filings in late spring 1999.
[20]: 15 U.S.C. 77r(b)(3).
[21]: Securities Act Release No. 7497 (January 28, 1998) [63 FR
6370].
[22]: Securities Act Release No. 7558 (July 29, 1998) [63 FR
41394].
[23]: Exchange Act Rel. No. 40518 (October 2, 1998) [63 FR
54404].
[24]: Exchange Act Rel. No. 37850 (October 22, 1996) [61 FR
55593].
[25]: Exchange Act Release No. 39670 (February 17, 1998) [63 FR
9661].
[26]: Exchange Act Release No. 41110 (February 25, 1999) [64 FR
11124].
[27]: Exchange Act Release No. 40109 (June 22, 1998) [63 FR
35299].
[28]: Exchange Act Release No. 40858 (December 29, 1998) [64 FR
1051]. Commission staff is working with the regional exchanges
to assure conforming changes to their rules. In December 1998,
the Commission approved proposals substantially similar to the
NYSE’s filed by the Boston Stock Exchange and Chicago Stock
Exchange. Exchange Act Release No. 40861 (December 29, 1998) [64
FR 1039] (Boston); Exchange Act Release No. 40873 (December 31,
1998) [64 FR 1253] (Chicago).
[29]: Exchange Act Release No. 40556 (October 14, 1998) [63 FR
56957].
[30]: Exchange Act Release No. 41056 (February 16, 1999) [64 FR
10041].
[31]: This includes the Comptroller of the Currency, the Board of
Governors of the Federal Reserve System, the Federal Deposit
Insurance Corporation and the Office of Thrift Supervision.
[32]: Securities Markets: Actions Needed to Better Protect
Investors Against Unscrupulous Brokers (Letter Report, September
14, 1994, GAO/GGD-94-208).
[33]: The NAIC’s five year strategic plan, issued in 1993,
included the development of a producer database and common
insurance/producer licensing procedures. PIN, developed in 1995,
is one of the tools to modernize the insurance licensing process.
The insurance industry will have access to the Producer Database
("PDB") through PIN. PDB access will include all non-
confidential information such as the states in which a producer
is licensed, what type of license is held as well as the status
of the license and lines of authority.
[34]: Exchange Act Section 3(a)(39).
[35]: Exchange Act Release Nos. 40162 and 40163 (July 2, 1998)
[63 FR 37668, 37688]; Investment Advisers Act Release No. 1769
(October 1, 1998) [63 FR 54308].
[36]: Exchange Act Release No. 40573 and 40574 (October 20, 1998)
and 40895 (January 7, 1999).
[37]: Exchange Act Release Nos. 40608 (October 28, 1998) [63 FR
59208] and 40587 (October 22, 1998) [63 FR 58630].
[38]: Exchange Act Release No. 40377 (August 27, 1998) [63 FR
47051].
[39]: 15 U.S.C. 80b-1 et seq.
[40]: Advisers Act Section 203A(a), 15 U.S.C. 80b-3a. The
Advisers Act also provides for registration with the Commission
of advisers that have their principal office and place of
business in a state that has not enacted an investment adviser
statute (currently, Wyoming), or that have their principal office
and place of business outside the United States. In addition,
the Commission has adopted rules exempting five categories of
investment advisers from the prohibition on registration with the
Commission. See Rule 203A-2, 17 CFR 275.203A-2.
[41]: Investment Advisers Act Rel. No. 1633 (May 15, 1997) [62 FR
28112].
[42]: The Commission published a Notice of Intention to Cancel
Registrations of Certain Investment Advisers on March 9, 1998.
See Investment Advisers Act Rel. No. 1705 [63 FR 12526].
[43]: 1996 Act Section 306.
[44]: SEC News Release 98-120.