--------------------- BEGINNING OF PAGE #1 ------------------- TESTIMONY OF ARTHUR LEVITT, CHAIRMAN U.S. SECURITIES AND EXCHANGE COMMISSION CONCERNING H.R. 2131, THE "CAPITAL MARKETS DEREGULATION AND LIBERALIZATION ACT OF 1995," BEFORE THE SUBCOMMITTEE ON TELECOMMUNICATIONS AND FINANCE COMMITTEE ON COMMERCE UNITED STATES HOUSE OF REPRESENTATIVES NOVEMBER 30, 1995 EXECUTIVE SUMMARY The dramatic growth and transformation of the U.S. securities markets presents new challenges for regulators and Congress. Together we need to determine how to keep the securities regulatory framework up to date; how to promote, rather than impede, market growth and development, while at the same time providing effective investor protection and supporting the investor confidence that plays so large a role in the success of our markets. H.R. 2131 contributes some provocative ideas on this score. In so doing, the bill has prompted the Commission to take a new, hard look at the laws and assumptions under which we operate. But the Commission's search for new ways to regulate more effectively and in a less burdensome way did not begin with H.R. 2131. Instead, the Commission has on its own initiative continually sought to "reinvent" itself: to streamline regulatory requirements, eliminate unnecessary burdens, and reduce bureaucracy, while at the same time providing effective investor protection. Over the past two years, accordingly, the Commission has undertaken significant projects to rationalize the agency's own structure and operations; promote capital formation by facilitating access to the capital markets; simplify disclosure requirements for corporate issuers and mutual funds; foster the international competitiveness of U.S. markets; promote market efficiency; facilitate access to market information through improvements to the EDGAR system; and enhance investor protection through a combination of vigorous law enforcement, examination, and investor outreach efforts. The Commission believes that these and other related efforts will do much to reduce regulatory burdens. We also recognize that still more can and should be done. H.R. 2131 suggests new areas where further deregulation might serve the interests of competitive and efficient markets. The bill suggests a reevaluation of certain traditional aspects of the federal securities laws and contains in almost every provisions suggestions that could result in productive change. Starting from that perspective, we hope today to engage in a vigorous and constructive dialogue regarding this bill, in a cooperative spirit, seeking ideas and input from all affected parties -- corporate America, the securities industry, our fellow regulators, and most importantly, the investing public. In the following testimony and the attached appendix, the Commission summarizes its views on the various provisions of H.R. 2131. We describe legislative concepts in the bill that we believe we can support; proposals that we believe may be better achieved through administrative rather than legislative action; and a few provisions of the bill that we simply disagree with. As the legislative process moves forward, we hope to work closely with the Committee. We appreciate Chairman Fields' comment that H.R. 2131 represents a "work in progress" and we appreciate this -------------------- BEGINNING OF PAGE #2 ------------------- opportunity to participate in the process. I. Legislative Concepts that the Commission Supports Rethinking the federal-state regulatory partnership (Section 3). Carefully crafted federal legislation could reduce regulatory redundancies and create greater uniformity of standards. As part of this process, Congress, regulators, and industry participants should work together to determine how best to reallocate responsibilities between the federal government and the states. Exemptive authority (Section 7). The Commission supports the concept of a broad grant of general exemptive authority under the Securities Act of 1933 and the Securities Exchange Act of 1934. While the Commission supports raising the small offering "cap" as proposed in Section 7(a) of the bill, there may not be a need for that provision if a general grant of exemptive authority -- such as the one contemplated in Section 7(b) of the bill -- is provided. Rules of self-regulatory organizations (Section 11). The Commission supports this provision. Securities margin requirements (Section 4). The Commission agrees there is a need to reexamine margin requirements, but proposes taking a more limited approach than that set forth in the bill. Specifically, the Commission supports codification of an agreement recently negotiated between Commission staff and three major securities firms. Responding to many of the industry's concerns, the agreement calls for the repeal or relaxation of certain margin requirements. At the same time, the agreement would retain for federal regulators and SROs the authority to establish appropriate margin provisions, taking into account such complex considerations as financial responsibility, investor protection, the interplay of margin requirements with net capital and other rules, and competition among different market participants. Prospectus delivery (Section 6). The Commission believes that greater study is needed before legislative or administrative solutions are adopted to substantially revise the prospectus delivery process. To this end, the Commission is engaged in several efforts to evaluate issues relating to prospectus content and delivery, the provision of information to investors in other forms, and related topics. Tender offer regulation (Section 5). The Commission believes that the Williams Act provisions work well and serve a vital market function and, therefore, does not support their substantial modification. However, the Commission could support (and has in the past supported) certain modifications to Exchange Act section 13(d). Trust Indenture Act (Section 14). The Commission would welcome input from industry participants about areas where this Act does or does not work. If it appears that the Act has fundamental problems, the Commission is willing to undertake a study (as it did with the Public Utility Holding Company Act) to determine whether an outright repeal or fundamental revision of the Act would be appropriate. Prior to completion of such a study, the Commission believes that it is not appropriate to recommend the outright repeal or fundamental revision of the Act. -------------------- BEGINNING OF PAGE #3 ------------------- II. Concepts that the Commission Believes May Be Better Achieved Through Administrative Action Designated Examining Authority (Section 12). The Commission is concerned that Section 12 as drafted may have broad and unintended consequences, and believes that it may be preferable to rely on rulemaking rather than legislation in this area. The Commission has authority to allocate responsibility for examinations of broker-dealers among the SROs, and has coordinated such examinations and eliminated duplication where possible. The Commission intends to convene a regular "planning summit" where the Commission, the SROs, and the states will work towards improving the examination process. These efforts should alleviate the industry's chief concerns and make much, if not all, of Section 12 unnecessary. Commission mandate (Section 8). The foremost mission of the Commission is investor protection. The Commission also strongly believes that efficiency, competition, and capital formation concerns are elements of -- and do not conflict with -- the public interest and the protection of investors. The Commission supports the goal of Section 8 (establishing a more formal mechanism for considering those concerns in rulemaking contexts), and is prepared to strengthen current cost/benefit analysis requirements by requiring staff to perform additional analysis of a rule's impact on these concerns. Treatment of Press Conferences (Section 13). The Commission has issued statements in this area intended to inform market participants of applicable requirements. In order to address continuing concerns about U.S. journalists' access to foreign press conferences, however, the staff currently is developing rulemaking recommendations. The Commission therefore believes that a legislative solution is not necessary at this time. Moreover, the Commission is concerned that Section 13 could go beyond its stated purpose to allow written selling efforts outside the prospectus and registration statement as long as they are made through the press, or by press release, even if the communications are made during the course of a registered U.S. offering. Privatization of EDGAR (Section 10). The Commission is committed to a "top to bottom" reevaluation of the EDGAR filing system and, toward this end, is soliciting public comment and working with outside experts regarding improvements to the EDGAR system. The Commission believes that this process should be allowed to continue and, therefore, that a legislative solution is not necessary at this time. III. Areas That Are Not Ripe for Legislation Suitability Obligations (Section 2). The NASD has recently proposed a rule that is intended to resolve many of the concerns raised by market participants concerning their suitability obligations. This rulemaking process should be allowed to continue before legislation is adopted in this area. Number of Commissioners (Section 9). The Commission believes that the ability to confer as a larger, five member body has contributed greatly to the quality of the Commission's decision-making process, and therefore supports retaining the current statutory make-up of the Commission. -------------------- BEGINNING OF PAGE #4 ------------------- -------------------------- TESTIMONY --------------------------- TESTIMONY OF ARTHUR LEVITT, CHAIRMAN U.S. SECURITIES AND EXCHANGE COMMISSION CONCERNING H.R. 2131, THE "CAPITAL MARKETS DEREGULATION AND LIBERALIZATION ACT OF 1995," BEFORE THE SUBCOMMITTEE ON TELECOMMUNICATIONS AND FINANCE COMMITTEE ON COMMERCE UNITED STATES HOUSE OF REPRESENTATIVES NOVEMBER 30, 1995 Chairman Fields and Members of the Subcommittee: I appreciate this opportunity to testify on behalf of the Securities and Exchange Commission ("Commission" or "SEC") regarding H.R. 2131, the "Capital Markets Deregulation and Liberalization Act of 1995." Today's markets are vibrant and growing. They serve the needs of more than 12,000 public companies, raising capital to support new industries, finance operations, create jobs, fund research and development, and support growth for the future. In 1994 alone, over $800 billion of securities were registered with the Commission for sale in U.S. markets. Capital was raised directly from the private sector, from both individual and institutional investors. Notably, almost one in three American households today invest their savings and retirement funds in the U.S. securities markets, directly or through mutual funds. At the same time, technological advances are changing the face of the marketplace itself. Investors are increasingly using electronic communications media to trade securities and obtain market information and advice. Likewise, the internationalization of the markets has spurred "round the clock" trading, as well as the development of new and complex financial products. The dramatic growth of the U.S. securities markets presents new opportunities for businesses and investors -- and new challenges for regulators and Congress. Together we need to determine how to keep the securities regulatory framework up to date; how to promote, rather than impede, market growth and development, while at the same time providing effective investor protection and supporting the investor confidence that plays so large a role in the success of our markets. H.R. 2131 contributes some provocative ideas on this score. In so doing, the bill has prompted the Commission to take a new, hard look at the laws and assumptions under which we operate. Chairman Fields is to be commended for encouraging this reevaluation of federal securities regulation. I. Introduction The Commission's search for new ways to regulate more effectively and in a less burdensome way did not begin with H.R. 2131. The Commission has, on its own initiative, continually sought to "reinvent itself:" to streamline regulatory requirements, eliminate unnecessary burdens, and reduce bureaucracy, while at the same time providing effective investor protection. We have done this, moreover, with a modest staff and limited resources, operating in partnership with the securities industry and its self-regulatory organizations ("SROs"). To cite just a few highlights of the Commission's ongoing "reinvention" process, over the past two years, the Commission -------------------- BEGINNING OF PAGE #5 ------------------- has undertaken to: * rationalize its own structure and operations by (for example) recommending repeal of the 60-year old Public Utility Holding Company Act (a statute administered by the Commission); and revising and streamlining its rules governing adjudications and administrative proceedings; * promote capital formation by streamlining and reducing various registration and disclosure requirements for companies that seek to access the securities markets; * simplify disclosure requirements for corporate issuers and mutual funds, thus reducing compliance costs while offering investors more user-friendly information; * foster the international competitiveness of U.S. markets through initiatives to facilitate foreign issuer access to U.S. securities markets; * promote market efficiency by working with the Derivatives Policy Group to develop a voluntary framework for oversight of over-the-counter derivatives activities; and by implementing new rules and procedures to expedite Commission review of SRO rule proposals; and * enhance investor protection through continued, vigorous law enforcement; more efficient examinations of securities firms and investment advisers; and investor outreach efforts. The Commission believes that these and other related efforts will do much to reduce regulatory burdens. We also recognize that still more can and should be done. H.R. 2131 suggests new areas where further deregulation might serve the interests of competitive and efficient markets. The bill suggests a reevaluation of certain traditional aspects of the federal securities laws and contains in almost every provision suggestions that could result in productive change. Starting from that perspective, we hope today to engage in a vigorous and constructive dialogue regarding this bill, in a cooperative spirit, seeking ideas and input from all affected parties -- corporate America, the securities industry, our fellow regulators, and most importantly, the investing public. In analyzing and evaluating the provisions of H.R. 2131, the Commission has focused on the following basic questions: First and foremost, how will the change affect investor protection? Will the proposed reform foster capital formation and market efficiency? Will it represent a sound use of scarce government resources? And, finally, will the reform result in any unintended consequences? It is with this focus that the Commission turns, below, to a discussion of H.R. 2131. We describe legislative concepts in the bill that we believe we can support; proposals that we believe may be better achieved through administrative rather than legislative action; and a few provisions of the bill that we simply disagree with. Additional (and more detailed) comments on the bill are set forth in the Appendix attached to this testimony. As the legislative process moves forward, we hope to work -------------------- BEGINNING OF PAGE #6 ------------------- closely with the Committee. We appreciate Chairman Fields' comment that this bill represents a "work in progress" and we appreciate this opportunity to participate in the process. II. Legislative Concepts that the Commission Supports A. Creation of National Securities Markets: Rethinking the Federal-State Regulatory Partnership Section 3 of H.R. 2131 contains proposed amendments to the federal securities laws that would preempt most state requirements with respect to securities registration, broker- dealer registration and regulation, and the regulation of investment companies and investment advisers. Under the bill, the role of the states in these areas generally would be limited to: (1) requiring notice filings and collecting fees with respect to certain securities filings; (2) enforcing certain antifraud provisions; and (3) registering securities professionals through a centralized registration system, and collecting fees for such registration. The bill also would grant the Commission authority to exempt certain state requirements from preemption if the Commission finds that the public interest, the protection of investors, and the maintenance of fair and orderly markets would be served by state regulation. Commission Recommendations. The current system of dual federal-state regulation is not the system that Congress -- or the Commission -- would design today if we were creating a new system. While securities markets today are global, U.S. securities firms still have to register securities personnel and certain securities offerings in 52 separate jurisdictions; to satisfy a multitude of separate books and records, qualification, and other requirements; to submit to the separate examination requirements of up to 52 different regulators; and to bear the substantial costs of compliance with these overlapping requirements. At the same time, however, state securities authorities play an essential role in the regulation of the U.S. securities industry. State regulators are often the front line of defense against developing problems; they are the "local cops" on the beat who can quickly detect and respond to violations of law. In short, this is an area where it is easier to identify the problem than to solve it. The issue is how to achieve a balance: how to retain the benefits of state regulation while reducing the burdens. The Commission believes that the best way to proceed would be to focus initial efforts on those areas where a consensus can be reached -- specifically (as described below) in the investment company and investment adviser contexts. In addition, it is the Commission's view that state preemption is not generally appropriate in the enforcement context. Rather, the Commission believes that, while greater coordination among federal and state regulators on enforcement matters is desirable, this can be accomplished without legislation. Investment Advisers. Today, there are approximately 21,000 investment advisers registered with the Commission. The ranks of registered investment advisers have increased by over 500 percent over the last decade, far outstripping the growth in the Commission's examination resources. As a result, smaller investment advisers are now examined, on average, once every 44 years -- which means that they are not examined at all. -------------------- BEGINNING OF PAGE #7 ------------------- There is clearly room -- and a pressing need -- for states to play an important role with respect to the regulation of investment advisers. The Commission has suggested, in fact, moving toward a system of "reverse preemption," under which state regulators would assume primary responsibility for examining advisers who manage assets under $5 million. Larger advisers, in turn, would remain registered with the Commission and would be relieved from state registration and regulation. Senator Gramm, sponsor of S. 148 (the "Investment Advisers Integrity Act"), proposed a similar approach earlier this year. The Commission has expressed its support for the concept contained in S. 148 (with minor modifications). Investment Companies. Allocating federal and state responsibilities for the regulation of investment companies involves an entirely separate set of considerations. State regulation can pose particularly significant obstacles to investment companies, which typically engage in business on a national scale and are constantly in registration. Investment companies, moreover, are comprehensively regulated at the federal level under the substantive regulatory provisions of the Investment Company Act of 1940, in addition to the disclosure provisions of the Securities Act of 1933. As a result, the Commission believes that state oversight of investment companies can be reduced without compromising investor protection.-[1]- Specifically, the Commission has proposed an approach under which a state could not prohibit any company registered under the Investment Company Act from selling securities in the state if the company satisfies certain requirements of federal law.-[2]- Investment companies, however, would continue to file their documents with the states and pay the same fees as at present. The Commission would continue to seek input from state regulators in the course of SEC rulemakings with respect to investment companies. Finally, the states would continue to have a role in enforcing sales practice rules. Securities Registration. The states have already taken important steps toward eliminating duplicative securities registration requirements by, for the most part, exempting from blue sky regulation companies that meet standards for exchange- listed and Nasdaq/National Market System securities. The Commission believes that it would be appropriate to codify standards comparable to these exemptions in federal law. --------- FOOTNOTES --------- -[1]- At the same time, the Commission recognizes that state common and corporate laws generally govern the structure and operations of investment companies and should be preserved. Thus, a "blanket" preemption provision would not be appropriate. Any legislation must be carefully drafted to consider the interplay between, and purposes of, these differing regulatory regimes and the federal securities laws. -[2]- Under this approach, a state would be precluded from prohibiting an investment company from selling securities in the state based on (a) a prospectus that meets the requirements of the Securities Act, (b) investment objectives or policies that are not prohibited by the Investment Company Act, or (c) the qualification of the company's directors if the directors are qualified under the Investment Company Act. -------------------- BEGINNING OF PAGE #8 ------------------- Moreover, as a general matter, the Commission believes that the states should continue to receive copies of Commission filings, and should continue to collect fees at the current level. Certain categories of offerings (those that have been a source of frequent disclosure and sales practice abuses, and which are sold primarily to retail investors) should remain subject to both state and federal registration. In addition, the Commission believes that there is room to modernize the exemption from federal registration for intrastate and certain other offerings. Just as states should defer to national offerings, so should the federal government defer to the states where local offerings are concerned. For other categories of offerings, several alternative options could be explored. One possible option would be to allow for an offering to be reviewed either at the federal level, or at the state level, at the issuer's option. The Commission recommends that Congress, federal and state regulators, and industry participants work together to determine how best to reallocate responsibilities between the federal government and the states with respect to securities registration. The North American Securities Administrators Association ("NASAA") has already begun to address these issues with the formation of a blue-ribbon panel (of which Commissioner Wallman is a member) that will study and report on the relative roles of state and federal securities regulation. The panel's report is expected in early spring of 1996. Broker-Dealers. The Commission recognizes that state regulators have a compelling interest in determining who may do business within their borders, and in how such business is conducted. The Commission also recognizes, however, that brokers and securities firms have a compelling interest in a centralized and predictable registration system. Balancing these two concerns, the Commission believes that states should continue to license broker-dealers that do business within their respective jurisdictions (and to receive fees for licensing such broker-dealers). The Commission also believes that states should continue to play a role in examining broker- dealers who operate within their jurisdictions. The states already have begun to take some steps to create greater uniformity by developing the central registration depository for broker-dealer registration. At the same time, the Commission has also called on NASAA to work toward still greater uniformity and coordination among the states with respect to registration and disqualification criteria, and has endorsed efforts to explore reciprocal or national licensing arrangements. In response to the problem of duplicative, overlapping examinations, the Commission has proposed that state, federal, and SRO examiners work toward better scheduling, coordination and information-sharing. The Commission has already begun to work with the states and the SROs towards this goal, and intends to convene a regular "Planning Summit" where the Commission, the SROs, and the states would join together to discuss scheduling, priorities, and other examination issues. The Commission also believes that states should not impose books and records and capital requirements that go beyond applicable federal and SRO standards. Instead, the states should come to the Commission with their concerns in these areas. -------------------- BEGINNING OF PAGE #9 ------------------- Already, for example, Commission staff and representatives of NASAA have tentatively decided that either the National Association of Securities Dealers ("NASD") or the Commission could adopt amendments to its books and records rules addressing the concerns articulated by NASAA. Approaching books and records problems on a federal level, or through the NASD, will prevent any potential problems that may arise in the adoption of varying books and records rules by the states, ensuring uniformity in broker-dealer recordkeeping requirements. In either case, we expect to be able to address NASAA's concerns on an expedited basis. B. Exemptive Authority Section 7 of H.R. 2131 generally would amend the Securities Act to increase the Commission's authority to exempt offerings from the Act's registration requirements. Section 7(a) would raise the statutory limit for the exemption of small offerings to $15 million (thus expanding the Commission's discretionary rulemaking authority to exempt small offerings from registration under the Securities Act),-[3]- while Section 7(b) of the bill would provide the Commission with a grant of general exemptive authority under the Securities Act. Commission Recommendation. Both the Investment Company Act of 1940 (section 6(c)) and the Investment Advisers Act of 1940 (section 206A) provide the Commission with broad grants of exemptive authority. The Commission supports the concept of a broad grant of general exemptive authority under both the Securities Act of 1933 and the Securities Exchange Act of 1934,-[4]- similar to the authority currently vested in the Commission under the two 1940 Acts. This type of exemptive authority would allow the Commission the flexibility to explore and adopt new approaches to registration, disclosure and related issues.-[5]- --------- FOOTNOTES --------- -[3]- The dollar ceiling for the small offering exemption contained in the Securities Act has been raised by Congress over the years; it started at $100,000 and was raised from $1.5 million to the current $5 million in 1980. In 1992, the Commission recommended legislation that would have increased the Commission's discretionary exemptive authority to $10 million. -[4]- Notably, a number of provisions of the Exchange Act grant the Commission exemptive authority. For example, Section 12(h) of the Exchange Act currently provides the Commission with authority to exempt in whole or in part any issuer or class of issuers from the registration provisions of Sections 12(g), 13, 14 or 15(d) of that Act, as well as to provide exemptions from Section 16 of the Act. -[5]- For instance, there has been a recent proliferation of electronic trading systems that do not fit neatly within the existing regulatory framework for exchanges and for which exchange registration may prove an unnecessary and undue regulatory burden. A grant of general exemptive authority under the Exchange Act would give the Commission the necessary flexibility to address appropriately the regulatory concerns that these entities may raise. Similarly, such a grant of (continued...) -------------------- BEGINNING OF PAGE #10 ------------------- Two far-reaching initiatives to develop such new approaches are already under way at the Commission. Last February, the Commission established an Advisory Committee on the Capital Formation and Regulatory Processes ("Advisory Committee") to consider comprehensive reforms of the registration and disclosure process. The Committee's mandate is broad in scope: it will consider, for example, whether Commission rules should permit a registration concept that relies more on company disclosure and market-driven securities disclosure ("company registration") rather than on the Commission's mandated transaction disclosure. This approach could streamline both registration and disclosure requirements, while actually enhancing information flow and protections to investors. The Commission expects to receive the Advisory Committee's recommendations early next year. The Commission also recently established an internal Task Force on Disclosure Simplification ("Task Force") charged with reviewing all forms and all disclosure requirements imposed on public companies. The Task Force -- whose outside advisor is Philip Howard, author of a book on regulatory simplification entitled The Death of Common Sense -- is expected to make its recommendations to the Commission at the end of this year. A grant of general exemptive authority could make it easier for the Commission to implement certain proposals that seek to assist small businesses with capital formation, such as the currently pending "test-the-waters" proposal. In addition, general exemptive authority could facilitate the implementation of "company registration" following the recommendations of the Commission's Advisory Committee (although it appears at this time that much of the company registration proposal could be implemented, albeit somewhat more awkwardly, under our existing rulemaking authority). In any event, a grant of general exemptive authority would make it unnecessary to give the Commission express authority to exempt any given class of securities (such as small offerings).-[6]- C. Rules of Self Regulatory Organizations Section 11 would require the Commission to publish notice of proposed self-regulatory organization ("SRO") rule changes within 30 days of the filing, unless the SRO consents to a longer period. Commission Recommendation. The Commission supports the provision, which should further streamline the process for the approval of SRO-proposed rule changes. The provision would codify a practice that the Commission was committed to achieving --------- FOOTNOTES --------- -[5]-(...continued) authority would provide the Commission with flexibility to exclude certain classes of persons from regulation as brokers or dealers under circumstances in which the activities of such persons would not pose risks to the investing public. -[6]- Thus, while the Commission supports raising the small offering "cap" (as proposed in section 7(a) of H.R. 2131), we believe that there may not be a need for section 7(a) if a general grant of exemptive authority (such as the one contemplated in the bill's section 7(b)) is provided to the Commission. -------------------- BEGINNING OF PAGE #11 ------------------- on its own initiative. D. Securities Margin Requirements Section 4 would exempt from the margin provisions a broad range of "institutional" entities deemed to be "excluded accounts" (e.g., certain corporations and employee benefit plans with assets exceeding $5 million, hedge funds, insurance companies, governmental entities, and certain financial institutions). The bill also would prohibit the exchanges and the NASD from imposing margin requirements that are in addition to, or inconsistent with, those of the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). In addition, the bill would exempt "excluded accounts" from section 11(d) of the Exchange Act, which prohibits a broker-dealer from extending credit to customers on securities that it helped to distribute for 30 days after its participation in the distribution. The bill also would eliminate margin requirements for all debt securities. Commission Recommendation. The Commission agrees that there is room for improvement with respect to the margin requirements. The Commission is concerned, however, that the broad approach proposed in H.R. 2131 could result in problems of excess credit and speculation in the market and could compound systemic risk.-[7]- The Commission, instead, has proposed an alternative approach: codification of the agreement that was negotiated earlier this year between the Commission staff and three major securities firms (Goldman Sachs, Morgan Stanley, and Salomon Brothers). If enacted, that agreement would: (1) eliminate federal margin treatment on most debt securities, while retaining federal margin requirements for debt securities that have been issued for less than 30 days; (2) exempt from federal margin requirements credit extensions by broker-dealers to broker-dealers that have a substantial public business or for the purposes of market-making or underwriting; and (3) give the Federal Reserve Board and the Commission the authority to exempt additional securities or transactions from the federal margin rules that each administers. Like H.R. 2131, the agreement also would repeal section 8(a) of the Exchange Act, which restricts the sources from which a broker-dealer may borrow to finance its securities operations. The Commission believes that this agreement, together with recent regulatory initiatives of the Federal Reserve Board, would resolve the industry's principal concerns regarding the ability of U.S. securities firms to obtain financing and to compete on a level playing field with banks and foreign entities. At the same time, the agreement would retain for the Federal Reserve Board, the SEC, the securities exchanges, and other SROs, the authority to establish appropriate margin provisions to address issues of systemic risk and investor protection. E. Prospectus Delivery --------- FOOTNOTES --------- -[7]- Reports indicate that in 1995, under existing margin requirements, the volume of margin loans has risen sharply to a total of $77.1 billion. See Floyd Norris, Borrowing to Get Rich in Funds, New York Times, Oct. 29, 1995, section 3, p.1. Consumer credit in general (second mortgages, personal loans, etc.) as a proportion of income is at a record high. See id. -------------------- BEGINNING OF PAGE #12 ------------------- Section 6 of H.R. 2131 would: (1) amend existing law so that a confirmation of the sale of a security no longer constitutes a "prospectus" under the Securities Act; (2) require that a final prospectus accompany or precede a security offered for sale or a security being delivered after sale only if the purchaser or prospective purchaser has requested a prospectus; and (3) give the Commission authority to exempt from the Securities Act prospectus delivery requirements any person, prospectus, class of person or class of prospectus. Commission exemptive authority could be exercised by rule, regulation or order. Commission Recommendation. The Commission agrees that the existing system does not serve either issuers or investors as well as we would like. As noted above, the Commission (through its Advisory Committee on Capital Formation and its Disclosure Task Force) has begun two major projects to evaluate the many complex issues related to prospectus content and delivery, the provision of information to investors in electronic form, and related topics. As a general matter, the Commission believes that these studies should be completed before significant legislative or administrative revisions to the prospectus delivery process are considered. In the interim, however, the Commission could support the section's grant of exemptive authority to the Commission, which would authorize the Commission to exempt certain offerings or issuers from prospectus delivery.-[8]- As noted above, the Commission has undertaken a number of initiatives to improve the current system, while minimizing the regulatory costs and burdens imposed on issuers. For example, the Commission has undertaken steps to bring its prospectus delivery requirements into the electronic era: recently, the Commission issued an interpretive release providing guidance regarding the use of electronic media to communicate with investors under existing rules. The Commission also issued a release proposing technical amendments to its rules that are currently premised on the delivery of paper documents. To some extent, Section 6 appears to be based on a concern regarding the complexity of many prospectuses. The Commission shares this concern and would like to make the prospectus more readable. The Commission has already begun this process. For example, the Commission has tried to improve the usefulness of the information received by investors by encouraging, among other things, "plain English" disclosures for mutual funds. The Commission has also worked with the mutual fund industry and state securities regulators to develop a fund "profile prospectus," the key element of which is a standardized, short- form summary of key fund features. The pilot "profiles" for eight mutual fund groups became available to investors last August. F. Tender Offer Regulation Section 5 of H.R. 2131 would amend the Exchange Act to --------- FOOTNOTES --------- -[8]- In any event, if the Commission is granted broad exemptive authority as proposed under Section 7 of this bill, it may not be necessary to include legislative provisions eliminating prospectus delivery; the Commission could use its exemptive authority in appropriate cases. -------------------- BEGINNING OF PAGE #13 ------------------- repeal various provisions that govern tender offers: beneficial ownership rules, issuer tender offer and going private provisions, third party tender offer rules, reports on changes in majority of directors, and the imposition of transactional fees for changes in control. Congress enacted these provisions (collectively known as the Williams Act) in 1968 and amended them into their present form in 1970. The Williams Act is based on a principle of neutrality between bidder and target; its provisions focus on the protection of investors. Commission Recommendation. The Commission believes that the Williams Act provisions have worked well and continue to work well, and therefore does not support the Act's repeal. However, we are open to considering appropriate modifications that may be suggested during the course of this Committee's hearings. In addition, the Commission can support (and has in the past supported) certain modifications to Exchange Act section 13(d) (a provision of the Williams Act which requires that an acquiring shareholder provide information about itself and its intent with respect to its investment within 10 days of reaching a 5% ownership threshold.) The Commission believes that persons do not need 10 days to file this information, which is of dramatic significance to the marketplace. Two approaches could be considered: the 10-day period could be shortened; or the filing person could be required to file the information prior to any further purchases. Either approach could enhance market efficiency. G. Repeal of the Trust Indenture Act of 1939 Section 14 of H.R. 2131 would repeal the Trust Indenture Act of 1939 ("Act") on the grounds that market forces currently cause trust indentures to contain many more inclusive provisions than are mandated by the Act. Commission Recommendation. The Trust Indenture Act was designed to protect investors in publicly offered debt securities by providing for an independent trustee to act on debtholders' behalf in the event of default and assuring certain minimum bondholder rights. Toward this end, the Act establishes obligations and standards for trustees and mandates that the bond indenture be governed by specified provisions in the Act. The Act was amended most recently in 1990, at the Commission's request, in order to provide the Commission with general exemptive authority to streamline the trustee conflict provisions, and to facilitate shelf registration. The Commission would welcome input from industry participants about areas where the Act still does or does not work, and how it can be improved. If it appears that fundamental problems exist with respect to the Act's substantive investor protection provisions, the Commission would be willing to undertake a study (as it did with the Public Utility Holding Company Act) to evaluate the continued effectiveness of specific provisions of the Act, and to determine whether an outright repeal or fundamental revision of the Act would be appropriate. Prior to completion of such a study, however, the Commission believes that it is not appropriate to recommend the outright repeal or fundamental revision of the Act. III. Concepts that the Commission Believes May Be Better Achieved Through Administrative Action A. Designation of Primary SRO and Examining Authority Section 12 of H.R. 2131 would require the Commission, after -------------------- BEGINNING OF PAGE #14 ------------------- notice and comment, to designate one SRO as the examining authority for each broker-dealer. In addition to enforcing its own rules, the designated examining authority ("DEA") would be required to enforce the rules of any other SRO to which the broker-dealer belongs. Commission Recommendation. The Commission agrees that duplicative and overlapping examinations impose unnecessary burdens on broker-dealers (and represent an inefficient use of regulatory resources). Accordingly, in recent years, the Commission has placed new emphasis on coordinating examinations of broker-dealers and eliminating areas of duplication. For example, the Commission recently created an Office of Compliance Inspections and Examinations to coordinate better the agency's own examinations, and has begun working with the SROs in an effort to encourage cooperation among SROs in scheduling examinations. The Commission also intends to convene a "Planning Summit" as soon as possible where the Commission, the SROs, and the states will work toward better coordination in this area. These efforts will continue and should alleviate the chief concerns of market participants. Such efforts should make many, if not all, of the aspects of this provision unnecessary.-[9]- B. Promotion of Efficiency, Competition, and Capital Formation Section 8 would require the Commission to consider or determine whether its actions will promote efficiency, competition, and capital formation whenever the Commission is required to consider or determine if that action is consistent with the public interest, the protection of investors, or both. Commission Recommendation. The Commission strongly believes that efficiency, competition,-[10]- and capital formation concerns are elements of -- and do not conflict with -- the public interest. Thus, in the Commission's view, existing law already requires the agency to give consideration to efficiency, competition, and capital formation concerns whenever the Commission is required to make a public interest determination. The Commission recognizes, however, that H.R. 2131 seeks to establish a more formal mechanism for ensuring that these concerns are considered, and the Commission supports that underlying objective. At present, the Commission generally requires a cost/ benefit analysis when it proposes or adopts its rules. The Commission is prepared to strengthen this requirement by requiring the staff to perform additional analysis of a rule's --------- FOOTNOTES --------- -[9]- Moreover, as discussed in the Appendix to this testimony, the Commission is concerned that the DEA provision as drafted may have broad and unintended consequences for the Commission's own examination and oversight authority with respect to broker-dealers. -[10]- Certain sections of the federal securities laws explicitly require consideration of competition (e.g., Exchange Act sections 6(a)(8), 15A(b)(9), 17A(b)(3)(I), and 23(a)(2)). These sections generally require a finding that any burdens a Commission regulation or an SRO rule imposes on competition are necessary or appropriate in furtherance of the purposes of the Exchange Act. -------------------- BEGINNING OF PAGE #15 ------------------- impact on competition, efficiency and capital formation. The Commission does not believe, however, that this analysis would be appropriate in the context of enforcement actions and adjudicated opinions. C. Treatment of Press Conferences Section 13 of H.R. 2131 would exclude from the definitions of "offer" and "offer to buy" under the Securities Act press conferences, press releases and meetings between issuer press spokespersons and journalists associated with publications having a general circulation in the United States. It also would amend the definition of "prospectus" in section 2(10) of the Securities Act to exclude press releases made generally available to U.S. journalists (provided that the press release contains a statement to the effect that it is not an offer and that any public offering will be made only by a prospectus, and specifies the person from whom a prospectus may be obtained). Commission Recommendation. Section 13 is apparently intended to eliminate perceived grounds for the exclusion of U.S. reporters from foreign press conferences regarding overseas offerings that are not available to U.S. investors (and, therefore, are not subject to U.S. registration and disclosure). Notably, the Commission and its staff have issued several statements in this area that were intended to assure market participants as to what is and is not required of them. The Commission has rulemaking authority to further address most of the concerns underpinning this provision. The staff of the Commission currently is developing rulemaking recommendations for the Commission to address concerns about access for U.S. journalists to offshore press conferences, interviews, and other news items. The Commission is sympathetic to the concerns reflected in Section 13 of the bill and believes there is ample room under existing law to resolve these concerns. The Commission is concerned, however, that Section 13 as drafted may go well beyond its stated purpose. In particular, it effectively may allow, without limitation, written selling efforts outside the prospectus and registration statement -- even in the case of registered offerings in the U.S. -- as long as those communications are made through the press, or by press release. This would represent a fundamental change and warrants further study. D. Privatization of EDGAR Section 10 would direct the Commission to: (1) issue a request for proposals ("RFP") for a privatized EDGAR system that will provide for a "return to the government on its investment in the establishment of such system"; (2) ensure that the new system provides for rapid dissemination of filings; and (3) transmit to Congress the legislation required to implement the selected proposal. The process of preparing the solicitation, evaluating the proposals, making a selection and completing the legislative requirements would be completed within 180 days of enactment. Commission Recommendation. The Commission recognizes the importance of EDGAR to the agency's mission and is committed to a fundamental reexamination of EDGAR and how it operates. Three months ago, for example, the Commission held a conference to obtain input from EDGAR users (filers, vendors, disseminators, analysts, investors, and others) on how to improve and update the EDGAR system. At the conference, Chairman Levitt noted: "In -------------------- BEGINNING OF PAGE #16 ------------------- this world of instantaneous telecommunications, EDGAR has come to resemble the Pony Express. That is precisely why we have called for this conference. We want to rethink EDGAR from the ground up." The Commission has already begun, and is committed to, this process. To follow up on some of the issues raised at the August conference, the Commission has asked the National Academy of Sciences Computer Science and Telecommunications Board to organize a panel of nationally-recognized computer industry experts to examine EDGAR. In particular, the Commission has asked the panel to offer ideas as to how the Commission should proceed with EDGAR to take advantage of the changing technological environment. In addition, the Commission has asked for advice regarding how the Commission should proceed with respect to existing private sector contracts, and whether further privatization of the system would be appropriate.-[11]- The Commission is currently in the process of soliciting public comment, working with outside experts, and coordinating closely with interested Congressional staff, regarding improvements to the EDGAR system. The Commission believes that this process should be allowed to continue and, therefore, that a legislative solution is not needed at this time. IV. Areas That Are Not Ripe for Legislation A. Suitability Obligations Under the federal securities laws, broker-dealers generally are responsible for making suitable recommendations, whether their clients are institutional or individual investors. Section 2 of H.R. 2131 would reverse this presumption with respect to "institutional clients" of broker-dealers: it would create a legislative standard that a broker-dealer is not liable for the investment decisions of such clients unless the parties have contracted to the contrary. The provision also appears to contemplate that, even where there is such a contractual agreement, the broker would have no duty to inquire into the financial needs and objectives of the customer. Section 2 would, moreover, define the term "institutional client" (i.e., all investors, other than natural persons, with $10 million or more in investments) in such a way as to include a wide variety of institutions with differing levels of sophistication and ability to make independent investment decisions, including municipalities that rely on local elected officials to make investment decisions. In so doing, Section 2 would deprive a large class of entities of important investor protections.-[12]- --------- FOOTNOTES --------- -[11]- In that regard, the Commission notes that the concept of "privatization" raises a number of complex legal and practical issues, ranging from issues related to security and liability (e.g., for the custody and accuracy of the corporate filings) to issues related to the recovery of private sector costs, fees, profits, and public access. -[12]- Although Section 2 appears to be directed at SRO suitability standards, the creation of a legislative standard that would apply in all actions brought under the Exchange Act also could affect Commission actions brought under Rule 10b-5. -------------------- BEGINNING OF PAGE #17 ------------------- Commission Recommendation. The Commission believes that the time is not now ripe for legislation in this area. The Commission only recently has published for public comment an NASD-proposed rule change that would provide, among other things, suitability guidelines for broker-dealers making recommendations to institutional customers. The NASD proposal generally would maintain the existing presumption that broker-dealers are responsible for making suitable recommendations, but would permit institutional parties to negotiate responsibility for investment decisions. While the Commission has not taken a formal position with respect to the NASD proposal, the Commission favors an approach that would maintain the existing presumption that broker-dealers are responsible for making suitable recommendations to their institutional customers, while permitting flexibility, in appropriate circumstances, for parties to clarify the nature of their relationship. The Commission also believes that, if adopted, the NASD's proposed approach may resolve many of the concerns raised by market participants concerning their suitability obligations.-[13]- We therefore urge Congress to allow the rulemaking process to continue before enacting legislation in this area. B. Reduction in Number of Members of Commission Section 9 would reduce the number of members serving on the Commission from five to three, and would provide that no more than two commissioners may belong to the same political party. In order to implement the transition to a three-member Commission, the provision would abolish two terms of the Commission and extend the expiration dates of the three remaining terms. It would maintain the duration of terms at five years. Commission Recommendation. The Commission supports retaining the current statutory make-up of the Commission. The Commission believes that the ability to confer as a larger, five member body has contributed greatly to the quality of the Commission's decision-making process.-[14]- Moreover, during the last several months (when there only have been two Commissioners at the agency), certain procedural issues have arisen, primarily with respect to complying with the provisions of the "Government in the Sunshine Act." With a three-member Commission, if the quorum were two members -- or if there were any vacancy -- there would be a recurrence of such issues. Conclusion The Commission is an agency that takes very seriously the --------- FOOTNOTES --------- -[13]- Notably, the Government Finance Officers Association has filed a comment with the Commission generally supporting the NASD's approach, which recognizes that a suitability obligation is potentially applicable to any institutional customer, but raises a number of other concerns regarding the NASD's proposed rule. These and any other concerns will be considered by the Commission during the comment process. -[14]- During its 60-year history, the Commission has had three or fewer members in office for a total of approximately 30 months, and has had five members more than two-thirds of the time. -------------------- BEGINNING OF PAGE #18 ------------------- directive to "reinvent" government. We have already begun to take important steps to reduce bureaucracy, streamline regulatory requirements, and eliminate regulatory burdens. We have done so throughout with the input of the industry we regulate, working in a public-private partnership. H.R. 2131 raises additional areas where deregulatory initiatives may be appropriate. The Commission looks forward to working with the Subcommittee, as well as any other interested parties, on the many important issues raised by the bill. Working together, we can promote the continued success of our capital markets, into the next century and beyond. -------------------------- APPENDIX A ------------------------ CAPITAL MARKETS DEREGULATION AND LIBERALIZATION ACT OF 1995 (H.R. 2131) Introduction. Chairman Fields introduced H.R. 2131, the "Capital Markets Deregulation and Liberalization Act of 1995" on July 27, 1995. Chairman Fields's stated intention is to "eliminate substantial amounts of duplicative regulation, lower the cost of capital to American business, and reduce compliance costs to business by billions of dollars." Toward those ends, H.R. 2131 would revise the existing laws governing, among other things: the responsibilities of broker-dealers to their institutional customers; the preemption of state securities regulation; margin requirements; the regulation of tender offers; securities registration and prospectus delivery requirements under the Securities Act; and the definition of the Commission's mission. The Commission's comments with respect to each of H.R. 2131's provisions are set forth below, together with its recommendations regarding each provision.-[15]- * * * Section 2: Investment Recommendations to Institutional Clients Section 2 creates a legislative presumption that a broker- dealer is not liable for the investment decisions of an institutional client (generally defined as other than a natural person having at least $10 million invested in securities in the aggregate in its portfolio), unless the parties have contracted to the contrary. The presumption would apply to all actions brought under "this title." Comments -- Suitability * Current Law. Self-regulatory organization rules contain explicit suitability standards. In addition, as part of the obligation of fair dealing under self-regulatory organization rules, broker-dealers are required to have a reasonable basis for believing that their securities recommendations are suitable. The Commission and the courts have enforced the suitability doctrine through the application of the general antifraud provisions of the --------- FOOTNOTES --------- -[15]- On August 18, 1995, the Commission's staff provided the Subcommittee with technical comments on the provisions of H.R. 2131. The Commission's comments largely incorporate the staff's technical comments. -------------------- BEGINNING OF PAGE #19 ------------------- federal securities laws. The Commission has adopted explicit suitability requirements in certain of its rules, such as the rules applicable to transactions in penny stocks. As a general matter, the existing presumption in the federal securities laws is that a broker-dealer is responsible for making suitable recommendations, regardless of whether the client is an institution or an individual investor. As part of its responsibility, the broker-dealer generally must inquire into the customer's financial needs and objectives, and must have a reasonable basis for recommending a particular security. * NASD Proposal. The National Association of Securities Dealers, Inc. ("NASD"), after gathering and reacting to the comments of numerous respondents, including industry and institutions, has suggested an approach that would provide, among other things, suitability guidelines for broker- dealers making recommendations to their institutional customers. The NASD approach would allow its members to consider the differing levels of ability among institutions to evaluate investment risk and to make independent investment decisions. These guidelines include consideration of whether any understanding exists between the parties regarding the nature of the relationship and the services to be performed by the broker-dealer, and would allow the broker-dealer to take into account the expertise of particular institutions in making their own decisions. * Effect on Current Law. H.R. 2131 would reverse the current presumption as to entities with at least $10 million in investments. Broker-dealers would be presumed not to be liable for unsuitable recommendations to institutional clients in the absence of a contractual agreement negating that presumption. The provision also appears to contemplate that, even where there is a contractual agreement in writing, the broker would have no duty to inquire into the financial needs and objectives of the customer. The provision would not appear to require the broker-dealer to disclose that it has no duty to make suitable recommendations unless it has entered into a contract with the customer. Although the provision appears to be specifically directed at self-regulatory organization suitability standards, the creation of a legislative presumption that would apply in all actions brought under the Securities Exchange Act of 1934 ("Exchange Act") also could affect Commission actions brought under Rule 10b-5 of the Exchange Act. * Scope of Definition. The term "institutional client," as defined in Section 2, is defined in such a way as to hinge solely upon the client's other security holdings, rather than also upon other factors that the Commission believes may be relevant to a suitability analysis. The current definition would include a wide variety of institutions with differing levels of sophistication and of ability to make independent investment decisions, including municipalities that rely on local elected officials to make investment decisions. Notably, the $10 million threshold for determining institutional status does not (as some other statutes do) -------------------- BEGINNING OF PAGE #20 ------------------- contain any exclusion for investments in such instruments as government securities (including investments in U.S. Treasuries) or the securities of registered investment companies. Commission Recommendation -- Suitability. The Commission believes that the time is not now ripe for legislation in this area. The Commission only recently published for public comment an NASD-proposed rule change that would provide, among other things, suitability guidelines for broker-dealers making recommendations to institutional customers. The NASD proposal generally would maintain the existing presumption that broker- dealers are responsible for making suitable recommendations, but would permit institutional parties to negotiate responsibility for investment decisions. While the Commission has not taken a formal position with respect to the NASD proposal, the Commission favors an approach that would maintain the existing presumption that broker-dealers are responsible for making suitable recommendations to their institutional customers, while permitting flexibility, in appropriate circumstances, for parties to clarify the nature of their relationship. The Commission also believes that, if adopted, the NASD's proposed rule may resolve many of the concerns raised by market participants concerning their suitability obligations.-[16]- The Commission believes that this rulemaking process should be allowed to continue prior to legislation in this area. Section 3: Creation of National Securities Markets Section 3 contains proposed amendments to the federal securities laws that would preempt most state requirements with respect to securities registration, broker-dealer registration and regulation, and the regulation of investment companies and investment advisers. Under the bill, the role of the states in these areas generally would be limited to: (1) requiring notice filings and collecting fees with respect to certain securities filings; (2) enforcing certain antifraud provisions; and (3) registering securities professionals through a centralized registration system, and collecting fees for such registration. The bill also would grant the Commission authority to exempt certain state requirements from preemption if the Commission finds that the public interest, the protection of investors, and the maintenance of fair and orderly markets would be served by state regulation. Overview. The states play an essential role in the regulation of the U.S. securities industry. The states are particularly well-equipped to police violative conduct of a local nature, and this role should not be undermined. Nevertheless, carefully crafted federal legislation could reduce redundancies in regulation by the various states and create a greater --------- FOOTNOTES --------- -[16]- The Government Finance Officers Association has filed a comment with the Commission generally supporting the NASD's approach, which recognizes that a suitability obligation is potentially applicable to any institutional customer, but raises a number of other concerns regarding the NASD's proposed rules. These and any other concerns will be considered by the Commission during the comment process. -------------------- BEGINNING OF PAGE #21 ------------------- uniformity of standards among the states. As part of this legislative process, Congress, federal and state securities regulators, and industry participants should work together to determine how best to allocate responsibilities between the states and the federal government. The Commission is pleased that the North American Securities Administrators Association ("NASAA") Conference has appointed a blue-ribbon panel (of which Commissioner Wallman is a member) to study and report on the relative roles of state and federal securities regulation. It is the Commission's understanding that the panel's report is expected in early spring of 1996. As a general matter, the Commission believes that it would be preferable to focus initial efforts (legislative and otherwise) on those areas where a consensus can be reached -- namely, in the investment company and investment adviser contexts. Comments -- Creation of National Securities Markets Registration of Securities -- Section 3(a) * Current Law. The Securities Act of 1933 ("Securities Act") currently requires that securities offered or sold in interstate commerce either be registered with the Commission or be exempt from registration. Section 18 of the Securities Act expressly preserves state jurisdiction over any security or person. Most state securities laws likewise require that securities offered or sold in a particular state either be registered with the state or qualified under state law for an exemption from state registration requirements. In recent years, there has been progress toward elimination of duplicative state registration requirements. Almost all states exempt from their blue sky laws companies listed on the major exchanges or designated for trading on the National Market System of the NASDAQ. When state registration is required, many states do not limit their review of securities offerings to disclosure matters, but engage instead in "merit review," which allows them to review offerings for conflicts of interest and other substantive issues, such as the operating history of the company, and to block the sales of securities in their states. In addition, states may have different substantive registration and exemption standards and different procedures from each other. * Effect on Current Law. Section 3(a) would preempt state regulation of most securities offerings, including those of mutual funds, that are registered with the Commission or qualify for exemption from federal registration. States would retain their current authority with respect to intrastate offerings and blank check offerings. Section 3(a) also would authorize the Commission, by rule or regulation, to exclude other securities from automatic preemption that are otherwise exempt from section 5 registration, thus making those other securities eligible for state regulation. States would retain the authority to require notice filings, consent to service of process, -------------------- BEGINNING OF PAGE #22 ------------------- and fees with respect to many securities offerings.-[17]- States also would retain the ability to enforce their own antifraud laws (with respect to securities otherwise exempted under this section), so long as the conduct involved would violate the antifraud elements of section 17(a) of the Securities Act. The bill also makes clear that the states retain the authority to regulate securities that are not exempted under new section 18(a). Section 3(a) also would amend the Securities Act to address the preemptive effects of the new provision in the context of federal-state cooperation, and authorize the Commission to cooperate with the states on securities matters that, in the Commission's judgment, could result in greater uniformity in federal-state regulation. * Effect on State Enforcement of Federal Securities Laws. The opening statement for H.R. 2131 suggests that the states would be empowered to enforce the federal securities laws. While the bill can be read broadly to achieve this purpose, the bill also can be read as simply preserving the authority of the states to enforce antifraud provisions of state law that are consistent with federal antifraud provisions. If the bill is intended to provide that states may enforce the federal securities laws' antifraud provisions, many issues arise regarding the binding nature of state cases on the Commission. In addition, questions arise regarding what statute of limitations and what remedies would be available to the states. These questions might be addressed in the legislative history of the bill. It also is not clear whether the states would be allowed to bring federal securities enforcement actions in state court. The federal courts now have exclusive jurisdiction over Commission enforcement actions. -[18]- This issue of federal/state court jurisdiction also may implicate the disparity concerning private actions that currently exists (as well as implicate, to a different extent, some of the issues raised just above). The Exchange Act provides for exclusive jurisdiction of the federal courts in all such private actions, see Exchange Act section 27, but the Securities Act and the Investment Company Act of 1940 ("Investment Company --------- FOOTNOTES --------- -[17]- The provision tracks the blue sky laws of most states in not permitting the state to require such notice filing, consent or fees in connection with securities listed or eligible for listing on the New York Stock Exchange, American Stock Exchange, or NASDAQ/NMS, or any securities of the same class or senior to such securities. -[18]- In contrast, Section 6(d) of the Commodity Exchange Act provides for state enforcement of the federal commodities laws, and permits such actions to be brought in state court. This enforcement authority includes injunctive actions, proceedings for other equitable relief, and damage suits. -------------------- BEGINNING OF PAGE #23 ------------------- Act") both provide for concurrent state court jurisdiction over private suits. See Securities Act section 22(a); Investment Company Act section 44. Commission Recommendation -- Registration of Securities and Enforcement Issues. The Commission recognizes that federal and state regulators can work harder to better divide responsibilities in registering corporate securities. There are several approaches that could be considered, such as: codifying the existing exemptions from state regulation based on the standards underlying the exemptions for listed and NASDAQ/NMS securities, and modernizing the exemption from federal registration for intrastate and certain other offerings. No matter what approaches are chosen, states should continue to receive copies of Commission filings, and the current level of fees should be maintained. Certain categories of offerings -- those that have often been a source of disclosure and sales practice abuses, such as limited partnerships, blind pool and blank check offerings, and penny stocks -- should remain subject to both state and federal registration. For the remaining categories of offerings, several alternative options could be explored. One possible option would be to allow for an offering to be regulated either at the federal level, or at the state level, at the issuer's option. The Commission recommends that Congress, federal and state regulators, and industry participants work together to determine how best to reallocate responsibilities with respect to securities registration. We note that NASAA has already begun to address these issues with the formation of its blue-ribbon panel. Finally, the Commission generally does not believe that state preemption is appropriate in the enforcement authority context; the Commission and the states need to work together to make the best use of limited enforcement resources, and this can be accomplished by greater coordination among federal and state regulators and without legislation. Broker-Dealers -- Section 3(b) * Current Law. The federal securities laws generally prohibit brokers and dealers from effecting transactions in securities unless they register with the Commission and become a member of a self-regulatory organization. Pursuant to its authority under the Exchange Act, the Commission has adopted regulations concerning registration, capital requirements, books and records, and reporting obligations of such broker- dealers and their associated persons. States also impose their own registration and licensing requirements on broker-dealers and their associated persons. The states have taken steps to coordinate their processes, and to create greater uniformity among states through the use of the Central Registration Depository ("CRD"), a system to register broker- dealers. Some states impose supplemental requirements on broker-dealers, including different qualification and disqualification provisions, and different books and records and financial reporting requirements. * Effect on Current Law. Section 3(b) of the bill would amend the Exchange Act to, among other things: -------------------- BEGINNING OF PAGE #24 ------------------- (1) preclude the states from applying registration, licensing or qualification requirements to any broker-dealer, municipal securities dealer, or government securities broker-dealer who is registered with the Commission or has been exempted from such registration, as well as associated persons of the foregoing; (2) authorize the states to impose registration, licensing, or qualification procedures on broker- dealers as long as such procedures are performed through a central registration depository system and the state's substantive requirements are substantially similar to and not inconsistent with those required by the Commission; (3) prohibit the states from establishing broker- dealer capital, books and records, and reporting requirements that differ from those established by the Commission; (4) give the Commission exemptive authority to permit certain state regulation of broker-dealers that would otherwise be preempted upon a finding that such state regulation is in the public interest; (5) retain for the states the right to charge fees for broker-dealer registration, licensing and qualification that is otherwise in compliance with the new section; and (6) preserve, to the extent not preempted by the new section, the authority of the states to regulate, and bring actions against, broker- dealers pursuant to state law. Commission Recommendation -- Broker-Dealers. State regulators have a compelling interest in determining who may do business as a broker-dealer within their borders, and in how such business is conducted. The Commission also recognizes, however, that brokers and securities firms have a compelling interest in a centralized and predictable registration system. The Commission believes that states should continue to license broker-dealers that do business within their respective jurisdictions. The Commission also believes that states should continue to play a role in examining broker-dealers who operate within their jurisdictions. The Commission has called on NASAA to work toward still greater uniformity and coordination among the states with respect to registration and disqualification criteria, and has endorsed efforts to explore reciprocal or national licensing arrangements. In response to the problem of duplicative, overlapping examinations, the Commission has proposed that state, federal, and self-regulatory organization examiners work toward better scheduling, coordination and information-sharing. The Commission has already begun to work with the states and the self-regulatory organizations towards this goal, and intends to convene a regular "Planning Summit" where the Commission, the self-regulatory organizations, and the states would join together to discuss scheduling, priorities, and other examination issues. -------------------- BEGINNING OF PAGE #25 ------------------- The Commission also believes that the states should not impose books and records and capital requirements that go beyond applicable federal and self-regulatory organizations standards. Instead, the states should come to the Commission with their concerns in these areas. Finally, the Commission believes that the states should continue to receive the same fees from broker-dealer licensing they receive currently. Investment Companies -- Section 3(c) * Current Law. The federal securities laws comprehensively regulate the operations of investment companies, both under the Investment Company Act and the Securities Act. However, as a general matter, the Investment Company Act does not regulate all aspects of an investment company's structure. Rather, its provisions are superimposed with respect to select issues over a large body of state common and statutory law governing the operation of business entities and commercial transactions. State regulation of the activities of investment companies is based on state corporate law and state registration of securities offerings. * Effect on Current Law. Section 3(c) would add language to the Investment Company Act to establish the Commission as having "the exclusive jurisdiction with respect to all securities and transactions" to which the Act applies, and to all persons to whom the Act applies. * Interaction with Section 3(a) of H.R. 2131. As a practical matter, provisions in section 3(a) amending the Securities Act would preempt all state regulation of investment companies (as noted above, current state regulation of investment company activities is based on state registration of securities offerings). Section 3(c) appears to be intended to preclude the states from initiating investment company regulation through a means other than the regulation of investment company offerings. * Effect on Current State Law. As noted above, the provisions of the Investment Company Act are superimposed to a large extent on state common and statutory law governing the operation of business entities and commercial transactions. The bill would appear to call into question a good deal of state law which the Investment Company Act assumes and upon which the current structure of investment companies depends, including state corporate, business trust, contract, uniform commercial laws, etc. Commission Recommendation -- Investment Companies. State regulation can pose particularly significant obstacles to investment companies, which typically engage in business on a national scale and are constantly in registration. Moreover, they are comprehensively regulated on the federal level by the Investment Company Act and the Securities Act and, therefore, the Commission believes that state oversight of investment companies can be reduced without compromising investor protection. However, as a general matter, state common and corporate laws -------------------- BEGINNING OF PAGE #26 ------------------- govern the structure and operations of investment companies and, thus, any legislation must be carefully drafted to consider the interplay between, and purposes of, these differing regulatory regimes and the federal securities laws. One approach that could be considered would be to exempt investment companies from state merit or disclosure regulation, but to continue to require them to file documents with the states and to pay the same fees as at present. The Commission would continue to seek input from state regulators in the course of SEC rulemakings with respect to investment companies. Finally, the states would continue to have a role in enforcing sales practice rules. Investment Advisers -- Section 3(d) * Background. There are approximately 22,000 investment advisers registered with the Commission. Forty-six states regulate advisers under similar statutes duplicating to some extent the provisions of the Investment Advisers Act of 1940 ("Advisers Act"). * Effects on Current Law. Section 3(d) would preempt state law with respect to the regulation of investment advisers. The Commission would be granted "exclusive jurisdiction with respect to all securities and transactions" to which the Advisers Act applies and to all persons to whom the Advisers Act applies. * Effect on Current State Law. Under current law, the Advisers Act does not apply to securities or transactions, so that some of the language in proposed section 3(d) of H.R. 2131 may not be necessary. In addition, by giving the Commission exclusive jurisdiction over investment advisers, the bill may unintentionally preempt a number of state criminal and civil laws governing the actions of individuals and businesses, and may otherwise affect existing contractual relationships. * Resources. Because of the large number of investment advisers registered with the Commission, there is a concern raised as to whether the Commission's current resources are adequate to have "exclusive jurisdiction" over federally registered investment advisers. Commission Recommendation -- Investment Advisers. As noted above, the number of investment advisers today exceeds 22,000, which is an increase of more than 500% in the last 10 years. Most of them are smaller advisers, who are examined infrequently, if ever. With respect to investment advisers, therefore, the Commission has suggested an approach whereby the states would assume primary responsibility for examining advisers with assets below $5 million. Larger advisers, in turn, would remain registered with the Commission and would be relieved from state registration and regulation. Senator Gramm, sponsor of S. 148 (the "Investment Advisers Integrity Act"), proposed a similar approach earlier this year. The Commission has expressed its support for the concept contained in S. 148. Such an approach could be referred to as "reverse preemption," because the federal government would step aside and defer to the states who could do a more effective job in certain circumstances. -------------------- BEGINNING OF PAGE #27 ------------------- Section 4: Securities Margin Requirements Section 4 would exempt from the margin provisions a broad range of "institutional" entities deemed to be "excluded accounts" (e.g., certain corporations and employee benefit plans with assets exceeding $5 million, hedge funds, insurance companies, governmental entities, and certain financial institutions). The bill also would prohibit the exchanges and the NASD from imposing margin requirements that are in addition to, or inconsistent with, those provided for in the bill or those of the Board of Governors of the Federal Reserve System ("Board"). The bill also would remove the restrictions on arranging for the extension or maintenance of credit by others. In addition, the bill would exempt "excluded accounts" from section 11(d)(1) of the Exchange Act, which prohibits a broker- dealer from extending, maintaining, or arranging for the extension or maintenance of credit to customers on securities that it helped to distribute for 30 days after its participation in the distribution. Finally, the bill would eliminate margin requirements for all debt securities. Comments -- Margin Requirements * Current Law. Exchange Act section 7(a) directs the Board to prescribe rules with respect to the amount of credit that may be initially extended and subsequently maintained on any nonexempted security; section 7(c) makes it unlawful for an exchange member, broker, or dealer, directly or indirectly to extend or maintain credit or arrange for the extension or maintenance of credit to or for any customer on any nonexempted security in contravention of the Board's rules. Pursuant to this authority, the Board adopted Regulation T, which sets forth margin requirements that apply to broker-dealers. Although the promulgation and interpretation of margin rules is the primary function of the Board, an exchange or NASD member also must comply with the maintenance margin requirements of the self-regulatory organizations of which it is a member. * Effect on Current Law. Institutional customers falling within the definition of "excluded account" would be able to leverage their positions in the equity markets to the extent allowed by their broker-dealers. The exchanges and the NASD would not be able to craft their own additional margin requirements as they do now to protect their members or to respond to a market crisis. * Excess Leverage. Margin requirements can help to prevent excessive leveraging by market participants and investors. The risk of firm defaults from excess levels of credit exposure would be greater for thinly capitalized entities. * Effect on Debt Securities Markets. Because the bill eliminates the margin requirements for debt securities, it would appear to facilitate the development of when-issued and forward trading markets in debt securities, either of which could create potential problems that deserve further -------------------- BEGINNING OF PAGE #28 ------------------- study.-[19]- Commission Recommendation -- Margin Requirements. The Commission agrees that there is a need to reexamine margin requirements. This, however, is a complicated subject involving more than simply the amount of credit in the market. Other important issues include: continued investor confidence and participation in the markets, the solvency of financial institutions, the interplay of margin requirements with other financial responsibility rules (such as capital), competition concerns among various market participants, as well as potential systemic concerns. The Commission is concerned, however, that the approach proposed in H.R. 2131 does not appear to take all of these considerations into account. The Commission, instead, has proposed a more limited alternative approach: codification of the agreement that was negotiated earlier this year between the Commission staff and three major securities firms (Goldman Sachs, Morgan Stanley, and Salomon Brothers). If enacted, the agreement would: (1) eliminate federal margin treatment on most debt securities, while retaining federal margin requirements for debt securities that have been issued for less than 30 days;-[20]- (2) exempt from federal margin requirements credit extensions by broker-dealers to broker- dealers that have a substantial public business or for the purposes of market-making or underwriting; and (3) give the Board and the Commission the authority to exempt additional securities or transactions from the federal margin rules that each administers. Like H.R. 2131, the agreement also would repeal section 8(a) of the Exchange Act, which restricts the sources from which a broker-dealer may borrow to finance its securities operations. The Commission believes that this agreement would help resolve many of the industry's concerns regarding the ability of U.S. securities firms to obtain financing and to compete on a level playing field with banks and foreign entities. Moreover, the agreement would retain for the Federal Reserve Board, the SEC, the securities exchanges, and other self-regulatory organizations, the authority to establish appropriate margin provisions. At the same time, further coordination among the various regulatory agencies is needed to fashion a more comprehensive approach to the margin issue, taking into account the broader margin-related issues discussed above. The Commission intends to pursue this issue through the Working Group and other appropriate forums. --------- FOOTNOTES --------- -[19]- In a when-issued market, trading begins in the security before it is issued. When-issued and forward markets are similar to futures markets, but lack organized clearing mechanisms, exchange-type circuit breakers, and surveillance mechanisms such as position limits and audit trails. -[20]- The self-regulatory organizations would retain margin authority for debt and equity securities. -------------------- BEGINNING OF PAGE #29 ------------------- Section 5: Minimizing Transaction Costs of Corporate Organizations (Tender Offer Regulation) Section 5 would amend the Exchange Act to repeal various provisions devoted to tender offer regulation: beneficial ownership rules, issuer tender offer and going private provisions, third party tender offer rules, reports on changes in majority of directors, and the imposition of transactional fees for changes in control. Section 5 would not affect several other Exchange Act sections related to tender offers and devoted to: ownership reporting, antifraud provisions, and roll-up disclosure provisions. Further, tender offers involving the issuance of a security subject to Securities Act registration or a merger transaction subject to the proxy rules would remain subject to Commission regulations. Comments -- Tender Offer Regulation * Background. Congress enacted sections 13(d) and (e) and 14(d)-(f) to the Exchange Act in 1968. These sections are collectively known as the "Williams Act," and they were amended into their present form in 1970. The Williams Act is based on a principle of neutrality between bidder and target;-[21]- its provisions are focused on the protection of investors. Section 13(d) requires that a shareholder provide information about the acquiring shareholder and the shareholder's intent with respect to the investment within 10 days of reaching a 5% ownership threshold. This information provides the market with timely information about persons making accumulations of stock of a particular issuer.-[22]- In addition, the regulatory scheme applicable to third party and issuer tender offers (sections 13(e) and 14(d)) provides target company shareholders with adequate time and information to make an informed decision as to whether to hold, tender or sell the securities subject to the tender offer and to assure equal treatment for investors. * Impact on Beneficial Ownership Reporting. The bill would delete section 13(d) reporting. In essence, the proposed rescission of section 13(d) would cut back on the disclosure required. Disclosures deleted would include: (1) background of acquiring persons, (2) plans or proposals with respect to the company, (3) contracts and understandings with respect to any securities of the company, and (4) the source of funds for the acquisition. H.R. 2131 would, however, retain the ownership reporting requirements under section 13(g). Exchange Act section 13(g) requires filing of a notice by a 5% shareholder that --------- FOOTNOTES --------- -[21]- The provisions are not designed to "tip[] the balance of regulation either in favor of management or in favor of the person making the takeover bid." S. Rep. No. 550, 90th Cong., 1st Sess. 3 (1967); H.R. Rep. No. 1711, 90th Cong., 2d Sess. 4 (1968). -[22]- The section also requires disclosure of the source of funds for the acquisition as well as any arrangements the shareholder has with respect to other securities of the issuer. -------------------- BEGINNING OF PAGE #30 ------------------- reports: (1) the shareholder's name, residency and citizenship; and (2) the number of shares in which the shareholder has an interest and the nature of that interest. Material changes in such information also are required to be filed. The timing and form of notice and amendments are left to Commission rulemaking. Currently, the Commission requires reporting under section 13(g) annually by persons exempt from Regulation 13D, such as institutions who acquire securities in the ordinary course of business and not with the purpose or intent of influencing control of the issuer of those securities. Many of the rules promulgated under section 13(d) are also made applicable to section 13(g). Since section 13(g) would not be repealed, it is possible that the Commission could, in the future, require the information reported under section 13(g) to be filed other than on an annual basis. Nevertheless, unless the legislative history for this bill was clear on the point, it might not be evident what impact the deletion of section 13(d) and the rules promulgated thereunder would have on the substantive requirements of section 13(g) and the Commission's rulemaking authority under that section. * Impact on Issuer and Third Party Tender Offer Regulation. The regulatory scheme applicable to third party and issuer tender offers is intended to provide target company shareholders with adequate time and information to make an informed decision as to whether to hold, tender or sell the securities subject to the tender offer and to assure equal treatment for investors. Issuer and third party tender offers are regulated pursuant to Exchange Act sections 13(e) and 14(d), which would be deleted. Section 13(e) provides a general grant of rulemaking authority to the Commission to regulate issuer repurchases of securities either by: (1) defining acts and practices that are fraudulent, deceptive or manipulative; or (2) prescribing means reasonably designed to prevent fraudulent deceptions or manipulative acts or practices. The Commission has used this authority to impose on issuer tender offers largely the same regulation as imposed on third party tender offers pursuant to section 14(d). Section 14(d) mandates that third party tender offers be conducted in accordance with such Commission rules as adopted under section 14(d). Section 14(d) specifies disclosures, withdrawal and prorationing rights, and that all tendering shareholders participate in bid increases. The Commission's exemptive authority under section 14(d) does not allow full flexibility to address cost and other issues. However, H.R. 2131 does not repeal section 14(e). Section 14(e) is a fraud prohibition with respect to any tender offer, and authorizes the Commission to "define, and prescribe means reasonably designed to prevent such acts and practices, as are fraudulent, deceptive and manipulative." Such type of authority has been used in the past as the basis for substantive and disclosure based requirements. Section 14(e) also provides the clearest authority for the prohibition of insider trading in the context of tender offers. Except to the extent the legislative history for this bill -------------------- BEGINNING OF PAGE #31 ------------------- would otherwise provide, much of the regulatory scheme currently applicable to issuer or third party tender offers could arguably be imposed based on section 14(e) authority.-[23]- Assuming this is not the legislative intent, the rescission of sections 13(e) and 14(d) and the rules thereunder would cancel current provisions designed to provide for: (1) equal treatment of shareholders; (2) mandated disclosure regarding the material terms of the transaction; and (3) prohibition of first come-first served provisions that potentially have a "stampede" effect. Notably, most friendly mergers are implemented not by means of tender offers but rather through a corporate merger or corporate acquisition. On a separate note, in contrast to the federal provisions, many state statutes to one degree or another provide protections for state-chartered corporations against hostile tender offers (the vast majority of state tender offer statutes restricting tender offers, for example, exclude friendly tender offers). As a result, many states have statutes that regulate unfriendly tender offers and share acquisitions in a substantive manner, and may otherwise increase the time and cost of the transactions. These state statutes have as their goal increasing investor protections. Moreover, and usually more costly than any of the federal or state statutory requirements, litigation brought in state court often adds to the time and cost of the transaction. * Deletion of Transactional Based Fee Requirement for Takeovers. Exchange Act section 14(g) provides for the payment of fees to the Commission in connection with an acquisition, merger, consolidation or proposed sale or other disposition of substantially all the assets (regardless of whether that transaction is subject to the tender offer or proxy rules). H.R. 2131 would remove section 14(g) and would, therefore, reduce the fees that are deposited into the U.S. Treasury. This may result in budget "scoring" difficulties for H.R. 2131. * Impact on Going Private Regulations. Section 13(e), discussed above, also serves as the basis for the Commission's "going private" disclosure scheme governing share repurchases by the company or its insiders that result in a company's going private. In these transactions, an issuer and/or its affiliate currently is required to disseminate to its shareholders and to file with the Commission a disclosure statement a certain period of time before the event addressing the transaction's fairness and any alternatives considered. Most management buyouts of the last 15 years have been subject to the Commission's going private rules. The bill would delete the current requirements. However, to the extent that the transactions used to effect a going private transaction are subject to proxy regulation or the Commission's tender offer antifraud rulemaking authority under section 14(e), the existing disclosure mandates likely could be continued. Transactions that occur outside of these areas, however, such as squeeze out mergers or reverse --------- FOOTNOTES --------- -[23]- In addition, tender offers involving the issuance of a security subject to Securities Act registration or a merger transaction subject to the proxy rules would remain subject to Commission regulations. -------------------- BEGINNING OF PAGE #32 ------------------- stock splits, would no longer be subject to the going private disclosures. * Impact on Other Miscellaneous Corporate Control Provisions -- Rules 13e-1 and 14f-1. Under Rule 13e-1, a target company subject to a section 14(d) third party tender offer is required to file with the Commission and disseminate to shareholders certain disclosures before purchasing those shares subject to the tender offer. In addition, under Rule 14f-1, an issuer is required to file with the Commission and transmit to all holders of record certain disclosures prior to changing the composition of a majority of its board outside of a shareholder meeting. The required disclosure is equivalent to that provided to shareholders in a proxy statement. By deleting section 13(e), the bill would also eliminate the requirement under Rule 13e-1 that a target company subject to a section 14(d) third party tender offer file with the Commission and disseminate to shareholders certain disclosures before purchasing those shares subject to the tender offer. By deleting section 14(f), the bill would also remove the requirement that an issuer file with the Commission and transmit to all holders of record certain disclosures prior to changing the composition of a majority of its board outside of a shareholder meeting. Commission Recommendation -- Tender Offer Regulation. The Commission is unaware of the class or constituency that supports the outright repeal or fundamental revision of these "Williams Act" provisions; in fact, the businesses most affected generally seem to be content with the Williams Act as a whole. Additionally, we do not believe that the states have sought exclusive jurisdiction in the tender offer area. The Commission believes that the Williams Act provisions have worked well and continue to work well, and the Commission does not support the Act's repeal. However, we are open to considering appropriate modifications that may be suggested during the course of this Committee's hearings. The Commission has in the past supported and would continue to support certain modifications to Exchange Act section 13(d).-[24]- The Commission believes that persons do not need 10 days to file the information required by that section, which is of dramatic significance to the marketplace. Two approaches could be considered: the 10-day period could be shortened; or the filing person could be required to file the information prior to any further purchases after reaching the 5% threshold. Either approach could enhance market efficiency. Section 6: Prospectus Delivery Section 6 of H.R. 2131 would: (1) delete from the definition of the term "prospectus" in Securities Act section 2(10) the phrase "or confirms the sale of any security" so that a confirmation of sale would no longer be a prospectus; (2) add the --------- FOOTNOTES --------- -[24]- As noted above, section 13(d) requires that a shareholder provide information (on Form 13D) about the acquiring shareholder and the shareholder's intent with respect to the investment within 10 days of reaching a 5% ownership threshold. -------------------- BEGINNING OF PAGE #33 ------------------- phrase ", if the purchaser or prospective purchaser of such security has requested a prospectus" at the end of section 5(b)(2) which requires that a final section 10(a) prospectus accompany or precede a security offered for sale or a security being delivered after sale; and (3) add a new section 5(d) that would give the Commission authority to exempt from section 5(b) any person, prospectus, class of person or class of prospectus. Commission exemptive authority could be exercised by rule, regulation or order. Comments -- Prospectus Delivery * Current Law. Section 5 of the Securities Act prohibits any person from offering or selling a security through the use of interstate commerce or the mails unless a registration statement has been filed or is in effect, and provides that a prospectus which meets the requirements of section 10(a) of that Act (which governs the contents of a full statutory prospectus), filed as a part of the registration statement, be furnished to the purchaser prior to sale or with the confirmation of sale or, in some cases, at the time of delivery of the security after sale. Section 2 of the Securities Act defines a number of the technical terms used within section 5. The definition of prospectus in section 2(10) of the Act includes any written communication that "confirms the sale of any security" and, thus, a full prospectus must precede or accompany delivery of the security or the confirmation, whichever occurs first. After the effective date, sales literature in addition to the prospectus may be used, as long as the section 10(a) prospectus precedes or accompanies the sales literature. * Effect on Current Law. The bill would amend the prospectus delivery requirements of the Securities Act in a number of respects. Section 6 of H.R. 2131 would amend the prospectus delivery requirements of the Securities Act to exclude sales confirmations from the definition of prospectus. The bill would eliminate the requirement that a final prospectus accompany or precede a security for sale or a security being delivered after sale, absent a request by the purchaser or prospective purchaser. Because the bill would eliminate the prospectus delivery requirement of section 5(b)(2) absent a request by a purchaser or prospective purchaser, an offering of securities could be undertaken solely by oral representations, relying wholly on sales practices. However, the bill would not amend the prospectus delivery requirements of section 5(b)(1). Therefore, written offers generally could be made only through a section 10 prospectus -- whether a preliminary prospectus or, in the case of mutual funds, a rule 482 "omitting prospectus" advertisement. The bill would authorize the Commission to exempt from the statutory prospectus delivery requirements any person, prospectus, class of persons, or class of prospectuses. The bill would require the Commission to adopt rules and regulations setting forth the procedures to be followed in requesting an exemption. Any exemption granted would have to be "necessary or appropriate in the public interest and consistent with the protection of investors" and through the bill's provision section 8(b)) must "promote efficiency, competition, and capital formation." The Commission would -------------------- BEGINNING OF PAGE #34 ------------------- have sole discretionary authority not to consider any application for an exemption, and the proposed provision would not require any notice or opportunity for hearing. Notably, after effectiveness, the final section 10(a) prospectus still would have to be used in connection with sales literature and other offering material. During the "waiting period," written offers still would have to be made by means of a section 10 prospectus. * Mutual Fund Sales. In effect, this provision would permit mutual fund shares to be sold without any delivery of a prospectus to the investor. Section 5(b)(1) would require written offers to be made by means of a section 10 prospectus. However, a mutual fund is permitted to advertise using an "omitting prospectus" under Rule 482, which is specifically a section 10 prospectus for purposes of section 5(b)(1). Although Rule 482 ads cannot include an application for fund shares, it would be possible to include an "800" number that an investor could call to purchase fund shares. Because section 5(b)(2) would be amended so that it would no longer require delivery of the prospectus with the confirmation of a sale, an investor who called the "800" number and purchased fund shares would not receive a prospectus unless he or she specifically asked for one. Therefore, the bill would permit sales of mutual funds to be made without the investor receiving any written communication other than an "omitting prospectus" advertisement under Rule 482. * Press Releases. Notably, while Section 6 of H.R. 2131 would not amend the definition of "prospectus" otherwise than with respect to confirmations, Section 13(b) of H.R. 2131 would amend section 2(10) of the Securities Act to deem press releases also not to be prospectuses. Commission Recommendation -- Prospectus Delivery. The Commission agrees that the existing system does not serve either issuers or investors as well as we would like. As noted below, the Commission is engaged in several comprehensive efforts to evaluate the many complex issues related to prospectus content and delivery, the provision of information to investors in other forms, and related topics. Most recently, the Commission issued an interpretive release providing guidance and a degree of certainty regarding the manner in which issuers and others may use electronic media to communicate with investors under current rules. The release discusses various ways to comply with existing delivery or transmission requirements using electronic means. The Commission also issued a release proposing technical amendments to its rules that are currently premised on the delivery of paper documents. In addition, the Commission is taking fresh looks at the entire existing securities disclosure system. Last February, the Commission established an Advisory Committee on the Capital Formation and Regulatory Processes ("Advisory Committee") to consider comprehensive reforms of the registration and disclosure process. The Advisory Committee's mandate is broad in scope: it is considering, for example, whether Commission rules should permit a registration concept that relies more on company disclosure and market-driven securities and transaction disclosure ("company registration") rather than on Commission's mandated transaction disclosure. -------------------- BEGINNING OF PAGE #35 ------------------- This approach could streamline both registration and disclosure requirements, while actually enhancing information flow and protections to investors. The Commission expects to receive the Advisory Committee's recommendations early next year. The Commission also recently established an internal Task Force on Disclosure Simplification ("Task Force") charged with reviewing all forms and all disclosure requirements imposed on public companies. The Task Force -- whose outside advisor is Philip Howard, author of a book on regulatory simplification entitled The Death of Common Sense -- is expected to make its recommendations at the end of this year. The Commission also is in the process of trying to improve the usefulness of the information received by investors by encouraging, among other things, "plain English" disclosures for mutual funds. The Commission already has worked with the mutual fund industry and state securities regulators to develop a fund "profile prospectus," the key element of which is a standardized, short-form summary of key fund features. The pilot "profiles" for eight mutual fund groups became available to investors in August. As a general matter, the Commission believes that the Advisory Committee and Task Force studies should be completed before significant legislative revisions to the prospectus delivery process are considered. In the interim, however, the Commission could support the section's grant of exemptive authority to the Commission, which would authorize the Commission to exempt certain offerings or issuers from prospectus delivery.-[25]- Section 7: Exemptive Authority Section 7 generally would amend the Securities Act to increase the Commission's authority to exempt offerings from the Act's registration requirements. Section 7(a) of H.R. 2131, the "small offering" exemption, would raise the statutory limit for the exemption of small offerings to $15 million, and thereby would expand the Commission's discretionary rulemaking authority to exempt small offerings from registration under the Act. Section 7(b) of H.R. 2131, the "general" exemption, would add section 3(d) to the Securities Act to provide the Commission with the authority to exempt any security or class of securities from that Act's registration requirements. Comments -- "Small Offering" Exemption (Section 7(a)) * Current Law. Section 3(b) of the Securities Act currently allows the Commission to exempt small offerings of up to $5 million. * History. The dollar ceiling in section 3(b) has been raised by Congress over the years; it started at $100,000 and was raised from $1.5 million to the current $5 million --------- FOOTNOTES --------- -[25]- In any event, if the Commission is granted broad exemptive authority as proposed under Section 7 of this bill, it may not be necessary to include legislative provisions eliminating prospectus delivery; the Commission could use its exemptive authority in appropriate cases. -------------------- BEGINNING OF PAGE #36 ------------------- in 1980. In 1992, the Commission proposed and adopted a set of major initiatives to streamline regulations affecting small businesses. As part of that process, the Commission acted upon its discretionary authority and expanded the small offering exemptions under the Act. The Commission also recommended legislation that would increase the Commission's discretionary exemptive authority under section 3(b) to $10 million. Several bills containing such a provision have been introduced in previous sessions of Congress, and the Commission testified in support of one of those bills. * State Regulation. A question that may be raised relates to the ability of the states to regulate small business offerings falling within the scope of the exemption, and how this provision will interact with the state preemption provisions of this bill. Absent a specific Commission determination that state regulation is needed, the bill's preemption provisions (discussed above) would bar from regulation small offerings under the $15 million cap unless such offering qualifies for the intrastate exemption or is a blank check offering. Comments -- "General" Exemptive Authority (Section 7(b)) * Current Law. The Securities Act does not now provide for a grant of general exemptive authority to the Commission. Both the Investment Company Act (section 6(c)) and the Advisers Act (section 206A), provide the Commission with authority to exempt any persons, securities or transactions from any provision of the statute or the rules thereunder. Further, section 12(h) of the Exchange Act provides the Commission with the authority to exempt in whole or in part any issuer or class of issuers from the registration provisions of section 12(g) of that Act. * Effect of Provision. The provision would add section 3(d) to the Securities Act to provide the Commission with the authority to exempt any security or class of securities from the Act's registration requirements. The bill's approach would appear to be more in line with the Exchange Act (section 12) model. * Certain Effects Unclear. The summary statement indicates that the Commission would be given a general grant of authority to eliminate any rule or regulation that no longer serves a valid purpose; proposed Section 7(b) appears to be limited to registration requirements, although it is broadly drafted in that context. As a result, there may be debate as to the provision's application to other provisions of the Securities Act. * Case-by-Case Review. Action "by order" would require the Commission to review and consider exemptive requests on a case-by-case basis. * Company Registration. The Commission's Advisory Committee on Capital Formation and Regulatory Processes may recommend a "company registration" approach. A grant of general exemptive authority could help implement such a recommendation, as well as other Commission proposals (although much of the company registration proposal could be implemented, albeit somewhat more awkwardly, under the Commission's existing rulemaking authority). -------------------- BEGINNING OF PAGE #37 ------------------- * Fees. At present, fees collected for securities registered with the Commission fund a large portion of the Commission's budget. An agreement in principle has been reached in the House that would, among other things, decrease the Commission's reliance on fees to fund the agency's budget. However, if a large scale exemption from the registration requirements was adopted pursuant to the bill's provision, there could be an impact on fees collected by the Commission. It also should be noted that if company registration were to be implemented, the aggregate amount of fees paid to the Commission actually might increase because the number of securities issuances subject to registration and payment of fees would likely increase, although the timing on the receipt of fees may be somewhat delayed as compared to the current system. Commission Recommendation -- Exemptive Authority. The Commission supports the concept of a broad grant of general exemptive authority under the Securities Act, as well as under the Exchange Act,-[26]- similar to the authority currently vested in the Commission under the two 1940 Acts.-[27]- This type of exemptive authority would allow the Commission the flexibility to explore and adopt new approaches to registration, disclosure and related issues, such as some parts of the currently pending "test-the-waters" proposal under the Securities Act.-[28]- While the Commission supports Section 7(a) of H.R. 2131 --------- FOOTNOTES --------- -[26]- Notably, a number of provisions of the Exchange Act grant the Commission exemptive authority. For example, section 12(h) of the Exchange Act currently provides the Commission with authority to exempt in whole or in part any issuer or class of issuers from the provisions of sections 12(g), 13, 14, or 15(d) of that Act, as well as to provide exemptions from section 16 of the Act. Similarly, a number of other provisions in the Exchange Act provide the Commission with specific exemptive authority in defined circumstances, see sections 15(a)(2) and 17(h)(4) of the Exchange Act. See also section 3(a)(12) of the Exchange Act, which authorizes the Commission to define particular securities as "exempted securities" for purposes of the Exchange Act. -[27]- Section 6(c) of the Investment Company Act, for example, covers all of the provisions of that Act (not just the registration requirements) and permits exemption by rule or regulation as well as by order. -[28]- Further, there has been a recent proliferation of electronic trading systems that do not fit neatly within the existing regulatory framework for exchanges and for which exchange registration may prove an unnecessary and undue regulatory burden. A grant of general exemptive authority under the Exchange Act would give the Commission the necessary flexibility to address appropriately the regulatory concerns that these entities may raise. Similarly, such a grant of authority would provide the Commission with flexibility to exclude certain classes of persons from regulation as brokers or dealers under circumstances in which the activities of such persons would not pose risks to the investing public. -------------------- BEGINNING OF PAGE #38 ------------------- (which would raise the "small offering" ceiling), we do not believe that there is a need for the provision if a general grant of exemptive authority -- such as the one provided for in H.R. 2131 -- is provided to the Commission. Section 8: Promotion of Efficiency, Competition, and Capital Formation Section 8 would require the Commission to consider or determine whether its actions will promote efficiency, competition, and capital formation whenever the Commission is required to consider or determine if that action is consistent with the public interest, the protection of investors, or both. Comments -- Promotion of Efficiency, Competition, and Capital Formation * Effect on Current Law. The provision would require the Commission's separate consideration of these three factors whenever a public interest consideration or determination is made. In certain contexts, this may have unpredictable effects. For example, the Commission may be required to consider efficiency, competition and capital formation apart from, and to the same extent as, investor protection and other aspects of the public interest in determining applicable sanctions in enforcement cases. Commission Recommendation -- Promotion of Efficiency, Competition, and Capital Formation. The foremost mission of the Commission is investor protection. The Commission strongly believes that efficiency, competition,-[29]- and capital formation concerns are elements of -- and do not conflict with - - the public interest and the protection of investors. In other words, the Commission believes that it currently must give consideration to efficiency, competition, and capital formation concerns whenever the agency is required to make a public interest determination. The Commission recognizes, however, that the provision seeks to establish a more formal mechanism for ensuring that these concerns are considered, and the Commission supports that underlying objective. At present, the Commission generally requires a cost/benefit analysis when it proposes or adopts its rules. The Commission is prepared to strengthen this requirement by requiring the staff to perform additional analysis of a rule's impact on competition, efficiency and capital formation. The Commission does not believe, however, that this analysis would be appropriate in the context of enforcement actions and adjudicated opinions. Thus, the Commission would oppose legislation that would mandate such an analysis in these contexts. --------- FOOTNOTES --------- -[29]- Certain sections of the federal securities laws explicitly require consideration of competition (e.g., Exchange Act sections 6(a)(8), 15A(b)(9), 17A(b)(3)(I), and 23(a)(2)). These sections generally require a finding that any burdens a Commission regulation or a self-regulatory organization rule imposes on competition are necessary or appropriate in furtherance of the purposes of the Exchange Act. -------------------- BEGINNING OF PAGE #39 ------------------- Section 9: Reduction in Number of Members of Commission Section 9 would amend section 4 of the Exchange Act to reduce the number of members serving on the Commission from five to three, and would provide that no more than two commissioners may belong to the same political party. In order to implement the transition to a three-member Commission, the provision would abolish two terms of the Commission and extend the expiration dates of the remaining terms. It would maintain the duration of terms at five years. Comments -- Number of Commissioners * Effect on Current Law * Staggering and Duration of Terms. In regulatory commissions, the number of members often equals the number of years in a term. Thus, a five-member commission with five-year, staggered terms results in the expiration of one commission membership each year. The bill would abolish the two terms that expired in 1994 and 1995, and would extend the expiration dates of the terms expiring in 1996, 1997 (Commissioner Wallman), and 1998 (Chairman Levitt) to expire in 1999, 2001, and 2003, respectively. This staggering of terms would result in an uneven distribution of expiration dates. The new five-year term that begins in 1999 would expire in 2004 (one year after the term that expired in 2003); the term that begins in 2001 would expire in 2006; and the term that begins in 2003 would expire in 2008. Thus, the pattern of expiration dates would be as follows: 2003, 2004, 2006, 2008, 2009, 2011, 2013, 2014, etc. Two terms on the Commission would therefore expire one year apart, while the other term would expire two years before and after the other two terms.-[30]- * Sunshine Act and Quorum. The effect of the provision on the Commission's administration of the Government in the Sunshine Act would depend on the quorum rule under the new law. If the Commission continues to require three members for a quorum when three are in office and not recused, the provision would appear to have no impact on the Commission's operations. If, however, the Commission (or Congress) were to provide that two out of three constitute a quorum (as would be expected with a three-person Commission), then the Sunshine Act results could seriously impair discussions between any two Commissioners. If two out of three commissioners were to constitute a quorum as to all matters, then discussions between any two commissioners would probably constitute a "meeting" under the Sunshine Act, which would require advance notice and opportunity for public attendance at such meetings unless the meeting satisfies certain exemptive criteria. * Other Effects. During almost all of the --------- FOOTNOTES --------- -[30]- To resolve this uneven pattern, terms could be lengthened from five to six years, with expiration every two years (as with the U.S. Senate), or could be shortened from five to three years, with expiration every year. -------------------- BEGINNING OF PAGE #40 ------------------- Commission's existence, four or five members have been in office, and the ability to confer as a five-member collegial governing body has contributed greatly to the quality of the agency's decision-making process. Further, a five-member Commission enables members to pursue initiatives that other members or Commission staff do not have time or resources to pursue. In recent years, when the Commission has generally had four or five members in office, commissioners have focused on such issues as: the regulation of municipal securities, the regulation of derivatives markets, the regulation of public-utility holding companies, and administrative proceedings before the Commission. * Savings. The provision is premised in part on the assumption that it costs the federal government $1 million each year to employ each commissioner (including staff) other than the chairman. The Commission's Office of the Comptroller estimates, however, that it costs the federal government roughly $480,000 a year for the employment of each commissioner, including the proportionate reduction of relatively fixed costs such as office space rental and other overhead (such as utilities). The aggregate savings from reducing the Commission from five members to three members would be close to, but less than, $1 million per year. Commission Recommendation -- Number of Commissioners. The Commission supports retaining the current statutory make-up of the Commission, and therefore we oppose this provision. The Commission believes that the ability to confer as a larger, five member body has contributed greatly to the quality of the Commission's decision-making process.-[31]- Moreover, during the last several months (when there only have been two Commissioners at the agency), certain procedural issues have arisen, primarily with respect to complying with the provisions of the "Government in the Sunshine Act." With a three-member Commission, if the quorum were two or if there was any vacancy, there would be a recurrence of such issues. Section 10: Privatization of EDGAR Section 10 would direct the Commission to: (1) issue a request for proposals ("RFP") for a privatized EDGAR system that will provide for a "return to the government on its investment in the establishment of such system"; (2) ensure that the new system provides for rapid dissemination of filings; and (3) transmit to Congress the legislation required to implement the selected proposal. The process of preparing the solicitation, evaluating the proposals, making a selection and completing the legislative requirements would be completed within 180 days of enactment. Comments -- EDGAR * Current Law. Exchange Act section 35A mandates the requirements for the EDGAR system. The system is designed to accelerate the processing, dissemination, and analysis of time-sensitive information filed with the Commission. The --------- FOOTNOTES --------- -[31]- During its 60-year history, the Commission has had three or fewer members in office for a total of approximately 30 months, and has had five members more than two-thirds of the time. -------------------- BEGINNING OF PAGE #41 ------------------- system is intended to automate the receipt, processing, and dissemination of documents filed with the Commission and to provide comprehensive automation capabilities for the full disclosure activities of the Commission. * Background. At least part of the EDGAR system already is privatized: a private firm operates the system, and another private firm is responsible for the dissemination subsystem. The system is almost fully implemented, with the final "phase-in" period for filers scheduled to occur in May 1996. The Commission's contract with the current EDGAR vendor is due to expire in 1997; the current schedule calls for a vendor to be selected in October 1996. The staff currently is reexamining certain technical and other aspects of the system, while also preparing an RFP for release in December 1995 or early 1996.-[32]- * Effect on Current Law/Current Operations. * "Return to the Government." The provision contains the conditional language "return to the government on its investment in the establishment of such system." The Commission is unclear as to the precise intention of that language, and requests clarification. While the language appears to contemplate more than just "privatizing" EDGAR, it also appears to call for some (or all) of the existing investment in EDGAR to be recovered. If that is the case, the new vendor's costs will include not only the cost of its system, as proposed, but also a "premium" payment to the government for the privilege of being the system operator.-[33]- * Bidding Process. A potential, unintended consequence of the provision could be to introduce uncertainty into the current bidding process, as potential bidders would have to consider whether the historical costs of the system would have to be recovered by the government. This would be especially problematic if the provision was enacted after a bidder's proposal was selected. Some vendors may choose not to bid in the face of such uncertainty or may bid in ways that would not meet Congress' intent and expectations. Such uncertainty, among other things, may make it difficult for the Commission to comply with the timetable imposed by the bill and the Commission's current schedule. --------- FOOTNOTES --------- -[32]- A conference was held August 14, 1995, to initiate the Commission's dialogue with various "users" of an electronic disclosure system: filers, vendors, disseminators, analysts, investors, and other securities industry practitioners. To follow up on some of the issues raised at the August conference, the Commission has asked the National Academy of Sciences Computer Science and Telecommunications Board to organize a panel that will examine EDGAR. The panel will consist of nationally recognized computer industry experts. -[33]- We reach this conclusion because it appears that it is this "premium" which satisfies the provision's condition. -------------------- BEGINNING OF PAGE #42 ------------------- * Other. The Commission notes that the provision would provide the agency with substantial system capabilities which are not financed through the traditional appropriations process. * Commission Staff Functions. One variable in the proposed privatization model is the extent to which Commission staff functions should or should not be included. The bill appears to suggest that, since the Commission is issuing an RFP and selecting a vendor, the Commission's own needs should be included. Document costs increase, of course, as the cost of meeting Commission staff requirements increases. Commission Recommendation -- EDGAR. The Commission welcomes continued Congressional oversight in this area. The Commission recognizes the importance of EDGAR to the agency's mission and is committed to a fundamental reexamination of EDGAR and how it operates. The Commission is in the process of soliciting public comment, working with outside experts, and coordinating closely with interested Congressional staff, regarding improvements to the EDGAR system. The Commission believes that this process should be allowed to continue and, therefore, that a legislative solution is not needed at this time. Section 11: Rules of Self Regulatory Organizations Section 11 would require the Commission to publish notice of proposed self-regulatory organization ("SRO") rule changes within 30 days of the filing, unless the SRO consents to a longer period.-[34]- Comments -- Rules of Self-Regulatory Organizations * Current Law. Exchange Act section 19(b) requires SROs to file with the Commission all proposed rule changes. These filings must be accompanied by a concise general statement of the basis for and purpose of the proposed rule change. The section also requires the Commission, after the filing of a proposed rule change, to publish notice of the proposed rule change so that the public may submit written comments, but does not expressly impose a time period as to how quickly the Commission must file notice in response to the SRO's filing. * Background. In its January 1994 Market 2000 Study, the Division of Market Regulation reasserted its continued commitment to work with the SROs to streamline the process for the approval of proposed rule changes. As part of this ongoing process, the Division has endeavored to reduce the period between filing and notice of SRO rule changes. That period has steadily declined since the beginning of 1994. During the first four months of 1994, 41% of the 156 rule changes filed were noticed within 30 days. In the first six months of 1995, 57% of the 260 rule changes filed were --------- FOOTNOTES --------- -[34]- The summary to the bill specifies a 90-day time period between receipt of a proposed rule change and its publication, rather than the 30 days provided in the text. -------------------- BEGINNING OF PAGE #43 ------------------- noticed within 30 days. In addition, the Commission recently eliminated the need for the agency's prior review of certain SRO rule filings. * Effect on Current Law/Practice. The provision would not appear to alter the scope of Commission review as currently provided for in the Exchange Act, but would reinforce current practice that the Commission process SRO- proposed rule changes expeditiously. Commission Recommendation -- Rules of Self-Regulatory Organizations. The Commission supports the provision, which should further streamline the process for the approval of SRO- proposed rule changes. The provision would codify a practice that the agency was committed to achieving by its own initiative. Section 12: Designation of Primary SRO and Examining Authority Section 12 of the bill would require the Commission, after notice and comment, to designate one SRO as the examining authority for each broker-dealer. In addition to enforcing its own rules, the designated examining authority ("DEA") would be required to enforce the rules of any other SRO to which the broker-dealer belongs. Comments -- Designation of Primary SRO and Examining Authority * Current Law. Section 17(d)(1) of the Exchange Act currently authorizes the Commission to allocate SRO examinations, and provides sufficient authority for the Commission to require SROs to eliminate any duplication with respect to the functions examined. Section 17(d)(1) also provides factors to consider in making such allocations, such as duplication of effort, cost, availability of staff, and protection of investors. Under the existing rulemaking authority under this section, the Commission has adopted two rules.-[35]- The first, Rule 17d-1, requires the Commission to allocate the financial examination function to one DEA, if the broker-dealer is a member of more than one SRO. In practice, one DEA is selected for each broker-dealer based on factors listed in the rule. The second, Rule 17d-2 provides procedures for SROs to allocate between themselves the responsibility to examine members for compliance with SRO and Commission rules. In general, the SROs allocate sales practice and other compliance examinations among themselves. * Effect on Current Law. Although the allocation of SRO examinations is addressed under section 17 of the Exchange Act, the proposed amendment would be added to section 15 of the Act. The bill could be read to result in the unintended consequence of leaving the Commission with no examination or oversight authority for broker-dealers (other than in enforcement actions). In addition, although the provision is designed to consolidate examinations of broker-dealers --------- FOOTNOTES --------- -[35]- The Commission could use its existing authority to require the SROs to eliminate duplication with respect to the functions they examine. -------------------- BEGINNING OF PAGE #44 ------------------- that are members of multiple SROs, it does not appear to give the DEA examination and oversight authority with respect to the federal securities laws. Moreover, the provision appears to be inconsistent with current section 19(g), which requires SROs to enforce compliance with their rules, and creates uncertainty as to whether sections 17(b) and (d) of the Exchange Act are intended to be supplemented or replaced. * Forum Shopping. Differing standards of enforcement between DEAs could create competitive inequities. "Forum shopping" concerns could arise as the provision would require the Commission to grant broker-dealer requests to change DEAs under certain circumstances. The notice and comment provision regarding the designation of each broker- dealer's DEA could raise somewhat different, but related, concerns. * Objectives. Investor protection and the efficient allocation of SRO resources are objectives of the current law under Exchange Act section 17(d)(1) (discussed above). To the extent that the provision emphasizes minimization of costs to broker-dealers of the examination and oversight process, it could be perceived as lessening the importance of those current objectives. * SRO Rulemaking Function Split from Enforcement/ Surveillance Function. The provision would require the DEA to enforce other SROs' rules. While an SRO has considerable incentive to enforce its own rules, its incentive to enforce the rules of other SROs may not be as strong. For example, one exchange's rules with respect to market manipulation are critical to that exchange's operation and reputation, but another exchange might have less incentive to make the enforcement of such rules a priority. Currently, SROs monitor trading activities on their own exchanges. The bill, however, appears to require the DEA to monitor trading on all SROs. This could be costly to the SROs, and could be significantly less effective than the current system. * NASD Role. The NASD currently takes responsibility for sales practices in several areas, including corporate underwriting, limited partnerships, municipal securities, government securities, and mutual funds. It is not clear whether such centralized administration would continue under the bill. Commission Recommendation -- Designation of Primary SRO and Examining Authority. Duplicative and overlapping examinations impose unnecessary burdens on broker-dealers (and represent an inefficient use of regulatory resources). Accordingly, in recent years, the Commission has placed new emphasis on coordinating examinations of broker-dealers and eliminating areas of duplication. For example, the Commission recently created an Office of Compliance Inspections and Examinations to coordinate better the agency's own examinations, and has begun working with the SROs in an effort to encourage cooperation among SROs in scheduling examinations. The Commission also intends to convene a regular "Planning Summit" where the Commission, the SROs, as well as the states will work towards, among other things, better coordination -------------------- BEGINNING OF PAGE #45 ------------------- in this area. These efforts will continue and should alleviate the chief concerns of market participants. Such efforts should make many, if not all, of the aspects of this provision unnecessary. The Commission believes that these initiatives may be preferable to legislation at this time. Moreover, as indicated above, the Commission believes that several aspects of the provision may have broad and unintended consequences for the Commission's own examination and oversight authority with respect to broker-dealers. Section 13: Treatment of Press Conferences Section 13 of the bill would amend the definition of "offer" and "offer to buy" to exclude press conferences, press releases and meetings between issuer press spokespersons and journalists associated with publications having a general circulation in the United States. It also would amend the definition of "prospectus" in section 2(10) of the Securities Act to exclude press releases made generally available to U.S. journalists (provided that the press release contains a statement to the effect that it is not an offer and that any public offering will be made only by a prospectus, and specifies the person from whom a prospectus may be obtained). These provisions are intended to eliminate perceived grounds for the exclusion of U.S. reporters from foreign press conferences regarding overseas offerings that are not available to U.S. investors (and, therefore, are not subject to U.S. registration and disclosure). Comments -- Treatment of Press Conferences * Current Law. U.S. securities laws do not require that U.S. press be excluded from foreign issuers' press conferences, meetings, or other press coverage concerning offshore offerings by foreign companies. The Commission already has taken a number of actions under its existing rulemaking authority to address the problems of U.S. press access to information about foreign companies' offerings, including a specific provision in Regulation S which states such contacts do not raise Securities Act registration concerns under certain circumstances. Regulation S, which provides that no registration under the Securities Act is required for offshore offerings, specifically states that: Nothing in these rules precludes access by journalists for publications with a general circulation in the United States to offshore press conferences, press releases and meetings with company press spokespersons in which an offshore offering or tender offer is discussed, provided that the information is made available to the foreign and United States press generally and is not intended to induce purchases of securities by persons in the United States or tenders of securities by United States holders in the case of exchange offers. * Effect on Current Law. The legislation would exclude from the definition of offer to sell, and from the definition of prospectus, contacts with the press, even if made by a domestic company with respect to an offering to U.S. investors, and with the purpose of inducing U.S. persons to invest. By removing press releases from the -------------------- BEGINNING OF PAGE #46 ------------------- definition of prospectus, misleading information disseminated through press releases would not be subject to section 12(2) liability. While the stated purpose of the provision is to allow U.S. press equal access to information concerning foreign issuers and their offerings, the provisions appear to go well beyond that purpose. The provisions appear to deregulate communications by all issuers -- foreign and domestic -- as long as they are made through the press, or by press release, even if the communications are made during the course of a U.S. offering for the purpose of conditioning the market for the securities in the U.S. Issuers would appear to have free writing ability through press releases, since press releases with the cautionary "not an offer" language would not be offers or prospectuses. * Concerns of Foreign Issuers. Notwithstanding the Commission's past statements in this area, it may be possible that foreign issuers continue to have concerns about their ability to demonstrate that a communication was not made for the purpose of inducing purchases in the U.S. As noted above, the Commission has rulemaking authority to address these and other concerns. Commission Recommendation -- Treatment of Press Conferences. As noted above, this provision is apparently intended to eliminate perceived grounds for the exclusion of U.S. reporters from foreign press conferences regarding overseas offerings that are not available to U.S. investors. Notably, the Commission and its staff have issued several statements in this area that were intended to assure market participants as to what is and is not required of them. The Commission has rulemaking authority to further address most of the concerns underpinning this provision. The staff of the Commission currently is developing rulemaking recommendations for the Commission to address concerns about access for U.S. journalists to offshore press conferences, interviews, and other news items. The Commission thus believes -- although it is sympathetic to the concerns reflected in the provision -- there is ample room under existing law to resolve these concerns. Moreover, as noted above, the Commission is concerned that the provision as drafted may have certain unintended consequences. Section 14: Repeal of the Trust Indenture Act of 1939 Section 14 would repeal the Trust Indenture Act of 1939 ("Act") on the grounds that market forces currently cause trust indentures to contain many more inclusive provisions than are mandated by the Act. Comments -- Repeal of Trust Indenture Act of 1939 * Current Law. The Act's purpose is to protect investors in publicly offered debt securities by providing for an independent trustee to act on debtholders' behalf in the event of default. The statute itself discusses the adverse effects upon public debt holders when they are not able to take concerted action through an independent trustee acting on their behalf, when the trustee's responsibilities and standard of conduct are not specified, or when the trustee is not entitled to a report of the financial condition of -------------------- BEGINNING OF PAGE #47 ------------------- the issuer.-[36]- The Act mandates various protections for debtholders including the obligations and standards for the trustee. Minimum debtholders' rights, such as the right not to have principal and interest payments (subject to specific exception) waived without the holder's consent also are mandated. Generally, the form of indenture is filed as an exhibit to the registration statement and a statement regarding the eligibility of the trustee is filed as part of the registration statement. The financial terms of the debt, including restrictive covenants and events of default, generally are not regulated by the Act. As such, the Act does not impose any limitation upon the type of debt securities which may be offered or the terms thereof. Among the more significant indenture provisions required for every indenture subject to the Act are those that: * require an independent trustee to represent the debt holders (specified trustee conflicts of interest prohibited); * specify high standards of trustee conduct (duties and responsibilities imposed on trustee both prior to and in case of default); * provide a structure through which debt holders can protect their interests in the event of default on either an indenture covenant or payment of principal or interest; and * provide procedural and substantive protections against inappropriate removal of collateral underlying secured bonds. * Background. In 1990, the Act was amended at the Commission's request to provide the Commission with general exemptive authority, to streamline the trustee conflict provisions and to facilitate shelf registration. The 1990 Amendments required provisions which are automatically included in the indenture, reducing the cost of drafting provisions which satisfy the statute. Similarly, as amended, the Act permits the naming of the trustee to be delayed in shelf offerings until the securities are issued (this removes the most significant cost resulting from the Act -- maintenance of an independent trustee -- until debt securities actually are outstanding). Recent amendments also significantly revised the "independent trustee" requirement to permit consideration of independence only at the time of an event of default, thus permitting a bank to be the trustee with respect to debt securities issued by persons with whom the bank has an on-going relationship. * Effect of Provision on Current Practices. The Act would be repealed. The market may or may not continue to include provisions that equate or expand upon the Act's --------- FOOTNOTES --------- -[36]- The Congressional hearings that led to the adoption of the Act described the significant abuses resulting from the ability of an issuer to replace the collateral for secured obligations with substitute collateral that may be of substantially lesser value. -------------------- BEGINNING OF PAGE #48 ------------------- required provisions. It also is possible that while the market may require the inclusion of provisions which provide protections for certain business events (e.g., "event risk covenants" that give debt holders enhanced rights upon certain adverse financial results), other Act-required protections may not be included. It is not certain that all costs related to the Act will decrease if these requirements are repealed; certain costs may increase for companies if the various rights of debtholders currently mandated by the Act are different (and have to be negotiated, and possibly disclosed) in each offering. Commission Recommendation -- Repeal of Trust Indenture Act of 1939. The Commission would welcome input from industry participants about areas where the Act does or does not work, and how it can be improved. If it appears that fundamental problems exist with respect to the Act's substantive investor protection provisions, the Commission would be willing to undertake a study (as it did with the Public Utility Holding Company Act) to evaluate the continued effectiveness of specific provisions of the Act, and to determine whether an outright repeal or fundamental revision of the Act would be appropriate.-[37]- Prior to completion of such a study, however, the Commission believes that it is not appropriate to recommend the outright repeal or fundamental revision of the Act. --------- FOOTNOTES --------- -[37]- For example, the Commission would be willing to consider the merits of an approach that would permit an offering to be made without a trustee, provided certain conditions were met. Under this approach, a trustee would be appointed on the occurrence of certain "triggering" events only, with the substantive provisions of the conditions included in the debt terms generally.