John T. Potratz, President
Researched Investments, Inc.
700 Fifth Avenue, Suite 5505
Seattle WA 98104
April 22, 1998
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
Mail Stop 6-9
450 Fifth Street, N.W.
Washington, D.C. 20549
Subject: File No. S7-3-98
Re: Comments on Proposed Rulemaking
Overall comment: Nice try; please don't adopt
This letter is in response to a request for comments on SEC Release No. 34-39670 which proposes certain changes to Rule 15c2-11. As an investor, I appreciate and thank you for the initiative you are undertaking to improve the efficiency and quality of the securities market.
My perspective starts from the following:
"Section 3(f) of the Exchange Act requires the Commission, when engaging in rulemaking, to consider or determine whether an action is necessary or appropriate in the public interest, and whether the action would promote efficiency, competition, and capital formation. (cf page 9673) "
As background, I have been investing since I was 7 with money saved from mowing lawns, and am now 50 years old. I currently own my own Investment Advisory firm registered with the State of Washington, and am writing this letter both from my firm's viewpoint and also as an investor. I have been professionally involved as an Investment Advisor, stock broker or equity analyst for the last 15 years, and I love the work. I focus on the inefficient market of small capitalization stocks, and taxable and tax-free bonds. Thus, the SEC's proposed rulemaking deals with the focus and love of my life. I will likely be significantly affected by the outcome of this rulemaking.
A continuing concern I have had, and I believe will continue to have, is sufficient market liquidity for securities, both stocks and bonds. I mean this to be firms which are willing to buy and sell securities from their positions. Without these firms, I would be unable to buy and sell those securities which I use for both my clients and my own personal portfolio. The SEC rules and regulations have provided a necessary framework within which business has been conducted. But they are burdensome in the information requirements when I have sought market makers to make a market and trade securities. I have been successful for my clients and myself in spite of some of the rules and regulations, and accept them as part of a regulatory framework to protect the general investing public from fraudulent activity. I believe the system is working fairly well.
The burdensome aspect arise from the difficulty of obtaining information from many of the companies. (The SEC seems to assume that much of this information is easily and readily available - a perspective which doesn't reflect the real world.) And if the data is obtained, it is time-consuming maintain the files up-to-date, let alone the requirements that are outlined in the proposed rule changes.
Remember, there are hundreds of legitimate companies with outstanding stock that have come into existence in our capitalistic society. They provide important services which are the thread that bind the fabric of our society together. Each company needs to provide a ready market for their stockholders. And they can be the microsized to the 300 million microcap stocks discussed by the proposed regulations.
For instance, I owned more than 1,000 shares of the public utility, gas distribution company, Concord Natural Gas (now part of EnergyNorth), which serves Concord, N.H., the State capital of New Hampshire. With just 22,000 shares outstanding, the market capitalization was just under one million dollars. Should not a company that provides the energy to heat the State government be provided a readily available market for its stock? It took me several years to accumulate my position, with sometimes years between purchases. What market maker has the time to keep updated files for stock which hasn't traded for maybe several years?
And then there were my purchases of Northern Utilities (now part of Bay State Gas - BGC) which public utility provided natural gas distribution to parts of New Hampshire and Maine, including Portland, Maine. It's market capitalization was not much more than Concord.
And we could include Concord Electric (now part of Unitil), Concord, N.H., or Mt. Carmel Electric, Mt. Carmel, Il, as other utility stocks which I have owned. I could expand my examples to other industries, such as manufacturing, hydroelectric, etc.
Approaching this topic from another perspective, I don't believe the proposed regulations will thwart fraud in the securities business. My observation from reading the Wall Street Journal is that the bigger frauds are perpetuated by people whose lies and deception often pass the scrutiny of auditors. If this fraudulent behavior is not found out by highly trained auditors, how is that you expect brokers whose training and experience is entirely different to uncover and be responsible to uncover the fraud? It seems that you are either setting up legitimate brokers to be victims or make them liable for just about anything such that it would be imprudent for them to make markets in securities.
Related to these rules, brokers need to be able to quote prices. Without price discovery, I believe that liquidity, efficiency, and fairness/competitiveness have been and will continue to be seriously hampered. For instance, I have requested brokers to get into the pink sheets to try and buy specific securities. I have provided a price level at which I would be interested in buying the security, and have received a commitment from the broker to reflect my price level if someone requests a bid. Subsequently, I will find that Bloomberg shows a trade for this security has occurred, but at a price level that is below the level that I have requested the broker to bid the stock. When I inquire to the broker, I learn that he hasn't even quoted the stock for sometimes several days! Were it a one time event, I would not be concerned. But it isn't. Thus, my experience is that lack of price quotes is unfair to both sellers and buyers: sellers are getting less than they might, and I am not buying stock that I want.
I conclude that the proposed regulations would result in even less price quotes, which would make the markets even less liquid, less efficient, and less competitive, thereby impeding capital formation.
Also, I believe that the SEC starts off with a fundamentally flawed perspective in its statement (page 9662):
"The Commission recognizes, however, that not all securities traded in this market sector are tainted by fraud"
I interpret this comment to mean that the SEC presumes a priori that each security is tainted by fraud. This seems to say guilty until proven innocent.
Yes, the world is imperfect, and fraud, unfortunately, exists. But let us not damn the whole world for the sins of a few. In general, the people I have known over the forty plus years I have invested try to do a fair and reasonable job.
Instead of these unrealistic, costly proposed rules, I would recommend a warning label of microcap purchases similar to what are on cigarette packages, as:
Warning. Small capitalization stocks, of which this is one, have a high amount of risk, and hence, are suitable only for experienced investors.
In conclusion, based on my experience and personal observation, I believe the goal of the SEC to prevent fraud in the securities market is laudable, but the proposed regulations are so misdirected and inappropriate as to thwart the directive stated in the second paragraph of this letter. And if the stated goal of the SEC is achieved, it will be by chance, not because of better regulation.
Very truly yours,
John T. Potratz, CFA
Following are responses to specific questions:
Q39. I agree that there should be full disclosure of any relationships between broker-dealers and other parties.