his fiduciary relationship to the issuer he must report his securities transactions, disgorge any short-swing profits, and not sell his company's stock short.

Section 8(b) of the bill exempts from the profit recovery provisions of section 16(b) and the short-selling prohibitions of section 16(c) transactions by a dealer which are part of his ordinary trading activities in a company's securities and incident to his establishment or maintenance of a primary or secondary market for those securities. This exemption would permit a dealer to make a market in an over-the-counter security, while at the same time represented on the board of directors and thus available to give advice to the company regarding its financial policies. Abuses by dealers would be dealt with by requiring that they file reports of all transactions and by the Commission's general supervisory power over their trading activities.

Mr. Lowe. Mr. Cary, section 8(b) of S. 1642 would exempt overthe-counter market makers from the insider trading provisions, except that the Commission may, and I quote:

define and prescribe terms and conditions with respect to securities held in an investment account and transactions made in the ordinary course of business and incident to the establishment or maintenance of a primary or secondary market.

Is that correct?

Mr. CARY. That is correct, sir.

Mr. Lowe. The special study, however, after discussing the effects of the application of sections 13, 14, and 16 of the Exchange Act to the over-the-counter market, and after minimizing the effect of sponsorship by those with board representation upon the price performance of stocks, concludes that, and I quote:

A general exemptive provision is unwarranted. If there are truly exceptional circumstances *** such exemption may be provided for by rules of limited scope or on application of the issuer.

It would seem that section 8(b) is in disagreement with the recommendations of the special study group. I wonder if you would agree, and if you do, would you care to explain why the Commission chose to overrule the recommendation of the special study group in this respect?

Mr. CARY. Yes, sir. Mr. Lowe, I think it is fair to say that on this point we have not gone as far as the special study recommended. This problem of sponsorship, as you described it, relates to a person who usually has been an underwriter of securities of a company going public for the first time and who then makes the market in that security, presumably with respect to the persons to whom he sold the stock and to whom other distributors sold the stock. He then becomes what might be called the primary market maker with respect to that security. The sponsor frequently is on the board of directors, and as you indicate, he therefore would be subject to section 16(b).

This is a point on which the industry differed strongly with the study in saying that it is their own experience that in many cases such a market maker was necessary and it was also necessary for him to be on the board. The Commission presently has supervisory authority over dealers; we will also get reports of their marketmaking transactions. Under those circumstances, we decided it would be

proper to make this amendment and offer this relief with respect to the sponsorship problem.

Mr. Lowe. Would this alter the position which the Commission took in Blau v. Lehman?

Mr. CARY. Blau v. Lehman is a different problem, as I see it. Actually, I think what was involved was a security held in an investment account and therefore this does not really relate to sponsorship. I am informed by Mr. Loomis it is not one in which the dealer made the market. It is a listed company and was not an over-the-counter security in which there was just one market maker, so I would say that this particular provision does not bear on the problem created by Blau v. Lehman.

Mr. Lowe. With regard to small business investment companies, the Commission, I believe, in the past has taken the position that directors of small business investment companies should not serve as sponsors or market makers in the stock of these companies. Would section 8(b) of S. 1642 alter that position in any respect?

Mr. CARY. This provision would alter that in this way, Mr. Lowe. If this bill were enacted, it would be an amendment to section 16 (b) generally. Being an amendment to 16 (b) generally, it would be carried over to the Investment Company Act, which of course bears on so-called mutual fund, open-end investment companies, and socalled closed-end investment companies, in which shares are not being regularly issued. Now the closed-end companies include the small business investment companies. Since the Investment Company Act applies or incorporates section 16(b) of the Securities Exchange Act, therefore it would also incorporate the amendment to section 16(b). Thus, under those circumstances, if this bill passed, our construction would be that the relief here given would apply also to market makers in the stocks of small business investment companies. Senator WILLIAMS. All right. Will you proceed?

Mr. CARY. Mr. Chairman, I would like to go on to the other provisions of the registration requirements for over-the-counter companies. Senator WILLIAMS. Is it realistic to feel we could finish this part of the presentation and go over to this afternoon for the next part?

Mr. CARY. I think I can shorten this, Mr. Chairman. At the moment there are really about six more pages, of which I do not think I will read about two of them. Therefore, I think I can shorten this somewhat.

Securities issued by foreign companies and certificates of deposits issued against such securities initially would be exempt from the proposed registration requirements for over-the-counter securities. The Commission could terminate the exemption for a class or classes of such securities only upon a finding that they enjoy a substantial public market in the United States and that continued exemption is not in the public interest or consistent with the protection of investors. These procedures would afford interested companies, brokers, dealers, and investors adequate opportunity to bring to the Commission's attention all relevant considerations. This provision recognizes the difficulties in enforcing the proposed obligations against foreign companies and permits the Commission to deal flexibly with situations where these problems do not exist and in

a manner comparable to that now provided for foreign issues listed on an exchange.

Under section 3(d) of the bill, the Commission would have broad powers to exempt companies, persons, and securities from the reporting, proxy, and insider trading provisions. Exercise of these powers together with a broad authority to classify-will permit a responsible accommodation of the requirements of the public interest with the varied circumstances of over-the-counter securities and their issuers. For example, if there were any company with no business activity or very limited trading interest, it could be exempted from all but minimal reporting requirements.

OTHER AMENDMENTS PROPOSED BY S. 1642

In addition to extending the disclosure protections of the Exchange Act, various provisions of S. 1642 are intended to make the basic disclosure philosophy of the securities acts more effective. A most important one of these, section 11 of the bill, would amend section 4(1) of the Securities Act to extend the present 40-day requirement for delivery of a prospectus by a dealer to 90 days for new issues– a distribution by a company which has not previously sold its securities pursuant to an effective registration statement under the Securities Act of 1933. Section 11 would also empower the Commission to shorten the 40- or 90-day period.

As indicated by the report of the special study of securities markets, during the years 1959 to 1961 the distribution of new issues reached the highest level in history. "Hot issues," usually stocks of companies in certain "glamor" industries, were eagerly sought in the expectation that their price would quickly rise to a substantial premium. Sometimes this expectation was fulfilled, but in many cases the market price of a "hot issue" later fell to a fraction of its original offering price.

The special study found that substantial redistributions of "hot issues" often occurred through trading in the aftermarket. These redistributions were frequently marked by intensive sales efforts by dealers to solicit purchases at high premiums over the initial offering prices. The report of the special study concluded that :

* * * persons who bought in the aftermarket were less sophisticated and more susceptible to the allure of publicity and rumor about "hot issues." These persons, who frequently purchased at premium prices, probably needed the benefits of the information contained in the prospectus more than the original distributees. Yet in many cases they never saw a prospectus or offering circular.

The Commission believes that a period of 90 days is a more realistic appraisal of the time during which the distribution process continues in the case of a new issue. This requirement is, of course, substantially shorter than the 1-year period, which prior to 1954 was required by section 4(1) for delivery of prospectuses for all issues.

This proposed amendment of section 4(1) will not be a cure-all for all the "hot issue" problems. It will, however, assist in the establishment of more orderly and informed trading in the aftermarket. Under this amendment, the Commission also could, where appropriate, shorten either the 40- or 90-day period in the case of

companies for which a reservoir of public information exists. This will permit greater flexibility in the administration of the disclosure requirements of the Securities Act of 1933.

Other sections of S. 1642 would also reinforce the fundamental disclosure principles. Under section 5(c) a company subject to the proxy rules which did not solicit proxies would be required to furnish shareholders with information equivalent to that contained in a proxy statement. The New York Stock Exchange now requires issuers of securities listed on that exchange to solicit proxies each year. The American Stock Exchange has embarked on a program to achieve the same result. However, similar requirements as to listed or unlisted securities are not imposed by other exchanges or by any other authority. Because evasion of the disclosures required by the proxy rules is made possible by the simple device of not soliciting proxies, many stockholders are deprived of material information. This problem would be accentuated by the extension of the proxy rules to over-the-counter securities where nonsolicitation could occur more frequently because of management's relatively larger holdings. Thus, section 5(c) is a necessary step in shareholders in over-the-counter companies, and certain listed companies, are to be assured of informed voting rights.

In addition, section 6(d) would require the filing of reports by any company which offers its securities under a registration statement so long as it had 300 holders of the class of security offered. This section is only a modification of the present law-section 15(d)— which reflects a general congressional intention that a company which goes to the public for funds should not subsequently be free to seal off its operations from disclosure.

Now, Mr. Chairman, I think I can generalize, if I may, about the last two pages prior to the material contained in part 2. These are important but, I believe, limited amendments, and therefore I will not refer to them in any detail. I would just point to several of them and state in one brief sentence what they refer to.

One of them refers to reporting requirements which would obligate reporting listed and over-the-counter companies to file their material contracts-contracts of major importance.

Senator WILLIAMS. Could you amplify that for us?

Mr. CARY. For example, many companies today have a major contract with the Government or with another company to which they are a supplier, which represents a very substantial part of their business. Under those circumstances, the judgment of what that contract involves and the scope of it would be a very important factor in deciding whether the company is a worthy one to invest in, because the company may be dependent on that supplier, for example.

Now, Mr. Woodside, I am sure, with his experience as Director of the Corporate Finance Division, perhaps could amplify further on that point.

Mr. WOODSIDE. Mr. Chairman, the Securities Act provides that when a company sells securities to the public the registration statement prospectus should contain summaries of the material contracts of the company, material to an understanding of the company's business, and copies be filed. The 1934 act, on the other hand, merely provides that contracts with management, management con

tracts or contracts with persons who are connected with the issuer shall be filed. In other words, the scope of the item calling for contract information in the 1934 act is somewhat more restricted than that in the 1933 act. It is our belief from our experience in administering the two acts that the annual reports, for example, of companies reporting under the 1934 act could be made much more informative documents, if there were power under the 1934 act to call for disclosure of the more important contracts of the company.

The basic purpose of this provision is to try to bring the two statutes a little bit more into line with the idea that (1) we improve the disclosure in the reporting of the 1934 act companies, and (2) it may afford a basis for us to move a little more in the direction of trying to integrate the requirements of the two acts, so that perhaps in some fashion companies going to the public under the 1933 act may rely to a greater extent on the material filed under the 1934 act. Mr. LowE. Under the 1934 act would there be filed a summary of the material contract, or the contract itself?

Mr. WOODSIDE. We would have the right to require disclosure by way of a summary of the contract in the annual report, and we would have authority to call for the contract itself as an exhibit to the report.

I might say also that the statutory provision governing confidential treatment of portions or all of a document would apply here to those also, if a showing could be made that public disclosure of some particular part of a contract, or in fact the whole contract, would be prejudicial. In other words, we would have the same flexibility to deal with the business secret or the business confidence or the situation where public disclosure might be detrimental to the company and therefore to the security holders.

Mr. Lowe. A point which the Commission has made with regard to State regulation of insurance companies is that the material filed by these companies with the States is often so bulky that the average investor finds it very difficult to separate the wheat from the chaff. I wonder, in connection with material contracts, if the Commission intends to require filing of the complete contract in all cases and if, therefore, investors seeking information will have a similar difficulty.

Mr. WOODSIDE. I think the answer to that, Mr. Lowe, is simply this. We have had 30 years of experience with this problem under the 1933 act. Initially, I think there was a considerable amount of uproar about the scope of the requirements. I think we have worked it out in a pretty reasonable fashion, and it is no longer, I believe, the problem that it was once considered to be. By calling for a summary of a contract, so that the essential relationship of the subject matter of the contract and the company's business is disclosed in a short, textual fashion, it is only the fellow who really wants to know the details who goes to the document anyway. I just do not think that it is likely to be any more of a problem than it is under the 1933 act, and I think we have largely solved that one.

Senator WILLIAMS. Thank you, Mr. Woodside.

Mr. CARY. Going on further, Mr. Chairman, and generalizing about the balance of the sections to which I referred, there is another section which permits the Commission to make findings that a person has failed to comply with sections 12, 13, and 15(d). This would