cumstance. I underline theoretical because, in our experience with really almost no exceptions, that-the number or percentage of persons voting proxies is not so great as to result in any disenfranchisement as a result of short-selling activities, recognizing again that short selling is a fairly small percentage of a company's outstanding shares with very few exceptions.

So I think beyond that, without a requirement to deliver the shares, while those positions are marked to the market and margined, there is more leverage built in than when you build in the requirement that the shares actually are delivered, and there is a potential to create, I think, a greater risk over time of a short squeeze because of the larger short interest that may again result in artificial impact when those shorts do have to buy back in.

So I think some reasonable controls over the delivery process is a sensible way to make sure you have markets that are fair and orderly and do ensure that customers are protected.

So I guess that is a long way of saying I agree with you. I think that is an area-that is the correct area, really, to be looking at with respect to regulation.

Mr. Cox. I thank you.

Mr. BARNARD. Thank you, sir.

Mr. Sturc, in response to question 5, which the subcommittee posed-I think it is on your page 24-your statement indicates that prepublication trading of the type that we suggested, would not necessarily be a violation of rule 10b-5.

What other circumstances would have to be added to that scenario for it to be a violation of rule 10b-5?

Mr. STURC. Presently, Mr. Chairman, the circumstance could be a violation of rule 10b-5 if there was evidence that there was a disclosure by-let's say the newspaper reporter-to a person buying or selling stock, in breach of a duty that the reporter owed to the publication, that there was a benefit to the reporter from the disclosure, and that the information was material to the marketplace. That is the case law as it exists today, although the Supreme Court, I should add, split 4 to 4 on that in the Carpenter case, in the Wall Street Journal case.

To charge that beyond that fact pattern, I think one would have to eliminate the obligation of a duty; that is, the obligation that the newspaper have a policy against advanced disclosure and eliminate the issue of benefit; that is, whether or not the reporter benefited from the disclosure directly or indirectly.

Those are, I think, the essential changes we may need to make to broaden the prohibitions on disclosure and trading. Whether or not, given the first amendment issues that are involved, as a policy matter that might or might not be wise, of course, is something that would have to be studied with great care.

Mr. BARNARD. Has the SEC looked into allegations that short sellers routinely conduct this type of prepublication trading?

Mr. STURC. We certainly did consider that possibility with respect to the Carrington case, Chairman Barnard. As I have indicated, we concluded not to pursue it further because it was not clear to us that the information had a material market effect and, in addition, the information that was contained in the articles was substantially accurate and had not previously been disclosed and that,

frankly, made it an unappealing case. It made it look a lot like the Dirks case, which, as you know, we lost rather resoundingly in the Supreme Court in 1983 under very similar facts.

Mr. BARNARD. Mr. Ketchum, do you find this activity of prepublication trading troublesome to the marketplace from a market regulation standpoint?

Mr. KETCHUM. Yes, I think that any activity that is based in one way or another essentially on misappropriation of information or taking advantage of information that an article is coming out is troublesome. It can expose both market professionals to greater risk that can impact liquidity and can result in customers effecting trades without having access to the same information as the person on the other side of the trade.

Building efficient and liquid markets, you try to avoid that whenever you possibly can, so yes, it does have an adverse impact on the market, and it is why I think clearly we support careful examination of those cases, to see whether persons have been taking advantage and whether or not the person involved in the trading had some duty that is actionable.

I would note, Chairman Barnard, that under self-regulatory rules with respect to their broader ability to set standards with regard to just and equitable principles of trade, it may be possible-and indeed, I know at least one self-regulatory organization is looking at cases involving theories of this sort-to bring cases regarding trading on information, even when they may not meet the duty analysis that has been required for misappropriation under the securities law, so▬▬

Mr. STURC. Mr. Chairman, if I could just add one thing. I mentioned the Wall Street Journal case. There were a number of securities involved in the case, and there were situations in which Mr. Winans' confederates sold short prior to publication of his stories in the Wall Street Journal. So the Commission has brought cases of that type.

In addition, the Commission recently has brought a series of cases alleging prepublication abuses with respect to stories appearing in Business Week. So it is a problem of which we are acutely

aware.

Mr. BARNARD. Mr. Ketchum, are you familiar with the Michael Foods letter?

Mr. KETCHUM. The Michael Foods letter? No, sir, I don't believe I am. Is that an interpretive letter of ours or no, I am sorry. I am not familiar with it.

Mr. BARNARD. Let me just go back and get the record on that. OK. This was a letter that I had—

Mr. KETCHUM. The one you quoted in your opening statement? I am sorry, I just didn't recognize it.

Mr. BARNARD. It actually wasn't furnished to you ahead of time. Let me just repeat some of it so that you-in this letter it says, "An example of distortion by short sellers is a situation which occurred where a short seller contacted a supplier of equipment. The supplier accurately told the short seller that we had canceled the order." You remember that illustration I brought out?

Mr. KETCHUM. Yes, I recall that quote in your statement.
Mr. BARNARD. All right.

In that regard, we view the stock market as principally a market for entrepreneurs to raise new capital, and when it does this fairly and efficiently, it is truly the financial engine for American entrepreneurs. That goes without saying.

However, there is some concern that continued repetition of the kinds of distortions and other practices described by this Michael Foods' letter may seriously interfere with the fairness and efficiency of this market for small, startup companies. So the obvious question is, is this the way you think the market should work?

Mr. KETCHUM. Well, no, to the extent that the allegations, which obviously none of us had an opportunity to look at, are true. It is not the way the market should work, nor do I think that there should be an assumption that the Commission or self-regulatory organizations have no weapons to respond to false statements made in the context of suppliers' financing or otherwise to the extent that that is part of the scheme-short-selling scheme to manipulate the price of the market.

I believe in those circumstances, what could be demonstrated as a part of a scheme-that we do have the ability to respond and should respond. Obviously, in these particular facts, they-to our knowledge, they haven't been communicated to either the Division of Market Regulation or Enforcement or any self-regulatory organization, so I can't speak to those.

Mr. BARNARD. I am going to leave that subject. I think that we have pretty well discussed those abuses, although we may follow up with some further questions about them.

I do have one more question, Mr. Sturc, about the American Stock Exchange Surveillance Report, where they said that they did not have the jurisdiction to gather information about certain key parties, and the American Stock Exchange recommended that the SEC continue the investigation. According to our information, the SEC has not done any followup investigations. Is that correct?

Mr. STURC. I don't believe that is correct, Mr. Chairman. We, indeed, briefed your staff on that several days ago. What we did do, with respect to that and following it up, was, one, request additional data from the issuers as to the source of the alleged rumors, which they were unable to specify; and second, we contacted the analysts who followed the stock for the three companies to determine if they had heard the rumors, and if so, from where.

We then made an evaluation as to whether the case was worth pursuing. The problem that we encountered was twofold. One, with respect to the source of the rumors, it was very difficult to pin down. The rumors were very generalized, and it was not at all clear that they had any effect on the marketplace.

Second, with respect to each of the companies, each of them had, during the period of the alleged manipulation, serious financial problems which could well have accounted for the decline. So in balancing our resources available against the likelihood of proving a case in court, which is how we have to evaluate these cases, we determined to put the matter on an inactive status pending the receipt of further information.

Mr. BARNARD. Mr. Ketchum, do you believe that shareholders have a right to abstain from casting a specific vote in a shareholder

vote if they wish their own shares to be recorded as being strictly neutral?

Mr. KETCHUM. I think that would be entirely a matter of State law, so I don't have a clear view on that as to-but I think generally speaking, the abstention does not in itself have any impact on shareholder votes, so I am not sure that it would be an effective move by shareholders.

Mr. BARNARD. What you have told us in your prepared statement is that brokers can provide votes to the customers whose shares are lent out to short sellers by letting them use the proxies of some other shareholders who choose to abstain.

Do you feel like this is right if they choose to abstain?

Mr. KETCHUM. I think there are two separate questions there, Chairman Barnard. I certainly-indeed, I guess, as one of the recommenders of rule 19c-4, that tried to assure that shareholders were not disenfranchised as a result of corporate action, that I believe strongly in the importance of the shareholder franchise and exercising that franchise.

I guess personally I would hope that everyone voted their shares. From a probabilistic standpoint, I think we recognize that, perhaps with the exception of very extraordinary proxy fights, nothing near to that is going to happen, just as nothing near to a 100-percent vote in our democratic elections are going to happen. Our point in that question was simply to recognize that while there is a clear theoretical problem over voting as a result of stock-lending practices, that that problem, to my knowledge, has not occurred virtually at all. I am only aware of one circumstance where there was at least a question that it may have occurred.

Indeed, even if it did occur, there are capabilities for a brokerdealer to respond to it by recalling their stock loans or otherwise borrowing stock in order to become the registered owner again of the securities.

So, as I weigh that, compared to the critical importance of stock lending in order to provide efficient marketplaces, recognizing that there are hundreds of structural reasons why there will be fails in the market and looking overseas at the absence of efficiency of a number of European markets that don't have developed stock-lending capabilities, I guess my reaction is I don't think that that concern, which is a legitimate one, rises to a level that I would want to significantly change the stock-lending process.

That doesn't mean that questions over disclosure aren't reasonable to look at, and we shall look at them, but I don't think it has been a practical-had a practical adverse impact on shareholders today.

Mr. Cox. Excuse me, Mr. Chairman, I didn't understand the answer to your question. I understood the chairman's question. He was asking about a shareholder who makes an affirmative decision to abstain.

Mr. KETCHUM. I guess my reaction is anybody should have the right to vote or not vote, whether that be a democratic election or not. I might not approve of it, but I don't think-

Mr. Cox. And so I wonder, you are not addressing the situation where the proxy card says yes, no, or abstain and somebody completes a proxy and checks abstain?

Mr. KETCHUM. No. I think that is-

Mr. Cox. If that were the case, then someone would have the Mr. KETCHUM. That would be passed through, and I am not aware of any circumstance where it hasn't been.

Mr. BARNARD. But on the other hand, if-OK, I am with you. OK.

So, in other words, what you are saying is that if a stockholder chooses to abstain, there is no-his shares will not be voted?

Mr. KETCHUM. I think there could be—and I apologize if I misunderstand your question, there needs to be distinguished a situation in which a stockholder has actively chosen to abstain and forwarded a proxy versus simply chosen not to vote, which is a substantial percentage of stockholders. All we have suggested in our comment is that as a result of the fact that a substantial percentage of stockholders do choose not to vote in proxy contests, we haven't had a practical problem regarding stock lending as to anybody who wishes to vote having those votes counted and passed through.

Mr. BARNARD. But a person who chooses to abstain-there is no guarantee that his shares will not be voted if they are being loaned to a third party?

Mr. KETCHUM. Again, I think you have to separate out two different things, which is the rights of a beneficial holder and the rights of a record holder. State law really governs corporate voting. State law says that the vote goes to the person who is the record holder. In any security held by street name, that would normally be the broker-dealer. Where the broker-dealer lends it to another party, that other party becomes the record holder. So that person, by State law, has the right to vote.

Separately, the Securities Exchange Act and Commission rules have imposed an obligation to make the whole system work in a fair manner for broker-dealers or banks to pass through those votes where they are the record holders, but where the beneficial holders are you and I. They are required to do that by either passing through the proxy or by getting an indication of the manner in which the person wishes to vote on all issues before the meeting and then effecting proxies to reflect the views of its beneficial hold

ers.

All of that happens. It is really a twofold-so I don't think anyone is voting anybody else's shares. Under State law, your right to vote is only if you are a record holder. The question is whether beneficial holders are getting to maintain their franchise, which is a matter of policy. The Exchange Act and Commission rules attempt to ensure them. I think in a practical standpoint, the answer is, without exceptions, yes, they absolutely are.

Is there a risk that it could happen that they would not? Yes, there is a risk. Is that clearly disclosed in the context where they have wholly owned securities? It is clearly disclosed and required to be clearly disclosed. For margin securities, the risk that their securities are going to be lent is clearly disclosed in print. The issue of voting is not, and I agree with you, Chairman Barnard, that that is an issue that we should look at, although I emphasize that what you want customers to look at when they make a margin lending agreement is the things that really matter to them and the real