SECOND RULE. Trading for joint account.-(a) No member, while on the floor, shall, without the prior approval of the exchange, initiate the purchase or sale on the exchange of any security classified for trading as a stock by the exchange for any account in which he, or the firm of which he is a partner, or any partner of such firm, is directly or indirectly interested with any person other than such firm or partner. (b) The provisions of this rule shall not apply to any purchase or sale (1) by any member for any joint account maintained solely for effecting bona fide domestic or foreign arbitrage transactions, or (2) by an odd-lot dealer or a specialist for any joint account in which he is expressly permitted to have an interest or participation by the 11th or 14th rules, respectively. THIRD RULE. Report of joint accounts.-(a) No member, and no firm of which he is a partner, and no partner of such firm, shall, directly or indirectly, hold any interest or participation in any joint account for buying or selling any security on the exchange, unless such joint account is reported to and not disapproved by the exchange. (b) Such report shall be filed with the exchange by any member, firm, or partner participating in such joint account before any transactions are effected on the exchange for such joint account and shall include in substance the following: (1) Names of persons participating in such account and their respective interests therein. (2) Purpose of such account. (3) Amount of commitments in such account. (4) A copy of any written agreement or instrument in writing relating to such account. (c) Every member, the firm of which he is a partner, and every partner of such firm who is directly or indirectly interested in any substantial joint account for buying or selling any specific security on the exchange, or in any joint account which actively trades in any security on the exchange, shall file with the exchange not later than Saturday of each week with respect to every such joint account existing at the close of business on the preceding Wednesday a report containing in substance the following information, unless such information is reported to the exchange by some other member, firm, or partner: (1) Name and amount of each security purchased or sold during the week ending on such Wednesday on the exchange. (2) Amount of commitments in such account at the close of business on such Wednesday. (3) Any change which renders no longer accurate any portion of the original statement filed under paragraph (b). (d) Every member, the firm of which he is a partner, and every partner of such firm who has knowledge of any substantial joint account for buying or selling any specific security on the exchange or of any joint account which actively trades in any security on the exchange by reason of transactions exe cuted by or through such member, firm or partner for such account, shall file with the exchange not later than Saturday of each week with respect to every such joint account existing at the close of business on the preceding Wednesday a report containing in substance the following information, if known, unless such information has previously been reported to the exchange: (1) Names of persons participating in such account and their respective interests therein. (2) Purpose of such account. (3) Name and amount of each security purchased or sold during the week ending on such Wednesday. (4) Amount of commitments in such account at the close of business on such Wednesday. FOURTH RULE. Discretionary transactions.-(a) No number, while on the floor, shall execute or cause to be executed on the exchange any transaction for the purchase or sale of any security classified for trading as a stock by the exchange with respect to which transaction such member is vested with discretion as to (1) the choice of security to be bought or sold, (2) the total amount of any security to be bought or sold, or (3) whether any such transaction shall be one of purchase or sale. (b) The provisions of paragraph (a) of this rule shall not apply (1) to any discretionary transactions executed by such member for any bona fide cash investment account or for the account of any person who, due to illness, ab sence, or similar circumstances, is actually unable to effect transactions for his own account; provided that such member shall keep available for inspection a detailed record of any such transaction and the grounds for exercising such discretion and shall file with the exchange on August 1, 1935, and quarter annually thereafter a report covering the preceding quarterly period showing the name of each account for which any such transaction was executed, the amount of such discretionary purchases or sales and the grounds for exercising such discretion with respect to each account, or (2) to any transaction permitted under the second rule for any account in which the member executing such transaction is directly or indirectly interested. (c) No member, and no firm of which he is a partner and no partner of such firm shall execute or cause to be executed on the exchange purchases or sales of any security classified for trading as a stock by the exchange for any account with respect to which such member, firm or partner is vested with any discretionary power, which purchases or sales are excessive in size or frequency in view of the financial resources in such account. FIFTH RULE. Trading by member while acting as broker.—(a) No member shall (1) personally buy or initiate the purchase of any security on the exchange for his own account or for any account in which he, or the firm of which he is a partner or any partner of such firm, is directly or indirectly interested, while such member personally holds or has knowledge that his firm or any partner thereof holds an unexecuted market order to buy such security in the unit of trading for a customer, or (2) personally sell or initiate the sale of any security on the exchange for any such account, while he personally holds or has knowledge that his firm or any partner thereof holds an unexecuted market order to sell such security in the unit of trading for a customer. (b) No member shall (1) personally buy or initiate the purchase of any security on the exchange for any such account, at or below the price at which he personally holds or has knowledge that his firm or any partner thereof holds an unexecuted limited price order to buy such security in the unit of trading for a customer, or (2) personally sell or initiate the sale of any security on the exchange for any such account at or above the price at which he personally holds or has knowledge that his firm or any partner thereof holds an unexecuted limited price order to sell such security in the unit of trading for a customer. (c) The provisions of this rule shall not apply (1) to any purchase or sale of any security in an amount of less than the unit of trading made by an oddlot dealer to offset off-lot orders of customers, or (2) to any purchase or sale of any security, delivery of which is to be upon a day other than the day of delivery provided in such unexecuted market or limited-price order. SIXTH RULE. Successive transactions by members.-No member, and no firm of which he is a partner and no partner of such firm shall execute or cause to be executed on the exchange the purchase of any security at successively higher prices or the sale of any security at successively lower prices for the purpose of creating or inducing a false, misleading, or artificial appearance of activity in such security, or for the purpose of unduly or improperly influencing the market price of such security, or for the purpose of making a price which does not reflect the true state of the market in such security. SEVENTH RULE. Trading by members holding options.-No member, while on the floor, shall initiate the purchase or sale on the exchange for his own account or for any account in which he, or the firm of which he is a partner or any partner of such firm, is directly or indirectly interested, of any security classified for trading as a stock by the exchange, in which he holds or has granted any put, call, straddle, or option, or in which he has knowledge that the firm of which he is a partner or any partner of such firm holds or has granted any put, call, straddle, or option. EIGHTH RULE. Record of orders.—(a) Every member or the firm of which he is a partner or any partner of such firm shall preserve for at least 12 months a record of every order transmitted by such member, firm, or partner to the floor of the exchange, which records shall include the name, amount, and price of the security and the time when such order was so transmitted. (b) Every member shall preserve for at least 12 months a record of every order originating on the floor of the exchange given to such member for execution, and of every order originating off the floor, transmitted by any person other than a member, firm, or partner, to such member on the floor, which record shall include the name, amount, and price of the security and the time when such order was so given or transmitted. NINTH RULE. Registration of specialists.—No member shall act as a specialist in any security unless such member is registered as a specialist in such security by the exchange. TENTH RULE. Trading by specialists.-No specialist shall effect on the exchange purchases or sales of any security in which such specialist is registered, for any account in which he, or the firm of which he is a partner, or any partner of such firm, is directly or indirectly interested, unless such dealings are reasonably necessary to permit such specialist to maintain a fair and orderly market, or to act as an odd-lot dealer in such security. ELEVENTH RULE. Joint accounts of specialists.-No specialist, and no firm of which he is a partner, and no partner of such firm, shall, directly or indirectly, acquire or hold any interest or participation in any joint account for buying or selling on the exchange any security classified for trading by the exchange as a stock in which such specialist is registered, except a joint account with a partner of such specialist, a member of the exchange, or a firm of which a member is a partner. TWELFTH RULE. Records of specialists. Every specialist shall keep a legible record of all orders placed with him in the securities in which he is registered as a specialist and of all executions, modifications, and cancellations of such orders, and shall preserve such record and all memoranda relating thereto for a period of at least 12 months. THIRTEENTH RULE. Registration of odd-lot dealers.-No member of the exchange shall act as an odd-lot dealer in a security unless such member is registered as an odd-lot dealer in such security by the exchange. FOURTEENTH RULE. Joint accounts of odd-lot dealers.-No odd-lot dealer, and no firm of which he is a partner, and no partner of such firm, shall, directly or indirectly, acquire or hold any interest or participation in any joint account for buying or selling on the exchange any security in which such odd-lot dealer is registered, except a joint account with a partner of such odd-lot dealer, a member of the exchange, or a firm of which a member is a partner. FIFTEENTH RULE. Options of specialists and odd-lot dealers.-No specialist or odd-lot dealer, and no firm of which such specialist or odd-lot dealer is a partner and no partner of such firm, shall acquire, hold, or grant, directly or indirectly, any interest in any put, call, straddle, or option in any security classified for trading as a stock by the exchange in which such specialist or oddlot dealer is registered. SIXTEENTH RULE. Short selling.—(a) No member shall use any facility of the exchange to effect on the exchange a short sale of any security in the unit of trading at a price below the last sale price of such security on the exchange. (b) The provisions of this rule shall not apply to any short sale (1) by an odd-lot dealer to offset odd-lot orders of customers, (2) by an odd-lot dealer to liquidate a long position which is less than the unit of trading, provided the net change in the position of such odd-lot dealer after any such short sale is not more than the unit of trading in such security, or (3) by any member, with the approval of the exchange, for the purpose of equalizing the price of a security on the exchange with the price of the same security on another national securities exchange which is the principal market for such security. Mr. MACK. On page 5 of your statement, you refer to the six functions of a specialist laid down by the SEC, Trading and Exchange Division in 1937. We would also like to have these six functions included at this point in the record, if you can submit them. Mr. REILLY. Yes. Mr. Chairman. (Information referred to follows:) 1. The function of a member acting as a specialist on the floor of the exchange includes, in addition to the effective execution of commission orders entrusted to him and the performance of his obligations as an odd-lot dealer, the maintenace. insofar as reasonably practicable, of a fair and orderly market on the exchange in the stocks in which he is so acting. 2. The maintenance of a fair and orderly market implies the maintenance of price continuity and the minimizing of the effects of temporary disparity between supply and demand. 3. In connection with the maintenance of a fair and orderly market, it is commonly desirable that a member acting as specialist engage to a reasonable degree in existing circumstances in dealings in full lots for his own account when lack of price continuity in the full-lot market or disparity between supply and demand in either the full-lot or the odd-lot market exists or is reasonably to be anticipated. 4. Transactions on the exchange for his own account effected by a member acting as specialist must constitute a course of dealings reasonably calculated to contribute to the maintenance of price continuity and to the minimizing of the effects of temporary disparity between supply and demand, immediate or reasonably to be anticipated in either the full-lot or the odd-lot market. Transactions not part of such a course of dealings are not to be effected. 5. A specialist's quotation, made for his own account, should be such that a transaction effected thereon, whether or not having the effect of reducing or increasing the specialist's position, will bear a proper relation to preceding transactions and anticipated succeeding transactions. 6. Transactions on the exchange for his own account of a member acting as specialist are to be effected in a reasonable and orderly manner in relation to the condition of the general market, the market in the particular stock and the adequacy of the specialist's position to the immediate and reasonably anticipated needs of the full-lot and the odd-lot market. The following types of transactions to establish or increase a position are not to be effected except when they are reasonably necessary to render the specialist's position adequate to such needs: (a) a purchase at a price above the last sale in the same session; (b) the purchase of all or substantially all the stock offered on the book at a price equal to the last sale, when the stock so offered represents all or substantially all the stock offered in the market; (c) the supplying of all or substantially all the stock bid for on the book at a price equal to the last sale, when the stock so bid for represents all or substantially all the stock bid for in the market. Transactions of these types may, nevertheless, be effected in less active markets where they are an essential part of a proper course of dealings and where the amount of stock involved and the price change, if any, are normal in relation to the market. Mr. MACK. This concludes our hearing. I want to thank you, Mr. McCormick, for your appearance before the committee, and your associates as well. I did not state at the outset of the meeting, but I did want the record to show that you appeared here as a voluntary witness and that you made such a request to appear before the committee. This concludes our hearings on House Joint Resolution 438. These hearings, in my opinion, have demonstrated a serious need for a thorough study and investigation of the rules of the national exchanges and associations, and I intend to do everything in my power to secure early approval of this resolution. This subcommittee will continue its watchfulness over the securities field for the next 18 months. Additional hearings on related subjects will be announced when our schedule permits. Among other things, this subcommittee hopes to visit each of the 13 national securities exchanges in the course of the next 12 months. I want to take this opportunity to thank you for your statement this morning. Mr. REILLY. Thank you, Mr. Chairman. Mr. MACK. The committee will stand adjourned. (The following information was submitted for the record:) Re House Joint Resolution 438. DEAR CONGRESSMAN MACK: Our office from time to time represents persons and companies in the securities field, and we have a continuing interest in legislative proposals in this area. We do not believe that an appropriation of public moneys for further investigations in the field of mutual funds can be justified at the present time, and would therefore recommend that the scope of House Joint Resolution 438 not be expanded beyond its originally stated purpose for the following reasons: First. SEC Chairman Cary has recently stated that mutual funds have been the subject of an intensive study by the Commission over a period of the last 2 years, under a contract with the Wharton School of Finance at the University of Pennsylvania. That study is expected to be completed in the near future, and it should be analyzed before further investigations are launched. Second. In December of last year the SEC circulated to investor advisers, investment companies, and distributors of securities a special questionnaire designed to elicit precise and up-to-date information on mutual fund operations. Third. There is a widespread feeling among investors and investment companies that continuing investigations shake public confidence in mutual funds. In looking over the transcript of testimony before your subcommittee, I was much concerned at the line of questioning developed on the amount of fees paid to investment advisers under the Investment Company Act of 1940. There seems to be a concern with the fact that the amount of fees paid by mutual funds for professional advice and management is not regulated by the Securities and Exchange Commission, apparently with the thought that such fees should be regulated as if management companies were public utilities. This question of management and adviser fees was exhaustively considered by Congress in 1940 when the act was passed. As you know, the original bill recommended by the SEC in 1940 was drafted on the basis of a 5-year study of investment companies. Congressional hearings occupied 21 days during a period of 3 months, and reflected considerable preparation. The final bill was drafted after 5 weeks of intensive work by the SEC and investment company counsel. (Hearings on S. 3580, Senate Banking and Currency Committee, and hearings on H.R. 10065, House Committee on Interstate and Foreign Commerce, 76th Cong. 3d sess. (1940).) After the most careful consideration the present provisions of the 1940 act were thought by Congress to be the best solution. The act is presently construed by the SEC as requiring the board of directors of a mutual fund to assure that adviser and management contracts, which must be approved annually by them or by the stockholders, are fair and equitable. In addition, the independent directors of the mutual fund, that is directors not affiliated with the adviser or management company, are expressly charged with the duty of approving the renewal of such contracts pursuant to section 15 (c) of the Investment Company Act as an alternative to a stockholder's vote. The SEC staff has long taken the position that the directors of a mutual fund have an obligation to determine whether an adviser or management contract with an outside company is to be preferred over the direct assumption of investment operations by the investment company (mutual fund) itself. The general consensus in the mutual fund industry has been for 20 years that the investors and the public are best served by having the highly technical and complicated management services performed by outside professional companies specializing in this kind of work. Likewise, over the years, it has become commonly accepted by the industry and investors that such professional services are best paid for on the basis of a contingent fee of one-half of 1 percent of net asset value. The Investment Company Act of 1940 sets a very high fiduciary standard of conduct for management in the investment company structure. This statute is very elaborately drawn to protect investors in every feasible way consistent with a free enterprise society. The declaration of policies and purposes of the Investment Act, contained in section 1(b) is in effect a codification of general fiduciary duties imposed upon directors, officers, investment advisers, and other controlling or managerial personnel of investment companies. The legislative objective is declared to be to eliminate various enumerated conditions adversely affecting the national public interest and interest of investors. Such documents as Senate Report No. 1775, 76th Congress, 3d session, 1, and House Report No. 2639, 76th Congress, 3d session, 5 (1940), should be reviewed by your subcommittee in this connection. Under section 14 of the Investment Company Act the SEC is presently authorized and required to make a continuing study and investigation of the size of investment companies and its effect on investment policy, on investment companies themselves, on security markets and related matters involving the protec |