Mr. CLAFLIN. It isn't quite that blatant because we do inspect these firms quite frequently. If we found that they did not answer one of these questionnaires correctly, I am not sure it would be automatic expulsion, but it would be very close to same.

Mr. MACK. Would you tell me how many cases you have under investigation at the present time, concerning manipulation or artificial stimulation in these instances?

Mr. WHITE. There are two areas you are discussing, one being the enforcement of our own interpretation. At the moment, in 1961, we have picked out 33 issues which have been the subject of questionnaires. We sent out 1,600 questionnaires to underwriters and selling groups in those 33 issues. Because there is a certain amount of disclosure of where these securities go in the first instance, we can check up on the surface accuracy of these questionnaires when they come in. There are some 35 questions on those. We ask not only ones which would point to a violation of our own interpretation, but which would point to other areas we might want to send an examiner

out to look at.

(The following table was submitted for the record by Mr. White:) Total number of "hot issues" and questionnaires investigated for the period of 1956 through March 1961

Mr. WHITE. When we find that on the face of it there appears to be a violation of the interpretation, those questionnaires are referred to the district where the member's principal office is located. We have had in the past 2 years, I would say, a third of all of our disciplinary cases which have arisen in this area. As a result of that activity in 1960, we put into effect a revised interpretation which strengthens and buttons up a lot of loopholes, and we find up until this last batch of questionnaires which have gone out, that we think it has been of great help. On the manipulation end of it, we have had several cases which perhaps could be interpreted as manipulation, but instead we have found it a violation of the free-riding interpretation, rather than go into the manipulation aspect. However, we have inserted in our manual the Commission's staff study in that area. But we don't have any specific free-riding cases where we allege manipulation as such. We have alleged a violation of our interpretation, because the securities either were withheld from the public or they were sold to other broker-dealers or sold to insiders who did not have investment histories to justify the purchase, or in amounts which were disproportionate or substantial.

Mr. MACK. There would be no question, though, about artificial stimulation being a manipulation of a stock?

Mr. WHITE. Do you mean artificial stimulation at the time of the offering or thereafter?

Mr. MACK. I would presume at the time of the offering.

Mr. WHITE. Certainly if we could prove that, we would take action on it, if not under the interpretation, then under the rules of fair practice.

Mr. MACK. At the same time, do you investigate tie-in sales, or is that more difficult to investigate?

Mr. CLAFLIN. Usually you have to be tipped on tie-in sales. In other words, you have to have somebody who tells you that it is tied in. So it is apt to come in from a complaint from a member of the public. But just going in and looking at the records, unless you have been warned, you would have quite a bit of difficulty picking it up in a routine examination. It is a hard thing to catch someone at.

Mr. MACK. What has been your experience with the tie-in sales? Have you had quite a few complaints or tips concerning the tie-in sales which you have investigated?

Mr. CLAFLIN. Actually, I don't know that we have a case on that. Mr. WHITE. We have no case on it. My knowledge of it stems from conversations or the newspapers. By that I don't mean that it probably doesn't exist, but I have no personal knowledge of it.

Mr. MACK. The people in the industry generally are acquainted with the procedure involved, and it seems to be a practice in the industry, but I conclude that your investigations haven't been successful in proving a case.

Mr. WHITE. In that particular area, we do not have a case as yet. Mr. MACK. Could I ask if your investigators in these cases-and we have referred to the hot issues-if the investigators would be out of your central office or do you generally rely on sending the information to your district office and turning the matter over to them?

Mr. WHITE. On that score, normally the district office would handle it. We have had various instances where we have found violations or any given violations, free riding or otherwise, in a particular area, and we will then supplement the staff in the district with examiners from the national office. While they are from this office, they are continually traveling around the country, and we move them from place to place as the need arises. So in that particular instance, if we had some information that it came out of our New York office or Washington office, which indicated some manipulation, we might send specal individuals who were more competent in that area to another district.

Mr. MACK. What have you done about cases where the underwriter or the dealer has reserved blocks of stocks for favored customers? Mr. CLAFLIN. For favorite customers or just reserved it and not offered it?

Mr. MACK. No; for favored customers, with the understanding that the price of the stock would increase and they could unload it at a very early date.

Mr. WHITE. At the present time, the interpretation covers that and they would not be able to withhold part of the public offering for placing with other broker-dealers or friends or insiders of other broker-dealers. That was one of the great areas we did not cover in the old interpretation.

The one in effect now specifically covers that. The Board looked upon that activity as unethical. Now the interpretation covers that. We specifically have covered the area even if it is disclosed. It still must meet the terms of the interpretation.

Mr. MACK. Then you amended your rules to cover this matter?
Mr. CLAFLIN. Our interpretation, yes.

Mr. MACK. What has been your experience with that? Does that not exist today? Do you have cases under investigation where this has been done?

Mr. CLAFLIN. Well, actually that became effective on April 1, 1960, so that a great many of the cases that we have been receiving in the last 6 or 8 months, of course, have been under the old interpretation. We are just now beginning to get cases arising from our new interpretation.

Mr. MACK. It has been in effect for a year?

Mr. CLAFLIN. I think in our examinations we are finding that this has closed many of these loopholes and stopped the practices.

Mr. WHITE. That is correct.

We saw a practice arising even when we put this interpretation into effect, where certain issuers were disclosing an arrangement to allot to insiders, and there was some understanding that this didn't cover it. The language of this covers that arrangement and we have so reaffirmed it, the Board has. So we saw that avenue and we have that covered.

I think that the situation so far is that the number of complaints is going to reduce principally because a lot of the members after reading this have decided they will not sell to insiders or other brokerdealers at all, which is a business decision of theirs. That is the indication we see. We haven't had enough experience with actual examinations yet to know whether the high number of these complaints is going to continue.

Mr. MACK. You probably wouldn't have a complaint if it was offered to a favored customer.

Mr. CLAFLIN. If this favored customer is a member of the public, our interpretation does not cover members of the public. What we are trying to cover is withholding, not offering, to members of the public, or using your stock for commercial bribery and other purposes of that nature, or keeping it yourself. But if it was sold to a member of the public who was not an insider, who was not connected with a financial institution, the sale would be considered all right.

Mr. MACK. Then you have no rule to prohibit any sales to favored customers?

Mr. CLAFLIN. That is correct, as long as they are members of the public.

Mr. MACK. And not insiders?

Mr. CLAFLIN. That is correct.

Mr. HEMPHILL. It occurs to me that you have to have some favored customers to keep up the business, wouldn't you? As a lawyer, if a fellow gives me all of his business, when he calls me on the telephone, I drop everything and attend to his business. I don't see anything unethical in having a favored customer. He is paying the same fee, I suppose, that everybody else is paying. There is no lack of ethics there as long as he is not being defrauded. He would probably have

you on the lookout for good things, would he not? I know if I was a favored customer, I would expect you to be looking out for me.

Mr. CLAFLIN. That is right, and although I haven't given it any thought, I would think superficially that a distribution that was in relation to the business done by a customer during the year would be perfectly sound. If a man is a little customer in your shop, you would probably give him a little allocation, and if a man was a big customer of yours, you would reflect that in your allocation.

Mr. HEMPHILL. If you had some bank stock that you got hold of and you knew John Doaks down the street was a good customer of yours and would like to have some, there is nothing wrong with phoning him and telling him "I have what you want." That keeps his business.

Mr. CLAFLIN. This is really aimed at where a broker-dealer withholds, either by putting in insider accounts or even just straight withholding in the firm account, to make an additional compensation in a new issue because he feels it is going up. He makes the profit instead of giving it to the customer. Or the other side of it, where you put it out to people whose business you hope you are going to influence.

Mr. HEMPHILL. The thing that concerns me is that you have to stay alive, and if you tie this thing up so tight you impede the national flow of business, you do the industry and public a great disservice. We do not want to do a great disservice to the public or to the industry either.

Mr. CLAFLIN. That is right. We have never looked at how they allocate it to the public. We want to see whether it is the public or whether it isn't. We feel a member going into an underwriting assumes an obligation to distribute those securities to members of the public, and that is what we try and determine as to whether he has done that or not.

Mr. HEMPHILL. As long as he serves the public, you have no quarrel with it?

Mr. CLAFLIN. We have no quarrel with it.

Mr. HEMPHILL. Thank you.

Mr. MACK. You investigate to determine whether he is withholding the securities from the market, do you not?

Mr. CLAFLIN. That is right.

Mr. MACK. And then if he distributes these securities to the public rather than keeping them for himself, his family, or colleagues, you would have no objection?

Mr. CLAFLIN. That is correct.

Mr. MACK. They could, of course, manipulate the price by withholding a security and then not taking the profit themselves but passing the profit around to some favored customer, is that correct?

Mr. CLAFLIN. You are speaking of a delayed sale at a later date? Mr. MACK. Yes.

Mr. CLAFLIN. Yes, I can see that. You mean at the original offering price?

Mr. MACK. At the original offering price.

Mr. CLAFLIN. Yes, that is possible.

Mr. MACK. He would be doing that for the benefit of the favored

customer.

Mr. CLAFLIN. We don't see much of that. Maybe you thought of a new way of doing it.

Mr. MACK. That wasn't the purpose of the question. In this field, I am not particularly impressed with the fact that they need new ideas.

Do you care to state your opinion on the imposition of additional safeguards regarding credit balances, related customers credit balances?

Mr. CLAFLIN. Is this segregation that you are speaking of, additional credit balances?

Mr. MACK. Well, safeguards to the customers credit balances, yes; to protect the credit balance of the customer.

Mr. CLAFLIN. I am afraid I haven't got the question quite straight. Is this in relation to margin accounts where there is excess equity in the account? Such as loaning of funds?

Mr. MACK. It is segregation of the funds, the credit balance, the balance of customers funds, or commingling of the funds.

Mr. CLAFLIN. I think most of that is stock exchange. I think you are in the area of the exchanges where they have their margin requirements and segregation of funds.

Mr. MACK. This came up in the legislative hearings a year ago, or 2 years ago. The Commission at one time opposed this. I just wanted today to see whether you had any views concerning it.

Mr. WHITE. I think, Mr. Chairman, I recall that it came up a year or so ago. I would certainly like to see what the Chairman then said so that I would see what our comments were. I don't recall. But I think we considered that a matter for the stock exchange and I think we commented on it, but I don't recall what our comment was. It is in the record of the meeting.

Mr. MACK. Then in regard to the margin requirements, do you have any views concerning the credit granted by various institutions, such as banks, in purchasing your securities?

Mr. CLAFLIN. Well, of course, banks are not in the same stream of policing, or whatever the proper term, but they are allowed to do things that we are not allowed to do. I am sure I am not qualified to discuss the Federal Reserve position on this, and whether they ought to be doing something they are not. As far as we are concerned, of course, we are not allowed to loan money on our over-the-counter securities anyway. It is a problem that really doesn't come up with

us.

Mr. MACK. Presently there is no limitation on the amount of loans for securities purchased over the counter, is that correct?

Mr. CLAFLIN. Are you speaking of the banks or brokers?

Mr. MACK. No, the banks.

Mr. CLAFLIN. No, there is no limit that I know of.

Mr. MACK. In other words, it has to be listed securities. The limitation is on the listed securities?

Mr. BURNS. That is right.

Mr. HEMPHILL. It is my understanding, to air out the thing he is exploring, that most of the States have trust laws defining the purchase of stocks or bonds from trust funds to certain types. Isn't that so generally?

Mr. WHITE. That is for purchases by a trustee or fiduciary.