Stock Exchange Regulation

The greatest criticism which has been leveled against specialists, and apparently the evil at which this section of the bill is aimed, is that they are allowed to buy and sell for their own account the stocks in which they accept orders from others. Most people believe this allows a specialist to trade against the orders which have been entrusted to him and, therefore, he is buying and selling to the disadvantage of his customers. This, of course, is not true.

For many years the rules of the exchange have prohibited a specialist from trading against his customers' orders. He is allowed to take stock or to supply stock on orders which have been entrusted to him only when the price is justified by market conditions and when the broker who gave him the order has been sent for and approves the transaction. Furthermore, before executing any such transaction, the specialist is required to bid and offer in the open market at the lowest possible differential away from his order before he can either take or supply stock on orders entrusted to him. This open bidding and offering insure the fact that no better price could be obtained for the customer. It has frequently been suggested that we should prevent specialists from dealing for their own account. We have been unwilling to adopt such a rule because we are convinced that the transactions of specialists make for a closer and better market which, in the last analysis, is greatly in the public interest. It frequently happens, for example, that the best bid and offer, even in well-known stocks, are a point or more apart. At such times a stock may be quoted at 30 bid and 32 offered. In this situation, if the specialist were not allowed to trade a buying order could not be executed except at 32, and no selling order would realize more than 30. The custom of the specialist is to buy and sell in between the bid and offered prices and, in the example which I have suggested, he would probably make a market at 30%-offered at 311⁄2. In other words, he would be willing to buy stock half a point above the best offer made by others and to sell stock half a point below the price at which others were offering to sell. This would give to the public an advantage of an approximate average price between the bid and the offer.

I do not see that this operates unfairly to the persons who have entrusted orders to the specialist, because they themselves have limited the price at which they are willing to buy or sell. I know critics have said that if the specialist did not trade the person who had entrusted his order to him would realize his price and they imply that, from this point of view, the trading of the specialist is a disadvantage to his customer. This may be theoretically true, but this argument entirely overlooks the fact that the advantage which this customer gets is at the expense of some other member of the public. As I pointed out in the example above, if a specialist were not allowed to trade when the market was quoted at 30 bid, 32 offered, any person buying would have to pay 32, while any seller would realize only 30. The specialist by trading gives the public a fairer price than would otherwise be realized and this is of value to all persons who are buying or selling securities.

It is, likewise, commonly believed that specialists by reason of the information which they secure from the orders entrusted to them have a great advantage in trading for their own account. thing, the contrary is true, because the specialist is bound to execute

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his customers' orders before he may trade for his own account. As a practical matter, he cannot refuse to accept orders and, therefore, when he trades he runs the risk that he may receive additional orders that will prevent his changing his position until after the market may have moved against him. The best proof that specialists do not have a tremendous advantage over the public and other members, is the fact that the officers of the exchange have, on many occasions, had to persuade members to act as specialists even in important stocks. While it is possible that specialists might take advantage of the information entrusted to them, the chance of their successfully doing so is remote. Their work is necessarily performed on the floor of the exchange under the constant scrutiny of the other members who have entrusted orders to them. These members are naturally interested in seeing that their orders are executed at the best possible price and they are quick to report to the governors of the exchange any transaction which is, in the least degree suspicious. When specialists trade between the bid and offered prices, they have a chance of making a profit out of small differences, but in order to do so they assume very definite risks.

There is another aspect of the work of specialists which is overlooked by critics of the exchange and that is the obligation on the part of a specialist to take full responsibility for any errors or negligence on his part. If a specialist fails to execute an order that has been entrusted to him when he has a reasonable opportunity of doing so, then he must, at the election of his customer, either take the transaction for his own account or cancel it. In other words, when a specialist makes an error the customer has the election to insist that the transaction be carried through if it is to his advantage or he may, if the market has turned against him, require the specialist to cancel it.

I would like also to call your attention to the devastating effect which the prohibition against a specialist accepting market orders will have. The function of a specialist is to stand at a particular post on the floor of the exchange and receive from other members such orders to buy or sell as they may elect to send him. Many of the orders so entrusted to a specialist are market orders for immediate execution.

They are given to the specialist because the floor members of firms cannot cover the entire floor. Some firms do not even attempt to execute any orders on the floor but give out their entire business to specialists and floor brokers. If no market order could be executed by a specialist, the delay which would occur between the receipt of an order and the time when a broker could be found who would be able to execute it might be great and would operate to the disadvantage of the customer. It is not unusual for a large house to receive market. orders in 300 or 400 different issues, all of which are to be executed at the opening of the market. If each large house had such a volume of orders, the number of brokers required to execute all of them promptly would run into the thousands. The membership of the exchange could not be increased so as to meet this situation because, although the floor of the exchange is one of the largest in downtown New York, it is already overcrowded by the approximately 800 members who are present almost every day. As a practical matter, this prohibition would be so unworkable that the market would be completely disorganized. Specialists make, in a certain sense, a market within the

market and the concentration of the buying and selling orders which are entrusted to them makes it possible for all orders to be executed quickly and at the price then prevailing in the market. In ordinary times, an order is executed within a minute or two of the time when it is received on the floor. Any such rapidity of execution would be impossible if specialists were forbidden to accept market orders and this would naturally operate to the disadvantage of investors and the public in general.

This section, likewise, includes a prohibition against specialists disclosing the orders which have been entrusted to them, unless such information is available to all members of the exchange. On February 13, the governing committee of the New York Stock Exchange adopted a rule prohibiting specialists disclosing the information contained in their books to anybody except a member of one of the standing committees of the exchange, acting in an official capacity. Sections 11, 12, and 13 of the bill deal primarily with questions which affect listed corporations. Section 11 requires, among other things, every corporation listing securities on the Exchange to file a registration statement with the Federal Trade Commission.

Mr. MARLAND. Mr. Chairman

The CHAIRMAN. Mr. Marland.

Mr. MARLAND. Mr. Whitney, if I may ask you a question

Mr. WHITNEY. Yes, sir.

Mr. MARLAND. Why could not a clerk on the exchange perform all of the duties that a specialist performs?

Mr. WHITNEY. Well, there is one particular reason why he could not, sir; and that is because of the responsibility involved upon the specialist. Who would be responsible for the clerk's actions?

In other words, if an order is received upon a specialist's books, to buy and sell, or an order to sell at a particular price, and, as I have said here, the market goes through that price, and the specialist misses it inadvertently, at the election of the customer, that stock must be put into him if it is a buying order, or taken from him, if a selling order. That can involve countless thousands of cases involuntary per week, and if it were a clerk, who would do this work, where could the responsibility rest?

Mr. MARLAND. Under your rules the specialist has no room for the exercise of judgment in executing his orders, has he? It is almost a machine proposition?

Mr. WHITNEY. No, sir; under our rules, he may exercise all and every judgment that he may care to take, the responsibility being his, and any such rule as that would prevent any exercise of judgment, because in the event that the judgment were wrong and he had to take or supply stock on his order because of that fact, he would or he then becomes or is in a position of being a dealer in those particular securities.

Mr. MARLAND. Well, do you feel that a clerk of the exchange could not perform the duties of the specialist?

Mr. WHITNEY. No, sir; because of the point of view of responsibility.

In that connection, also, sir, that involves actual trading. Naturally the specialist trades at all times with other members of the exchange.

Mr. MARLAND. Trading or executing their orders?

As

his customers' orders before he may trade for his own account. a practical matter, he cannot refuse to accept orders and, therefore, when he trades he runs the risk that he may receive additional orders that will prevent his changing his position until after the market may have moved against him. The best proof that specialists do not have a tremendous advantage over the public and other members, is the fact that the officers of the exchange have, on many occasions, had to persuade members to act as specialists even in important stocks. While it is possible that specialists might take advantage of the information entrusted to them, the chance of their successfully doing so is remote. Their work is necessarily performed on the floor of the exchange under the constant scrutiny of the other members who have entrusted orders to them. These members are naturally interested in seeing that their orders are executed at the best possible price and they are quick to report to the governors of the exchange any transaction which is, in the least degree suspicious. When specialists trade between the bid and offered prices, they have a chance of making a profit out of small differences, but in order to do so they assume very definite risks.

There is another aspect of the work of specialists which is overlooked by critics of the exchange and that is the obligation on the part of a specialist to take full responsibility for any errors or negligence on his part. If a specialist fails to execute an order that has been entrusted to him when he has a reasonable opportunity of doing so, then he must, at the election of his customer, either take the transaction for his own account or cancel it. In other words, when a specialist makes an error the customer has the election to insist that the transaction be carried through if it is to his advantage or he may, if the market has turned against him, require the specialist to cancel it.

I would like also to call your attention to the devastating effect which the prohibition against a specialist accepting market orders will have. The function of a specialist is to stand at a particular post on the floor of the exchange and receive from other members such orders to buy or sell as they may elect to send him. Many of the orders so entrusted to a specialist are market orders for immediate execution.

They are given to the specialist because the floor members of firms cannot cover the entire floor. Some firms do not even attempt to execute any orders on the floor but give out their entire business to specialists and floor brokers. If no market order could be executed by a specialist, the delay which would occur between the receipt of an order and the time when a broker could be found who would be able to execute it might be great and would operate to the disadvantage of the customer. It is not unusual for a large house to receive market orders in 300 or 400 different issues, all of which are to be executed at the opening of the market. If each large house had such a volume of orders, the number of brokers required to execute all of them promptly would run into the thousands. The membership of the exchange could not be increased so as to meet this situation because, although the floor of the exchange is one of the largest in downtown New York, it is already overcrowded by the approximately 800 members who are present almost every day. As a practical matter, this prohibition would be so unworkable that the market would be completely disorganized. Specialists make, in a certain sense, a market within the

market and the concentration of the buying and selling orders which are entrusted to them makes it possible for all orders to be executed quickly and at the price then prevailing in the market. In ordinary times, an order is executed within a minute or two of the time when it is received on the floor. Any such rapidity of execution would be impossible if specialists were forbidden to accept market orders and this would naturally operate to the disadvantage of investors and the public in general.

This section, likewise, includes a prohibition against specialists disclosing the orders which have been entrusted to them, unless such information is available to all members of the exchange. On February 13, the governing committee of the New York Stock Exchange adopted a rule prohibiting specialists disclosing the information contained in their books to anybody except a member of one of the standing committees of the exchange, acting in an official capacity.

Sections 11, 12, and 13 of the bill deal primarily with questions. which affect listed corporations. Section 11 requires, among other things, every corporation listing securities on the Exchange to file a registration statement with the Federal Trade Commission,