The CHAIRMAN. But you have a pretty short time. Go ahead, and speak a little louder, if you please.

Mr. SPRAGUE. In any discussion of the activities of specialists in the New York Stock Exchange, and particularly with reference to operations for their own account, to which attention is now being especially directed, it is important to note that in these operations they are in effect dealers in securities. So before proceeding to an examination of the present bill which refers to this question I feel it would be well to say a few words, in general, on the question of dealers in securities, which would perhaps lead to a somewhat clearer understanding of the subject than perhaps generally prevails.

Now a dealer in anything, be it securities or commodities, who is ready at all times to make contracts to the satisfaction of his customers must certainly possess an economic value, and in a broad securities market of fluctuating prices, dealers who are prepared to absorb the speculative risks incident to such price fluctuations, when the public market is unable to do so, must surely by virtue of this fact act as a stabilizing agent, whose value in the public interest is very real.

Practices on foreign exchanges confirm this observation. On the London Stock Exchange a special class of members, called "jobbers" is designated by exchange regulation. The jobber deals directly with brokers, makes purchases and sales for his own account at prices in which he can make a differential or profit. Brokers customarily do not trade with one another. Transactions are not a matter of published record as with us, direct responsibility for the proper filling of an order does not obtain as we know it, and the ticker tape only records at intervals the prices of a small list of securities. These and many other differences in business would make the English system of dealing in securities unsuitable on our exchanges.

On our own San Francisco Exchange only a few years ago an attempt was made to provide a public market, in which the specialists were prohibited from dealing for their own account. Fluctuations were so wide and the liquidity of the market generally was so seriously affected that this prohibition was soon removed.

I have a telegram from the San Francisco Stock Exchange, in confirmation of this, which reads as follows:

SAN FRANCISCO, CALIF., February 24, 1934-1 p.m. When San Francisco Stock Exchange adopted specialist system May 19, 1926, specialists were prohibited trading their own account. A complete test was given and found inadequate from market as well as public point of view. Specialists were then allowed to trade their own account beginning May 19, 1930. We found this change to be to best interest of public.

SAN FRANCISCO STOCK EXCHANGE,
F. M. DWYER.

There is also a letter from the Los Angeles Exchange which cites similar views.

MR. RAYMOND SPRAGUE,

LOS ANGELES STOCK EXCHANGE,
Los Angeles, February 26, 1934.

39 Broadway, New York, N. Y. DEAR SIR: In connection with your analysis of the "specialist system" in the operation of stock exchanges, the experience of the Los Angeles Stock Exchange may be of interest.

When we first instituted specialists we denied them the privilege of trading for their own account in those stocks for which they acted as specialists. Our rule was conceived under the theory that they were in the possession of certain

confidential information and therefore should not be in a position to take advantage of it. From the inception of this plan studied disapproval began to manifest itself, specialists were so restricted that their very purpose-the conduct of an orderly market—was being defeated. Finally as an experiment, not being willing to entirely surrender the theory upon which our original ruling was based, we decided to permit specialists to trade and now, after several years operation of the "experiment" I doubt that a return to our original plan would even be considered. Our rules are such that a specialist can never place his interests ahead of the public or a member broker and every transaction in which he participates as a principal must have the approval of the interested broker. Through our system of time stamping all orders and executions every action of a specialist is subject to closest scrutiny down to the fraction of a minute and thus far we have found in no instance the necessity for disciplining any specialist for any action detrimental to the public or the exchange. We find our specialists develop a pride in maintaining fair markets which obviously is of real advantage to the exchange, its members and in turn the public.

Trusting this information will be of service to you, I am,

Yours very truly,

W. F. PAUL, Secretary.

The examples cited would seem to demonstrate the fact that a necessary component of a liquid public securities market is a class of persons who are willing and able at all times to entertain commitment for their own account when these commitments cannot be absorbed by the market furnished by public orders in hand, and that by thus providing a liquidity which otherwise would not exist, that such operations are in the public interest.

A specialist on the New York Stock Exchange is both a broker and a dealer. He is both accountable and responsible for the proper execution of every order entrusted to him, and he may make no commitments for his own account at any time or under any circumstances when the interest of any orders in hand would be prejudiced thereby. Regulations of a highly technical character govern all phases of his activities and severe penalties are prescribed for infractions of the rules.

I would like to say that section 10 of the bill practically eliminates the specialist. It would have the effect of driving the competent specialist out of business. The market, therefore, would suffer because of privations, and I will take that up as I go along and explain to you just exactly what I mean.

To go back to the specialists, and what they are, we have had 25 years of bad advertising. The popular description of a specialist is that he is a parasite who just simply feeds on others. I can assure you this is not true.

Men become specialists fer three reasons. One is by choice; the second is by request; and the third is by drafting.

In the matter of choice, a man may elect to act as a specialist. He must provide facilities to handle his business. In my case, I am a specialist in 11 stocks. I am an individual. I require 7 clerks to handle my business, 2 clerks on the floor of the stock exchange; 1 clerk on part time on the stock exchange, and 5 clerks in my office. I refer to 7 clerks because of the fact that the part-time clerk is not included on my pay roll.

The second group, by request, have been where service has not been performed and commission houses find that the specialist is not giving service, and they select a member and ask him to take that position for the benefit of all concerned, particularly the public.

The third are those who are drafted. In many cases it has been necessary for the exchange to supply a man to handle stocks in which

greater volume has developed, and the existing facilities have broken down.

A specialist must be on his job every business day, or have representatives to handle his business for him. He cannot back away and fix his days. He must be thoroughly able to handle his business in every detail. He cannot refuse orders. The refusal of orders would simply put him in a position of inviting competition or driving him out of business entirely.

In the matter of orders, I would like to describe the character of orders, or the three characters of orders:

The market order, the limited order, and the stop order.

The market order in effect says, if you have an order to buy at the market that you buy at the best price obtainable and "to sell" at the market, you must sell at the best price obtainable.

The limited order says "you may buy for my account 100 shares of X at 35 and no more.' Or, you may sell 100 shares of X at 36 and no lower, there are limits on the price.

The third character of order, the stop order, is an order which we enter to buy on stock, on stop at a price above the current market which means that when the price is reached in the market, that order becomes a market order.

A sell order on stop becomes a market order; when the stock sells at or below a designated price.

I do not think that the general liability of the specialist is generally understood. The specialist in accepting an order is, in effect, guaranteeing the contract when he sells stock for an account of a member firm; he must stand behind that contract.

He receives for his work a commission which varies with the price of the stock. There are three scales of commissions, varying from a dollar and twenty-five per hundred to $2.50 per hundred, and $3 per hundred.

Using the middle commission as a basis, I would like to illustrate what that means. I receive an order from a member house to sell 100 shares of a stock at a given price. I sell that stock. The disclosure of that principal's name does not relieve me of the responsibility of that transaction. The liability remains mine until the contract goes through, which by the rules ordinarily would mean that that would be 24 hours. Under the present 2-day delivery, it carries through to 48 hours, and in the event of a transaction made on Friday, the liability carries until Tuesday.

I do not think that that liability has been very stressed. We have been popularly supposed to be just acting as agent and therefore have no liability beyond that. We have restrictions in our own trading. The rules of the stock exchange state that no member while in possession of an order to buy securities at the market, may buy for his own account until that order has been completed.

The rules state that no member of the stock exchange while in possession of an order to sell at the market may sell for his own account, that stock, until his order has been completed.

The rules state that no member while in possession of a limited order to buy at a price may buy for his own account at that price any stock until his orders have been executed. It applies also on the selling side.

A great many times we have heard stresses the fact that the specialist has some particular advantage. That his book discloses to him all of the orders; that thereby he can gage the trend and knows what is going on, and he can take advantage of that to his own probable benefit. That is rather a far-fetched view, in many cases. The market itself very often runs contrary to the trend of the orders. We have seen a great volume of orders on the selling side of the books, and in that market, most of the times stocks rise; we have seen many times when there was a great volume of orders, a great volume of buying orders, and the market would decline through those prices.

I have distributed before you gentlemen three copies of books marked "A", "B", and "C", and in making the comment on what the books disclose, I will say this, they are not synthetic. They are actual books taken from one day of this week's record. They contain every order received or entered that day, or any orders on the books which were open.

I mean by "open", that orders given "good until canceled" are good for a period of time.

Mr. KENNEY. Mr. Chairman

The CHAIRMAN. Mr. Kenney.

Mr. KENNEY. What harm would the specialist suffer if he were stopped from trading on his own account?

Mr. SPRAGUE. I think the question there, Mr. Kenney, is not so much what harm the specialist would suffer. I think it is what harm the general public will receive. I am not trying to be altruistic; neither am I trying to make you think I do not trade on my own account. I do. But, I believe in that.

Mr. KENNEY. Does not the specialist sometimes trade for men of large means, whose transactions do not pass through any brokerage house?

Mr. SPRAGUE. If I understand your question, you mean that he trades directly with members of the public?

Mr. KENNEY. Yes, that he deals on the stock exchange, buying and selling as a specialist, and buys for his own account, which is financed by outside sources, outside funds, by individuals; men of means?

Mr. SPRAGUE. I do not know as I can answer that, except from my own observation that I have not.

Mr. KENNEY. What harm could come to the specialist if he were prohibited from trading on his own account; provided, of course, the he could execute any order coming through the firm of which he is a member?

Mr. SPRAGUE. Just this, that your markets would not be liquid. We have many variations in price, each stock having a different scheme of movement, and in the booklets which I have put before you, I am going to try to illustrate what that means. I would say that as to any particular advantage that a specialist would have in making market in stocks, stabilizing or sustaining the market is, the character of stocks, of all stocks, vary. They are like three children, each one having different characteristics and different reactions, and the specialist being on the scene is of some advantage to him, but the general characteristics and general trend of the market are his chief sources of profit.

Mr. KENNEY. He buys and sells in anticipation of filling some order that comes along?

Mr. SPRAGUE. He buys the stock, naturally, to make profit, if possible.

Mr. KENNEY. For himself?

Mr. SPRAGUE. For himself.

necessary.

He also is performing a service that is

Mr. KENNEY. That profit is over and above his commission?

Mr. SPRAGUE. That is entirely apart from his commission; it does not conflict with his orders. He is bound as I have stated, by the rules of the exchange. On the present rules, he has a right to trade, and he can establish a much narrower market by his services, than the book bid and offer. As shown by these books, he is at times the sole means of dealing, for the outside public, and in that respect, I would like to say that we have to regard ourselves as the general medium for all of the firms and through all of the firms, the outside public.

If we can provide better prices for the execution of their orders, we can do a service.

To follow that up, I think that the commission houses will vouch for the fact that they obtain better markets in stock exchanges, in stocks which are handled by the specialists, who deal for their own account than in stocks in which the specialists does not deal. That, I would like put before you by a representative member of the commission houses, who can speak on it.

Mr. MARLAND. Mr. Chairman

The CHAIRMAN. Are you through, Mr. Kenney?

Mr. KENNEY. Yes, Mr. Chairman.

The CHAIRMAN. Mr. Marland.

Mr. MARLAND. Possibly you can give me light that I have been asking for for several days.

Mr. SPRAGUE. I will try, sir.

Mr. MARLAND. I asked this question the other day, asked a witness to tell me what he would do as a specialist under a given circumstance, when we will assume that as a specialist you have an order to sell 100 shares of "X" stock at the market.

Mr. SPRAGUE. At what price?

Mr. MARLAND. At the market, at not less than 5. What would you call that kind of an order?

Mr. SPRAGUE. That is a limited order, Mr. Marland.

Mr. MARLAND. Assuming that you have then another order to buy 100 shares of the same stock at the market, at not more than 51⁄2, what would you do?

Mr. SPRAGUE. With all things being equal, Mr. Marland, the market condition at the time, other orders which might surround it, and the price of the day before, might govern, though, with everything being equal, I would say that both buyer and seller are entitled to the same advantages and that 51⁄2 would be a fair price to transact that order at or both orders.

Mr. MARLAND. How would you execute that order? I mean what price would you execute the order? It would be entirely a matter of your own judgment, would it not?

Mr. SPRAGUE. I think that is a fair statement.

Mr. MARLAND. There is no rule of the exchange that would require you to execute the sell order first?

Mr. SPRAGUE. I know of none.