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type of efforts and supervision you expect from the Fed if the committee were to assign this sole authority to it as you have suggested!

Mr. Bevis. I understand. I can illustrate the problem. It is the natural desire of everyone and particularly I should think would be the desire of SEC to have a depository expand in some given area awfully fast. Fast expansion can involve problems, including loss of money and securities.

We have seen CCS start up in 1968, going wild in expansion and it had very severe digestive problems and almost had to freeze the situation until it worked out of its troubles.

The Pacific Depository jumped very quickly up to eligible issues in the neighborhood of 8,000 or so. This was awfully fast, and too fast in my judgment, and that then caused them to have difficulty in processing their securities transactions.

An agency charged with widening the system, a modern system for processing securities transactions would probably—and I would if I were in their position-put pressure on for fast expansion.

If I were a bank regulator with my great concern for the financial integrity and soundness of that institution, I would say let's make sure we don't bite off more than we can chew. These questions would not be easy to resolve but both are very important. That is my whole point.

Mr. CURTIS. The effect of this system then would be to deal great authority to the SEC to tie the system together but to give to the Fed the ability to say, no, that is unsafe, and, in effect, to stop the proposed ordered interface that the SEC may have made.

Mr. Bevis. I think that is a fair summary and, with the Chairman's permission, I will ask Mr. Potter to comment.

Mr. Moss. Indeed, we would be most interested.

Mr. POTTER. I think that is fair. It is where the consideration of safeguards rubs up against a proposed rule that the Senate S. 2058 would give primacy to the Federal Reserve Board.

Mr. CURTIS. The last thing I would wish to explore, Mr. Chairman, is the suggestion that the SEC made in testimony before the committee yesterday that it be given rulemaking responsibility to establish standards for safe custody of funds and securities but to permit the bank regulatory agencies for those entities organized as banks to engage in these functions to establish additional standards.

If Mr. Stewart is correct, and he probably is, when we put the national system together, all segments are going to be members of the Federal Reserve Board, don't we arrive at the same result ?

Mr. Bevis. Mr. Curtis, it sounds awfully good to say the SEC would establish minimum standards and if the bank authority established higher standards, of course no one would expect the SEC to object to higher standards. That sounds fine. The higher standards may get into precisely the point I was talking about earlier, you don't move this fast, or you don't give credit immediately to this participant, all of which could either slow down or have some impact on the movements of a processing system which would be SEC's primary concern.

So, I don't think we should be under any illusions that the setting of higher standards, because it sounds like being for motherhood, would not raise some questions about the other side of the coin, namely, a system for processing securities transactions.

Mr. CURTIS. I am reminded of one other thing, that you did not comment on today but your supplement memorandum certainly does on the access provisions and especially the need to preserve in the depositories the ability to deny participation on the basis of character of the applicant. To the extent that we tie a national system together, will anyone segment of that system need to pass on the character of an applicant to participate in any other segment of it?

Mr. Bevis. I would think, Mr. Curtis, that generally participants would be a participant of only one depository and not necessarily participants in all three.

Our plea for a depository's right to attempt to screen applicants is essentially based on the fact that we don't believe that mass screening done by others can necessarily be as effective as one focused on a particular applicant at a particular time.

Certainly, as I have said before, and to pick some names out of the paper—if I am right, they have not yet been convicted of any crime--if a depository received an application from the Meyer Lansky brokerage firm, or the DiCarlo Bank or the Lansky-DiCarlo Mutual Fund, I don't think that a depository should be precluded from examining them and their background very much and perhaps denying them participation. I would not, of course, leave that to subjective judgment, but subject to review by the regulatory authority. I think that is essential.

Mr. CURTIS. I was trying to ask a smaller question. If that entity applied for participation in Pacific Securities Depository, would the DTC refuse an interface unless it also reviewed the character of applicants to any interfaced segments of a national system, that is, would DTC say, "We won't interface with you, Pacific, unless we have the right to interview all applicants in your system.” If not, are you satisfied you can maintain the integrity of the system without that?

Mr. Bevis. I would doubt that any depository would try to second guess any admission into another depository of a particlar participant. I would, however, say that any depository that leaves securities with another depository as its custodian, and some of these amounts can become very large, would want to make an overall appraisal of the effectiveness of operations, controls and financial reliability and it is possible that access could be a part of that overall evaluation.

May I ask whether Mr. Stewart or Mr. Coriaci wants to add to that ?

Mr. STEWART. I would add one brief comment. It seems to me the problem you envision, Mr. Curtis, is one of the problems to be resolved in developing the rules for interface and that necessarily any body who is a member in good standing of one depository would have to have the availability of whatever facilities came through the interface system when it was worked out without applying for separate membership in the other depositories.

Nr. CORIACI. Mr. Curtis, this one one of the areas our working committee has looked at and, as you know from previous testimony, one of the ideas is for a depository to have an account with another depository so we can accomplish this interface. Prior to that, the depository must

satisfy itself with the controls, rules, et cetera, of the other depository before this entire interface procedure begins.

As far as the regional organization is concerned, that is one of the advantages, the knowledge of your people in the area that wish access to the depository. It broadens it to that scale.

Mr. CURTIS. Thank you, Mr. Chairman.
Mr. Moss. Mr. Goldwater.

Mr. GOLDWATER. Just for a point of clarification, in order to achieve your objective of immobilization, isn't it important that you have almost total participation?

Mr. Bevis. The more the better.
Mr. STEWART. May I comment on that?
Mr. GOLDWATER. Surely.

Mr. STEWART. That is the ideal. In fact the ultimate ideal, I think, is to get rid of the certificate completely and have total transfer by book entry. If you will forgive a colloquialism, I think it will be a long time before any Aunt Mary or Aunt Susan will give up that feel of the stock certificate that she can hold in her hand and walk out. It will take a generation to work that out. Meanwhile, if we can handle the bulk of the securities handled by an institution, we will have gone a long way, say 80 percent of those.

Mr. GOLDWATER. It seemed to me you were getting into an area of SEC law in regard to the integrity of the operation and procedures, and the financial ability of, say, a brokerage concern. Why would you necessarily be concerned about that other than just in a cursory way? Isn't your main concern the integrity of the securities more so than the integrity or the character of the institution that has them on deposit with them?

Mr. Bevis. In addition to the integrity of the securities, there are very important financial risks that arise from the depository's dealing with a participant. For example, if a participant has securities delivered to it during the course of a day against payment and it disposes of those securities during the day but, at the end of the day it cannot pay up, the depository has a loss.

If a firm delivers securities to a depository, deposits them, it receives immediate credit and may redeliver those securities by book entry. Meanwhile, they go to transfer and, if a couple of days later it is found that those securities have been stolen and are rejected by the transfer agent and the person who deposited them cannot make good, it becomes insolvent, then there is a loss to the depository.

So, in addition to the integrity of the securities in the vault, there are very important financial and operating considerations that have to do with the participants, broker-dealers or otherwise.

The third aspect, if a broker-dealer organization has clerical people who process transactions with the depository who can't read or write or do arithmetic very well—and there are some of those—so that transactions with the depository have to be rejected and so forth, this fouls up the operation of a depository which deals in an extremely high volume, rapid operation where all concerned have to have a maximum of accuracy and promptness or the operation is fouled up.

Mr. GOLDWATER. What you are talking about then, is replacing the SEC in its enforcement of its regulations. I can see where a depository would be concerned about the capability of an institution, a depository, but certainly those problems that you cite are problems the industry has always been faced with, and if you become so exclusive by your standards that you exclude; then you would be infringing on the total immobilization that you are talking about. It would seem to me that through your regulation or requirements to be a participant, you could protect yourself in that regard by requiring bonding or some sort of financial capability.

But, to get down to the point where you are passing on the integrity and the practice of a brokerage concern, it seems that you are getting into enforcement of SEC regulations, and that is not your area of authority. I just throw this out for discussion.

Mr. Bevis. I would be glad to talk to that point because it is a very important point. To a proposition that anyone admitted as a brokerdealer, or a bank, should automatically have access to the depository I would say that the screening that has been done by the agencies who admitted or gave charters is not enough for a depository. I point to the SIPC report, to the weekly or biweekly reports of the NASD on the disciplining of members and why they had to discipline, the newspaper reports of SEC actions—all as proving that the screening for the purpose of requesting a broker-dealer is not sufficient for a depository. I think the record should be quite clear on that.

Now, as regards subjective rejections of applications, improper or unwise, I wouldn't leave that decision with the depository's management for a moment. I would have it reviewed by the regulatory authorities to make sure that there was no arbitrariness or capriciousness involved.

My final point is that participants in a depository get more value out of the depository, the more participants that are in. There will be pressures to expand the number of participants always because otherwise a participant has to operate two systems, one making deliveries through the depositories and the other making physical deliveries outside and he would like everything to be in the first category. But it will have to be worked out on a practical basis with these important considerations in mind, in my judgment.

Mr. GOLDWATER. Thank you, Mr. Chairman.
Mr. Moss. Gentlemen, there are no further questions at this time.

The Chair does want to express the appreciation of the committee for your appearance and for your testimony.

The committee will adjourn until tomorrow morning at 10 o'clock, at which time we will have two representatives of the American Bankers Association as the scheduled witnesses for the morning.

[Whereupon, at 12 noon, the subcommittee adjourned, to reconvene at 10 a.m., Thursday, September 13, 1973.]

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