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But if you want to buy 200 of Texaco, then sell 30 percent of it to buy something else and have them hold your stocks and have recommendations in that situation, then I think you should pay the full, fair, or greater commission than what you are paying now. It depends. In other words, I think you should pay for what you get, and this is where the broker comes in and he has made a big error. With institutions, they have negotiated the commission rates on institutional orders over $300,000 much too less, because many times firms will have to position stocks and take a great risk in handling that trade; and the institutional people will come in and say we will pay you four cents a share, fifteen cents a share, and I think the brokerage people are starting to do this now, they just throw their hands up and say we don't want the trade, it is not a profitable business transaction.
But I think generally the brokerage business has tried to be all things to all people and, you know, they don't really design their business to succeed in one area, to be good in one area, and that is why currently certain firms are doing well because they are block positioners, they have a knack of doing a good job in their own area.
Mr. Young. Do you think that having negotiated commissions as has been discussed will provide an element of uncertainty in the market, so that a customer might call two or three firms before he decides where he wants to buy in order to shop commissions ?
Mr. Rose. Not really, because I think customers generally establish a rapport with the person they are doing business with; and if they feel they are getting a fair, you know, charge, you know, you are happy to do business with that person.
Mr. YOUNG. Will a person feel he is being fairly treated if he buys from you at one commission and he learns the next day he could have bought the same stock at a lower commission from another firm, or vice versa, he buys it from somebody else and he learns he could have saved fifty percent of his commission if he would have bought it from you? Would this promote confidence? Or do you think this will —
Mr. Rose. Some people, I guess, will be upset. Personally, I wouldn't be upset. I would make a decision on the firm that I would want to do business with and the person I wanted to do business with and in the style of business I wanted to do.
Mr. Young. Now, I suppose one of the handicaps that you have is those customers who just want a brokerage service, who know what they want to buy, as you say, and ask you to execute it. You can compete for that business. But you are, in effect, not able to complete for the customer who want to give maybe he wants part of his recommendations from you and he makes the rest through other sources ?
Mr. Rose. Yes. Well
Mr. Young. Do you feel you are not able you don't go for that kind, or you don't try to obtain that type of business?
Mr. Rose. No, that is not our ballgame.
What we do, if we try to promote that business, we just try to promote it through an investment counselor or a bank.
Mr. YOUNG. Are your customers large purchasers? Or do they tend to be
Mr. Rose. They are pretty much—our average ticket is the three hundred, as far as individuals are concerned, the three hundred to five hundred share ticket.
Mr. Young. In other words, he is a sophisticated investor who is conscious of brokerage commissions ?
Mr. Rose. Right, and he kind of likes a choice. He doesn't like to be told what he has to pay as far as commissions. I think he wants a choice, and with us at least he gets a choice as far as where the trade will be executed, and also the commission structure.
I think it would be popular with a lot of people, and I think the Exchange would be smart, too. It is not a problem. You know, don't make it a problem.
Mr. YOUNG. You are only able to serve the customers that you do business with, with a percentage of the commission on the over-the-counter market, isn't that right, because if you trade through W. E. Hutton they have got to charge the full commission the same as
Mr. ROSE. Over-the-counter or third market. So Texaco could trade over the counter or in the third market and trade on the Exchange.
So if we buy Texaco in the third market, then we can give an unbundled or reduced commission rate.
If we buy it on the exchange, then it has to be a full commission rate.
But either approach, as far as we are concerned-you know, we don't have a conflict of interest, when a client calls us.
We like to go to the Exchange. There are very good exchange specialists, and there are very bad ones, likewise there is a very good third market firm and there are very bad ones. And this morning as I was listening they were kind of bad-mouthing the third market dealers.
Mr. YOUNG. Some of the witnesses.
Mr. Rose. Yes, some of the witnesses, you know, were bad-mouthing the third market dealers, and this is justified. There are bad ones, but likewise there are bad specialists, too; and that is why say if with this 394 Rule—or if they open up the Exchange to more competition for market making abilities, this would solve the liquidity problem or the ability to buy and sell stocks.
Mr. YOUNG. Would you become a member of an Exchange, then, if it were opened up to anyone?
Mr. Rose. We are not opposed to it as long as we can do business in our style and charge our commission rates. You know, we are for uniform standards and regulations, you know, as far as the mechanics of clearance, settlements and things like this.
But as far as what we charge, and things like this, I think we should have a right to say that.
I think member firms would be better off if they just had that right. They really don't have a right now to determine their profitability.
Mr. YOUNG. Well, thank you very much, Mr. Rose, I appreciate your willingness to come here and testify.
Mr. Vincent, I believe you stated you wanted to make a statement, and we would solicit your comments.
Incidentally, I would like at this time to make part of the record as Exhibit 2 a letter I received from Allstate Insurance Company, which I will identify as Exhibit 2. This letter is dated October 19, 1971, and a second letter that they wrote to the Securities and Exchange Commission, dated September 29, 1972, which I have designated Exhibit 3. [The letters referred to follow:]
ALLSTATE INSURANCE Co.,
Northbrook, ill., October 19, 1971. Re Public Investigatory Hearings, section 21 (a) of the Securities Exchange Act
of 1934. SECURITIES AND EXCHANGE COMMISSION, Washington, D.C.
GENTLEMEN : On August 26, 1971, Chairman Casey announced that the Commission would hold public investigatory hearings beginning on October 12, 1971, to receive testimony and relevant data on six broad topics concerning the structure, membership and regulation of the securities markets in our country and the need for additional disclosure of information concerning all markets. In response to Chairman Casey's request for the views of all interested parties, Allstate Insurance Company is pleased to submit its comments on these important matters and requests that this letter be included in the record of the above mentioned hearings.
Allstate Insurance Company is the largest member of the Allstate Group of companies which also includes Allstate Life Insurance Company, Allstate Enterprises, Inc., and Allstate Insurance Company of Canada. The Allstate Group conducts a multiple line casualty insurance business, offers life insurance, health insurance, motor club membership, auto finance, and the Allstate Enterprises Stock Fund, Inc.
As of June 30, 1971, the total assets of the Allstate Group exceeded $3.7 billion. As of June 30, 1971, the total market value of all common stocks held in the Allstate Group exceeded $1 billion.
There are many positive attributes of the public securities markets, and the purpose of this letter is to enumerate ways to strengthen the best public securities markets in the world. They should include:
1. The furthering of competition between all markets and all market makers.
2. The full disclosure of all transactions and additional vital source information to augment the effective control of these public markets for the benefit of the public.
3. The increase of permanent capital for all securities firms, not necessarily and exclusively from the public ownership of shares. Further consideration should be given to (a) long term institutional investors, (b) retained income from the entrepreneurs and/or originators of the enterprise as well as from (c) public stock ownership.
4. The preservation and expansion of the profit motive incentive. We now turn to the six broad topics outlined in the SEC release dated August 26, 1971. Each one of these topics will be discussed in the framework and desire to strengthen the best public securities markets in the world.
1. STRUCTURE OF SECURITIES MARKETS
Central Market-We define a "central market” as, an integrated auction market complex that would uniquely exist as the composite exchange for all securities. Such a "central market” would provide maximum liquidity, uniform definitions and regulations, fair and consistent commission structure with universal application, and a consolidated tape for reporting all securities prices and shares traded.
We feel that a "central market" consisting of the nation's stock exchanges without the over-the-counter market is not desirable.
Mr. Gordon S. Macklin, Jr., President of the NASD has indicated that the OTC volume exceeds the cumulative total of all registered stock exchanges except the N.Y.S.E. It is obvious that the OTC market is an “exchange" and should be included in the "central market" concept now and not sometime in the distant future.
We disagree with a "central market” concept that would provide one market for each listed security. We feel that as long as all securities trading is subject to uniform regulations and a consolidated tape, having several trading markets as well as competing specialists in the same security would promote healthy competition and as a result, “better markets”.
A "central market" and its uniform regulations should cover the entire securities trading industry and not merely the more recognizable segments of the industry.
Competition—Competition applied to securities trading operations means that trading in securities should possess the elements of fairness, freedom, and flexibility.
Accomplishing this necessarily requires competing specialists and markets. Investors should be free to trade at all times at the best possible price. A one. specialist market does not allow this freedom nor the flexibility of choosing markets.
In addition, competing specialists enforce competition by the simple fact that there is competition. This promotes the auction market aspect of pricing.
2. INSTITUTIONAL MEMBERSHIP
We oppose institutional membership. It is nothing more than a subterfuge to reduce commissions paid. It is quite apparent that institutions do have the capital, management, and technological capabilities to enter this business. C'ertain legal considerations make it advisable, at the moment, to pursue the course of membership, however.
We believe that mutual funds, insurance companies, banks, and affiliated companies should not be allowed to operate a general securities business. Likewise, no firm engaged in the general securities business should be permitted to be a part of any mutual fund, insurance company or banking complex. Minor investment interests should not be prohibited.
3. ACCESSIBILITY TO SECURITIES MARKETS
Institutional Access—The controversy of institutional access to the leading exchanges has been around for some time. We define “institutional access" as the ability of institutional investors (ie, insurance companies, mutual funds, banks, pension funds) to have increased communication and direct dealings with those that “make the markets".
We know that institutions have sought to reduce their commission dollar and to obtain faster and better executions by the increased use of the so-called Third and Fourth markets. This draws business away from the leading exchanges. We feel that allowing institutional access to the exchanges would inevitably bring some of this business back to the exchanges and strengthen all the markets.
We do not favor the abolition of the Third or Fourth markets in listed shares but believe that all forms of trading markets should continue in order to preserve competition.
4. REGULATION OF SECURITIES MARKETS
In effect, we believe all segments of a "central mraket" should be regulated equally and, if practicable, uniformly. Regulations should be minimal with the emphasis on the “self-regulating” aspect now prevailing.
5. ADDITIONAL DISCLOSURE ON PRICES, VOLUME, QUOTATIONS, AND TAPE
Consolidated Tape-Confusion is automatically built into a system whereby some security trades are printed on a tape (ie, N.Y.S.E.-A.S.E.); some are not reported on a tape but announced on a public address system (ie, P-B-W) ; some show price and no volume (ie, NASDAQ); and some are not reported at all (viz. Third and Fourth markets).
Therefore, we agree that a consolidated tape, showing all trades (including the Third and Fourth markets) increases communication and affords all investors, both public and institutional, information necessary to trade securities effectively and fairly. This disclosure would increase the public confidence.
6. COMPETITION AMONG EXCHANGES, BETWEEN EXCHANGES, AND OTHER MARKETS
Specialists—Mr. Ralph D. DeNunzio, Chairman of the N.Y.S.E. stated recently that the exchange's procedure for measuring the specialist's performance “is outmoded, archaic, and should be changed". We agree with the Exchange's development of new steps that will improve the evaluation of specialists and their performance. We have always believed that there should be competing specialists; that is, specialists in different "markets" trading the same security. This promotes healthy competition, narrows spreads, and increases liquidity.
Regarding the specialist, we believe that many improvements should be made concerning his activity :
a. Increased timely and meaningful disclosure regarding the trading and positions in his specialist accounts. (e.g. monthly reports filed for public disclosure within five days after each month end.) Annual profit and loss statements and balance sheets should be filed with the exchanges and the SEC.
b. Additional capital should be required, where necessary, so that he can perform on the larger blocks.
C. Institutions are not currently allowed to communicate directly with the specialist on the national exchanges. It is, therefore, more difficult to assess the current market trend. On the other hand, institutions do talk to the "market maker" in the OTC and Third markets. This direct communication is one reason for the increased institutional activity in recent years away from the major exchanges.
Commissions—The public interest is not served by the present and projected commission rate schedule. The general public cannot take advantage, as institutions can, of substantial commission savings in the Third and Fourth markets.
Clearly, the public is paying more, and steps should be taken to ease the burden so as to allow the private investor to enjoy some commission savings as well as the institutional investor.
Instead of a minimum commission schedule, “negotiated rates”, volume discounts, etc., a maximum commission schedule should be approved periodically, providing the individual customer with the right to negotiate his own commission charges, below the maximum, if his size and activity warrant.
Commissions, to the extent justified, should be used to repay useful research effort.
7. OTHER IMPORTANT MATTERS
Management-Mr. Lee Kendall, President of the Association of Stock Exchange Firms, recently stated that Congress cannot "legislate good management". However, the industry itself could do much to improve the management of its brokerdealer firms.
One idea would be to require the formal training of the registered representatives. Not only through the initial test to become a registered representative, but with a continuing education as to their responsibilities, industry trends, and personal development.
Other areas should be strengthened primarily on the management level. A formalized training program could be developed to promote the ideas and concents of good management. Additional financial yardsticks and an "early warning system” should be developed so that deviations from the “norm" are easily determined.
“Early Warning System"—Good management dictates not only the enforcement of its principles, policies, and procedures, but the ability to detect problems that exist and to deal with them before they happen or, at least, in their earliest stages. We believe that an early warning system should be created to deal with the potential problem areas.
Accordingly, the N.Y.S.E. should establish, define, and expand guidelines of operation, financial guidepoints, etc., that are helpful to broker-dealer managers to aid in evaluating their own financial condition regularly and their operating effectiveness constantly.
Regulation—It is obvious that the implementation and administration of the proposed "central market” concept with its uniform regulations cannot last or be maintained without some sort of enforcement.
We agree with Mr. Donald T. Regan, Chairman of Merrill Lynch, that a small regulatory group be set up to “make sure that the private investor is protected, that competition stays alive and well, and that the vital parts which make up a sound market are installed and stay in place”. The effectiveness of management in regard to its regulation is paramount. This area must also remain dynamic, not static. It should be under constant review.
CUSTOMER'S CREDIT BALANCES Restrictions should be placed on brokerage firms' use of customer's credit balances . . . possibly an establishment of a reserve against these balances.
Board Membership of the N.Y.S.E.—We agree with Mr. Martin's report recommending a Board of Directors consisting of twenty directors ... ten from the officers, partners, and proprietors of the member firms, and ten from the public. (Two of the ten public members being recommended by the SEC or approved by the SEC.) The selection of directors should be made by the N.Y.S.E. voting members.
We especially agree with the recommendation to include public members on the board and the resultant de-emphasis of the role and control of the floor brokers and specialists. We believe in, and espouse, a truly public exchange.
Communications–Encouragement should be given to a continuous, free, honest, and meaningful dialogue between corporate managements and professional security as who represent stockholders and brokerage firms.
To summarize our views, we submit that the long term interests of the securities industry and the public interest will be best served if the following steps are taken to :
(1) Require the capital of brokerage firms be more permanent, thereby increasing public confidence in the financial stability of the securities industry.
Strengthen all securities markets by integrating all trading activity and providing institutional access to all securities markets with the objectives of increasing the depth, liquidity and competition.
(3) Formulate and implement an equitable commission rate schedule which will maintain the profit incentive and provide the individual customer with the right to negotiate his own charges based upon service rendered.
.COMMUNICATIONS (4) Introduce a consolidated tape providing all investors with all relevant information concerning the trading in all securities markets so that all investors will be better informed.
We hope that our comments and recommendations will be taken in the spirit of assisting the industry to overcome the current problems and to expand its opportunities. In addition, we fervently hope that the resultant decisions and recommendations that arise from the SEC hearings be made not merely from the possible short-run economic effects and savings, but from the long-run benefits to the securities industry, its investors, and the public interest.
RONALD E. CRAMER,