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ALLSTATE INSURANCE Co.,
Northbrook, 111., September 29, 1972. Re Proposal to Adopt Securities Exchange Act Rule 196–2 (Institutional Mem
bership on Registered Exchanges). SECURITIES AND EXCHANGE COMMISSION, Washington, D.C.
GENTLEMEN : In August 1971, the Securities and Exchange Commission solicited interested parties to submit their views on six broad topics concerning the structure, membership and regulation of our securities markets.
By letter dated October 19, 1971, a copy of which is attached, Allstate Insurance Company submitted its views on the stated topics. On the subject of Commissions we said :
“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."
Our position on Institutional Membership was:
“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. Certain 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."
Our views regarding the above subjects have not changed.
ALLSTATE TRADING COMPANY
In light of the prolonged opposition of a significant segment of the membership of the larger national securities exchanges to the concept of negotiated commissions, and certain other legal considerations, Allstate felt obligated to seek a membership on the Philadelphia-Baltimore-Washington Stock Exchange.
On November 15, 1971, Allstate Trading Company became a member firm of the Philadelphia-Baltimore Washington Stock Exchange (“PBW").
Allstate Trading Company performance its brokerage services only for Allstate Insurance Company, its affiliated companies, and Allstate Enterprises Stock Fund, Inc. (The “Fund”). Under an agreement between Allstate Trading Company and Allstate Enterprises Management Company, the Fund's manager and investment advisor, the management and investment advisory fee payable by the Fund will be reduced by the amount of the net profits derived by Allstate Trading Company from “Fund” related transactions.
Allstate Trading Company became a member of the PBW for two reasons: (1) to afford the Fund's shareholders an opportunity to reap the benefits of a reduction in the Fund's management and investment advisory fee and (2) to reduce the amount of brokerage commissions paid by Allstate Insurance Company and its affiliates.
INEQUITABLE REGULATION In 1972 the Commission has (1) permitted members firms to commence marketing insurance products and to continue the management of affiliated investment funds and (2) seeks to exclude institutional members affiliated with insurance companies from membership on a national securities exchange unless they do at least 80% of their business with unaffiliated persons.
Allstate Insurance Companv believes strongly in the benefits of competition in all spheres of our economy. We welcome the competition the securities industry is bringing to the market place for insurance products. We think that the public is best served when vigorous competition exists.
Consequently, we are concerned by the Commission's proposal to adopt Rule 19b-2 insofar as it represents a step toward a lessening of competition in the securities industry. Through Rule 19b-2, the Commission proposes to eliminate institutional members from membership on the regional stock exchanges since they obtain a reduction in commissions for the pools of invested capital they represent. However, under the proposed definition of "affiliated persons”, the Commission would permit certain Wall Street institutions to execute securities transactions for the investment funds they manage.
In this connection, we note the following passage in President Nixon's 1970 Economic Report:
The American experience with regulation, despite notable achievement, has had its disappointing aspects. Regulation has too often resulted in protection of the status quo. Entry is often blocked, prices are kept from falling, and the industry becomes inflexible and insensitive to new techniques and opportunities.
“There is no clear safeguard against these dangers, but more reliance on economic incentives and market mechanisms in regulated industries would be a step forward .."
We submit that the interests of all investors will be best served and enhanced by the prompt abolition of the minimum commission schedules maintained by all national securities exchanges.
Institutional membership on the regional stock exchanges exists as a result of the desire to reduce the commission expense of the institutional member's affiliated investment funds. Furthermore, we don't believe it has been demonstrated that abuses have resulted from present or former institutional memberships.
We do note that the Commission took remedial action in 1964 by promulgating Rule 11a-1 under the Securities Exchange Act of 1934. Section 11 of that Act authorizes the Commission “... to regulate or prevent floor trading by members of national securities exchanges ..." which concerned floor trading abuses.
In our opinion, the 1934 Act does not confer similar authority upon the Commission to eliminate institutional membership on a national securities exchange. Therefore, we believe that the Commission should draft and submit to Congress an appropriate bill regulating institutional membership which would then be subject to the legislative process and the attendant hearings by the appropriate committees of Congress.
We recommend that the Commission withdraw proposed Rule 19b-2.
We originally stated, and still believe, that the securities markets in this country are the best public securities market in the world. The New York Stock Exchange has made excellent progress in selecting a more representative board of directors, and further immediate steps should be taken to establish a "central market", a consolidated tape ... including the transactions from all segments of the market .. and to increase permanent capital for all securities firms. The increase of capital, however, should not necessarily and exclusively come from the public ownership of shares.
As we look back over the record of activity and accomplishments in the last 8 to 10 months, one must conclude that a great deal of progress has been made.
Once again, we believe that in the best interests of the public, institutional investors, and a truly public securities market, institutional membership should not be allowed. The method of accomplishment, however, is for Congress to establish regulation and the SEC to administer the resultant legislation.
We strongly favor free competition and it should possess the elements of fairness, freedom, and flexibility. We are not opposed to the sale of insurance by the securities industry. Nor are we opposed to their management of investment funds if adequate safeguards and conflict of interest rules are established and enforced. Under this philosophy, we would expect and desire an opportunity to compete in the same arenas under the same circumstances and rules as do the present members of the securities markets.
Our heritage is merchandising and we are proud of it. We believe in competition and we welcome it. We do, however, object to being inequitably enjoined from participating in certain phases of the business world when competition can participate in ours.
Specifically, we recommend the withdrawal of the proposed Rule 196–2, urge the immediate consideration of a maximum commission schedule and emphasize the continuance of free competition in both the insurance and securities industries.
RONALD E. CRAMER,
Vice President. NOTE: Italic supplied.
Mr. Young. I also have a copy of a release which was furnished to me by Mr. George Barnes of Wayne Hummer and Company, which is an announcement of a bank offering of investment opportunities to customers.
Mr. Vincent, would you state your name and your business affiliation ?
STATEMENT OF BURTON J. VINCENT
Mr. VINCENT. Burton J. Vincent, President of Burton J. Vincent and Company.
Mr. YOUNG. I would appreciate it, then, if you would care to comment on any of the provisions of H.R. 5050, particularly those that appear to you to be more controversial than others.
Mr. VINCENT. Well, in my judgment, H.R. 5050 in its present form would not be in the public interest and although I have definite feelings regarding most areas of the proposed legislation, I will confine my comments to the areas of institutional membership and negotiated rates.
In my judgment the life blood of our free enterprise system is based on the free flow of equity capital. The free flow of equity capital not only finances new business and the expansion of growing businesses, but serves the important function of allocating capital resources throughout the economic system.
Many factors influence the flowability of equity capital including federal tax policies but two elements are absolutely essential, namely marketability of equity interests in a secondary market and market prices of equity interests that reasonably relate to intrinsic value.
It is my view that the increasing institutional dominance of our equity markets adversely affects these essential elements to the free flow of equity capital.
It is an established fact that institutions have increased their ownership of New York Stock Exchange stocks by one percentage point per year between 1962 and 1972 and now own outright approximately 30 percent of all issues registered on the New York Stock Exchange. This figure does not include securities owned by bank trust funds.
Although reliable data is not available regarding equity ownership by bank trust funds it is probable that well over fifty percent of all issues listed on the New York Stock Exchange are owned or managed by institutional investors. It is factual that institutions now account for over seventy percent of the total trading on the New York Stock Exchange as opposed to 35 percent in 1963.
A number of articles have been written recently regarding the so-called “twotier” market that has evolved due to this increasing dominance of our financial markets by institutions. Common stocks that are in favor with institutions in general enjoy great liquidity and issues out of favor enjoy little liquidity. In fact, at this point in time there are literally hundreds of equity issues both listed and over-the-counter that are virtually illiquid.
Institutional dominance therefore not only adversely influences the liquidity of our equity markets but also causes an artificial disparity in the price valuations of securities "in favor” as opposed to those “out of favor."
Institutional dominance also causes erratic and sudden changes in market prices of issues either under accumulation or in liquidation.
The increasing institutional dominance also concentrates economic power into a few hands and therefore the allocation of capital resources through the flow of equity capital becomes a decision of relatively few individuals as compared to such decisions being made on the basis of a broad and liquid market that dictated such decisions before the period of institutional dominance.
We only have to look to Europe to visualize the natural consequences that evolve from such concentration of economic power in financial institutions.
An individual should certainly have the right to turn his investible capital over to an institution to invest for him. He should also have the right, however, to make his own investment decisions and expect absolute liquidity in a secondary market for equity issues.
It is my view that it is not in the public interest for institutions to be members of national security exchanges which, of course, would result from the passage of H.R. 5050.
Mr. Young. Excuse me for interrupting. You are aware that this bill does pro vide if they do become members they are not permitted to do any transactions with their affiliates ?
Mr. VINCENT. I want to comment on that in just a moment.
Mr. VINCENT. Actually, in effect, Congress took institutions out of the securities business in the early 1930's for good reason.
H.R. 5050 would permit institutional membership on the basis that the affiliate would not transact orders for its parent.
Security firms in the United States perform many functions and probably no two firms perform exactly the same functions.
A dominant percentage of all firms, however, perform the functions of giving some advice to their clients and executing orders.
It would stand to reason that affiliates of institutions that enjoyed exchange membership would give advice to individuals and presumably other institutions.
It also stands to reason that since more than seventy percent of all the business done on the New York Stock Exchange is done by institutions, the brokerage affiliates of institutions would solicit the business of other institutions. It would be a simple economic fact of life that an institution would favor the affiliate of another institution for its brokerage business if that other institution favored its affiliate with its brokerage business.
As a practical matter I cannot visualize a regulatory body with enough resources and regulatory personnel that would eliminate such reciprocity in one form or another.
To the extent that such reciprocity inevitably takes place, all institutional membership accomplishes is the recapture of brokerage commissions by institutions.
Presumably the brokerage affiliate of an institution would give advice to other institutions and to individuals. The institution itself would, of course, manage a large portfolio of its own. It is inconceivable that a brokerage affiliate of an institution would offer investment advice that would be detrimental to the investment portfolio of the parent company and, in fact, would be in a position to give investment advice that would benefit the portfolio of the parent company.
A significant and unavoidable conflict of interest would immediately arise and such a conflict of interest could not possibly be in the best long term public interest.
Institutional membership that would bring with it automatic volume based on some form of reciprocity would only add to the increasing dominance of institutions within our financial markets.
Over a period of time it is logical to assume that institutions would not only dominate our financial markets but also the underwriting of new securities issues, private placements, mergers, and so on.
Based on the above it is my view that institutional membership would not only not be in the public interest but would be, in fact, detrimental to the public interest.
In my view increasing institutional dominance is also related to the negotiated rate controversy. At the present time fixed minimum commission rates as established by national stock exchanges must be approved by the Securities and Exchange Commission.
As we all know, the SEC does not take this responsibility lightly, and over the years a change in minimum commission rates has at times been a matter of great controversy between the industry and the SEC.
As a practical matter, commission rates are presently set by the SEC by virtue of its power to approve such rates. In effect, the securities industry is a highly regulated industry with commission rates set by a Federal agency.
Fully negotiated rates presumably would mean that each firm would set its own rates for execu orders for individuals and institutions.
As a practical matter, a handful of large retail firms in our industry would establish specific rates and the rest of the industry for obvious competitive reasons would substantially follow those rates.
In effect, fully negotiated rates would simply transfer the authority to set commission rates from the SEC to a few large retail firms within our industry.
From a selfish point of view, I believe this would be in the best economic interest of my firm. However, I do not believe it would be in the best public interest. It would appear to me that the real issue in the negotiated rate question is not which entity determines commission rates, but is once again related to the issue of institutional dominance.
The industry has now had an experience of negotiated rates with institutions over a two-year period. The very word negotiation presupposes some degree of bargaining power on both sides of the negotiation. Such bargaining power does not exist, and as a practical matter commission rates are simply dictated by institutions.
It is an established fact that the two largest institutions in the United States have a greater combnied net worth than the combined net worth of the entire securities industry.
Based on the unequal bargaining power between the “negotiating parties" institutions emerely tell the broker handling the execution the rate that they will pay.
As a consequence commission rates paid by institutions have decreased dramatically. In 1967, before the volume discount in Deecinber of 1968, an institution paid 39 cents per share on block of 25,000 shares selling at $40.
At that time an individual also paid 39 cents a share on 100 shares of stock selling at $40.
Based on statistics supplied to the Committee on Interstate and Foreign Commerce by the SIA, on June 15, 1973, industry statistics now indicate that the individual today pays 58 cents per share for the same stock selling at $40 and institutions pay 15 cents per share.
It does cost money to operate a securities firm and in effect at this point in time individual investors are subsidizing institutional investors.
Costs increase in the securities business as they do in any other business, which is the reason the New York Stock Exchange has recently submitted a new increased commission rate schedule to the SEC.
Rate relief is essential to the health of our industry, but unfortunately due to negotiated rates to institutions, such relief will result in even greater subsidization of institutions by individual investors. Such subsidization gives the individual an even greater incentive to turn his savings over to institutions to manage and invest for him, which in turn accelerates the trend of institutional dominance of our financial markets.
It is, therefore, my belief that the experiment of negotiated rates with institutions has been a failure even though it has resulted in lower commission rates to institutions. The experiment is resulting in higher costs to the individual investor and an acceleration of the trend of institutional dominance.
In my judgment, the public interest would best be served by recognizing the experiment as a failure and develop an equitable system of flexible across-theboard minimum rates that would take into account reasonable volume discounts. Such minimum rates should apply to individuals and institutions alike.
In conclusion, it is my view that H.R. 5050 would be detrimental to the long term public interest.
Mr. YOUNG. Thank you, Mr. Vincent. That was a very well done statement, and it shows you put a lot of thought into it.
Did you prepare this for another occasion, or what is this?
Mr. VINCENT. No. I actually heard about this hearing late yesterday, and I prepared it this morning.
Mr. Young. It is very well done. I would like to have a copy of it, if I could.
Mr. VINCENT. Yes. It is kind of—I will send you a copy. It is marked up as it is now.
Mr. YOUNG. All right. I would appreciate it, and no need to edit it. You can just Xerox it, if you want.
Mr. VINCENT. All right.
Mr. YOUNG. One thing I would like to get your opinion on is the need for speeding up the processing of securities.
I have been advised by many brokerage firms here in Chicago that it would be of great help to the cost of their doing business if they had better and speedier transfers, and that if they had to borrow securities before they can make a delivery, why, this inures to the benefit of firms that are large enough to loan them securities, and it is costly to them and to their customers.
One of the things that we have been discussing, of course, is the proposal of the exchanges that a central certificate depository will speed up this process.
Another area, though, that there has been some discussion about, mostly my own, is about whether or not we shouldn't just eliminate the stock certificate, at least for all investors who do not expressly request a stock certificate, using very much the same pattern that the mutual funds have used successfully for fifteen or twenty years now.