NATIONAL SECURITIES EXCHANGES, H.R. 7852 FRIDAY, FEBRUARY 23, 1934 HOUSE OF REPRESENTATIVES, COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE, Washington, D.C. The committee met, pursuant to adjournment, at 10 a.m., in the committee room, New House Office Building, Hon. Sam Rayburn (chairman) presiding. The CHAIRMAN. The committee will come to order. STATEMENT OF RICHARD WHITNEY, PRESIDENT OF THE NEW YORK STOCK EXCHANGE, NEW YORK, N. Y.-Resumed Mr. WHITNEY. Mr. Chairman and gentlemen of the committee. The CHAIRMAN. Mr. Whitney, are you going through with all of that statement, or are you going to read all of it? I am afraid that it is going to take all of the remainder of your time if you do. Mr. WHITNEY. It being my understanding, Mr. Chairman, that the committee is pressed for time The CHAIRMAN. We are very much pressed for time, and you are going on somebody's else time this morning. That is the reason why we are having an afternoon session. Mr. WHITNEY. I was planning, if time sufficed, to go through a few more sections that are most important. The CHAIRMAN. You will have an hour and forty-five minutes, Mr. Whitney, and you can use it as you think best, except what time the committee uses in asking you questions. Mr. COOPER. Mr. Chairman The CHAIRMAN. Mr. Cooper. Mr. COOPER. Mr. Whitney, I would like to ask one question. Mr. COOPER. I think you agree with me that this measure gives the Federal Trade Commission tremendous power over the regulation of private industries and business. Mr. WHITNEY. Yes, sir. Mr. COOPER. Do you know whether industries, businesses, and banks were consulted at all in any way in the drafting of this legislation? Mr. WHITNEY. I have no knowledge, sir, at all of their being consulted in any way. The CHAIRMAN. That is not final though, that they were not? The CHAIRMAN. I say that is not final; you say you do not know whether they were. Mr. WHITNEY. I say, I do not have any knowledge. The CHAIRMAN. You just do not know. Mr. WHITNEY. No, sir. The CHAIRMAN. All right. Mr. WHITNEY. We were on section 10 of the bill, and if I may say, parenthetically, how this section will affect the various separate businesses engaged in by our members, as will be told you by our representatives, and as I have previously stated, provided time suffices, either today, or at a future time at the pleasure of the committee. The consequences of the enactment of this section would be very grave. It would absolutely prohibit the odd-lot business, which today provides a market for all purchasers and sellers of listed stocks in amounts of less than 100 shares. There are literally millions of investors who hold odd lots of securities, and it would be grossly unfair to deprive them of the benefirs of a market on the exchange purely for the purpose of separating completely the functions of broker and dealer. Mr. Hetherington will speak to you more in detail in regard to this subject, but I would like to give you certain statistics which prove what an important part of the market consists of the purchases and sales by small investors. In the year 1929, when the total reported sales on the New York Stock Exchange amounted to 1,124,000,000, our rich odd-lot houses bought in odd lots more than 142,000,000 shares and sold in odd lots more than 156,000,000 shares. Together those small purchases and sales exceeded in that year 300,000,000 shares. The year 1929 was unusual because it included a period of rising prices followed by a panic. This fact, however, did not unduly affect the volume of odd-lot transactions and odd-lot purchases and sales have been as important, if not more important, throughout the entire depression. From April 1 to August 1, 1933, odd-lot sales aggregated nearly 57,000,000 shares and, in the same period, odd-lot purchases were nearly 56,000,000 shares, or a total in odd-lot transactions of nearly 113,000,000 shares in a 4-month period. During these same months the total sales reported on the New York Stock Exchange were 403,000,000 shares. This section also makes it unlawful for a specialist to trade for his own account and prohibits him from accepting orders except at a fixed price. Mr. Sprague, one of the governors of the exchange who deals in specialties is here, and will explain this particular business. This prohibition will completely destroy the specialist system as we know it today and would have serious consequences for the whole market. This sytem originated many years ago when a member who had met with an accident was unable to move around the floor. We, therefore, sat in a chair at one post and offered to accept orders from other brokers and execute them as the market permitted. It was soon found that he could render better service in executing orders at limited prices, and that he could also execute market orders more rapidly than the average broker because he was constantly present at the post. Other persons imitated his example and there were soon many specialists. At the present time there are about 325 members of the exchange who act regularly as specialists and there are two or more competing specialists in every important active stock. The existence. of the specialist system facilitates trading and is, in my opinion, an essential part of any important market for securities. 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 If any 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. 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? |