Page E. Application of the Antitrust Laws to the Securities Industry. 219 1. Introduction____ 219 2. Reconciliation of the Antitrust and Securities Laws-The Cur- 220 c. The Judicial Amplification of the Silver Case d. Summary of the Substantive Principles.... 3. Reconciliation of the Antitrust Laws with the Governing a. Banking.. b. Broadcasting. c. Power... d. Shipping e. Commodities... 4. The Primary Jurisdiction Question_. a. Preclusive Primary Jurisdiction_. b. First Cansideration Primary Jurisdiction_. 5. The Proposals for Legislative Immunity-The Subcommittee's a. Purposes and Benefits of the Application of the Anti- b. An Analysis of the Proposals for Immunity. 220) 221 222 222 224 227 E SECURITIES INDUSTRY STUDY INTRODUCTION In December 1970, toward the end of the 91st Congress, the Senate met in an atmosphere of crisis to consider the Securities Investor Protection Act. The successive failures of a number of large New York Stock Exchange firms, and the possibility of others, carried the threat of massive losses to investors. Action was needed to protect the public and restore confidence in the securities markets. During the debate on the Act, a number of Senators expressed concern that government-backed protection of customer accounts would permit the industry to continue the practices which had led to its near-downfall, and would inhibit much-needed reforms. Assurances were given, therefore, by the manager of the bill and other members of the Committee on Banking, Housing and Urban Affairs that the protections provided by the Act were a necessary condition to reform, and not an alternative to reform.2 It was apparent during the debates that fundamental reforms could not be implemented until the immediate crisis had passed. It was equally clear, however, that reform was not to be delayed indefinitely but commenced promptly in the new Congress. The product of that determination was the authorization by the Senate, in June 1971, of a complete study of the securities industry and the securities markets. The study was to be conducted by the Securities Subcommittee of the Committee on Banking, Housing and Urban Affairs. This Report is the culmination of that study. At a distance of two years from the height of the crisis which provoked it, this Report attempts to assay the steps which have been taken toward fundamental reform, and those which remain to be accomplished. The Report is based on 18 months of study, during which the Subcommittee held 18 days of hearings and received testimony from 78 witnesses, a large part of which related to legislation growing out of the Study's initial Report issued in February 1972. In addition, the Subcommittee obtained information directly from industry and government sources, including responses to a detailed questionnaire on institutional membership which was sent to 104 firms, organizations and individuals in March 1972. The Subcommittee also conducted four detailed case studies of the operation of the regulatory system in the securities industry, focusing on the decisions involved in (1) the inclusion of listed stocks in the NASDAQ quotation system, (2) the sale of life insurance by stock exchange firms, (3) regulation of specialists on the New York and American Stock Exchanges, and (4) the administration and enforcement of the New York Stock Exchange's net capital rules. These case 1 See, e.g., 116 Cong. Rec. 21103 (Senator Proxmire), 21107 (Senator Brooke) (December 22, 1970). studies, which are set forth in full in Parts 3 and 4 of the Securities Industry Study hearings, represented the first independent Congressional study of how the system of self-regulation, with government oversight, actually operates in the securities field. The results of these hearings, questionnaires, case studies and other inquiries are set forth in 8 volumes of hearings, aggregating 3,843 pages, as well as in the initial Report of the Study and in this Report. This Report represents the considered judgment of the Subcommittee as to the appropriate resolution of the most fundamental · questions now facing the securities industry and the securities markets. It is intended, however, to look beyond the resolution of current controversies to the long-range structural features that will determine the course to be followed in future years and decades. The Subcommittee's findings and conclusions are divided into three broad areas: the structure of the industry, the structure of the markets, and the structure of the regulatory system. BASIC CONCLUSIONS Our securities markets are an important national asset. Under the wise and far-sighted system of federal regulation established by Congress in the 1930s, those markets have flourished. They have provided a means for millions of Americans to share in the profits of our free enterprise system, and have facilitated the raising of capital by new and growing businesses. Growth and success, however, have brought problems in their wake. Rapid unanticipated increases in the volume of trading found the industry unable to handle the operational aspects of the business it had solicited. A shift in public investment patterns, with a constantly increasing proportion of investment being made through institutions, rather than through direct purchases by individuals, has placed serious strains both on the operation of the markets and on the industry's compensation structure. And development of new technology and communication systems, while offering the promise of a more efficient, better coordinated marketplace, has produced conflict between differ- : ent groups within the industry, each striving to preserve or improve its economic position. On the basis of an 18-month study of these problems, the Subcommittee has reached a number of basic conclusions, leading to the recommendations which are summarized in the following pages. Among these basic conclusions are the following: Greater flexibility is needed if the industry is to adapt successfully to current challenges and to those which will face it in the future. Regulation, by government and by industry groups, is an essential element in protection of investors, but is not an effective substitute for competition in assuring a flexible and healthy industry. The concept of industry self-regulation, subject to SEC oversight, is well-adapted to dealing with problems of conduct and ethics, but is not well-adapted to dealing with general 2 See, e.g., 116 Cong. Rec. 19966 (Senator Muskie), 19969 (Senator Williams and Senator McIntyre) (Dec. 10, 1970). economic questions involving competitive interrelationships The division of responsibility between the SEC and the The SEC and the self-regulatory organizations have given insufficient attention to the need for fair, orderly, and open procedures in reaching important decisions. In attempting to implement these basic conclusions, the Subcommittee has not tried to devise a legislative solution for every problem facing the industry. In many areas, the legislative framework erected in the 1930s is adequate to provide for resolution of the problems through action by other agencies of government or through the natural workings of the competitive process. The Subcommittee has not hesitated, however, to recommend legislation in areas where the problems do not appear to be soluble through other means, or where the decisionmaking structure itself is in need of reform. The Subcommittee hopes and believes that the recommendations contained in this report will lay the foundation for a regulatory structure that will prove adequate for many years to come. SUMMARY OF CONCLUSIONS AND RECOMMENDATIONS CHAPTER I. STRUCTURE OF THE INDUSTRY A. FINANCIAL AND OPERATIONAL ASPECTS Because of the large amounts of customers' funds and securities held by brokerage firms, the investing public has a substantial interest in assuring that those firms are financially responsible. The principal regulatory tool in assuring the financial responsibility of broker-dealers has been rules limiting the ratio of their indebtedness to their "net capital." The Securities and Exchange Commission ("SEC") has had a net capital rule in effect since 1944. However, that rule contains a provision exempting members of eight principal stock exchanges, including the New York Stock Exchange ("NYSE"), "whose rules, settled practices and applicable regulatory procedures [were] deemed by the Commission to impose" more comprehensive requirements than the SEC's own net capital rule. During the financial crisis experienced by the securities industry in the 1968-70 period, a substantial number of major brokerage firms, including prominent NYSE member firms, either failed or were acquired by other firms to prevent their collapse. These failures and near-failures threatened the savings of hundreds of thousands of investors, and caused substantial losses to many of them. In light of these facts, the Subcommittee, as one of its case studies of the operation of the regulatory system in the securities industry, examined the application and enforcement of the NYSE's net capital rules during the period of the crisis. Among the principal findings of that study were the following: (1) The NYSE at times interpreted its net capital rule in such a way as to permit member firms to remain in business despite what would otherwise be considered violations of the rule. (2) This flexibility of interpretation made it difficult for the SEC to determine whether or not member firms were in compliance with the NYSE rule. Since the interpretations were not considered rule changes, they were not required to be, and in some cases were not, disclosed to the SEC. (3) The SEC made inadequate use of its power to inspect NYSE records, or to compel the keeping of adequate records. (4) The SEC at times disagreed with the NYSE's appli cation or enforcement of the net capital rule, but did not fully utilize its statutory powers to bring the NYSE into compliance with its views. In light of these findings, the Subcommittee has concluded that the SEC should terminate its exemption for stock exchange members and make them fully subject to the SEC's net capital rule in addition to (4) |