securities industry were significant enough that in the Subcommittee's interim report it made specific findings and legislative recommendations designed to provide the regulatory framework to prevent future paper handling breakdowns.

The Subcommittee found two primary functional causes for the paperwork crisis. First, the industry had failed to develop a nationwide system for clearance and settlement of securities transactions. Second, there existed a lack of uniformity and coordination among the various methods of clearing and settlement in use. The Chairman of the Board of Directors of the Securities Industry Association described for the Subcommittee in May the complex procedures whereby many large firms have to interface with as many as 15 different systems in their daily operations.75

Analyzed from a legislative point of view, securities handling problems suggested a lack of supervision, coordination and central decision-making which had delayed implementation of many of the technological innovations standing ready to help solve the problem. Accordingly, the Subcommittee recommended that:

a. The Securities Exchange Act of 1934 be amended to make it clear that the Securities and Exchange Commission has the power and the responsibility to direct the evolution of clearance and settlement methods employed by national securities associations and by broker-dealers engaged in interstate commerce;

b. Legislation be enacted requiring clearing agencies and depositories to register with and report to the SEC and empowering the Commission to review and amend the rules of such entities;

c. The Commission be directed to proceed with dispatch toward elimination of the stock certificate as a means of settlement between broker-dealers by December 31, 1976, and to report to the Congress annually through 1976 the steps it has taken and progress it has made pursuant to this direction as well as its recommendations, if any, for further legislation to eliminate the certificate;

d. Legislation be enacted prohibiting the imposition of state and local taxes in such a way as to unnecessarily inhibit the development of efficient national clearing and depository systems;

e. The Commission be directed to consider the practice of registering securities in "street name" to determine whether such registration is consistent with the policies of the Securities Exchange Act of 1934 and whether steps can be taken to facilitate communications between corporations and their shareholders while at the same time retaining the benefits of "street name" registration.

Shortly after the Subcommittee filed its report, legislation was introduced to implement its recommendations. At hearings on this legislation, held in May 1972, it became clear that transfer agents and

75 Clearance and Settlement of Securities Transactions, Hearings Before the Subcomm. on Securities at the Senate Comm. on Banking, Housing and Urban Affairs, 92d Cong., 2d Sess. 139 (1972) [hereinafter noted as "Clearance and Settlement Hearings"].

registrars should be included within the regulatory framework created by the securities processing bill. Furthermore, the hearings disclosed that the creation of an effective nationwide system of clearing and settlement of securities transactions is not a matter to be resolved solely at the federal level. State banking and fiduciary laws, for example, may make it impossible for many financial institutions to make use of securities depositories. Therefore, the Subcommittee recommended the creation of a fourteen-man National Commission on Uniform Securities Laws to assist the states in modernizing their laws, where necessary, to facilitate more efficient methods of transferring securities.

The May hearings underlined for the Subcommittee the important role which can be played by the bank regulatory agencies in solving securities handling problems. After the hearings the Subcommittee determined that, although the SEC should have general rule-making power over all participants in the securities handling process, the Comptroller of the Currency, the Federal Reserve Board and the Federal Deposit Insurance Corporation should have the enforcement authority over entities falling within their respective jurisdictions. Provisions were also inserted in the Senate bill to assure cooperation and coordination among the various responsible agencies.

On June 27, 1972, the Subcommittee, without objection, recommended passage of the securities processing bill, and the full Committee on Banking, Housing and Urban Affairs took similar action on July 25. On August 4, S. 3876 passed the Senate and was sent to the House of Representatives. Unfortunately, however, by the time the House of Representatives passed a similar bill, insufficient time remained in which to work out the differences between the two versions before the session ended.

The Subcommittee is still convinced that the conclusions stated in its February report are correct. It is necessary to vest the Securities and Exchange Commission with the power to oversee the entire securities handling process. The Commission's jurisdiction should include authority over all brokers and dealers, clearing agencies, securities depositories, national securities associations and exchanges, transfer agents and corporate issuers of securities. The three federal bank regulatory agencies should be relied upon for their assistance in assuring compliance by those clearing agencies, depositories and transfer agents which fall within their respective jurisdictions.

The Subcommittee also continues to believe that federal legislation is necessary to eliminate the possibility that state stock transfer taxes may be imposed on transfers effected through depositories in such a manner as to inhibit the development of a coordinated nationwide system. Uncertainty surrounding the application of such taxes should be removed in order that maximum use may be made of automated methods of handling securities transactions.

Other problems and uncertainties dictate the need for prompt federal legislation regulating securities transfers. The Banking and Securities Industry Committee ("BASIC") has proposed amendments to State Uniform Commercial Codes affecting the legality of transfers of securities consummated in certain kinds of depositories. By March 31, 1972, the proposed amendments has become law in two states and

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been introduced in nine others.76 Proposals to amend provisions of other state laws were also pending. It appears that concern has been expressed as to whether this new state legislation would remove securities depositories from SEC regulation. These concerns were met by references to proposals pending before Congress for increased SEC jurisdiction over clearing agencies and depositories." The possibility that states may be enacting legislation in reliance upon complementary federal legislation is further evidence of the need for prompt action.

Other recent developments also reinforce the Subcommittee's conclusion that prompt legislation is needed. For example, one provision of S. 3876 would have required all clearing agencies and depositories to be open to membership by all brokers, dealers, other clearing agencies and depositories, registered investment companies, banks, and other classes of persons designated by the Commission, subject only to limited exclusionary rules to assure fiscal protection of clearing agencies and depositories and to meet other practical considerations. The Subcommittee feels that existing laws are sufficient to keep persons of questionable character or ability out of the securities and banking businesses without superimposing an unnecessary layer of qualifications on the clearance and settlement process.

Yet, in spite of the fact that a bill containing a similar provision passed both houses of Congress, the recently proposed rules of Central Certificate Service, Inc.,78 the largest certificate depository in the United States, contained broad discretionary standards for exclusion such as the "character, financial ability and operational history and capability necessary to fulfill . . . commitments in an efficient and business-like manner. . . . " S. 3876 was designed to prohibit such provisions because of the Subcommittee's belief that all firms and institutions involved in the securities handling process should have access to a national system for processing securities transfers.

Another provision of S.3876 (and of the corresponding House bill) required that the rules of clearing agencies and depositories assure fair representation of shareholders or members and participants in the decision-making process. The Subcommittee does not feel that management of clearing agencies and depositories should be left entirely to the relatively few financial institutions which are able to obtain a substantial equity investment. The proposed rules submitted by Central Certificate Service, Inc. contain no provision for representation of participants on the board of directors or in the selection of directors.

In light of all these considerations, the Subcommittee intends to address itself early in the 93d Congress to legislation containing the provisions in the bill which the Senate passed in 1972.

76 Clearance and Settlement Hearings at 523. See Potter and McLean, Introduction to Book Entry Transfer of Securities, 28 Bus. Law. 209 (1972).

77 Clearance and Settlement Hearings at 816, 820, 821, 824-25.

7 See SEC Securities Exchange Act Release No. 9849 (Nov. 8, 1972).

B. COMMISSION RATES

The initial report of the Subcommittee's Securities Industry Study, submitted in February 1972, set forth in detail the pressures on the NYSE's fixed commission rate structure as a result of the growth of institutional trading, and the difficulties involved in maintaining a fixed rate system under current circumstances.1 It described the techniques used by institutions to avoid the impact of high fixed rates, and analyzed the arguments for and against the fixed rate system. It also described the procedures followed by the SEC in passing on the current rate structure, noting the absence of adequate information or standards by which to determine appropriate levels of rates, the unavailability of effective review of the SEC's actions, and the failure of the process to produce a "fair and economic" rate structure.5

On the basis of this analysis, the report concluded that fixed commission rates were not appropriate for institutional-sized transactions, and should be phased out in an orderly and systematic manner. In March 1972, the Subcommittee held three days of hearings on legislation designed to implement those conclusions." The most striking aspect of these hearings was that, subject to various qualifications, the witnesses unanimously supported the concept of competitive rates, at least for institutional-sized transactions. Chairman Casey of the SEC affirmed the SEC's intention to reduce the ceiling on fixed commissions to $100,000 by April 1974.8 The New York Stock Exchange, withdrawing from its formerly vigorous defense of the fixed commission system, came out, in principle, in favor of competitively determined commissions, at least on institutional-sized orders." However, many of the witnesses were of the opinion that, in the light of the SEC's clear determination to eliminate fixed commissions on institutional-sized transactions by April of 1974, legislation in this area was unnecessary and that the matter should rest with the SEC, at least for now.10

The Subcommittee reaffirms its earlier position in favor of moving to competitive rates in a prompt and orderly manner. It is encouraged by the general acceptance of this approach within the industry. In light of this acceptance, and the articulated desire of the SEC, the

1 Securities Industry Study, Report of the Subcomm. on Securities of the Senate Comm. on Banking, Housing and Urban Affairs for the Period Ended February 4, 1972, 92d Cong., 2d Sess. (Subcommittee Print 1972) (hereinafter cited as "Initial Report").

2 Id. at 53, 56-57.

3 Id. at 57-58.

4 Id. at 58-59. The SEC took the position that it had not "approved" the commission rate schedule but had merely "not objected" to it. Ibid.

5 Id. at 59-60.

6 Id. at 60.

7 Hearings on S. 3169 Before the Subcomm. on Securities of the Senate Committee on Banking, Housing & Urban Affairs, 92d Cong., 2d Sess. (1972) (hereinafter cited as "Commission Rate Hearings").

8 Id. at 9, 29.

Id. at 161.

10 E.g., id. at 9 (testimony of SEC); id. at 120 (testimony of Dr. William C. Freund); id. at 148 (testimony of Alan Greenspan); id. at 166-67 (testimony of Paul A. Samuelson); id. at 176 (testimony of John E. Leslie); id. at 527 (Report from the Department of Justice).

NYSE and industry leaders to move ahead on this subject, the Subcommittee does not believe that legislation is necessary at this time. However, should the present steady progress toward competitive rates falter in the future, the Subcommittee would promptly address. itself to the matter with a view to a legislative resolution.

In reaffirming its view that competition is the appropriate mechanism for setting commission rates in the brokerage industry, the Subcommittee has considered the affirmative benefits which the public will derive from such competition and evaluated the arguments presented in opposition to free competition.

1. THE BENEFITS OF COMPETITIVE COMMISSION RATES

a. Efficiency

The [New York Stock] Exchange has for almost two hundred years maintained a monopolistic fixed commission rate scheme. During the last decade, this scheme has been especially detrimental to the industry and to the investing public, due to changes in the nature of trading in the securities markets, particularly a sharp increase in volume and the rise of institutional investors to a dominant position. The two major results of the anti-competitive pricing policy have been a proliferation of grossly inefficient firms which could not serve their customers adequately and which took business away from their competitors, and the contortion of price competition into bizarre rebative schemes which benefited not the public but the members of the industry."1

Vigorous competition is a vital element in creating an efficient industry. In a freely competitive marketplace, efficient firms prosper and grow and inefficient firms wither and die. By rewarding the capable competitor and eliminating the inept, this winnowing benefits the public in a number of important ways. The efficient firms have a salutary effect on all prices in the industry, preventing, to some extent, the inefficient from raising prices to a level reflecting their inefficiency.12 Because of their greater profitability at any given price level, the efficient firms are also better able to attract capital than their inefficient competitors; thus, economic resources are directed to those best able to use them.13 This is one of the fundamental principles of American capitalism and of the free enterprise system. Fixed prices inhibit this process. A recent detailed study (the "Friend and Blume Study") of the potential consequences of price competition in the brokerage industry confirmed the applicability of these principles to the securities industry, and concluded that competitive pricing would benefit both the industry and the public:

In summary, the abolition of fixed commission rates might be expected to lead to a better allocation of resources within

11 BARUCH, WALL STREET: SECURITY RISK 306 (1971) (hereinafter cited as "Baruch"). Hurd Baruch was a Special Counsel at the SEC during the height of the crisis in 1969-70.

12 Testimony of Donald E. Farrar, 6 Study of the Securities Industry, Hearings Before the Subcomm. on Commerce & Finance of the House Comm. on Interstate & Foreign Commerce, 92d Cong., 2d Sess. at 2947 (hereinafter cited as "House Hearings"). Parts 1-5 of these hearings were held in the 1st Session of the 92d Congress; parts 6-9 were held in the 2d Session.

13 Irwin Friend & Marshall E. Blume, The Consequences of Competitive Commissions on the New York Stock Exchange (1972) reprinted in Commission Rates Hearings, supra note 7, at 259, 264 (hereinafter cited as "Friend & Blume Study").