117 ܙܙ.

so as to make such accounts appear to be unaffiliated. In dealing with sophisticated investors, the industry displayed great ingenuity in avoiding the fixed commission rate structure. 116 There is little basis to expect that the "mazes of blatant gimmickry” 117 which have been prevalent in recent years can be avoided in the future. Robert W. Fischer, Chief Executive Officer of a regional securities firm, has described this process:

It seems we are wrapping ourselves up like an octopus, trying to save a piece of the business so that we can construct some definition for it that may escape under the rug some

where when we try to get the pension fund in there.118 (5) While it may well be appropriate to seek to assure that brokers serve public rather than private purposes, Rule 196–2 does not seem particularly well suited to accomplish this objective. The Antitrust Division aptly described the deficiencies in the SEC's method for determining whether business is "public" or "private”:

The Commission's proposed Rule 196–2 makes the questtion of "public" versus "private” business turn on whether the broker is dealing with an "affiliated" person. The definition of "affiliated” person in Rule 19b-2 ignores most of the traditional affiliations of man (e.g., blood and marriage) and ignores some of the traditional affiliations of the securities world (e.g., pension fund management). On the other hand, it emphasizes to the exclusion of others two particular affiliations as being private": first, the investment advisor mutual fund affiliation; and, secondly, the right to participate in the earnings of a broker to the extent of more than 25%.

This definition produces some anomalous results: a broker who represents nobody but four members of his wealthy family is doing a "public" business, and a broker who does nothing but represent a mutual fund with 100,000

shareholders is doing a "private” business. 119 In short, while the SEC's concern for assuring that the securities markets serve public purposes may be appropriate, the means it has chosen to deal with the question of the combination of money management and brokerage and the use of exchanges for private purposes appear inappropriate to the task.



a. Eliminating the Combination of the Brokerage and Money Manage"Institutional accounts” would include the accounts of banks, insurance companies, investment companies, separate accounts, profitsharing retirement plans, pension benefit plans, foundations and educational endowment funds. The test of "management" for purposes of this prohibition would focus upon the de facto authority to make the day-to-day investment decisions for the fund without reference where the ultimate legal responsibility lies for the investment of the institution's assets. This practical test should reduce the danger of evasion of the prohibition through artificially structured arrangements.

ment Functions After extensive consideration of the matter, the Subcommittee is of the view that the question of the combination of money management and brokerage should be resolved by prohibiting stock exchange members and their affiliates from effecting any transactions on national securities exchanges for institutional accounts which they manage. 116 See Chapter I.B.1. C., supra. 117 Address by Robert . Tlaack before the Economic Club of New York, Nov. 17, 1970, quoted in The New York Times, Nov 18, 1970, p. 76 col. 8. 118 8 House Ilearings at 4173. 119 Comments of the United States Department of Justice in Response to SEC Release No. 9716 (Oct. 3, 120 41 of the 62 respondents to the Subcommittee's questionnaire concerning institutional membership asserted that there was no evidence of abuse resulting from the combination of brokerage and money management. No respondents cited any examples of abuse. 2 Institutional Membership Hearings at 435

The Subcommittee's proposal would deal effectively with most of the previously discussed problems which result from the combination of money management and brokerage functions.

1. By eliminating self-dealing with respect to the brokerage on managed institutional accounts, the conflicts of interest created by that combination, such as churning, choice of market, appropriate commission level, and dumping, will be eliminated.

2. This absolute and uniform prohibition on self-dealing will eliminate the problem of market distortion which arises from the different relationships between money management and brokerage allowed by the various exchanges. The incentive to take transactions to the market which affords the opportunity to earn or recapture the most commission income will be removed. In this way the artificially created market fragmentation resulting from the existing pattern can be eliminated.

3. The Subcommittee's proposal applies even-handedly to all money managers and will, therefore, provide a fair basis upon which all can compete for money management business. The unjustifiable discrimination suffered by non-broker money managers under the existing arrangements will be eliminated.

4. The Subcommittee's proposal will eliminate the artificial inducement to money managers to get into the brokerage business. The elimination of this inducement will permit more flexible movement toward the creation of a new central market system without being frozen into current patterns.

This legislation will not provide the perfect solution for each of the separate problems previously described, but any suggested remedy that would completely eliminate one problem would exacerbate one of the others, or would be so draconian that its burdens would outweigh its advantages. For example, this proposal will not eliminate all of the conflicts which arise when a broker has customers with differing interests. A money manager/broker may still be tempted to favor one type of account over another in providing research or may use its knowledge of the portfolio transactions of a managed account to enable its other customers to trade against the managed account.

One way to eliminate almost all of the conflicts would be to prohibit any firm, or group of affiliated firms, from engaging in both brokerage and money management. However, the case has not been made for so drastic and disruptive a step. As noted above, there does not appear to be any evidence of widespread abuse.120 Such a com

et seq.

plete separation would also deprive the industry of the relatively steady income available from money management to offset the cyclical nature of the commission business, and would eliminate financial institutions as a source of much needed capital for the brokerage industry. It would deprive pooled accounts of the money management expertise of the securities industry.

The Subcommittee's proposal, of course, will do nothing to alleviate whatever problems may exist in connection with the managed or discretionary accounts of individuals. The Subcommittee has not considered this question in depth in the course of this study. However, it appears that there are important distinctions between institutional and individual accounts. Because individuals receive detailed current information about their accounts, unlike the beneficiaries of pooled accounts who receive at best only the most summary reports of their portfolio transactions, individuals are in a better position to protect their interests than the beneficiaries of pooled accounts. Congress has previously recognized this distinction, and voiced its concern for the beneficiaries of pooled accounts, in the Investment Company Act of 1940 and the recent amendments strengthening that Act. b. Implementation

The legislation proposed above is designed to deal with the problems which the money management/brokerage combination poses for the competitive market of the future. So long as commissions continue to be fixed on institutional-sized transactions, it does not seem appropriate to eliminate current efforts by financial instutitions to recapture excessive commission costs exacted from their beneficiaries. Because of this, the prohibition on the combination of brokerage and money management should become effective only after fixed commissions on any portion of a transaction over $100,000 have been eliminated. However, the prohibition should apply immediately with respect to any new affiliations between brokers and managed institutional accounts.

In addition to deferring effectiveness of the proposal as to existing relationships until the elimination of fixed rates on institutional-sized transactions, the industry may well need a period of adjustment after the elimination of fixed rates. Vany present exchange members now rely upon the combined sources of income made available by doing the brokerage on managed accounts. These members should be allowed time to prepare for the separation of functions. While the Subcommittee will seek additional testimony on this question, it appears that a two-year graduated phase-in would be appropriate.



The question of the future shape of the Nation's securities markets has occupied the attention of government, industry and outside observers for several years. There is agreement that substantial improvements can be made in the present markets for equity securities, and there is agreement on some of the general goals to which a market system should be directed. However, there is a good deal of disagreement as to the techniques by which those goals can best be achieved, and as to the order in which various steps should be taken to reach the desired goals.


Recent discussion of the market structure of the future has reflected virtually unanimous sentiment in favor of a “central market system.” The SEC has stated that the purpose of such a system is “to maximize the depth and liquidity of our markets, so that securities can be bought and sold at reasonably continuous and stable prices, and to ensure that each investor will receive the best possible execution of his order, regardless of where it originates. . . ."'1 While the various formulations of the concept differ in important respects, they have all contemplated the existence of a communication system through which (1) all orders and quotations in a particular security would have an opportunity to meet, and (2) all transactions would be reported.


The volume of trading in common stocks now runs in excess of 8 billion shares a year. Of this total, approximately 5 billion shares represent trading in issues listed on the New York Stock Exchange (NYSE), of which over 4 billion are reported as transactions on that exchange, while the remaining 1 billion are traded through regional exchanges or the over-the-counter (OTC) market. Approximately 2 billion shares represent trading in issues which are not listed on any exchange and are quoted and reported through the NASDAQ system, the automated quotation system for the OTC market. Approximately 1 billion shares represent trading in issues listed on the American Stock Exchange (AMEX), which are traded almost exclusively through the facilities of that exchange. a. The OTC Market

An estimated 20,000 or so "unlisted” securities are traded solely in the "over-the-counter" or "OTC" market. The OTC market hus no

I SEC, Statement on the Future Structure of the Securities Markets 7 (1972) (hereinafter cited as “Market Structure Statement").

2 See 7 Study of the Securities Industry. Hearings Before the Subcommittee on Commerce and Finance of th House Committee on Interstate and Foreign Commerce, 92d Cong., 2d Sess., at 3562 (1972) (hereinafter cited as "House Hearings"). Parts 1-5 of those hearings were held in the 1st session of the 92d ('ongress; parts 6-9 were held in the 2d session.


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