general debate on the pending legislation, the committee cannot sit during the reading or amendment, so we will adjourn until Thursday morning at 10, at which time the committee will reconvene in room 2154, the main hearing room of the Committee on Government Operations, and at that time the questioning may resume at this point.

Mr. Eckhardt, you have a question?

Mr. ECKHARDT. I have one matter that I would like to clear up with respect to Mr. Rowen's questions. I am concerned a little bit with your answer to the questions, Mr. Pollack. It seems that where the matter is subject to the exchange's rules, in effect, you treat that as preempted by those rules, so that your own net capital rules don't apply to it, yet you may not enforce the exchange's rules.

It would seem to me there might be two possible alternatives to this process; one, some minmum rules by the exchange; or two, the adoption by the Commission as its own rules-the exchange's rules-where the exchange's rules have in effect preempted that field. Would you comment on that?

Mr. POLLACK. I think that the exemption that our rule grants is what led to Mr. Rowen's question, because that is the basis which made it impossible for the Commission to enforce its own rule. Indeed the special study made comment on it; insofar as financial responsibility, enforcement, or regulation was concerned, they felt that the self-regulatory bodies had done a good job; and indeed, should do more of it, and continuation of the exemption was based on that premise.

Mr. ECKHARDT. The exemption itself is a rule of the SEC, is it not? Mr. POLLACK. The exemption is part of a rule which says, "This rule shall not apply to exchanges which the Commission has found have more comprehensive rules than the particular rule that contains the exemption."

Mr. ECKHARDT. That is right, so that can be changed by the Commission itself?

Mr. POLLACK. Oh, yes.

Mr. ECKHARDT. The only thing I am suggesting is that there would be two possible approaches to the thing, and that would be some rules that would be promulgated by the Commission itself, which could not be relaxed, even though the exemption is in existence; or two, the adoption by the Commission of the exchange's rule in the area in which the exemption applies, so that the Commission could enforce exchange rules in accordance with its own interpretations, if it felt that the exchange was not enforcing those rules.

Mr. POLLACK. What you are suggesting, sir, is almost the approach of the NASD which would use our rule, and if I can use the phrase piggyback on it, additional things that they think are necessary or suitable for their membership.

Mr. ECKHARDT. The result of that would be, of course, to make your rule the minimum rule?

Mr. POLLACK. Correct,

Mr. ECKHARDT. Thank you.

Mr. Moss. The committee will stand adjourned until 10 o'clock Thursday morning.

(Whereupon, at 12:30 p.m., the subcommittee adjourned, to reconvene at 10 a.m., Thursday, September 16, 1971.)

STUDY OF THE SECURITIES INDUSTRY

THURSDAY, SEPTEMBER 16, 1971

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON COMMERCE AND FINANCE,

COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE,

Washington, D.C.

The subcommittee met at 10 a.m., pursuant to recess, in room 2123, Rayburn House Office Building, Hon. John E. Moss (chairman) presiding.

Mr. Moss. The subcommittee will be in order.

This morning the subcommittee reconvenes its hearing, commenced last Tuesday, September 14, on matters relating to the financial stability of broker-dealers and the safeguarding of customers' funds and securities. For any of the subcommittee members who may have been unable to attend Tuesday's session, our panelists here this morning are:

Mr. Irving M. Pollack, Director of the Division of Trading and Markets of the Securities and Exchange Commission;

Mr. Edward R. Gilleran, vice president, regulation of the National Association of Securities Dealers, Inc.;

Mr. Fred J. Stock, Jr., assistant vice president, New York Stock Exchange, Inc., member firms department;

Mr. Edwin P. Fisher of Arthur Andersen & Co., a member of the Committee on Stock Brokerage Accounting and Auditing of the American Institute of Certified Public Accountants;

Mr. Roger E. Birk, vice president and director of the operations division of Merrill Lynch, Pierce, Fenner & Smith, Inc.; and

Mr. Solomon Litt of Asiel & Co., a member of the board of governors and chairman of the Capital Committee of the New York Stock Exchange, Inc.

Before we begin, it might be well to make a brief announcement concerning our future plans. After this hearing is concluded we shall have an additional September hearing on accounting practices, including the need for uniformity and customer disclosure of brokerdealers' financial condition. Planned hearings in October will concern problems of the stock certificate, including the development of depositories, the possibility of a machine-readable certificate and the possibility of eliminating stock certificates entirely.

In November, we plan to explore the role of the SEC in supervising the various self-regulatory organizations, with particular reference to rulemaking. Commencing with December and continuing on through the early spring we shall carefully review the various topics dealt with by Mr. William McChesney Martin in his report submitted on August 5, 1971, to the board of governors of the New York Stock Exchange, including the question of whether there should be one central marketplace and who should be given access to that market(875)

place. We shall also explore the problems of Commission rates, both whether the commissions should be fixed or negotiated at some level and the extent to which separate commissions can be charged for separate services.

Also dealt with in the Martin report and planned for consideration in our hearings are questions such as whether brokerage can and should be separated from money management, and the proper role of the antitrust laws. Rather than entering into a prolonged description of what we plan to do, I shall make available at this time a detailed schedule, which remains of course purely tentative and subject to change as the plans of the subcommittee, or the schedule of the House, makes necessary.

When the meeting recessed on Tuesday, we were discussing net capital rules, and subcommittee staff members were inquiring into some of the more technical aspects of this area. Before that questioning resumes, do any subcommittee members have questions to ask of the panelists at this time, or do any of the panelists have questions they would like to direct between themselves?

The Chair then recognizes Mr. Rowen to continue with his line of questioning.

Mr. RowEN. Thank you, Mr. Chairman, We were discussing at the recess on Tuesday the exemption from the Securities and Exchange Commission's net capital rule which the Commission has granted to firms which are members of the New York Stock Exchange. We were discussing the effect that exemption has had and could have in the future on the protection afforded the investing public in this area.

We have been told that the exchange's new net capital rule with its 15 to 1 ratio is more stringent than the Commission's net capital rule with its 20 to 1 ratio. But I am wondering whether it would be possible for a firm to be in compliance with the exchange's rule and yet not to be in compliance with the Commission's rule, assuming a firm was subject to both rules, which of course, we know would not be the case. I would like to have one of the panelists direct himself to that question.

STATEMENTS OF IRVING M. POLLACK, DIRECTOR, DIVISION OF TRADING AND MARKETS, SECURITIES AND EXCHANGE COMMISSION; EDWARD R. GILLERAN, VICE PRESIDENT, REGULATION, NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.; SOLOMON LITT, ASIEL & CO., CHAIRMAN, CAPITAL COMMITTEE, MEMBER, BOARD OF GOVERNORS, NEW YORK STOCK EXCHANGE; FRED J. STOCK, JR., ASSISTANT VICE PRESIDENT, MEMBER FIRMS DEPARTMENT, NEW YORK STOCK EXCHANGE, INC.; EDWIN P. FISHER, ARTHUR ANDERSEN & CO., MEMBER, COMMITTEE ON STOCK BROKERAGE, ACCOUNTING, AND AUDITING, AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS; AND ROGER E. BIRK, VICE PRESIDENT, DIRECTOR OF OPERATIONS DIVISION, MERRILL LYNCH, PIERCE, FENNER & SMITH, INC.

Mr. POLLACK. I think I commented on that in response to Mr. McCollister's question last time that that would be possible.

Mr. RowEN. It would be possible.

Mr. Moss. I think it would be helpful if you would speak into the microphone.

Mr. POLLACK. That would be possible.

Mr. RowEN. That would be possible even though the ratio is 15 to 1 in the exchange's rule and 20 to 1 in the Commission's rule. Now, I have here a copy of the Bureau of National Affairs Securities Regulations and Law Report dated September 1, 1971. In that publication they have a hypothetical computation based on the exchange's rule and on the Commission's rule and it shows on the identical set of facts, the firm's ratio would be 7 to 1 under the exchange's rule but yet almost 21 to 1 under the Commission's rule.

Mr. Chairman, I ask that we insert this into the record.

Mr. Moss. If there is no objection, that will be inserted in the record. Hearing none, that will be the order of the committee. (The information referred to follows:)

BUREAU OF NATIONAL AFFAIRS SECURITIES REGULATION AND LAW REPORT, No. 117, SEPTEMBER 1, 1971, PAGES A7-A8

HILL INQUIRY TO PROBE ADEQUACY OF BIG BOARD'S NET CAPITAL RULES IN SEPTEMBER

Is it possible for a brokerage house to be in compliance with the New York Stock Exchange's new 15:1 net capital rule, and in violation of SEC's more lenient 20:1 ratio? A number of industry observers are convinced it is, and the House Securities Subcommittee is likely to explore the idea at its September 14– 15 hearings when net capital will be the subject.

Broker-dealers are presently exempt from SEC's net capital requirements if they are in compliance with the net capital rules of a registered stock exchange. The policy, which has stood for 30 years at the Commission, was originally adopted because Exchange requirements were considered more stringent than SEC's. The exemption could be revoked at any time, however, if SEC deemed the exchange's rules insufficient.

Those who maintain NYSE's rules are more lax than the Commission's, despite the broad disparity in required ratios, say the key lies in the methods of computation.

SEC regards all unsecured claims of the firm as items that cannot be counted upon, particularly when the industry is experiencing difficulties and brokers have their greatest need for liquidity. Thus, the Commission deducts the full value of unlocated securities owed to customers and other firms (short count differences), dividends receivable over 30 days old, and unpaid customer's brokerage fees in deriving net capital from net worth. The Commission also debits the full value of funds on deposit with clearing corporations, and securities shipped free, applies a 25 percent charge to dividends receivable that have aged less than 30 days, and haircuts all short positions.

A HYPOTHETICAL COMPARISON

The Exchange, on the other hand, requires no deductions for commissions receivable, securities shipped free, and clearing corporations deposits. It "haircuts" short positions only when they exceed long positions, and makes no deduction for dividends receivable that are less than 30 days overdue.

Until recently it made no adjustment for short count differences, but under its new Rule 325 amendments it makes a full deduction, in line with SEC policy. Thus, it is possible to take a firm with, say $560,000 net worth, and derive a net capital figure of $114,000 under the amended NYSE capital rule, while 5 additional deductions for unsecured receivables under SEC Rule 15c3-1 would reduce that figure to $39,000. A hypothetical computation is shown below: