tive CSDS which gains the confidence of the investing public will probably attract more and more of these certificates into the system, thus also eliminating their movement.

If the only hope of helping the financial community's certificate handling problem was the machine-readable certificate, I would be among the foremost advocating it, notwithstanding all of the problems yet to be solved and the costs that would have to be incurred. However, this is largely a choice among alternatives with the time factor a very important consideration. I believe that immobilization of certificates in a CSDS will take over the problems as quickly, if not more quickly, more effectively, and with more lasting benefits than an extensive industry-wide system centered on the machine-readable certificate. A memorandum that I presented to BASIC along these lines is attached as Exhibit E. Mr. Chairman, I should be more than glad to answer any questions.

Thank you.

Mr. Moss. Mr. Richard Howland, president, Stock Clearing Corporation, New York Stock Exchange.

STATEMENT OF RICHARD B. HOWLAND, PRESIDENT, STOCK CLEARING CORPORATION, NEW YORK STOCK EXCHANGE, INC.

Mr. HOWLAND. Thank you, Mr. Chairman.

My name is Richard B. Howland. I am executive vice president of the New York Stock Exchange and president of the Stock Clearing Corporation.

I am pleased to respond to the chairman's invitation to appear as a panelist on behalf of the New York Stock Exchange, Inc. I want to take the opportunity to express the exchange's desire to cooperate fully with the subcommittee.

Chairman Moss' letter of September 23, inviting the exchange's participation at these hearings, outlined three major topics to be considered at the hearings. I have already submitted a 44-page statement— with exhibits—which gives the exchange's views in detail on the three subjects. For purposes of today's hearings, I will briefly summarize those views.

1. DEVELOPMENT OF DEPOSITORIES

The concept of a central securities depository is not, in itself, new. They have existed in Europe since the previous century, and have been under study by the exchange since 1938. In 1957, when daily volume averaged 2.2 million shares per day, the exchange embarked upon a long experimental effort on a method for "centralized handling of

securities."

In April 1962, the exchanges board of governors authorized the staff to proceed toward implementation. Clearing members actually began depositing in their CCS accounts in June 1966.

Initially, CCS involved only New York Stock Exchange member brokerage firms and New York Stock Exchange listed stocks. During 1970, banks began effecting deliveries and receipts through their CCS

accounts.

In late 1970 and early 1971, some 960 American Stock Exchange issues were phased into the system, followed in mid-1971 by some 150 over-the-counter issues. At present, over 1 billion shares of more than 2,500 stocks are on deposit in CCS-about double the number of shares in CCS at the start of 1971.

The basic legislative change needed for the development and use of the central depository concept permitted transfer of title to shares

67-228 O 72 pt. 3 - 2

of stock by bookkeeping entry rather than by endorsement and physical delivery of stock certificates themselves. This legislation is included in article 8 of the Uniform Commercial Code and consists essentially of section 8-320.

In order that the shares of all U.S. corporations might be included in the central depository, the new law had to be adopted in all 50 States, and this has been done.

This same change made possible the valid pledge of securities within the central depository which also may be created by bookkeeping entry. This provides the basis for a collateral loan service. This was initiated on a pilot basis in 1970 and expanded in 1971.

Under this program, brokerage firms wishing to borrow money from banks may pledge securities on deposit in their CCS accounts without physically making delivery of the certificates to the lending bank.

It is apparent, then, if the central depository concept is to fulfill its promise, it will be essential to include institutional holdings as well as securities held by broker-dealers. The Congress last year very wisely amended the Investment Company Act of 1940 to permit deposit of securities in a depository by investment company custodians. Additional large amounts of securities, presently held in the vaults of banks, insurance companies, and other institutions, could be left on deposit with the central depository and thus be immobilized. To accomplish this, substantial legislative change on the State level will be required.

The exchange does not at this time see a need for any Federal law dealing with clearance, settlement, and transfer of securities transactions. All of these matters are receiving vigorous top-priority attention from the self-regulatory bodies. There doesn't seem to be reason to doubt the success of efforts now underway, and we do not see prospective advantage to Federal legislation that would attempt to preempt the field in this area.

2. DEVELOPMENT OF A MACHINE-READABLE CERTIFICATE AND
ACCOMPANYING DOCUMENTS

The exchange continues to monitor closely developments which may enhance the feasibility of converting documents which customarily are associated with the stock certificate in the overall securities handling process to a machine-readable form which would be compatible with the operation of CSDS.

The machine-readable certificate is no more than an interim solution to the overall securities processing problem. The exchange has recognized that the viability of the machine-readable certificate approach would depend upon cost and timing.

From the outset, the exchange's position has hinged on whether the cost of developing and implementing a machine-readable certificate would produce a useful systems change for a long enough period on the way to the development of a central securities depository, or whether such a depository would preempt the usefulness of a machinereadable certificate and render the latter economically unfeasible.

The progress and development of a depository has already brought this latter to pass. The exchange does not at present support the con

cept of the machine-readable certificate, but rather is directing its major effort toward the establishment of the comprehensive securities depository system.

3. DEVELOPMENT OF A MORE EFFICIENT SYSTEM FOR CLEARANCE, SETTLEMENT, DELIVERY, AND TRANSFER OF SECURITIES

Essentially, two types of stock clearing systems are in operation in the United States today. One is the daily balance order, or daily netting system, which is employed by the New York and American Exchanges and the NOTC in New York.

The New York and American systems are operated in conjunction. with the CCS depository and delivery system. The second system, known as net-by-net or continuous net is employed by the Pacific Coast Stock Exchange and is planned to be used by the Midwest Exchange and the National Clearing Corporation.

The New York Stock Exchange has been working on the development of an automated delivery system. On instructions from the delivering broker, the automated delivery system will permit automatic matching by computer of balance orders due for settlement against the broker's deliverable CCS positions, thereby eliminating movement of CCS-delivery paperwork and providing the basis for closer monitoring of clearing members' fails.

Thus, at present, the exchange does not contemplate adoption of a system in which the Stock Clearing Corporation would be the opposite side to clearing members' trades as in the net-by-net system. The exchange believes that in building the additional capabilities into the existing daily balance order system, coupled with CCS, it will be possible to achieve within a relatively short time the essential goal of bringing clearance, settlement, and delivery procedures to a state of near-maximum efficiency.

For the longer run, the exchange has under development the total automation concept of the locked-in trade, whereby the trading floor of the exchange would become, in effect, an electronic bridge between brokerage firms entering transaction orders for their customers, and the clearance, settlement, and delivery operations.

Essentially, the locked-in trade concept envisions a series of automatic operations, triggered by the transmission of an order to the trading floor, and following through all the subsequent steps. This would include execution of the order, reporting and confirmation of trade data, clearance and settlement of the transaction, deliverywhether by computerized bookkeeping entry or physical delivery of a certificate to a customer at his request.

The eventual goal of this and other current projects is to link the trading floor with the brokerage offices that generate transaction orders and with the clearance, settlement, and delivery operation-to complete the fully automated transaction loop which has become known as the locked-in trade.

To be colloquial in conclusion, this field is 90-percent plowed, and we can look forward to the harvest, so why start plowing in a new field? The exchange has been working in this field for years. We have spent some $25 million to get CCS going. Actually, that figure is $37 million;

$12 million in revenues have been collected from our members, so there has been a net outgo of $25 million. Until March of 1970 when BASIC was formed we were working alone. Yet, with a lot of effort and expense, we were able to accomplish changes in the Uniform Commercial Code which allowed the system to go ahead.

Sophisticated computer systems were designed and put into operation. Today, CCS is working successfully. It can now be expanded into a national system. Steps for this have been taken. We recently announced the application by the Midwest and the Pacific Coast Stock Exchange Clearing Corporations to open accounts in CCS.

This is too important an effort to be a question of New York versus the rest of the world, or separate regions fencing with each other. All we want to do, Mr. Chairman, is to provide our membership, and in turn, the investor, with the best possible service.

Thank you.

Mr. Moss. Thank you very much.

At this point, I will ask unanimous consent to include the exhibits accompanying your statement in the record.

(The prepared statement follows:)

(For exhibits, see appendix S through U, on pp. 1908–1929.)

STATEMENT OF RICHARD B. HOWLAND, EXECUTIVE VICE PRESIDENT, NEW YORK STOCK EXCHANGE, INC.

(Filed on October 12, 1971)

I am pleased to respond to the Chairman's invitation to appear as a panelist, on behalf of the New York Stock Exchange, Inc., in the fourth in the series of hearings being conducted by the Subcommittee in its study of securities industry practices.

I want to take the opportunity to express, as other Exchange panelists have done in connection with the earlier proceedings, the Exchange's desire to cooperate fully with the Subcommittee.

Chairman Moss' letter of September 23, 1971, inviting the Exchange's participation at these hearings, outlined three major topics to be considered at the hearings scheduled for October 18 and October 19, 1971. The remainder of this statement will present the Exchange's views on these three topics: I. Development of Depositories; II. Development of a Machine-Readable Certificate; and III. Development of a More Efficient System for Clearance, Settlement, Delivery and Transfer of Certificates.

I. DEVELOPMENT OF DEPOSITORIES

Prior to the announcement, less than a month ago, of the establishment of a new securities depository by the Pacific Coast Stock Exchange, the Central Certificate Service activated by the New York Stock Exchange in 1968 was the only securities depository in existence in the United States. The Exchange's comments, therefore, will be limited to the establishment, operations and current and future plans for the expansion of CCS.

Historical Background

The concept of a central securities depository is not, in itself, new. As long ago as 1938, the New York Stock Exchange commissioned an outside consulting organization to study the feasibility of a central depository. The conclusion reached at the time was that it would be impractical to consider beginning such a project before average daily volume on the NYSE were to reach 2 million shares. (Average daily volume in 1938 was just above 1 million shares and did not reach 2 million until 1954.)

In 1957, when daily volume averaged 2.2 million shares-and the industry was still a decade away from the kind of securities handling problems which were ultimately to plague it-the Exchange embarked upon a long experimental

effort to develop a method for what was then called "Centralized Handling of Securities." The following quotation from the Exchange President's 1957 Annual Report to the Exchange Membership heralded the start of what was to become the most important single securities industry innovation of the 1960's and 1970's:

An experiment which may prove as important to our industry as the establishment of the clearing function has been worked out by a Special Committee (of the Board of Governors). Fifteen firms, twenty listed companies, one transfer agent *** and a newly created division of Stock Clearing Corporation, the Central Stock Bookkeeping Service, are cooperating in this one-year pilot operation for the centralized handling of securities. The plans hold great promise for future savings.

Under this experiment, the securities placed in the plan by the member firms are held in the name of the bank nominee in large denomination certificates, subject to instructions transmitted by the Clearing Corporation. Inter-firm securities movements are reflected by bookkeeping entries in the Clearing Corporation rather than by physical movement of certificates, thus avoiding much of the work involved in handling, accounting, assignment and delivery of share certificates. The plan also provides for the elimination of due bills for inter-pilot firm deliveries, more effective control of dividend payments, and for channelling corporate communications to the beneficial owners of the stock held in nominee name.

The initial "experiments" were gradually expanded and refined over the next five years without, if may be acknowledged, a great sense of urgency-as daily average volume continued to hover in the area of 3 to 4 million shares through the early 1960s, causing few problems in the traditional methods of clearance, settlement and delivery.

Nevertheless, in April 1962, the Exchange's Board of Governors authorized the staff to proceed toward implementation of a "Central Stock Bookkeeping Service" and, at the same time, the Exchange began the long and arduous task of securing the enactment of legislation in all 50 states to establish the valid transfer of title to shares of stock by bookkeeping entry.

The name, Central Certificate Service, was adopted in 1964, and the initial target date for implementing the first phase of the new system was late 1965. However, delays in working out CCS' complex operating procedures, obtaining key personnel and training existing personnel for new tasks-combined with inevitable problems in revising computer programming at member firms and drastic alteration of longstanding operating procedures in hundreds of back offices-retarded the start of the "Bulk Deposit" phase of CCS. Clearing Members actually began depositing in their CCS accounts certificates of some 1200 eligible NYSE-listed securities which they were holding in their vaults as "dead storage" in June 1966. Additional thorough computer testing proceeded through 1967, and limited activation of CCS began in June 1968. The system was fully activated for all 1,200 eligible listed issues in February 1969. However, as was noted in testimony prepared for the Subcommittee in connection with its study of the problems of the securities industry during 1967-70, operational difficulties which persisted through August 1969 had the effect of limiting the effectiveness of CCS through the remainder of that year.1

How CCS Works

Though the technical aspects of the Central Certificate Service are complex, the basic operations are quite simple. Brokerage firms maintain shares of eligible securities on deposit in their CCS accounts. These accounts are credited with the number of shares deposited, and stock certificates representing these shares are registered in the name of a common nominee, "Cede & Co." CCS does not acquire any beneficial interest in these shares.

To make delivery, the selling brokerage firm instructs CCS to debit its account by, say, 500 shares of XYZ Corporation and credit the buying broker's CCS account with the same number of shares. Title to the shares is thus transferred by a computerized bookkeeping entry while the certificates themselves remain immobilized. At the same time, the offsetting changes in the buying and

1A summary of CCS contributions to improving the efficiency of brokerage operations since 1969 appears on pp. 28-29 and pp. 35-36 of the printed booklet version of testimony presented to the Subcommittee on July 30, 1971, "Crisis In the Securities Industry-A Chronology: 1967-1970."