selling members' daily cash balances are also made by electronic bookkeeping entry. Under the old system, a firm executing a sale for one of its customers would have to get the certificates, make certain that it was signed, checked, stamped, counted, then put in an envelope and make physical delivery through the Stock Clearing Corporation. Similarly, the buying brokerage firm would have to receive the certificate physically, examine it, log it in, check it, stamp it, etc.-a reciprocal sequence of many time-consuming manual steps. With CCS, it is estimated that about 75% of brokers' certificate-handling can be eliminated.2 Present Capabilities of CCS Initially, CCS involved only New York Stock Exchange member brokerage firms and NYSE-listed stocks. During 1970, banks began effecting deliveries and receipts through their CCS accounts, although they were unable to leave securities on deposit in CCS: and, in late 1970 and early 1971, some 960 American Stock Exchange issues were phased into the system-followed in mid-1971, by more than 100 over-the-counter issues. At present over one billion shares of more than 2300 stocks are on deposit in CCS-about double the number of shares in CCS at the start of 1971. More than 1.6 billion shares were delivered by computerized bookkeeping entry in 1970-and it is expected that the total number of shares delivered in 1971 will exceed 3 billion by a wide margin. Two important additional services provided for Clearing Members by CCS involve accounting for dividends and handling proxies. In 1970, CCS disbursed a total of $503 million in cash dividends and voted approximately 85% of all eligible shares by proxy, on instructions from Clearing Members. It is anticipated that dividend-disbursement will total $600 million in 1971. Recent Developments During 1970, a number of New York Clearing House Banks began participating in CCS as deliverers and receivers of stock via bookkeeping entry. The program of bank-to-broker and broker-to-bank deliveries substantially reduces the need for brokers to make deposits and withdrawals from the system. Each of the banks maintains a CCS account similar to those of Clearing Member brokers; by electronically transferring balances of both money and securities in and out of these accounts, CCS has now eliminated many of the clerical steps formerly required in deliveries involving banks. (By mid-1971, ten New York Clearing House Banks were participating in the system to this extent.) The basic legal change that made the establishment of CCS possible-permitting valid transfer of stock ownership by bookkeeping entry-was accompanied by another legal step of nearly equal significance. This provides that a valid pledge of securities within the central depository may also be created by bookkeeping entry, thus providing the basis for a "Collateral Loan Service" initiated on a pilot basis in 1970 and greatly expanded during 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. When a firm wishes to take its shares of XYZ Corporation out of pledge and substitute shares of ABC, that, too, can be accomplished, with the proper authorizations, simply by appropriate computerized bookkeeping entries rather than by the physical exchange of certificates. During 1970, more than $1.8 billion in collateral loans was initiated through CCS, with 10 New York Clearing House Banks and 44 brokerage firms as participants. The program resulted in a sharp reduction in stock certificate traffic and, in 1971, the program has been expanded to include some 115 brokers. In addition, four leading out-of-state banks have agreed to participate in this program and are scheduled to begin prior to year-end. Legal and Legislative Problems As already noted, the basic legislative change required to permit the development and use of the central depository concept was adoption of legislation providing for transfer of title to shares of stock by bookkeeping entry, rather than by endorsement and physical delivery of the stock certificates themselves. This 2 Additional information about CCS operations and capabilities is contained in a new booklet_published by the Exchange in September 1971-"CCS: The Billion-Share Automated Depository"- -a copy of which is appended as Exhibit A, p. 1833. new legislation was included in Article 8 of the Uniform Commercial Code and consists essentially of Section 8-320. In order that the shares of all United States corporations might be included in the central depository, the new law had to be adopted in all 50 states. Even today, CCS does not include the shares of any foreign corporation because no foreign country has made appropriate amendments in the laws governing the transfer of shares of its corporations. The implementing legislation, as passed in all 50 states, also was drafted to authorize the creation of a lien on securities within the central depository by bookkeeping entry. This did away with the need to deliver stock certificates in order to create a valid pledge of the shares thus represented. With this legislation now on the books, future legislative efforts can be directed toward permitting full use of the central depository by institutions of various types. Institutions purchasing stock normally insist upon physical delivery of stock certificates before paying for the purchase. With institutions becoming increasingly important buyers and sellers of securities, this requirement of payment only against delivery has created a serious handicap to the smooth operation of CCS. Even though the securities purchased by an institution are in the central depository and could be transferred to the buying broker by bookkeeping entry, the buying broker, in order to receive payment from his institutional customer must withdraw the securities from the central depository and deliver them to the institution. This obviously diminishes much of the value and efficiency of the central depository operation. It is apparent, therefore, that 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, in the depository. If this can be accomplished, an institution buying a security could "receive" delivery within the depository, by bookkeeping entry and could thereupon pay for the purchase. 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. Banks provide a good example of the extent of the necessary changes. Banks, of course, hold large amounts of securities in their vaults, mostly for the accounts of others, and in a variety of capacities; e.g., as custodian, as trustee, and as executor. The duty and obligation of the bank with respect to securities held in each of these capacities is governed in part by agreement with the customer, in part by the terms of the will or trust agreement under which the bank is acting, in part by applicable state law (which, in any given case, may include the laws of several different states), in part by federal statute, and in part by regulations issued by state and federal agencies such as state superintendents of banks or the Comptroller of the Currency. State law governing the obligations of fiduciaries, for example, often requires the fiduciary to hold securities held as fiduciary separate and apart from all other property. Co-mingling is not permitted. (At present, bank participants in Central Certificate Service must close out their CCS accounts each day.) Obviously, to permit fiduciaries, including banks, to leave on deposit in the central depository securities held by them in a fiduciary capacity, will first require amendment of any controlling law or regulation-state or federal-which currently would prohibit the fiduciary from giving up physical possession of those securities and from permitting them to be co-mingled with other property. BASIC has already addressed itself to this matter as a question of top priority, and draft legislation is being prepared for submission to the New York State Legislature, which would be designed to overcome problems of this sort. This is a procedure which ultimately will have to be taken in most, if not all, of the 50 states. In addition, there are specific regulations of the Comptroller of the Currency which will have to be amended to permit national banks acting as fiduciaries to leave on deposit in a central depository system securities held by them as fiduciaries. Where institutions other than banks are concerned, it may well be necessary to effect changes in state and federal law and regulations before they may properly give up physical custody of securities held by them. For example, various state laws and regulations require securities owned by insurance companies to be available for physical inspection by appropriate regulatory agencies. Another problem identified some time ago was the provision of the Investment Company Act of 1940 which had the effect of requiring the custodians of open-end and closed-end investment companies to maintain physical possession of the portfolio of securities owned by the investment company. This provision would have effectively prevented such portfolios from being deposited in any central securities depository. This barrier was removed last year when Congress enacted appropriate amendments to that provision of the Investment Company Act of 1940. Another legislative change which must be effected, and is currently being addressed, is the need to amend the New York State Stock Transfer Tax law so that stock transfers which are not otherwise subject to the stock transfer tax do not become subject to that tax simply because a central depository located in New York State reflects the change of ownership by bookkeeping entry. As can be seen from this brief discussion, numerous changes in state laws will be needed; and, in fact, it is planned to submit draft legislation for consideration by the legislatures of New York and various other states beginning with the next legislative session. We are hopeful that action in a number of states will be sufficiently rapid to permit the total number of shares on deposit in CCS to increase from 1.3 billion shares, anticipated by year-end 1971, to as much as 4 billion by year-end 1972. It is not anticipated that the changes in law and regulation are likely to prove controversial, as it appears that widespread support exists in favor of the required changes. Thus, the Exhange does not believe at this time that a federal law pre-empting the field is necessary. At the same time, we would certainly be receptive to constructive suggestions from the Subcommittee with respect to any legislative efforts either at the federal or state level-which would be conducive to speeding up the timetable for expanding participation in the central depository. 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 does not appear to be any reason to doubt the success of efforts now under way and, therefore, we presently do not see prospective advantage to federal legislation that would attempt to pre-empt the field in this area. Current Expansion Plans Work is currently progressing in a number of areas in which the services of CCS can be extended without need for Federal or state legislation. These include: (1) Inclusion of Nonmember Brokers.-In an effort to encourage use of CCS facilities for delivery of over-the-counter issues, Stock Clearing Corporation is now developing plans for accepting qualified NASD brokerdealers as Associate Clearing Members. This would enable them to participate in CCS deliveries of all eligible securities, including over-the-counter issues, the total number of which is also to be expanded. (2) Participation by Regional Clearing Corporations.-Plans are also going forward for the inclusion of the Pacific Coast and Midwest Stock Exchange clearing corporations in CCS-a step that will have obvious benefits for the clearing members and correspondents of those regional exchanges. When accepted into the system, each of the clearing corporations would open an omnibus account in CCS. Thereafter, any member of the regional exchanges-including, of course, those which hold NYSE membership could receive or deliver through CCS any CCS-eligible security from or to any other member of the regional exchanges, without any physical movement of certificates. Additional planning contemplates the inclusion of the National Clearing Corporation in CCS. (3) PDQ System.-Now in the advanced planning stage at CCS is a new program aimed at cutting paperwork and clerical effort associated with balance-order deliveries-a pre-authorized delivery system known as PDQ. This will enable Clearing Members to avoid having to notify CCS of each specific delivery to be made by computerized bookkeeping entry. Instead, a Clearing Member will inform CCS only of those deliveries which should not be made by bookkeeping entry-having previously authorized CCS to make all other deliveries automatically. This program is expected to go into operation on a pilot basis before the end of 1971. (4) Computerized Bond Deliveries.-CCS plans to begin a pilot program for the computerized delivery of a limited number of NYSE-listed domestic corporate registered non-callable bonds before the end of this year. Eligible American Stock Exchange and over-the-counter bonds are to be added at a later date. Comprehensive Securities Depository System Although the Central Certificate Service today is in full operation—and expanding its services in the areas already enumerated-its scope remains limited in comparison with the potential for further computerization of the securities delivery process. Recognizing this, a joint Banking and Securities Industry Committee (BASIC) has been addressing itself to the larger task of making CCS-type services available to virtually everyone who can benefit from them. BASIC was formed in March 1970 to establish a central joint-industry authority to direct a coordinated effort aimed at preventing any future recurrence of the kind of paperwork problems which beset the industry during 1968 and 1969.3 Although BASIC's activities have covered the full range of securities industry operational problems, the Committee has given its highest priority to the development of a national securities depository. Last month, the Committee announced the culmination of more than a year of intensive study and investigation: a historic first step toward the establishment of a Comprehensive Securities Depository System, endorsed by the New York and American Stock Exchanges, the National Association of Securities Dealers and the eleven member banks of the New York Clearing House Association. The memorandum of understanding signed by the 14 organizations is not a binding contract. However, it commits each of the signatories to extend its best efforts, in good faith, to achieve the objective of creating, in New York, a comprehensive depository for stocks and other securities and, possibly, a net work of regional depositories.* After carefully weighing the various alternatives identified by a special task force appointed by the Committee, BASIC concluded that the establishment of such a depository system would be the most effective approach. Six major potential advantages were cited: (1) Feasibility of relatively rapid start-up of operations, despite the likelihood of some delays for the passage of enabling legislation. (2) Maximum flexibility in interrelating with broker/dealer clearing systems and the constraints on fiduciaries. (3) Minimum cross-assumption of risks among depositor groups. (4) Maximum protection of certificates. (5) Maximum building upon-and minimum interruption of CCS. (6) Immobilization of the stock certificate to a degree that would enhance the feasibility of a final step of legislation to eliminate the stock certificate, should that prove desirable. The Comprehensive Securities Depository System would build upon the existing Central Certificate Service. It would include all actively traded securities and be geared to serve the needs of banks, other institutions, stock exchange member firms and nonmember broker/dealers. CSDS would, in effect, be a "super-CCS." It has been estimated that deposits of CSDS of some 4,400 eligible NYSE, Amex and over-the-counter securities by participating brokerage firms and banks could readily exceed 5 billion shares; and that CSDS could handle as many as 75,000-100,000 transfers of ownership a day by computerized bookkeeping entry. Where CCS has eliminated approximately 75% of the physical movement of certificates among NYSE member brokers, CSDS would have the potential for eliminating 75% of the physical movement of certificates among all brokers, banks and institutions in the United States. Initially, CSDS would function much as CCS does today-but on a much broader, more inclusive scale, the key to which would be its usage by banks and institutions (assuming the elimination of existing legal barriers, none of which appear to involve controversial legislative changes). Ultimately, the delivery process could be further speeded-for example, through possible installation of computer terminals in the offices of CSDS depositors to effect transfers and determine securities and cash positions almost instantaneously. A full-time task force, including representatives of the participating securities industry organizations and the Clearing House banks, has been assigned to carry out the objectives of the memorandum of understanding signed in September, under BASIC's guidance. Implementation of CSDS is tentatively targeted for mid-1937. In the interim, of course, planned expansion of CCS facilities, as described earlier, will continue in tandem with CSDS planning. 3 The Committee is composed of the Presidents of the NYSE, Amex and NASD, the Chairmen of three major New York Clearing House Banks and as Executive Director, a retired Senior Partner of Price Waterhouse & Co. A copy of the memorandum of understanding is appended as Exhibit B, p. 1838. The memorandum of understanding calls for a two-stage evolution of the present CCS into an expanded depository system. In the first stage, CCS is to become a direct, wholly owned subsidiary of the New York Stock Exchange, instead of a division of the Stock Clearing Corporation, as at present. The Amex, NASD, Clearing House banks and other users are to be represented on the board of directors of the subsidiary, which will seek a charter as a trust company incorporated under New York State banking law. It is hoped that this can be accomplished by March 1972. In the second stage of the expansion, ownership of the depository will be shared by its users. The agreement contemplates that the New York Stock Exchange will be appropriately compensated for unrecovered start-up costs of the original Central Certificate Service and its successor. It should be clear from the foregoing discussion that the New York Stock Exchange, the other leading securities industry organizations and the banking industry regard the Comprehensive Securities Depository System as potentially the most important development toward the earnestly shared common good of immobilizing and, possibly, eliminating the stock certificate and streamlining the delivery of securities among the various parties to securities transactions. II. DEVELOPMENT OF A MACHINE-READABLE CERTIFICATE AND ACCOMPANYING DOCUMENTS A number of intensive studies conducted by various banking and securities industry authorities over the past five years have conclusively demonstrated the feasibility of developing a machine-readable certificate and accompanying documents. In 1969, the New York Stock Exchange endorsed the basic concept of a machine-readable certificate after it had been demonstrated by banking industry proponents that various technical problems-including processability, document security, cost and conversion factors-were capable of being satisfactorily resolved, and that it was feasible to extend machine-readability to other documents which accompany certificates as they are processed, such as transfer instructions, comparison and confirmation forms, dividend instructions, etc. At the same time, the Exchange has always regarded the machine-readable certificate as no more than an interim solution to the overall securities processing problem. The Exchange has recognized that the viability of the machine-readable 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 pre-empt the usefulness of a machinereadable certificate and render the latter economically unfeasible. The earliest authoritative studies suggested that a machine-readable certificate could be adopted three to five years before a central depository could be placed in operation. On that assumption, the Exchange supported the concept. Early experience in start-up problems surrounding the Exchange's Central Certificate Service tended to support the three-to-five-year-time-lag assumption with respect to the development of a comprehensive depository system. However, as CCS became fully operational—and as its capabilities were rapidly expanded-the probable time-lag factor began to diminish and the Exchange gradually altered its views with regard to the viability of a machine-readable certificate as an interim solution. By late 1970, it became apparent that the most useful allocation of manpower and resources would involve passing over the machine-readable certificate and concentrating on the establishment of the central depository. The discussion in the preceding section of this statement, with regard to the progress being made toward the establishment of CSDS, supports the Exchange's present view that, barring any unforeseen developments, the most rapid implementation of a machine-readable certificate would result in a systems change with a questionable useful life span, and that the disruption necessitated by a changeover from the present system, combined with the costs of implementation, would far outweigh whatever benefits might be derived during that period. It should be noted that a machine-readable certificate, in whatever physical form, is subject to definite limitations. The principal advantage of machine 5 The NYSE's stock clearing corporation will continue to perform the comparison, clearance and settlement functions as it does now. |