1

handling, leads to an environment in which the certificates cannot be protected against loss and theft economically.

C. FAILS

As indicated above, reliable records on Fails are not available on a routine basis. Consequently, the sources of Fails, the manner in which they depend on volume, and the degree to which they have a compounding or "domino" effect, cannot be evaluated quantitatively. There is reason to suspect that the system operates in a "degenerative" mode, in the sense that once a critical Fails level has been exceeded, the situation will tend to get worse, rather than to stabilize.

D. DELIVERIES

In the area of deliveries, numerous complaints are made by and about all participants brokers, banks, customers and transfer agents – and there are no means for establishing valid performance measures in any sector of the process. Time delays in transfer, and in physically effecting inter-regional movements of certificates, obviously produce a need for a large cash float. As institutions become a larger factor in the market, this problem will become more severe. Delivery DK's add to the times involved, and further increase the float. The full costs involved in deliveries are not known; but with institutional trading amounting to $200 million a day - and growing rapidly the costs clearly are significant and growing.

In addition to the above items, there is one major problem area which has not been considered within the scope of this work the acquisition of error free trade data. Available evidence suggests that a significant number of errors are introduced in the ordering process and during trade data collection. Some of these errors will be picked up and corrected in the trade comparison process, while others (primarily errors in order taking) may not be until they reach the transfer process, or until the customer receives his securities. All of these errors increase the clerical workloads. The important factor at this stage is to recognize that, even after some form of locked-in trade mechanism is developed, errors will continue to arise; and the securities handling system of the future must be a robust one which is capable of handling them.

III. APPROACH TO A SOLUTION

We believe that proper solution of the problems of the securities industry involves focusing attention on the need to reduce labor intensiveness and to introduce and make available system-wide audit and control information. Of the available possibilities, the only approach that appears practical involves radically increasing the extent to which securities settling, transfers, and delivery can be conducted through a system of computerbased bookkeeping entries. Employing this approach it becomes practical to acquire centralized records in a form that can be made widely available to the various participants, while simultaneously minimizing clerical requirements and duplication of manual data recording. Properly developed, a system of this type can even permit participants to perform a majority of their personal auditing activities by automated means.

The intensive use of bookkeeping entries implies the development of an effective depository, or a system of depositories, organized in a fashion that permits decentralized acquisition - but centralized storage - of data. The installation need not be physically centralized; in fact, there are good reasons why physical centralization may not be desirable. But this use does imply a need for central awareness of all transactions taking place within the segment of the industry that is being served.

The basic reason for developing a depository system is to permit a maximum fraction of all transactions to be effected by bookkeeping entries. Therefore, it is important that the depository design encourage deposit of as high a proportion of all eligible securities as possible, and that it minimize legitimate requirements for repeated withdrawals and re-entries. To achieve this objective requires participation by brokers, banks and institutional customers. A collateral loan capability that did not require withdrawal of certificates from the depository system, could be developed with minimal banking cooperation. However, penetration of the handling system into the areas of rapid transfer and delivery of securities simply is not practical without strong banking and institutional support. The system structure must, therefore, encourage this participation.

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A. SYSTEM FUNCTIONAL STRUCTURE

The functional structure of the system we propose involves three basic modules, which have the following responsibilities.

1. Broker Module

The Broker Module will operate as the nominee owner (as CCS does now) of all securities within the system that have been entered and are being retained on behalf of Clearing Members who belong to the module. The module will:

Provide a set of self-contained services, oriented to
the brokerage community, that include all types of
transactions which remain within this community.

Process transactions for Clearing Members which lead
to interactions with the other two modules in the
system.

Maintain a complete set of position and activity rec-
ords that cover all securities and transactions with
which the module is involved.

2. Banking Module

The Banking Module is nearly a mirror image of the Broker Module. It will employ a separate nominee name for securities held within the banking community. However, it may also maintain separate records of securities that have entered the system with an institutional name of record, but with a suitable custodian bank address. The latter feature provides a means of meeting institutional requirements' which is not necessary in the Broker Module.

The Banking Module can provide a wide range of separate services appropriate to the banking community and will maintain appropriate records in a form that meets banking requirements.

3. Custodian Module

The Custodian Module is the central module in the system. It will:

Maintain custodial responsibility for all securities in the system, storing them either centrally or in regional locations as desirable.

Have an associated co-transfer agent activity, to permit rapid and efficient transfer of ownership records between the Banking and Broker Modules and between either of these modules and outside owners.

Have complete control and responsibility for system entry or withdrawal of certificates.

Have responsibility for managing the movement of securities between the Broker and Banking Modules, certifying in each case the availability of free securities adequate for such transfers, and of cash for payments involved in the securities movements.

Provide an interface with systems developed to service other securities markets.

Manage relationships between the Securities Handling System and the outside world, including book transfer agents and corporations.

Maintain complete position records, activity records and audit trails covering all inter-modular transactions. Separate position records will be kept for the Broker and Banking Module nominee owners, plus individual accounts for institutions that employ custodian bank addresses.

B. BASIS FOR SYSTEM STRUCTURE

There are a number of important reasons for creating the system organization described in the preceding paragraphs. These include:

Discipline and Policing: Effective operation of a large
system requires that participants be subject to a variety of
rules and regulations. We do not believe a single unit can
be responsible for policing performance and applying disci-
plinary measures for two groups as different as banks and
brokers; the operation can be performed best by making
each group responsible for its own performance.

Individual Interests: The brokerage and banking commu-
nities have different as well as common interests, and have
customarily operated with different sets of procedures. We
consider it appropriate that this form of independence
continue. If all transactions which influence both modules
are subject to standards acceptable by all participants,
neither side need be concerned with the details of opera-
tions on the other side of the system. Even more impor-
tant is the fact that very different sets of services may be
appropriate for the two modules. For example, the pro-
posed securities movement system will establish facilities
that could be applicable to a wide range of current and
potential bank services. Separation of the two modules will
allow these individual sets of services to be developed more
efficiently and responsively.

Legal Considerations: The Banking Module must be capa-
ble of "looking like a bank." It must maintain records and
employ standards and procedures acceptable within the
framework of traditional banking. These standards and
procedures probably are neither necessary nor desirable
within the Broker Module.

Integrity and Trust: The proposed system will work well
only if it possesses high integrity and creates trust on the
part of all participants. This can be achieved best by