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Senator WILLIAMS. I wonder, Mr. Lemkau, if you could describe the operation of what we call "making the market." There will be an exemption here for directors, officers, or 10 percent owners of corporations who as broker/dealers are making a market in the company's stock. It would be helpful, I believe, if our record had your description of just how broker/dealers do make a market in securities. Mr. LEMKAU. Thank you, Mr. Chairman. If I may, I think I will ask Mr. Haack to answer that question.

Mr. HAACK. Thank you, Mr. Lemkau. The market-making function I would say is closely related to the supply and demand of a security as it exists. A firm, possibly the originating underwriter, possibly one which has no relationship to a company, may for several reasons decide to become a marketmaker. This would involve its taking a risk position, possibly being long or short securities at any given time.

They would publish a quoted bid or offer, those being prices at which they would be willing to purchase stock or offer stock to anybody who was interested in acquiring it. Its function would be to impart to the market a degree of liquidity.

As I say, this would at all times involve a principal status with the firm's capital at risk. These purchases or sales would be made for the principal account of the firm itself, as distinguished from that of a broker.

Mr. LEMKAU. Might I add, Mr. Haack, the purpose being to make sure that there always would be a market, always would be a quotation for the security of the subject company.

Mr. HAACK. This marketmaking ideally exists in markets which are increasing in price or which are decreasing in price. And at all times this willingness to buy or sell stocks does impart, as I say, the desired liquidity to any stockholder who may wish to sell or any member of the public who may wish to become a stockholder.

Senator WILLIAMS. Does this compare in any degree to the specialist who makes the market for a stock listed on one of the exchanges? Mr. HAACK. I would say there is a degree of similarity. One difference is that a specialist on the floor of an exchange sees almost all of the traffic in that particular security, whereas a marketmaker might be 1 of 10 or 15 or 20 people who would be acting as a principal, and he would not be exposed to all of the trading that takes place. But there is a comparability of function.

Senator WILLIAMS. What is a sponsor? Is he just one type of marketmaker?

Mr. HAACK. I would say yes.

Mr. Lowe (subcommittee counsel). Would you care to explain, sir, what the sponsor's obligations are in his function as a marketmaker? Mr. HAACK. I would think that most sponsors-and I assume you are equating sponsors with underwriters

Mr. Lowe. That is right.

Mr. HAACK (continuing). Feel an obligation and a responsibility, once having brought the issue to market publicly, to insure continued activity and trading in that market merely to provide the liquidity, the additional trading, which is desirable from the standpoint of the people to whom they have initially sold stock or again of people who might subsequently wish to become stockholders.

Mr. Lowe. He would have a continuous responsibility then?

Mr. HAACK. I personally think so. I think the importance that is attached to that varies with underwriters. Some minimize it, and some feel a great obligation.

Mr. Lowe. I would suggest that we review the relationship of marketmaking to section 16(b) of the Securities Exchange Act. I believe Mr. Lemkau mentioned this in his statement at page 5. The special study group of the SEC in its report came to conclusions which differed from the conclusions of the Commission with regard to the applicability of section 16(b) to marketmakers-that is, those who, for example, are directors of companies and at the same time make markets in the companies' stock.

For the record I will just read a few sections of the special study report stating the position of the special study group.

On page 47, the special study notes:

Against this background, the section 16 (b) question is largely reduced to determining whether the demands of over-the-counter marketmaking or sponsorship, while simultaneously serving as director, are still so compelling in overthe-counter markets generally as to necessitate a general exemption for marketmakers when the section is extended to over-the-counter securities.

Going further on the same page, and in support of the special study's position, the report continues:

As a senior partner of one of the largest brokerage concerns in the country put it: "With respect to directorships in companies whose securities are not listed, it is my opinion, that if disclosure *** [is] required in the future, the need for investment bankers or brokers sitting on the boards of such companies will be minimized.”

A little further in the special study, on page 54, the study notes, and I quote:

The broad conclusion of the study, which is in accord with the publicly expressed view of one of the most knowledgeable authorities covering over-thecounter markets, Wallace H. Fulton, the retiring executive director of the NASD, is that section 16 (b) should apply generally to unlisted securities.

I wonder, Mr. Lemkau, if you would care to give the case for the other side.

Mr. LEMKAU. Yes, Mr. Lowe. The present thinking of the Board of the NASD is that an unlisted company, an over-the-counter company, should not have a privilege of keeping short swing profits. However, in order to have a broker-dealer who happens to have a director on the board of a company in a position to make a market which is short term we feel that this exemption from the operation of 16(b) for that specific type of activity should be permitted.

Mr. Lowe. Do you think that in his capacity as director he is in a better position with regard to making a market?

Mr. LEMKAU. No, not necessarily. But I do think that, if a firm has sponsored a company, a little, unknown company, sometimes the investment banker could be one of its most valuable directors, and I think it would be an error to deprive that company of such consultation and advice as he might contribute.

Mr. Lowe. Do you feel that any problems of conscience might arise for the person who on the one hand acts as the director of a company and consequently has an obligation to the shareholders of that company, and who on the other hand acts as the marketmaker in the company's stock and therefore has an obligation to the customers of his broker-dealer firm?

Mr. LEMKAU. Well, of course, it is always difficult to wear two hats. But it seems to me that a broker-dealer who is making a market is functioning in a buy-and-sell area for the short swing-that is all this applies to-and would conduct his operation there as the market demanded, as the supply came in or as demand came in.

Mr. Lowe. You would feel that whatever the disadvantages such a circumstance might pose, the advantages of permitting the director to also be a marketmaker and not subject to 16(b) would far outweigh these disadvantages? This would be your conclusion? Mr. LEMKAU. That is correct.

Mr. Lowe. I wonder if we might go

to page 4 of your statement?

Mr. LEMKAU. Mr. Rockefeller wanted to add one comment.
Mr. Lowe. Certainly.

Mr. ROCKEFELLER. În many cases the nonsponsoring marketmaker may feel, under the pressure of the way the market is moving, that he wishes to abandon that market, whereas, as I think you brought out before, the sponsoring marketmaker does feel a responsibility in varying degrees of sticking with that market no matter what may

come.

Mr. Lowe. Thank you. Now, how many companies, Mr. Lemkau, do you estimate would be covered under the 1,000-shareholder test? For your information, the special study group found that approximately 2,500 companies would be covered under this test.

Mr. LEMKAU. We have been so informed.

Mr. Lowe. Do you feel that there is any reason why banks and insurance companies should not be included in this group?

Mr. LEMKAU. Well, we feel that banks and insurance companies should give full disclosure just as any other company does.

Mr. Lowe. In other words, you would say that the investors of bank and insurance companies are entitled to adequate protection just as the investors of other companies are?

Mr. LEMKAU. I certainly would think so.

Mr. Lowe. You state on page 4 of your statement:

We would favor modified reporting requirements to stockholders for companies with from 500 to 1,000 stockholders.

Section 5(c) of S. 1642 provides that a company not soliciting proxies would, nevertheless, when the time comes for elections, send the shareholders the type of information which would ordinarily appear in a proxy statement.

Would this requirement be burdensome for companies at the 500 to 1,000 shareholder level which do not choose to solicit proxies?

Mr. LEMKAU. That is the way we felt about it. You have to pick some figure, and it was our judgment that the 1,000 shareholder figure, with the $1 million assets, was one where there was sufficiently broad trading in the security that that would be the level at which we would cut off.

Mr. Lowe. And this cutoff would also apply to insider trading provisions for those with shareholders of less than 1,000?

Mr. LEMKAU. It would not have any reporting on it.

Senator WILLIAMS. At the bottom of the fifth page, or rather toward the middle, you mentioned rule 3(a) 12-3. Would legislation be required in order to fulfill your recommendation here?

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Mr. WHITE. It is our understanding that the present rule 3 (a) 12-3 has the effect of exempting from the provisions of section 14, which is the proxy solicitation, and section 16, the insider trading restrictions, foreign securities, whether governmental issues or private issues. The rule itself says that issuers reporting on certain numbered forms are exempt from sections 14 and 16.

I believe that the Commission could expand that rule or adopt another one which would afford the same treatment to foreign securities which would come under this bill if they made the finding necessary to change the blanket exemption.

Mr. Lowe. So legislation would not be required to meet your request here?

Mr. WHITE. That is correct.

Mr. ROCKEFELLER. Could I go back one step? When you asked about reporting of banks, I think Mr. Cary handled this very well yesterday in his testimony when he said:

To say that bank regulation renders this disclosure philosophy unnecessary is to say that bank regulation is an effective substitute for the free exercise of an investor's judgment. Controls which protect against embezzlement and which assure adequate reserves serve important objectives, but not the objective of informed investment. To hold otherwise would be to imply that, because of such regulation, bank securities are, without more, worthy investments.

Mr. LowE. Thank you, Mr. Rockefeller.

Mr. ROCKEFELLER. I just wanted to tag that before we went on. Mr. Lowe. I wonder if we might go to page 8 now? Would you like to tell the subcommittee what additional regulations you have in mind under the quotations section?

Mr. WHITE. Well, generally speaking, we have been studying the area of quotations for some time. We found a few instances where perhaps we need certain rules. About the time we arrived at that conclusion, the study group was also investigating and studying the area of quotations.

The association felt that there might be something in this study report relating to quotations soon to be released which would require specific rules of the association in this area. We felt that it would be helpful to have a statutory base for those rules. And that is the reason that I think the Commission agreed to submit this particular section of the bill, or one of the reasons I might say.

Mr. Lowe. In its public hearings last year the special study group of the SEC-that is, in its hearings on the sales practices of the industry-left the impression that the staff of the NASD should be increased in order to provide the type of self-regulation which the Commission had in mind.

Would you care to comment on your action in this respect since those hearings and also on what plans you have in meeting the increased responsibility which enactment of S. 1642 would require?

Mr. LEMKAU. Mr. Lowe, I believe at the time of those hearings we had 30 examiners, which we have since increased to 37 at the moment, and 5 new ones coming on who are in training, which will be 42. Overall last year the staff of the NASD was 164. This year we are budgeting for a total of 174.

So we realize that there are possibly going to be many additional responsibilities which the organization will have to undertake, and we are getting ourselves set for it.

Mr. Lowe. Thank you.

Senator WILLIAMS. Senator McIntyre?
Senator MCINTYRE. No questions.

Senator WILLIAMS. Senator Dominick?

Senator DOMINICK. No questions.

Senator WILLIAMS. We are very grateful to you, Mr. Lemkau, and to the other representatives of the NASD who are with you. And let me reiterate our feeling that you statement represents high quality statesmanship.

Mr. LEMKAU. Thank you very much, Mr. Chairman.

STATEMENT OF BAYARD DOMINICK, DOMINICK & DOMINICK, NEW YORK, N.Y., AND PRESIDENT OF THE ASSOCIATION OF STOCK EXCHANGE FIRMS; ACCOMPANIED BY GEORGE J. OTTO, IRVING LUNDBORG & CO., SAN FRANCISCO, CALIF., CHAIRMAN OF THE PACIFIC COAST STOCK EXCHANGE; G. SHELBY FRIEDRICHS, HOWARD, WEIL, LABOUISSE, FRIEDRICHS & CO., NEW ORLEANS, LA., A CURRENT GOVERNOR OF THE NATIONAL ASSOCIATION OF ́SECURITIES DEALERS, INC.; JAMES CRANE KELLOGG III., SPEAR, LEEDS & KELLOGG, NEW YORK, N.Y., FORMER CHAIRMAN OF THE NEW YORK STOCK EXCHANGE; AND FRANCIS J. HUGHES, GENERAL COUNSEL, ASSOCIATION OF STOCK EXCHANGE FIRMS

Senator WILLIAMS. We are privileged to have Mr. Bayard Dominick with us this morning. He is president of the Association of Stock Exchange Firms. Mr. Dominick, I would say that you must feel as though you are coming before a very friendly forum.

Mr. DOMINICK. Thank you. I certainly do, Mr. Chairman. Senator WILLIAMS. Perhaps one of your friends might like to say a word at this point. Senator Dominick.

Senator DOMINICK. Thank you, Mr. Chairman. I want to welcome my esteemed brother to the witness stand. I think it only fair to say, Mr. Chairman, that, as you know, I am not a member of this subcommittee, and I think I should add to this that I know very little about the securities business except what I learned in my legal practice in trying to get various issues qualified before the SEC.

As a further disclaimer, I suppose I should also add that I have no interest, financial interest, of any kind in the firm of which my brother is one of the head partners. But having said all that, I welcome him here and hope that we will have a friendly discussion.

Mr. DOMINICK. Thank you very much, Senator Dominick. I did not know you were going to be here. I am delighted.

Senator WILLIAMS. I wish you would introduce your associates and friends who are with you, Mr. Dominick.

Mr. DOMINICK. Do you want me to start right at the beginning and start reading my report?

Senator WILLIAMS. Perhaps you would care to introduce your friends and associates first.

Mr. DOMINICK. All right.

Senator WILLIAMS. I see my friend Jim Kellogg.

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