Senator WILLIAMS. I appreciate that. Thank you very much. Mr. Gardiner, chairman of the Securities Industry Association, accompanied by the president of the association, Mr. Kendall.

STATEMENT OF ROBERT M. GARDINER, CHAIRMAN OF THE BOARD OF DIRECTORS, SECURITIES INDUSTRY ASSOCIATION; ACCOMPANIED BY LEON T. KENDALL, PRESIDENT, SIA; AND ROGER E. BIRK, VICE PRESIDENT AND DIRECTOR, OPERATIONS DIVISION, MERRILL LYNCH, PIERCE, FENNER & SMITH, INC.

Mr. GARDINER. I am Robert M. Gardiner, chairman of the board of directors of the Securities Industry Association.

Accompanying me are Leon T. Kendall, SIA's president, and Roger E. Birk, vice president and director of the operations division at Merrill Lynch, Pierce, Fenner & Smith, Inc.

Our association appreciates this opportunity to address itself on behalf of its brokerage members to the legislative proposals now before your subcommittee on the subject of securities transactions processing.

The causes of the securities transaction processing problem in our view are twofold: paper and "segmentation" of the securities processing industry itself.

Incidentally, this conclusion is documented in a very comprehensive North American Rockwell study report delivered in September 1969, to the American Stock Exchange.

The paper problem has been commented on widely and probed extensively. We believe that the creation of certificate depositories and new clearing methods, development of automated paperwork handling systems, improved communications facilities, and development of standard numbering systems, are all positive contributions pointing to the solution of this problem.

Our goal here is the creation of an integrated, national clearance and settlement system which, by linking New York and regional centers, holds great promise for both lowering costs and raising operational efficiency and capacity in the securities industry.

Such efforts will continue to move all too slowly and risk falling down, however, unless we also solve problems in the area of segmen

tation.

Segmentation of the industry refers to the fact that the clearance and settlement of every securities transaction demands prompt and coordinated action by a number of different organizations each functioning within the processing network.

These various participants include brokerage firms, banks, transfer agents, depositories, the exchanges, public corporations, institutional investors, and banknote printers.

Exhibit A shows in detail the steps involved in the completion of a securities transaction. Note its complex nature. We believe that segmentation has proved to be the most difficult problem to resolve, but that its resolution is absolutely essential if the paperwork question is to be laid to rest.

Although the members of that community allegedly have a common interest in making this system work for the benefit of the investor, the

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separate units also have individual self interests that can work against the overall desired result.

The conflicts thus generated can work to increase rather than reduce "fails," lead to excessive transfer time, place dividends in limbo, lead to incompleted trades and the rejection of partial deliveries.

They also reflect the fact that the stock certificate is not merely a piece of paper. It represents a significant sum of money and that money is at interest, with one party paying the interest and the other party receiving it.

The Rand Corp. identified a dollar cost of $180 million to NYSE members alone in 1968 resulting from the failure of the elements in this system to work together.

To us the compelling conclusion to be derived from this study is that the industry was unable to make decisions to gain operational efficiency and lessen costs because there was no single agency available to arbitrate the financial differences and make rules in the public interest.

Until ways and means are found to bring about the coordination of the self-interested parties in the securities industry, prospects of resolving the operational problems of the securities industry will be marginal at best.

We view the prospect of positive action by your subcommittee this year on a securities transaction processing bill as the most important single step that can be taken to attack segmentation and thereby permit resolution of the industry's paperwork difficulties.

No group has a stronger interest in a modernized, efficient securities processing system than our brokerage members. If our individual or institutional customers are beset by errors or delays, whether we caused them or not, our customer goodwill is injured.

Brokerage firms must pay the overtime, pay the cost of corrections, put up the extra capital, submit to the new rules and restrictions, pay for the operational experiments by exchanges and others, and repair the damaged public image caused for our industry. Yet we have no control over the other participants in the process.

This association as well as its predecessor organization, the Association of Stock Exchange Firms, has conducted a long and frustrating quest for operational efficiency in securities processing.

In September 1967, when the first evidence of an operations jam was manifesting itself we advocated and pushed for elimination of the stock certificate.

Our Committee to Eliminate the Stock Certificate, chaired by Henry M. Watts, a former chairman of the New York Stock Exchange, in an effort to achieve practical, early relief, proposed a plan to automate the existing stock certificate and make it machine processable-to make it an engraved punch card-sized, magnetically encoded document. The American Bankers Association joined us in this goal.

This was deemed a necessary interim step, a halfway house, that would honor the existing infrastructure but also give our members and others in the business of processing securities the near term capacity to do our job for the American investor. It deserved to be fully tested.

Almost immediately the concept was attacked by organizations in the infrastructure that has built up around the stock certificate. The

reason behind these objections, we suspect, was that as parties at interest they would have to change what they were doing and, perhaps, risk the economic advantage they enjoy under the existing system.

The individual exchanges are prone to use their clearance and settlement mechanisms to encourage orders to flow to their trading posts. The banks tend to view transfer or custodial services simply as a cost center for serving corporate clients whose deposit and loan business they seek.

Institutional investors can seek to maximize their money flows and floats through complex delivery instructions. Banknote companies have obvious proprietary interests in the engraved certificate.

So, again, even such modest progress was impossible because there was, and still is, no single organization with authority to set down the standards for directing systemwide priorities and resolving conflicts. Let me try to describe briefly the system of regulation that prevails with respect to the clearance and settlement of securities transactions. Basically, each exchange and the over-the-counter market makes and enforces its own rules and procedures for clearing the trades that take place in that particular marketplace.

At present, a large firm has to interface with as many as 15 different systems in its daily operations. These systems and the various procedures are enumerated in our exhibit C. It should be emphasized that the vast bulk of OTC trades is still cleared in the old trade-by-trade, firm-to-firm fashion. With respect to overall operations supervision, the system is equally uneven.

If a broker is an NYSE member firm, it is regulated by that exchange; if an AMEX member, but not an NYSE member, by the AMEX; if a regional exchange member, but not an NYSE or AMEX member, by that regional exchange; if an NASD member but not an exchange member, by the NASD, all subject to the general oversight of the Securities and Exchange Commission except that a nonexchange, non-NASD member is under the SEC only. Furthermore, since many brokers are members of one or more exchanges and are also NASD members, one firm can, and often does, come under the jurisdiction of several organizations at the same time.

Performance of the transfer function does not appear to be subject to regulation in any significant degree. Although many of the organizations during that work are banks or trust companies, the SEC stated in its recent "Study of Unsafe and Unsound Practices": "The power of the bank regulatory officials over the transfer function is not specific. Rather their concern is whether the performance of the transfer function may endanger the financial stability of the bank." Indeed, to the extent there is any such regulation at all, it too is dispensed among various agencies. In the case of bank transfer agents, if the bank is a national bank, it will come under the Controller of the Currency; if State chartered, but Federal Reserve System member bank, under the Federal Reserve; if a State chartered, non-Federal Reserve member, under the FDIC and the State authority.

If the transfer function is performed by an autonomous service bureau owning 50 percent or 75 percent of the bank's transfer department, as it is now the case at several New York banks, we are not sure who has surveillance and examination powers. If the transfer function is performed by a corporate transfer agent, that is, by the

corporation itself, or by an independent nonbank transfer agent, there is apparently no regulatory control mechanism.

We would like to emphasize that it is not enough to solve these problems only for the listed market in New York. For example, although there are 11 major banks doing most of the transfer agent business in New York Stock Exchange securities, there are as many as 400 more entities, both banks and nonbanks, located around the country performing that function in securities traded over-the-counter. In the past, some of our most serious operational difficulties have occurred with respect to unlisted stocks. We would like to think that new legislation in this area would take into account the clearance, transfer, and settlement of all transactions in all issues traded by our members in all markets including over-the-counter, irrespective of geographic location.

Recapping, there are at least a dozen noncoordinated organizations sharing the regulatory responsibility for securities transaction processing. None has the responsibility or the authority to exercise the leadership needed to set the standards for successful modernization of our system for completing securities trades.

This recital identifies, we believe, the primary need-the need to convert today's self-limiting segmentation into a coordinated whole, a modernized unity consistent with the speed and efficiency demanded by the volume of securities trading today and anticipated for tomorrow.

Reviewing the specific bills before this committee, we are satisfied with the approach to the segmentation problem proposed in both S. 3412 and S. 3297. Thus, we believe a single agency must be given the primary jurisdiction over all organizations in the clearance, transfer and depository process, and we feel that the Securities and Exchange Commission is the appropriate public agency in which to invest that responsibility.

In this respect, we would suggest that S. 3297 be amended to give the Commission rulemaking authority as relates to all entities in the performance of the transfer function. The SEC has the staff expertise and the historical understanding of securities industry operational mechanisms. Moreover, it is already clearly identified in the public mind as the body responsible for doing the job.

If that agency feels that compliance with its rules and regulations can most effectively be enforced through inspections by the already established Federal bank examination instrumentalities, such as the Federal Reserve, Controller of the Currency and the FDIC, then we would accept that judgment. Any division of powers, however, would not appear constructive and, in fact, would run the risk of preserving today's segmentation. Further, we would view any grant of powers to banking authorities in the 50 States as a step backward and a setback to early resolution of either the paperwork or segmentation issues. Historically, the financial field was one where various institutions remained in neat and somewhat mutually exclusive compartments. Commercial banks did a deposit and lending business, stock brokers sold equities, life insurance companies sold life insurance, and so forth. Now, "scrambled finance," rather than orderliness, seems to be the order of the day. Life insurance companies now sell equities, stock

brokers sell insurance, savings banks sell both life insurance and mutual funds, savings and loans seek checking account powers, and banks, through holding companies, seek to become financial congenerics entering a long list of functionally related lines of activity.

Given such scrambling, the public interest is unlikely to be protected by regulatory agencies that are set up on or operate along rigid industry lines. The public interest ties not to the interest of the particular institution, but to the service the consumer desires. Given the realities of change, Congress more and more is likely to be faced with the need to give the primary or lead public interest responsibility in an area to one agency on the basis of functional rather than industry lines. It is the best way to get both the benefits of interindustry competition and equity among the participants.

Some maintain that it is inefficient or impractical to have one business enterprise under two governmental agencies. As stock brokers we can attest that the system can work. For example, our organizations fall under the Federal Reserve as far as margin Regulation T is concerned. We fall under the Treasury Department for certain foreign recordkeeping and reporting procedures. We fall under State insurance commissioners with respect to the sale of life insurance.

The Securities Industry Association believes that we must streamline the operational side of our business internally as well as in its interrelationship with other organizations. To this end we advocate a single unified clearance system that will both take the intramural competition among exchanges out of clearance and permit the development of a modern, national system linking all participants. Our board has committed itself to work within our industry to eliminate existing duplications.

Summing up, the objectives of the Securities Industry Association in the resolution of the paper and segmentation problems can best be set forth as follows: "To foster the development and implementation of an integrated system, to be privately owned and operated, for the prompt and accurate processing and settlement of securities transactions effected on national securities exchanges and in the over-thecounter markets, which will assist in assuring the proper functioning of the securities markets and which will be responsive on a nondiscriminatory basis to the needs of issuer companies, brokers, dealers, banks, and other members of the securities industry and the public investors."

These words are taken from the preamble of S. 3412. We urge swift action by the Congress to codify the sense of this preamble so that we can get on with our job of financing this Nation's corporate growth and improving the safety and liquidity of its wealth assets.

Thank you very much, sir.

(Mr. Gardiner's full statement, with exhibits, may be found at p. 145.)

Senator WILLIAMS. Thank you very much, Mr. Gardiner.

We certainly are in the most complete kind of agreement on the objectives here.

We have two bills that deal with clearing and settlement, designed to create some order and efficiency out of the segmentation situation that can create some degree of chaos.