Under NYSE rules 451 and 452, brokers can vote shares on uncontested matters if the proxy solicitation material was provided to the customer at least ten days in advance, but on contested matters such as the proposals which appeared in the General Motors proxy statement as shareholder proposals number 4, 5, 6, and 7, the brokers could vote only if the shareholders gave instructions to vote. Because signing a proxy card without a contrary indication could be construed as voting for management regarding those proposals, the Exchange has adopted several form letters that are supposed to make clear to the customer what his options are. Seven of the brokerage firms surveyed sent the wrong letter to their customers. The letters they sent either authorized the brokerage houses to vote without instructions or stated that the proxy contained no proposals which were to be voted upon.

An additional four companies sent letters which did not conform to the Exchange specimens, but these might be interpreted as providing sufficient notice in accordance with the spirit of the Exchange rules. A number of other firms which responded failed to indicate which form letter they sent to their customers. 1 We believe it is necessary to change the policy that permits the broker's letter to say that unless the customer gives specific instructions signed proxies will be voted as recommended by management, if not contrarily indicated. Such a letter appears to us to make the communication a solicitation to which the proxy rules apply. At present the Exchange views the letter as a solicitation to which the rules do not apply by virtue of rule 14a-2 (b), since it is claimed that the broker merely functions as a conduit. However, in order to be a conduit, and have the solicitation exempt from the rule, a person may do "no more than impartially instruct the person solicited to forward a proxy to the person, if any, to whom the person solicited desires to give a proxy, or impartially request from the person solicited instructions as to the authority to be conferred by the proxy and state that a proxy will be given if no instructions are received by a certain date." In a contested matter, indicating that the votes will be cast for management unless otherwise indicated, seems to take the broker out of the realm of acting impartially, even if not prohibited by SEC regulation.

It is our view that the recommended form letters are confusing. Some letters do not state which proposals require instructions and which do not. This tends to encourage the shareholder merely to sign the proxy rather than to specifically instruct the broker.

Apart from the letters, the vote totals of some of the firms suggest some violations of the Exchange rules. As noted in an article by the Project's counsel, Donald Schwartz, in the October, 1971, issue of the Georgetown Law Journal, page 71. "A surprising aspect of the General Motors vote was the high percentage of shareholder votes cast on propositions requiring the owner to mail his proxy either to the company or to the brokerage firm. Approximately 82% of the total share eligible to vote were cast at the General Motors meeting on uncontested issues. These figures are even more surprising in view of the result of a Campaign survey which showed that in many cases, large blocs of stock had not been voted, evidently for lack of instructions."

The article goes on to point out that of the largest brokerage block, Merrill Lynch, Pierce, Fenner & Smith, Inc., only 48% of the more than three million shares were voted.

Three brokerage firms indicated that all of their shareholder customers responded, and voted in favor of the candidates for director and against the shareholder proposals. Six brokerage firms cast all votes in favor of the candidates and against the proposals, although not all of the customers cast their votes. Twelve brokerage firms voted all of their customer shares in favor of the candidates and a smaller number against the proposals. These firms show no shares voted in favor of the proposals.

These last three groupings show a voting pattern that is suspiciously unlike the overall pattern. In particular, the first group of firms referred to must have received a positive response from all of their customers in order to so cast their votes, which is extraordinary shareholder behavior. The next six firms demonstrated a voting pattern whereby all the proxies it received from its customers were signed but not specifically voted so that the brokerage firm exercised its discretion and voted in favor of management recommendations. Finally, the last twelve firms seemed to have voted only with specific instructions, but showed no votes in favor of the proposals, which again is unlike the voting pattern elsewhere reported.

Some firms more obviously violated the Exchange rules. One firm sent a form which indicated that there were six proposals when in fact there were eight proposals. Moreover, the forms sent in by the client indicate that one customer voted his 24 shares in favor of the proposal but the firm voted these shares against the proposals contrary to instructions. The proxy manager indicated that all of this was a result of oversight. Another firm showed 4,117 shares in favor of the directors and 4,281 shares against the proposals with zero in favor. It seems highly unlikely that a firm would have received instructions to vote less shares for directors than it would have had to vote against shareholder proposals.

In view of this study, it appears that the New York Stock Exchange rules and practice do not furnish adequate protection to investors. Thus far, the Exchange has limited its role to the mere sending of a letter to the brokerage firms informing them of the rules and regulations. It is clear that greater surveillance is necessary. We are persuaded on the basis of our study that the violation of the rules does not result from any intentional misconduct by brokers but rather are the results of carelessness and lack of supervision.

Nor do we think past errors of brokerage firms had any appreciable effect on Campaign GM. But we do believe that in some contests (such as the Medical Committee for Human Rights-Dow Proposal) brokerage carelessness does have a meaningful effect on the vote, and we certainly believe that all shareholders are entitled to a full and fair opportunity to cast their votes as they wish. Therefore, the most constructive step that could be taken would be to make the brokers' solicitation subject to the SEC's rules so that the supervisory power of the commission could be brought to bear to enforce this important obligation.

Sincerely,

PHILIP W. MOORE, Executive Director.

Senator WILLIAMS. We will adjourn until tomorrow at 10 a.m. (Whereupon, at 12:40 p.m., the hearing was adjourned, to reconvene at 10 a.m., on Thursday, May 11, 1972.)

78-429 0-72-26

CLEARANCE AND SETTLEMENT OF SECURITIES

TRANSACTIONS

THURSDAY, MAY 11, 1972

UNITED STATES SENATE,

COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS,

SUBCOMMITTEE ON SECURITIES, Washington, D.C. The subcommittee met at 10:05 a.m., pursuant to adjournment, in room 5302, New Senate Office Building, Senator William V. Roth, Jr., presiding.

Senator ROTH. The Subcommittee on Securities will please come to order.

We are pleased to have before us today Mr. David Morgan, president of the National Clearing Corp., accompanied by Mr. Lloyd J. Derrickson.

Mr. Morgan, you may read your statement or, if you prefer, speak extemporaneously and have it incorporated in its entirety.

STATEMENT OF DAVID H. MORGAN, PRESIDENT, NATIONAL CLEARING CORP.; ACCOMPANIED BY LLOYD J. DERRICKSON, VICE PRESIDENT AND GENERAL COUNSEL, NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.

Mr. MORGAN. Thank you, Senator Roth. Mr. Macklin expresses his regrets that he could not be here with us today. We do appreciate the opportunity to testify before the Securities Subcommittee. Our written testimony runs just four pages. Our oral discussion will be equally brief.

The first two pages of our testimony discuss NCC's progress to date.

At the present time we are now clearing some 10,000 trades per day in New York through our continuous net settlement system. When we appeared before this hearing body last year, we were at that time. not in operation. We are also clearing some 5,000 trades per day through the daily balance order system in New York which we

operate.

In cooperation with the two respective regional exchanges, we have started a pilot operation in Boston this past Monday and plan to start a pilot operation in Philadelphia on the 22d. Financially our operation now is self-supporting.

I would like to quote from just a few letters of commendation from the brokers in New York as to their acceptance of our system. From a

large retail firm, also a member of the New York Stock Exchange, I quote, "Now that NCC has been in operation for 3 months, I would like to express my satisfaction with your operation. During the initial pilot phase, the few bugs in operations were quickly resolved and were far fewer than anticipated. This can be attributed to the cooperation between the NCC staff and the member firms. Best wishes for your continued success and expansion."

Another large firm, "We have been clearing through the continuous net settlement system since its inception and deliveries are 58 percent of what they would have been under the balance order system. I am looking forward to the participation of all NCC members and the realization of the full import of continuous net settlement with respect to physical certificate movement."

And from a large market maker, "Our firm is very pleased with the benefits afforded by the partial implementation of National Clearing Corp.'s system. With the increased volume, we find we are able to handle more trades with less personnel. This is especially evident in our buying department and there is less work in stock transfer, dividends, and the cage. We are very anxious that the adding of new members be accelerated as we are confident that the benefits will increase geometrically rather than arithmetically when there are fewer firms remaining outside the system.'

Progress to date, while it has been commended, is not enough. Our company was born out of need to improve securities transactions processing by establishing a uniform and standard, nationwide OTC clearing system. This we continue to face as our primary objective and hope to have the system functioning on a nationwide basis in 18 months.

Our technical staff is now working on the design of a trade reporting system. Our goal will be to provide facilities to members so that they will be in a position to report trades through such a system for comparison, clearance, and settlement. It is expected that the first phase of such a transaction reporting system could be operational shortly after the end of this year.

Further, we are continuing to work to prepare the technical interface with the Central Certificate Service in New York. We hope that a permanent, standardized depository interface will be developed and working in New York by the beginning of next year. This standard interface should serve as a basis for an interface with depositories in other major cities as they become established and as we establish regional facilities for the continuous net system. In this respect, we are working with the National Coordinating Group in its efforts to coordinate the establishment of depositories throughout the Nation. Our last two pages of testimony state our position relative to the three bills under consideration. S. 2551, introduced by Senator Roth in September of 1971, represents an early and laudable catalyst in achieving solutions to these problems. In view of developments since that time and the advances made in planning for and implementing continuous net settlement and in developing a standard interface with the national depository system, it does not now appear to us necessary to establish the organizations described in the bill. Although we would add, as Chairman Casey pointed up in his testimony, and I quote,