DEAR RALPH AND BOB: As I have indicated to you previously, I would now like to step down as Chairman of the Surveillance Committee. The year that has passed since its creation saw one crisis after the other. At present we seem to have weathered the storm. Our present member firm status is satisfactory; from a high of over 50 firms under surveillance about a year ago, we are now down to one firm with a ratio of 1200% or more. No major firm is on our list. Du Pont, Goodbody, Hayden Stone were crises that left deep and lasting scars but the system survived. Our most productive work involved firms which never made the headlines. The Liquidation of those firms for which the Trust Fund assumed responsibility prior to the creation of our Committee is proceeding although I suspect we will still have some unpleasant surprises there. You, Ralph, more than anybody else, were responsible for the creation of SIPC which, to a large extent, now gives ultimate protection to the investor.

Any regulation involves reliance upon certain tools. As far as we are concerned, chief among these tools are reliable financial statements. As I indicated to the Board in my letter of October 23, 1970, I have been disenchanted for a long time with the accuracy of member firm interim reports. I will now extend this to audited reports as well. The roughly $100 million which the Exchange Community may be required to pay, either through Trust Fund payments or through the Goodbody and Du Pont assessments, were not simply moneys lost from operations in 1970. Naturally, operating losses due to reduced volume and lower market levels were a factor; so was the impermanence of a good portion of capital. However, in my judgment, much of what surfaced in 1970 dates back to prior years and was probably the result of the speculative exuberance of the late 1960's. The enormous security shortages, the dividend errors, unsecured accounts, non-marketable positions, etc. were only picked up belatedly, if at all, in the case of those firms which we all got to know too well.

The questions raised by the not infrequent inaccuracy of both internal and audited reports will have to be studied by the Exchange. In my opinion, they involve the entire concept of self-regulation since, if our tools are inadequate we either have to get new tools or someone else should do the job.

I think we have, at enormous cost and with little public recognition, paid for the sins of the past and have stopped the current bleeding. I am not convinced that we have adequate early warning and adequate measuring to prevent recurrence if industry conditions should change again.

The creation and the functioning of our Committee came as a result of the feeling of the Board that the crisis had gotten to the point where the Staff needed toplevel support. The Committee, however, cannot and should not be considered as a substitute or even as a permanent addition to the Staff in the area of selfregulation. Only a very dramatic increase both in the number and in the caliber of the New York Stock Exchange staff can begin to cope with the problem and, even under these circumstances, the outcome may still be in doubt.

In my letter of October 23 I urged stringent tightening of the capital rules, and that is now well along with Sol Litt's committee. I would now add to that a recommendation for a mandatory change of auditors every three years. I believe that capital rules that are not only stricter but less subject to interpretation, together with the new rules with respect to box counts and the aforementioned mandatory change of auditors every three years could provide the Exchange with a safe member firm structure and surveillance tools that should be more effective.

The commission rate structure, on which you have been working so diligently will also be a key factor. No amount of surveillance will do the job if the_rat structure cannot provide a reasonable level of profitability for the industry. I ar fearful that the trend to negotiated rates will do just the opposite.

I am sure that Bill Martin's report, when it is completed, will address itse much more completely to the problems of self-regulation and to the best stru tural answer to those problems. It may be that the Surveillance Committee, bor in crisis, should be dissolved and its responsibilities returned to the Staff. That up to you to decide.

In closing, I want to thank both of you for your unceasing help and support a members of the Committee. The concept of self-regulation, which the Exchange dedicated to, will be subjected to the glare of considerable questioning in the nes

future. I don't believe we can take the position that it has been a success over the last few years. Hopefully, we may convince our critics, which will include the Congress, the SEC, and the public, that very costly lessons have been learned and will result in greater effectiveness. The proof of the pudding will obviously be in the eating.

I would appreciate it if you would make this letter available to the other governors with my thanks for their support.

Sincerely yours,

FELIX G. ROHATYN.

Mr. Moss. And I would like to request that you supply to the committee a copy of the letter referenced in the letter of June 11, 1971, dated October 23, 1970. Is there objection? Can you supply that?

Mr. ROHATYN. Yes, I will..

Mr. Moss. Thank you very much."

(Letter to Mr. Robert Haack, president, New York Stock Exchange, follows:)

Mr. ROBERT W. HAACK,

President, New York Stock Exchange,

New York, N.Y.

OCTOBER 23, 1970.

DEAR BOB: The question of the effectiveness of the New York Stock Exchange's early warning system has to be examined in the light of the current situation with Goodbody. One may well ask whether there is such a thing as an early warning system if results of a firm's audit can be as widely at variance with a firm's internal figures as was the case with Goodbody and with so little advance notice. As Chairman of the Monitoring Committee, as you may remember, I reported to the full Board, at the time of the Hayden Stone situation, that I did not want the Board to be misled or lulled into a sense of confidence by the so-called early warning system, since I personally was most skeptical of its true effectiveness. I have repeatedly told the Board since then that there can be no early warning system if, as I believe to be the case, the reporting figures of the firms to the New York Stock Exchange staff may be considerably off. This is especially true of firms with past or present back office problems whose true condition seems to come to light only with a full audit.

I think the New York Stock Exchange should consider whether, in the light of this situation, it can really talk seriously about having an effective early warning system or whether entirely different procedures such as more frequent or possibly continuous auditing procedures of member firms should be studied. I am very uncomfortable with the idea that the Securities & Exchange Commission, the Congress and the public not be misled about what we can or cannot do in terms of early warning or monitoring, and I know that in this I speak for our full committee. I am coming to the conclusion that only by adopting more stringent capital rules, which must include a definite limitation on the proportion of subordinated capital to total capital, with a cash maintenance provision, with a drastic reduction in the 20 to 1 ratio and additional haircuts (all of which I hope will be included in the current studies of the Rule 325 Committee) will be really be reducing the risks to the public.

I would appreciate it if you would make this letter available to the members of the Board. Even though I have verbally made these thoughts known to the Board on previous occasions I think it worth while that we seriously consider this matter in the light of the present situation, and see if we can come up with a more appropriate solution.

Sincerely,

FELIX G. ROHATYN.

Mr. Moss. Our next panelist will be Mr. George L. Shinn, vice chairman of Merrill Lynch, Pierce, Fenner & Smith, Inc.

STATEMENT OF GEORGE L. SHINN, VICE CHAIRMAN OF THE BOARD OF DIRECTORS, MERRILL LYNCH, PIERCE, FENNER & SMITH, INC.

Mr. SHINN. Mr. Chairman and members of the subcommittee, I am George Shinn, vice chairman of the board of Merrill Lynch, Pierce, Fenner & Smith, Inc.

I am happy to assist in any way I can in the efforts of this committee to determine what lessons can be drawn from the history of the securities industry between 1968 and 1970.

Wall Street, of course, seems always to be in a state of excessive joy or depression. But the experiences of 1968 and 1969 were somewhat special. William L. Cary, a former Chairman of the SEC who is now assisting this subcommittee, said in an article recently:

Portents of distress appeared while volume and prices were still at their peaks *** then, when volume and prices fell, a flood of ills threatened to submerge large parts of the broker-dealer community.

As you know, the enormous growth of the securities industry in 1960's exceeded the forecasts of all the experts. Many of the procedures and practices that were routine on the street, and that to some degree still survive today, were inadequate under the strain of increasing volume. In addition to the unprecedented and unexpected rise in volume, institutional power began to be felt, with a resultant fragmentation of the marketplace.

During this period of boom, as in other such periods in the past, the brokerage industry attracted large numbers of adventurers and profit seekers. Many of these people had never heard about the public interest and could not have cared less. Our industry's standards for admission and the qualifications necessary to continue as a bona fide member of the securities industry have never been very high. For a while when everything was coming up roses, many people who operated on very short-term objectives took advantage of the opportunity that such low standards offered.

Because of the historically cyclical nature of the securities business and the inability to forecast with assurance what the volume will be 1 year ahead, or even 1 month ahead, the financial community generally is reluctant to increase staff and overhead costs during the initial stage of an increase in volume. This is understandable. There were few who expected that the upsurge in volume would persist for any length of time.

However, as time went on with no letdown in volume or workload, brokers hired hastily in a tight labor market. They had to take on people with less and less experience, education, and capacity. Because of the nature of the industry, they also had to handle every trade every day. If you are selling automobiles, you can take an order and deliver the car 90 days later. But if you are in the securities business, you can't stretch out your orders-you have to keep up with the daily volume somehow.

Additionally, many firms rushed into computers and electronic data processing-admittedly, a direction which promises to yield big improvements in the industry's services in the future. But such changes in basic procedures cannot be made quickly. Put into effect on a crash basis, such programs more often than not led to compounded

disasters, as the manual systems that they were designed to supplant were abandoned before the new methods were proven.

These deficiencies were not limited to the brokerage industry; banks and other institutions involved in the transactions process faced the same difficulties. They also were affected by high volume. They also had to hire inexperienced clerks. Their records also were slipshod and generated more confusion.

No firm was immune from trouble under those circumstances. Indeed, it was impossible for any single firm to be completely immune. All the complicated procedures of processing transactions involve other firms and other institutions, so that no single organization can make a total reform by itself. At Merrill Lynch, we had our troubles in the big years, especially in 1968. On the whole, however, we were able to come through the deluge of 1968 and the drought of 1970 in good shape.

Our experience with real trouble came about principally as a consequence of Merrill Lynch's reluctant acquisition of Goodbody & Co., in December 1970. We took over that troubled firm then at the request of the New York Stock Exchange. We formed a new entity, Goodbody & Co., Inc., which assumed the business and certain assets and liabilities of Goodbody & Co., then a general partnership. As you know, the liabilities and estimated necessary reserves at Goodbody turned out to exceed the assets by something over $24 million, $20 million of which is indemnified under the terms of the arrangement we made with the New York Stock Exchange at the time of the acquisition. We do not yet know the precise cost to Merrill Lynch of the Goodbody takeover. Our investment to date is well over $20 million. It would be presumptuous of me to attempt any precise account of what went wrong at Goodbody during the 1968-70 period. Whatever observations I am able to offer are based on what I learned as vice chairman of the board of Merrill Lynch and newly appointed president of Goodbody & Co., Inc., in the months following December 11, 1970, the date of the takeover.

Generally, however, it seems fair to offer the judgment that the troubles at Goodbody were very deep and very basic. They can be traced back to a very unhappy mix, the mix of inadequate and impermanent capital with inadequate management. Similar combinations elsewhere survived for a time in a thriving and uncritical environment which allowed thin capital and permissive management practices to be concealed by a general wave of prosperity. But when both stock and volume began to fall, stress became apparent. Those firms with capital contributed in the form of securities or with capital in speculative ventures had to reduce their overhead very rapidly or raise new capital; both roads, as it turned out, were pretty rocky. I want to make clear here that Merrill Lynch does not use its capital for any other purpose than the conduct of our business.

We found Goodbody's capital position to be very troublesome. The firm was being very shakily held up by subordinated lenders, most of whom were quite eager to abandon a sinking ship. Cost control was lax or nonexistent. In the flush of prosperity, the firm had been opening additional offices as rapidly as it could without the adequate surveys or preliminary work, and with a notable lack of long-range planning. Relationships between the branches and the home office was tenuous, and some branch managers used the author

ity and autonomy delegated to them most unwisely. Training programs, so necessary to efficient operations, had been entirely abandoned. No one knew exactly what the security position differences

were.

In essence, our treatment for all these sicknesses came down to liquidation. We had not been in control of Goodbody for very long before we made the policy decision to close down Goodbody as a separate entity and to integrate its operations with those of Merrill Lynch. Since December, 17 Goodbody offices were sold or closed completely, 50 were integrated into Merrill Lynch offices, and 32 became new Merrill Lynch facilities. We have also added to the Merrill Lynch payroll some 2,274 former Goodbody employees, including 725 account executives. All this was accomplished in 6 months. But much remains to be done before all of the recordkeeping is finally straightened out and all securities differences are resolved. It may also be years before various kinds of litigation are settled. In conclusion, I would like to restate that I am pleased to participate here today in a somewhat dual capacity from my experience as an officer of both Merrill Lynch and Goodbody & Co., Inc. I understand the experimental nature of this proceeding and think it is appropriate in this time of self-analysis and change for a vital industry. I sincerely hope that the results will be valuable. I read with great interest the staff study entitled, "Review of SEC Records of the Demise of Selected Broker-Dealers," dated July 1971. I believe that the findings are a constructive step toward our common goals. Thank you.

Mr. Moss. Thank you, Mr. Shinn.
Mr. Harold Rousselot?

STATEMENT OF HAROLD A. ROUSSELOT, CHAIRMAN OF THE BOARD OF DIRECTORS, duPONT GLORE FORGAN, INCORPORATED

Mr. ROUSSELOT. Mr. Chairman, my name is Harold Rousselot, and I am chairman of the board of directors of duPont Glore Forgan, Incorporated. Mr. Chairman, I will spend some time in my prepared statement to correct a confusion of names, and I am sorry that the staff has exacerbated the situation by billing me improperly on your agenda, but I am sure you will understand why I am sensitive to this point as I proceed.

I am pleased to join my colleagues here today to provide this distinguished committee with whatever information I can.

In my judgment, you are performing an extremely useful service in spotlighting some of the problems of Wall Street, so the mistakes of the past are not repeated in the future.

Your concern is the same as our concern-to safeguard the investing public.

Let me begin with a word of history about my own firm. As you may recall, in mid-1970 Francis I. duPont & Co. consummated acquisition agreements with Glore, Forgan, Wm. R. Staats, Inc., and with Hirsch & Company. As a result, the firm, a partnership, operated under the name of F. I. duPont, Glore Forgan & Co., beginning in July 1970. On May 14, 1970, the partnership transferred almost all of its assets and liabilities to a new corporation, duPont Glore Forgan Incorpo