Stock Exchange had made cost studies which had been reviewed and analyzed by the Commission's staff, and after numerous conferences with the Exchange on the question. We estimate that the change in break-point will save investors $5,000,000 annually. In requesting the change, we indicated our expectation that the Exchange would undertake a further review of the odd-lot differential after the end of 1966. Since the action taken by the New York Stock Exchange has an important effect on other national securities exchanges, it is also essential for us to undertake a detailed review of the structure of the odd-lot industry, the different mechanisms for effecting odd-lot transactions on the various national securities exchanges, and, perhaps most important, the economic impact of the change in the break-point. The study of the odd-lot business will necessarily take the Commission into other areas. We will have to consider how automation might change the present method of odd-lot execution, the relative merits of having odd-lot transactions handled by odd-lot firms or by a specialist, and whether procedures for executing odd-lot transactions should be uniform for all exchanges. We will work closely with the various exchanges in this effort. 3. Commission Rate Structure.-The Commission has express statutory authority over the rules of the various national securities exchanges which fix the minimum commission rates to be charged by their members in all dealings with non-members. In seeking to discharge its responsibility, the Commission has been reviewing with the securities industry the effects of the existing rate structure in light of the great changes taking place in the markets and in particular the enormous growth and changing character of institutional use of these markets. Our staff has been holding discussions with representatives of the major exchanges for the purpose of identifying and defining the issues and problems involved and for the planning of further inquiry. At the same time, the staff is analyzing the data contained in income and expense reports filed by members of the New York Stock Exchange and supplied by the Exchange to the Commission. One focus of the inquiry is the growing practice, to which attention was called by the Special Study, under which an executing broker "gives up" a portion of his commission, at the direction of the customer, to other brokers who may have had no connection with the execution of the transaction. Another is the question of the appropriateness of discounts for large transactions. 4. Institutional Membership on National Securities Exchanges. The present rules of the New York Stock Exchange (NYSE) prevent institutional investorsmutual funds, insurance companies, pension funds, etc.-from being members. Many of these institutions deal largely in securities listed on the NYSE and would consider exchange membership a logical and appropriate means of saving brokerage commissions. Unlike the NYSE, some of the regional exchanges permit institutions to become members. Four mutual fund groups have recently obtained representation on the Pacific Coast Stock Exchange through wholly-owned broker-dealer subsidiaries. The NYSE questions the desirability of this development, and has suggested that the broad question of institutional membership is one of the most serious questions facing the financial community. In considering this matter, the Commission will have to know how institutional membership would affect the functioning of the different components of the trading markets in securities. We will also have to consider the potential benefits and harm which would accrue to those who do business in the markets and to the shareholders of mutual funds and the beneficiaries and owners of other institutions. Still another aspect of our study will be the impact of institutional membership on regional exchanges. 5. Off-Board Trading. Recently the New York Stock Exchange, at the request of the Commission, revised its rules to allow members of the Exchange to deal with qualified non-member market-makers in the execution of orders for listed securities off the floor of the exchange under designated conditions. We hope that this change will facilitate obtaining better prices for the investor, and will add greater depth to the markets in a number of important securities. However, a careful and continuing examination into the operation and effects of this change, in cooperation with the New York Stock Exchange, is essential. The foregoing are studies in which the Office of Regulation is now engaged and which will continue to occupy its attention in 1968. In addition, the extensive changes in the securities markets noted above will undoubtedly give rise to other problems requiring intensive and immediate analysis. We believe that continuing work on these problems is a more effective and more economical way of fulfilling our responsibilities than an occasional major study, which, as the Committee knows, involves a very substantial expenditure of money. Administrative agencies have been validly criticized in the past for failure to keep abreast of developing situations, and we believe that our current approach to regulation of the markets is the appropriate way of meeting that criticism. REGULATION OF PUBLIC UTILITY HOLDING COMPANY SYSTEMS For 1968, four additional positions are requested for the Branch of Public Utility Regulation in the Division of Corporate Regulation, The year 1966 saw a marked upsurge of activity in the formation of new publicutility holding company systems. For the most part this reflects new develop ments in technology, including atomic energy plants for the generation of elec tric energy. As a consequence of these vast technological changes, it has become more economical to construct larger generating units, conventional or nuclear, far beyond the specific needs of any one company. The holding company is now recognized as one technique by which non-affiliated companies can be brought under single management and control in order to take advantage of the larger generating units to serve the combined needs of all affiliated companies. Northeast Utilities, organized in 1966, brought under a common affiliation two large electric utility companies in Connecticut and one in Massachusetts. A number of plans are also being formulated for the joint ownership and opera tion of atomic energy and pumped storage generating facilities by subsidiary companies of registered holding companies in conjunction with non-affiliated companies. Each of such proposals will require continuing regulation by the Commission of the corporate and financial transactions of companies not now subject to the Act and pose additional Section 11 problems. Apart from these new matters, there are at least six holding company systems with important problems under Section 11 which have remained unresolved for many years. A recent Supreme Court decision affirming the Commission's interpretation of Section 11 emphasizes the importance of a beginning to dispose of this backlog. Such an effort is, however, as a practical matter, an impossibility with the existing Staff. Due to the fact that, until recently, our activity in this area of responsibility had not increased, and to our decision to deal only with the most pressing needs, we have over a period of years reduced the number of persons assigned to this work. However, the need for additional personnel has now become acute, not only because of the wholly unanticipated increase in the number of applications filed during fiscal 1966-an increase which seems likely to continue indefinitely-but also because of the time-consuming nature of certain pending and anticipated proposals. Furthermore, we can no longer defer a beginning effort to dispose of the long-standing problems referred to above. We now are faced with a completely unanticipated increase in new problems, new cases and new holding companies. Around the beginning of fiscal 1967, seven applications (a number unprecedented in recent years) were filed, on which public hearings are now, or shortly will be, in progress. Processing of certain of these problems is expected to carry over into fiscal 1968. Specifically, these seven matters consist of four plans for divestiture or simplification under Section 11(e) of the Act and three proposed acquisitions of stock by means of tender offers. Each of them raise important and difficult problems under the standards of Section 11 and other provisions of the Act. In addition, the three tender offers, if approved by the Commission, will require the submission of further proposals to bring the resulting systems into compliance with the standards of Section 11 (b) of the Act. The Branch of Public Utility Regulation presently has eight professionals and one secretary. It administers and enforces compliance with the Holding Company Act of 1935, which regulates interstate public utility holding company systems engaged in the retail distribution of electricity or gas. A principal purpose of the Act is to promote the geographic integration and corporate simplification of holding company systems. This undertaking involves complex and interrelated questions of law, engineering and finance. The work of the Branch includes the processing of applications, proposals, and reports relating to a broad range of corporate and financial transactions by 21 registered holding company systems. Eighteen of these systems, with aggregate assets of $16.2 billion as of June 30, 1966, are active and will be subject to the jurisdiction of the Commission under the Act in fiscal 1968. These systems include 213 separate companies, of which 14 are solely holding companies, 7 are combined holding-operating companies, 88 are electric and/or gas utility subsidiaries, 69 are non-utility subsidiaries, and 35 are inactive companies. During fiscal 1966, a total of 136 applications for approval of various transactions were filed with the Commission. Of these, 36 involved public issues of long-term debt and capital stock, totalling $823 million, to finance plant and equipment expenditures. These 136 applications should be contrasted with the 81 filed during fiscal 1965. In addition, the Branch is required to maintain continuing survellance over 225 holding companies which have been exempted from the Act, by compliance with a rule or by order, to make certain that the circumstances which gave rise to the exemption have not changed. PURCHASE OF THE COMPUTER The Commission presently leases an IBM 360 Model 30 Computer and certain auxiliary equipment (punches, sorters, verifiers, etc.). The annual rental cost is $146,100. Our leasing agreement provides for an option to purchase this equipment in 1968 at a cost of $488,325. After careful study, we have concluded that the computer and auxiliary equipment (1) can be used advantageously and successfully and (2) will be adequate to satisfy our current and projected needs. Our study has shown that a saving of at least $400,000 can be achieved in five years by purchasing the computer and auxiliary equipment rather than continuing to lease them. A special addition of $342,225 will be required in 1968 to consummate this transaction and assure the savings in future years. We are participating in the Government-wide ADP sharing exchange program and we have sharing arrangements with two other agencies. The GSA has estimated that the hourly rate the Commission is charging these agencies, as compared to the prevailing hourly rate of outside sources, will result in a saving to the government of about $110,000 a year. Since we started renting the computer about nine months ago, we have abolished five positions and are in the process of shifting eleven employees from activities taken over by the computer to strengthen other activities of the Commission. But the computer has not only eliminated existing jobs; it has enabled us to undertake important additional tasks which we could otherwise not have done without substantial increases in personnel. For example, in the past, the Commission did not have the manpower to check on a regular basis all 8,000 securities quoted in the over-the-counter market on an average day, but was forced to rely on checks of selected issuers and brokers, and on complaints from the public, as the primary bases for surveillance. This approach was spotty and unsatisfactory. Our computer is programmed today to identify on a regular basis unusual price movements and other unusual activity in any of such securities at any time. Under certain "built-in" criteria, the computer will print out the security and the dealer involved, permitting us to detect potentialy troublesome situations quickly. We estimate that to do this work manually would have required at least an additional six positions, and the work still could not have been done as rapidly or reliably as it is being done by the computer. It is the unanimous opinion of the Commission that the positions requested are necessary if we are to fulfill our statutory responsibilities to protect the investing public. Sincerely, MANUEL F. COHEN, |