X. CONSIDERATION OF CHARGE

Either before any motion is made or after a motion is seconded, any governor may ask that the question be considered informally. After such informal

discussion, the board can again consider the question formally.

There are ordinarily three kinds of motions to be considered. Briefly, the three types of motions are:

1. Motions as to guilt.

The person is either guilty or not guilty.

A majority vote of the governors in office (17) is required.

2. Motions as to penalty.

In determining the penalty, consideration is given to the degree of seriousness of the offense and the degree of culpability.

The penalties which the board can impose are:

(a) Censure.

(b) Censure and fine not exceeding $5,000.

(c) Suspension.

(d) Expulsion (obligatory) for fraud (see. 1 or 2 of art. XİV). (e) Expulsion for other than fraud (secs. 3 to 9 inclusive of art. XIV).

(A vote of a majority of the governors then in office (17) is required, except in the case of explusion for other than fraud, where a vote of two-thirds of the governors then in office (22) is required.)

In any instance in which the board may suspend or expel, the board by a majority vote of the governors in office (17) may in lieu thereof impose

(a) a fine not exceeding $5,000 for each violation, or

(b) a censure, or

(c) may remit or reduce the penalty on such terms and conditions as the board shall deem fair and equitable.

The motions are put to a vote in the order of severity; e.g., the most severe is voted on first.

3. Motions as to publicity.

Publicity with name of person involved is required in the case of suspension or expulsion.

If penalty is other than suspension or expulsion, the board determines whether or not publicity shall be given to its decision.

In certain cases, the board has felt publicity concerning a particular case would have a salutary effect. This publicity (in most cases without names) has taken the form of a brief description of the violation and of the penalty imposed. In floor procedure cases, the notice has been posted on the exchange floor bulletin boards and, in office procedure cases, it has been disseminated as an educational circular.

In the board proceedings, is has been the practice over the years for the chairman to preside, and the vice chairman and the president to participate in the discussion and to vote on the determination of guilt as well as the penalty to be imposed. This is specifically provided for by section 2 of article III of the constitution, the pertinent part of which reads:

"No governor shall be disqualified from participating in any meeting, action, or proceeding of the board of governors by reason of being or having been a member of a committee which has made prior inquiry, examination, or investigation of the subject under consideration. No person shall participate in the adjudication of any matter in which he is personally interested."

Also, "Robert's Rules of Order" contains the following provision:

"The members of the committee preferring the charges vote the same as other niembers."

XI. NOTIFICATION OF THE DECISION

Promptly after the board arrives at its decision, the chairman notifies the person charged of the results of the board's deliberations. The SEC is also notified of the board's decisions.

SUMMARY

In its efforts to administer justice, the exchange and its board have not followed either court-marital or trial practices, but have evolved procedures proven to be fair, just, reasonable, and expeditious, both from the viewpoint of the exchange and from that of the person charged.

Although the staff ascertains the facts, the board itself or its advisory committee considers each case individually, determines whether a violation has occurred, decides the penalty to be imposed, and then administers the discipline. The minor (less serious) cases are considered by the advisory committee. All other cases are placed before the chairman, vice chairman, and the president, acting as an informal committee. This committee does not determine the guilt or innocence of the person charged; it merely decides a procedural question: Is the case of such serious nature that it should be submitted to the board for decision, or should it be referred to the advisory committee?

In either proceeding, the person involved is furnished in writing with full information concerning the case and is given every opportunity to present his defense or explanation to the governors before a decision is reached.

Inasmuch as each case involves conduct directly connected with the securities business, and the governors are well versed in the business, it appears unnecessary, and it probably would be confusing, to have the person charged permitted to be represented at a hearing by professional counsel. Experience over the years has demonstrated the wisdom of the constitutional provision which prohibits the person charged from having professional counsel present. Mr. MACK. The Chair recognizes Mr. Glenn.

Mr. GLENN. Mr. Funston, are there any material differences between the rules and enforcement procedures of the New York Stock Exchange and the American Stock Exchange?

Mr. FUNSTON. Yes, sir; very great differences. Our rules generally are tighter and the enforcement is much tighter.

Mr. GLENN. I notice in your statement you say that the rules and enforcement procedures of the American Stock Exchange are being looked into by the Securities and Exchange Commission, but you don't think there is any necessity for doing the same thing to the rules and procedures of the New York Stock Exchange?

Mr. FUNSTON. No, sir; I do not.

Mr. GLENN. That is all I had, thank you.

Mr. MACK. Mr. Keith?

Mr. KEITH. Mr. Funston, in a recent article in the Wall Street Journal there was considerable discussion about the activities of specialists on the American Stock Exchange. It was a rather critical commentary, I would say. Do you have specialists that operate in essentially the same way in which they do on the American Stock Exchange, and is there an opportunity for the type of activity that was commented upon in the Wall Street Journal?

Mr. FUNSTON. Yes, Mr. Keith, our specialists operate generally in the same way that they do in the American Exchange, except our specialists do not handle odd lots, which are less than 100 shares. That is handled by another organization. The difference is that up until recently the American Stock Exchange did not have the same enforcing procedures that the New York Stock Exchange does. I will just give you some examples of that. In policing the dealings of the specialists, we have surprise reports in detail for each stock for a 2-week period, four times during the year. In other words, at times unbeknownst to the specialist we go in and call for a record of all of his dealings. We have a series of statistics to judge the performance of a specialist which are just as detailed as the manager of a baseball team has for judging the performance of a ballplayer. In contrast to that, until within the past weeks when they have adopted the same policing rules that we have, the American Exchange just reported monthly reports of total dealings only of a specialist, not by stocks.

The second thing is that when it comes to allocating stocks at the exchange, our board assigns stocks principally on the basis of the past performance of the specialist as a dealer. In other words, on his record. On the American Exchange the procedure was more to allocate stocks, on the basis of how the listing was obtained.

With respect to capital requirements, we require proof of compliance of our specialist with our capital requirements, at least twice a year, and they are being audited all the time on a surprise basis. The American Exchange, as far as we could make out, made no specific check of this at all.

The enforcement staff of the exchange-we have 21 enforcement people whose sole job it is to police and enforce the specialist rules. In addition to that, we have 31 floor officials who are following these matters. We don't know exactly what the situation was on the American, but we have the impression that the enforcement staff was very small. Then the final thing is that with respect to market studies, we make continuing market studies of the performance of all specialists, covering 30-day periods in each stock that he deals. We determine the percentage of his stabilization records, the percentage variations between his bids and asks, between actual sales and so on and so forth. As far as we know, those sort of studies were not made at the American, but I believe it is their intention to make them from now on. But we have, of course, reviewed what happened over there very carefully to insure that it couldn't happen where we are. We believe we are adequately protected and have not had to change. The only place that we have really felt we had to change our auditing procedure was that we felt we ought to get an affirmative statement from specialists in the future as to whether they bought any stock off the board or not.

Mr. KEITH. I am advised by counsel, who has looked into this in some detail, that a very substantial portion of your business is concerned with the specialists activity, some 15 percent of the total volume.

Mr. FUNSTON. Yes, sir.

Mr. KEITH. So it is a most significant area. The thought that comes to my mind concerning these surprise inspections is: What do they reveal that causes you to continue that kind of auditing activity?

Mr. FUNSTON. They reveal how good a job the specialist is doing in his main responsibility of making a close, continuous market in the stocks in which he is dealing. For example, the 15.8 percent figure, or whatever it is of specialist dealings, is an average figure. In the case of an individual stock the percentage varies. In so-called bread and butter stocks, like General Motors, Standard Oil of New Jersey, the big stocks, where the public activity is such that there is enough buying and selling so that the specialist does not have to participate very much in those dealings, the specialist maybe deals in 5 percent of the transactions. On the other end of the scale are the least well known stocks, where the public is not so active in the market, where the specialist may have to deal in 30 or 40 percent of the dealings. One of the studies made is to see if he is participating in the market as much as he should to keep a close, orderly, active market. Another study is the percentage of stabilization. A specialist in making

a market in the stock is supposed to have a great preponderance, and the rule of thumb is about 80 percent, of his trades to be so-called stabilizing trades. In other words, buying when the market is going down, selling when the market is going up, a stabilizing factor. Another criterion that is looked at is the amount of stock that he goes to bed with at night, as it were. In other words, they are supposed to make a market in the stock and buy when the demand is weak and sell when the demand is strong. They are either long in the market or short in the market. That is all checked up to make sure he is doing his job.

Then another percentage that is looked at is the spread between his bid and asked prices. Say it is a $40 stock. Unless 95 percent of all of his bids and asks are within a half point he is not regarded as doing a good job. It is the same way on the price variations from the last sale. Unless a very high percentage represents a very small variation from the last sale, he is not doing a good job. Last year, 88 percent of all the transactions on the stock exchange occurred at either the same price as the last sale or a quarter of a point variation. One of the reasons that happens is that the specialists are checked on so closely to see that they make that kind of market.

Mr. KEITH. Did I understand you to say that his job was to buy when the market was going down and to sell when it was going up? Mr. FUNSTON. No, that isn't his job. His job is to make a market in the stock. I don't know whether this will help clarify the thing, but before I went to the stock exchange, I always wondered why it was that someone was always willing to do just the opposite of what I wanted to do in buying stock at a price which was very close to the last sale. In other words, I thought "Well, here I want to buy. Therefore, who is willing to sell at a price close to the last one?"

The reason why that happens is the specialist. The specialist is on the floor of the exchange from 10 in the morning until 3:30 in the afternoon at his post, and all dealings in the stock in which he is the specialist have to take place on the floor right in front of him. The buyers and the sellers meet there and the auction market takes place. Sometimes there will not be a member representing the public who wanted to buy or sell at a price near the last sale. Say on a $40 stock some member of the public is willing to pay $38 for it and some person is willing to sell it for $40. Well, that is a two point spread. That is much too big a spread. The specialist is supposed to keep in between $38 and $40 a market which varies no more than half a point. So, say between 3834 and 3914. And he has to be willing to either buy or sell the opposite of what the public wants to do within that range.

Mr. KEITH. Would the public interest be served if a specialist handling public orders was not permitted to buy or sell for his own account?

Mr. FUNSTON. I think that would be one of the-wait a minute. What you are saying is do you think that a specialist who is buying and selling-what you mean is a specialist who is buying and selling for his own account, should he be permitted to act as an agent. Is that the question?

Mr. KEITH. The question has been prepared for me by counsel, but I think it is intended to mean that he, himself, can get in on this arrangement.

Mr. FUNSTON. You see, sir, the way the question was phrased did not make clear that the essence of being a specialist is dealing for his own account. That is being the specialist. So that a man who is acting as an agent for others cannot be a specialist. I think I get the question. The question is, Should a specialist who is dealing in his own account be permitted to act as an agent buying and selling for other people? Is that the question?

Mr. KEITH. Yes.

Mr. FUNSTON. Well, I would say that if you want to ruin the auction market, and if you want to hurt the public more than most anything else I can think of, you would separate these two functions because the fact that the specialist, who is a dealer, can also act as an agent, is one of the things that gives him the incentive to make a good mar ket. He knows that if he can make a good, close market as a dealer, then that will encourage transactions in that stock, which transactions will ease the burden on him as a dealer, and in certain instances, acting as a broker's broker, he may be able to participate as an agent. The only time that a dealer can participate as an agent is when he is acting for another broker who is willing to give up part of his commission so that he will not have to stand around at that post and wait until the price changes are such that it will fall to the point where some customer of his is willing to buy it or will rise to some point where some customer of his is willing it sell it. That is a long-winded answer, but I can expatiate all the more, if you want.

Mr. KEITH. I am advised by counsel that it is a good one.

Mr. FUNSTON. I am grateful.

Mr. DINGELL. Mr. Curtin ?

Mr. CURTIN. Mr. Funston, you mentioned forms of disciplinary action. What other forms of disciplinary action do you have in addition to expulsion?

Mr. FUNSTON. Yes, sir. Expulsion is the worst. Suspension is the next. A fine is the next, and a censure is the next. These are all actions that are taken by the board. Then there are actions taken by the staff which may involve a warning, and then there are actions also that are taken by the staff where the board gives me the authority to suspend registered representatives.

In other words to fire them. They are registered representatives of member firms. And also the same thing with employees of member firms. We can't be arbitrary, of course, we have to have good

reason.

Mr. CURTIN. Have you had certain members that you have had to take disciplinary action against frequently and then finally expel? Mr. FUNSTON." I think there are certain members that our organization watches more closely than others, because of past problems. But I think that the numbers we expel, sir, are really very few. You have to be there to get an idea of the iron discipline that the exchange endeavors to carry out, and I believe does.

Every public governor that we have, at the first trial that he sits through, or the first disciplinary action, is aghast at the tightness and the pervasiveness of our disciplinary action.

Mr. CURTIN. How many members are there in your exchange? Mr. FUNSTON. 1,366 members, and there are associated with them as partners who are subject to all of the same jurisdiction as members, about 4,000 more allied members.