STUDY OF THE SECURITIES INDUSTRY

MONDAY, OCTOBER 18, 1971

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON COMMERCE AND FINANCE,

COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE,

Washington, D.C. The subcommittee met at 10:15 a.m., pursuant to notice, in room 2321, Rayburn House Office Building, Hon. John E. Moss (chairman) presiding.

Mr. Moss. The subcommittee will be in order.

This morning the Subcommittee on Commerce and Finance of the House Committee on Interstate and Foreign Commerce opens the fourth in its series of hearings in its study of the securities industry.

In our last hearing we focused on problems of accounting, specifically the need for uniform accounting procedures and uniform and more extensive disclosure to customers of broker-dealers' financial condition, as well as the adequacy of audit procedures.

Now we shall turn to another important problem, namely, the pervasive effect of the stock certificate as a primary factor in back office difficulties and an obstacle to the rapid and efficient processing of transactions both on the exchanges and over the counter.

These hearings will focus on the feasibility and desirability of one or more depositories to immobilize stock certificates, the development of a machine-readable certificate and accompanying documents, and the development of a more efficient system for clearance, settlement, delivery, and transfer of securities.

A later hearing, scheduled for October 26 and 27, will consider the possibility of totally eliminating the stock certificate.

As in our prior hearings, we have determined that this hearing will take the form of a panel discussion rather than the usual formal presentation of statements. In this way, the subcommittee hopes, it will be possible to achieve an interchange of views, both between this subcommittee and the panelists and between the panelists themselves. At the outset, each panelist has been asked to present a brief summary of his views. The written statements will, of course, be made a part of the record and the Chair, at this point, requests unanimous consent to include such statements in the record as they are presented.

Is there objection? Hearing none, that will be the order of the

committee.

I appreciate the difficulties inherent in the next request, but I ask that you keep your summaries as brief as possible. I hope that 10 minutes will suffice. If there are points left uncovered, you may pick them up at a later stage in our discussion.

To make the record clear and simplify the task of the reporter, please identify yourself before presenting your remarks and also later in the discussion, if this seems necessary.

We are pleased to have with us this morning as panelists:

Commissioner James J. Needham, Securities and Exchange Commission;

Mr. Herman Bevis, executive director, Banking and Securities Industry Committee;

Mr. Richard B. Howland, president, Stock Clearing Corporation, New York Stock Exchange, Inc.;

Mr. Phillips M. Montross, president, Midwest Stock Exchange Clearing Corporation;

Mr. Christopher J. Delahunty, president, Pacific Coast Stock Exchange Clearing Corporation;

Mr. David H. Morgan, president, National Clearing Corporation; Mr. Frank Kaestner, senior vice president, Manufacturers Hanover Trust Company.

Mr. Junius W. Peake, general partner, Shields & Company; and Mr. W. Henry du Pont, chairman of the board and president, SCITEK, Incorporated.

I want to welcome all you gentlemen with us here this morning.

I am very pleased to recognize the first member of the panel, Hon. James J. Needham, Commissioner, Securities and Exchange Commission.

STATEMENT OF HON. JAMES J. NEEDHAM, COMMISSIONER,

SECURITIES AND EXCHANGE COMMISSION

Mr. NEEDHAM. Thank you, Mr. Chairman. I am pleased to be here on behalf of my colleagues and to contribute whatever expertise we may have.

I am accompanied by three of our staff personnel, who will be present at your hearings this week in the absence of any commissioner. However, as I indicated to you earlier this morning, in the event that you should decide that you might want a member of the Commission present, we will be glad to make ourselves available.

I have with me Mr. Sporkin, who is an associate director of our Division of Trading and Markets, the division principally concerned with the matter before you this week.

I have with me also Mr. Simkin, who is special counsel of the Division of Trading and Markets, and who is specifically charged with the responsibility of maintaining liaison with the organizations present here today.

I also have with me Mr. Millstone, who is a staff attorney also involved in this important area.

Mr. Chairman, my statement as submitted to the committee is brief. If you like, I can read it, or we can proceed past it if you wish.

Mr. Moss. You may summarize the statement. The record has included in it all statements in their entirety.

Mr. NEEDHAM. At the risk of personalizing the testimony, let me point out, then, what I consider the most important aspect of the testimony, and that is, Mr. Chairman, that the Commission has main

tained continuous surveillance in this area and at times, if I may say so, has been a stimulant to the industry in moving forward with back office and systems problems.

Our position, very simply stated, is that we recognize and are aware of what is going on with the activities of the various self-regulatory organizations, and we are reserving at the moment our final decision as to which, if any, of several techniques and proposals that will be presented to you this morning are the answers.

We are also not persuaded completely that Government intervention is absolutely necessary in this area.

That, essentially, is our position, Mr. Chairman, and we look to your record, frankly, to assist us in making a final determination as to the participation of the Federal Government.

Mr. Moss. Thank you very much.

(The prepared statement follows:)

STATEMENT OF JAMES J. NEEDHAM, COMMISSIONER, U.S. SECURITIES AND EXCHANGE COMMISSION

Mr. Chairman and members of the subcommittee, I am glad to be here to discuss with you the problem of the stock certificate as it relates to the brokerage and banking industries and the possible approaches to improve the handling and processing of these certificates. At the outset I wish to reaffirm what has become obvious, that present methods of handling the stock certificate are outmoded and inefficient. The Commission believes that the time has come to institute changes, but in our efforts to bring about change, we must take care not to lose sight of the complexity of the issues.

We must take steps promptly in the avenues immediately available, and we must remain aware of the need to interface those steps with the longer range innovations. We must also remain aware that the foundation of the Exchange Act is the protection of a national public interest. It is that interest which is the foremost responsibility of the Commission.

The Exchange Act charges the Commission with a broad range of responsibility over the exchange markets, the over-the-counter market, and the broker-dealers themselves. We are charged with oversight of exchange rules, and of the rules of the NASD. We are charged with responsibility for the reasonableness of commission rates, rules governing the books and records of broker-dealers, and most recently with preparation of rules governing the custody and use of free credit balances. Furthermore, while the regulatory framework does not spell out detailed provisions with respect to the matters under consideration today, we have taken an active role in overseeing the development of new programs in the operational sector of the industry.

The Special Study outlined three problem areas as targets of the efforts to improve the operational programs of the industry. First, modernization of the present methods of securities handling and recordkeeping. Second, the development of clearing facilities for all markets. Third, the reduction in the movement of stock certificates. We have encouraged and participated in steps to solve these problems.

When the CUSIP Committee was established the Commission assigned a senior staff member to sit on the Committee. When the list of CUSIP numbers was published the Commission advocated its adoption and adopted it for forms filed with the Commission. Others here today have or will soon adopt CUSIP numbers.

The Commission also had members of its staff working with BASIC and the SIP task force and we have cooperated in their efforts to improve the industry. We have worked very closely with the NCC in the development of over-thecounter clearing facilities and with the exchanges in the development and improvement of clearing and depository systems.

In February 1969, the Commission held a conference on the need for the development of over-the-counter clearing facilities and the allocation of responsibility in such development.

In April of this year, we held a conference among the exchanges and the NASD concentrating on the operational problems of the industry.

Most recently, in June, we held a conference on the stock certificate and emphasized the need to act quickly and to interface the various solutions.

Finally, we are engaged presently in a broad based study of unsafe and unsound practices in the industry and possible avenues of improvement.

The question we face today, however, is not what has been done but what needs to be done.

We have read the testimony of the other witnesses who appear today. Most of what they say is not new to us. We are familiar with the ideas, the timetables for, and the feasibility of each approach. The discussion of legal problems and regulatory problems largely comports with our understanding of these problems. We are of the opinion that there can be no permanent solution to the operational problems that are with us today without radical changes in the processing and handling of certificates. We are firmly convinced that the ultimate solution requires either the immobilization or the elimination of the certificate. While significant strides have been made the Commission is deeply concerned that the pace at which present systems are being introduced and interfaced on a large scale may not be adequate to meet the needs of the public interest. Our efforts to work with BASIC, the NCC, the national and regional securities exchanges and others are continuing. But time is short and it is necessary that there be continuous and rapid movement toward the eventual objectives. If future events indicate that programs now pending do not meet this test, then we will give consideration to additional governmental participation in this area. Mr. Moss. Our next witness is Mr. Herman W. Bevis.

STATEMENT OF HERMAN W. BEVIS, EXECUTIVE DIRECTOR, BANKING AND SECURITIES INDUSTRY COMMITTEE

Mr. BEVIS. Mr. Chairman and members of the committee, my name is Herman W. Bevis, executive director of the Banking and Securities Industry Committee, and a member of that committee.

Let me tell you first a little bit about the formation of the Banking and Securities Industry Committee, or BASIC.

It was formed in March 1970, after a series of discussions between the New York Clearing House banks and the New York and American Exchanges. It was actually organized in March 1970, had recruited a task force and went to work in June of 1970. It is sponsored by the New York and American Exchanges, NASD, and the 11 New York Clearing House banks.

The composition of the committee is this: Mr. John Meyer, sitting behind me, is chairman. Mr. Meyer was chairman of Morgan Guaranty Trust until about 2 months ago when he retired. The committee includes the heads of the American Exchange, NASD, and New York Exchange, Messrs. Kolton, Macklin, and Haack, respectively.

Representing the New York Clearing House banks, besides Mr. Meyer, are Mr. William Moore, chairman of Bankers Trust, and Mr. Walter Wriston, chairman of First National City Bank. I make the seventh member.

The committee has a task force of five people on loan from the two industries, two banks, two exchanges, and one from my former firm of Price, Waterhouse & Company, where I was senior partner.

I might add that they are all full time, and since Mr. Meyer's retirement, I think I can consider another full-time worker for the committee to have been added.

The committee to date has spent about 100 man-months of work on this problem. The supporters are out-of-pocket some $500,000 in support of the effort, and before the job is done I think it will be more than double that amount.

The objective, stated simply, is to bring the processing of securities transactions back within acceptable limits of time and expense. BASIC's approach is not one of theory, not one of debate and reports, leaving the reports to someone else, but action, to try to come up with solutions and get them accepted and get them implemented.

So far as I personally was concerned, I was never asked, in looking for solutions to the problem, to consider the special interests of anybody, be they banks against banks, brokers against brokers, or communities against communities. The solution to the problem is all that I was asked to come up with.

The scope of BASIC is limited to interindustry problems. That means that any problem which could be solved entirely within either industry without considerable impact on the other is outside BASIC's scope. Nonetheless, our scope, so limited, is still enormous because it covers a great deal of the aftertrade processing of securities transactions.

We in BASIC have studied and reached conclusions on a number of projects and still have some under consideration. These are aside from the particular inquiries of the committee, so I won't mention them, but will be glad to go into them, if the committee would like, later.

We found as a general proposition that the problem almost always is a choice among alternative approaches to a solution, and that there are just no absolutes in terms of a solution sticking out to the exclusion of all others. And often the problem is one of considering the time factors: How quickly can the solution be put into effect?

I think the committee will probably find something of the same problem when it considers the various ideas.

BASIC is unanimous and firm in its belief that immobilization of certificates in regional depositories, in a comprehensive depository system across the country, is by far the most important and promising of all projects to solve the major portion of the problems in processing securities transactions.

This has already been done to a very large degree among brokers by CCS, it is done in a comprehensive way in Europe, particularly in France and Germany, where these systems have been in effect for decades. I personally went over to inspect these systems in those two countries.

We in BASIC visualize a series of locally owned and managed CSDS's, comprehensive securities depository systems, serving their regional areas. These would be interrelated as depositors in one another, to the end that securities transactions across the country could be accomplished by book entry rather than physical movement of certificates.

How many of these regional depositories are envisioned? We have had discussions in the task force with representatives from Boston, California, and Chicago for something more than a year. Out of that has evolved a working hypothesis that perhaps three regional centers across the country may suffice.

By centers, I actually mean service centers to provide the recording of ownership of securities and changes therein by book entry, as opposed to movement of enormous volumes of physical certificates, which will not be necessary.