Study of the Securities Industry

for local problems requiring broader assistance for solution, would be composed entirely of local members, and would produce trained candidates for the National Board.

CAPITALIZATION

The initial capital of the Corporation should be raised by a subscription of its members based upon their capital at the time of their admission to membership. Subsequent rules on this subject could be modified from time to time if necessary. Operating expenses would be paid by fees charged for services rendered.

Gentlemen, property is a major part of the individual's fundamental drive for identity. Any solution to the securities industry's paper processing problem must not only climate that unnecessary paper, but must also assure the individual the right to hold his property, whether for a real or imagined need.

Many problems would be solved by elimination of the use of the physical certificate for "street" transactions, but performing its function by electronic means within a truly comprehensive, National Securities Service Corporation, performing the services presently done by the many transfer organizations.

Banks, too, would benefit. A recent study of the New York banks made by the Federal Reserve Bank of New York proved that the paper shuffling aspects of the trust departments of these major institutions are unprofitable.

REGULATORY DUTIES

The Service Corporation should have the power to provide rules governing the operational aspects of the industry, including net capital and other requirements for financial responsibility. In addition to its rulemaking power, the Corporation should have the power and the staff to enforce its rules, and examine members on a regular basis.

The regional boards would have the power to arbitrate business disputes between members and would serve as "trial court" of members for disciplinary cases brought before them by the Corporation's staff. The national chairman and the two vice chairmen would have the power to review any regional decision, as well as the power to call up. cases on their own initiative if they believed that action was warranted. By this method, the group which imposes discipline would also be involved in both the day-to-day business and the long-term rulemaking of the entire organization. Final appeal would be permitted to the Federal courts.

SUMMARY

In time, this Service Corporation could interfere with similar organizations established in other countries of the world. If a modern, integrated, and efficient system for settling securities transactions, re

cording ownership, and ensuring satisfactory financial stability were created, an investor anywhere on earth, 24 hours a day, 7 days a week, would be able to buy or sell securities without being concerned that the mechanics of the business have been outstripped by imaginative and creative marketing steps that will surely occur in the years to come. Self-regulation can only be effective if the statutory mandate provides an adequate structure and adequate power for the exercise of selfregulation.

The creation of this structure and power has been the purpose of my discussion today. I thank you for the opportunity to present it. Mr. Moss. I thank you.

(The prepared statement follows:)

(The document referred to appears in appendix W, p. 1960.)

STATEMENT OF JUNIUS W. Peake, General PARTNER OF SHIELDS & COMPANY

The securities industry has reached a critical time of decision: Does the existing business and regulatory structure have the resources, authority, motivation, and ability to solve rapidly and permanently what has been described in the past several years as the "operational crisis." Without your assistance, which will make possible certain fundamental advances in specific areas, the answer is probably, "No."

The most rapid, most effective, and least costly solution would be the creation of an agency which I suggest be called the Securities Industry Service Corporation. This entity should have a federal charter, be organized regionally like the Federal Reserve System, be owned by its users, and be operated as a profitmaking entity. Its users would all be "members" or stockholders in the Corporation. Membership would be open to all commercial banks who belong to the Federal Reserve System, and would also be open to all broker/dealers who are registered with the Securities and Exchange Commission. Foreign agency banks which have signed required agreements with the Federal Reserve would be permitted associate membership. This new entity should be created using all existing resources within the industry. The cornerstone, or more correctly stated, the foundation of the proposed Service Corporation would, of course, be the Central Certificate Service, the present depository developed and run by the New York Stock Exchange. When Central Certificate Service was conceived, it represented a farsighted, logical step for the industry; but it was created without the benefit of our present knowledge. Experience has demonstrated and the New York Stock Exchange recognizes the absolute necessity for inclusion of the commercial banking system in any future operations organization.

The Corporation should perform the following functions:

1. Compare, clear, and settle all securities transactions for its broker/ dealer members.

2. Act as a truly nationwide depository for all securities of publicly owned corporations and for all exempt securities, except those securities which are physically in the possession of the individual public investor. 3. Keep all records and perform all clerical functions necessary for the Issuance and cancellation of stock certificates on behalf of the present transfer agents.

4. Hold as a fiduciary those securities which are held in trust or under other similar conditions.

5. Transmit money and securities over a nationwide wire system, which would permit the Corporation, as agent for commercial banks, to extend cerdit and hold collateral to finance members of the securities industry.

6. Have both rule-making and enforcement power to regulate the operational and financial aspects of its broker/dealer members, specifically those aspects now governed by record keeping, financial responsibility, and net capital rules.

7. Assume the present duties of the Securities Investor Protective Corporation, act as trustee for its funds, and liquidate any of its members whose business must be terminated.

If the proposed Securities Industry Service Corporation is created with at least these elements, numerous current problems in the industry will be solved

or made less troublesome. For example, protection of the individual and institutional investor will be increased many fold, broker/dealers will be relieved of overlapping and sometimes conflicting regulation, segregation of customers' free credits and securities will be simplified or made totally unnecessary, regulation of operational and financial responsibility will be more efficient and effective by its concentration in one body, the cost of essential support services to the securities industry will be reduced by at least 50 percent, the cost paid by the public for participating in the securities market will be reduced, and the new entity will be sufficiently flexible to interface with any system of markets developed in the future. The operational requirements of the securities industry are large enough, are sufficiently specialized, have a great enough effect on the public interest, and have created such pervasive national problems to justify the formation of this type of entity. This corporation would not regulate the marketplace, which should evolve through its own efforts and which should continue its own self-regulation. The Service Corporation would truly be a service organization, dedicated to the operational needs of the national financial community. An organization like this is consistent with the recommendations of the Martin Report.

The Governing Board. In the construction of such a new administrative entity, the composition of the governing board should be given great thought because numerous "interest groups" should be represented on it. The board should be thirteen in number. The President of the United States should appoint a chairman and two vice-chairmen who would be paid and who would serve full time. Four governors should be nominated by the members of the Corporation who are commercial banks; and four governors should be nominated by broker/ dealer members. The Federal Reserve Board and Securities and Exchange Commission should nominate one governor each. All nominations would be subject to Senate approval.

In this proposed new corporation, the Board of Governors should act by an affirmative vote of two-thirds of the total Board (i.e., a vote of 9). This would prevent one interest group from voting as a block and preventing the implementation of a proposal which the remainder of the Board deemed beneficial to the industry and to the public at large.

Structure.-A national organization ought to provide a network of regional facilities, which would give local representation and local service. The views and ideas from all sections of the country could be communicated easily and directly in any national entity with regional facilities. Therefore, regional boards should be established which would satisfy the operational needs of particular areas, would be spokesmen for local problems requiring broader assistance for solution, would be composed entirely of local members, and would produce trained candidates for the national board.

Capitalization.-The initial capital of the Corporation should be raised by a subscription of its members based upon their capital at the time of their admission to membership. Subsequent rules on this subject could be modified from time to time if necessary. Operating expenses would be paid by fees charged for services rendered.

Operation. The Corporation would perform on a nationwide basis two basic functions for all its members: (1) compare, clear, settle, and record all securities transactions between members; and (2) register, cancel, and record those stock certificates which are required to be issued. Both of these functions are directly related to the problems posed by the current use of the stock certificate throughout all phases of the industry.

Much has been written about the stock certificate and its role in causing the difficulties which our industry has experienced and will experience. Within the past week, a major trade association and the chairman of the nation's largest brokerage firm called for its elimination. With that ultimate objective, I heartily concur; and the creation of the proposed Service Corporation would make that possible at least in the areas where the certificate causes the most problems.

As Robert Ardrey said in the title of his book, all humans have a strong "Territorial Imperative." Property, whether in the form of a house, a car, a niece of land, or a stock certificate, is a major part of the individual's fundamental drive for identity. As a consequence any solution to the securities industry's paper processing problem must not only eliminate that unnecessary paper but must also assure the individual the right to hold his property, whether for a real or an imaginary need.

(1) Transfer.-Many dissertations proposing the elimination of the certificate have been made in recent years. Studies, both requested and voluntary, have focused on the transfer of registration from one name to another as the single most time-wasting process in the movement of securities. However, no more than lip service has been given to abandonment of the transfer role because no present transfer agent wishes to reduce its business relationship with its corporate clients. The proposed Service Corporation would resolve this impasse by continuing the desired relationship while removing the burden of clerical functions.

The clerical problems would be solved by eliminating use of the physical certificate within the proposed Service Corporation but performing the function of the certificate by electronic means. The record of ownership and interest would be recorded, maintained, and transferred; and the recording entity would be able to account for it at all times. A truly comprehensive, national securities depository, performing the functions presently done by the many unrelated transfer organizations would reduce the flow of paper to a minimum and would satisfy the public's felt need for the comfort of tangible property by permitting the delivery of certificates outside the system.

The rights of the public citizen to hold property registered in his own name would be continued by issuing a security to him if he requested that it be removed from its status as an electronic record within the Service Corporation. By making the Corporation perform this function for the transfer agent, an important reduction of certificate movement immediately takes place. Through the regional offices of this corporation, any certificate of any company could be electronically issued at the nearest district office anywhere in the country promptly and without physical movement within the organization. Today the Federal Reserve System receives government securities at one Federal Reserve Bank, cancels them there, wires the details of the transaction to another bank, and reissues the securities across the country at the other bank. This proven technology would be applied in the new corporation.

(2) The Ordinary Securities Transaction.-At the same time that the Service Corporation recorded the issuance, transfer, or cancellation of certificates, it would also assume much of the operational burden connected with ordinary securities transactions. All banks and broker/dealers who were members of the Service Corporation would have an account with it. The Corporation would electronically record, compare, clear and settle the transactions of its members for their accounts and would give them periodic statements of their business and positions. In effect this would eliminate the "street name" security, including all securities held by banks and brokers, whether as principal or fiduciary, in their own name or in nominee name. Because the banks and brokers would be members of this new Corporation and because the Corporation would also be acting as the "transfer" agent for the securities, it would be unnecessary to issue certificates; and an electronic impulse debiting or crediting the accounts of the banks and brokers would suffice.

By removing from circulation the millions of "street name" certificates and by requiring the Service Corporation to transfer all publicly traded securities, including municipal and government bonds, the threat of theft and the problems of inventory control for broker/dealers would be almost totally eliminated. Banks, too, would benefit. A recent study of the New York banks made by the Federal Reserve Bank of New York proved that the paper shuffling aspects of the trust departments of these major institutions are unprofitable.

Thus, the burdensome and unprofitable physical clearing of securities would be reduced to an imperceptible amount for both banks and broker/dealers. The National securities exchanges could reapply their resources to their primary objective, the operation and regulation of the marketplace. The banks would retain their present relationship with their corporate customers, while divorcing themselves from the unprofitable business of transferring and safekeeping securities themselves. Thefts would be minimized.

Regulatory Duties.-The Service Corporation should have the power to provide rules governing the operational aspects of the industry, including net capital and other requirements for financial responsibility. In addition to its rulemaking power, the Corporation should have the power and the staff to enforce its rules, and examine members on a regular basis.

and the two Vice-Chairmen would have the power to review any regional decision, as well as the power to call up cases on their own initiative if they believed that action was warranted. By this method, the group which imposes discipline would also be involved in both the day-to-day business and the longterm rule making of the entire organization. Final appeal would be permitted to the federal courts.

The SIPC legislation passed in 1970 was farsighted, necessary, and responsive; but the proposed Service Corporation, if it is to make, alter, and enforce rules of financial responsibility and capital, should logically carry out the SIPC mandate for investor protection. The Chairman of SIPC might well be the first chairman of this organization, and the present SIPC staff could be made the core of the reuglation and examination arms of the new corporation.

Summary. In time, this Service Corporation could interface with similar organizations established in other countries of the world. If a modern, integrated, and efficient system for settling securities transactions, recording ownership, and ensuring satisfactory financial stability were created, an investor anywhere on earth, 24 hours a day, 7 days a week, would be able to buy or sell securities without being concerned that the mechanics of the business have been outstripped by imaginative and creative marketing steps that will surely occur in the years to come.

This Service Corporation I have proposed is not an organism which must stand or fall as a unit. Perhaps a portion of my suggestion is feasible and the rest is not. The most important point, however, is the beginning of an effective dialogue which recognizes the need for a co-operative effort among banks, broker/dealers, exchanges, and regulatory bodies. These groups must jointly solve the numerous difficult problems which plague the operational aspects of the industry. In 1967 before the current problems really surfaced, this need was foreseen by an Executive Vice-President of the New York Stock Exchange, when he said:

*** There is no secret in identifying problems within the securities industry today, and there is no magic in developing solutions. There is no difficulty in finding someone with whom to discuss these problems, but the securities industry is famous for lack of implementation, lack of cooperation. and lack of continuity. It will be interesting, by hindsight, to identify the prime motivating factor behind effective solutions to back office operational problems. Will it be the public, will it be the federal government, or will it be industry self-development?

And Mr. Ralph Saul, in 1969 when he was President of the American Stock Exchange, narrowed the focus to the basic issue:

We will face a choice, one that has confronted this industry at other times and one that other industries have had to resolve. Will self-regulation be adequate to meet the demands placed upon that industry or will its failure to meet this challenge weaken its place in the eyes of the public? But self-regulation can only be effective if the statutory mandate provides an adequate structure and adequate power for the exercise of self-regulation. The creation of this structure and power has been the purpose of my discussion today. I thank you for the opportunity to present it.

Mr. Henry Du Pont, chairman of the board and president, SCITEK, Incorporated.

STATEMENT OF HENRY W. DU PONT, CHAIRMAN OF THE BOARD AND PRESIDENT, SCI-TEK, INCORPORATED

Mr. DU PONT. Mr. Chairman and members of the committee, I am W. Henry du Pont, chairman of the board and president of SCI-TEK. Incorporated.

I am pleased to have been invited to participate in this committee's hearing, relative to the problem of the stock certificate as it relates to the brokerage and banking industries today.

Gentlemen, your basic mission for this particular discussion is primarily directed toward the future, I repeat, the future, enhance

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