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Mr. PEAKE. I certainly shall, Mr. Painter. You will be the first

, to know.

I had not finished reading from this quotation: We feel, with proper industry support, a card certificate can be developed that will meet ANSI specifications and can be processed through punchcard with satisfactory results.

Mr. Moss. Mr. Bevis, you had some comment ?
Mr. PEAKE. That was dated December 17, 1970.

Mr. BEVIS. On the machine readable certificate matter, we have done extensive research including visiting all of the OCR equipment reading manufacturers who purported to have equipment that would do the job and tested actual engraved certificates on such as their equipment as could process them.

We found some couldn't even feed them. Some could. We have never in our study of the problem suggested that the problems of getting a machine readable certificate into operation could not be overcome. There are technical and equipment and systems problems, and problems of economics in banks and brokerage houses and others. All probably could be overcome.

We considered this question in the context of alternatives and how quickly relief could come about as among the alternatives.

We decided, as the ABA committee apparently has, to set this project aside because the immobilization of certificates in depositories promised more lasting relief and almost as soon, if not as soon, as the very extensive problem of getting industrywide and nationwide a system in operation based on the machine readable certificate.

We do not say that the technological and other problems could not be overcome. I am sure they could.

Mr. Moss. Mr. Ware?
Mr. WARE. Thank you, Mr. Chairman.

May I inquire as to whether anyone on the panel contemplates that there would be any problem with a machine readable certificate as to those who want to use the certificate for collateral, and secondly, pose any problem for those who have to audit individual accounts or corporate accounts?

Mr. Bevis. Mr. Ware, I don't think of any problems that would be involved in pledging certificates as collateral merely because they are machine readable.

As regards the problems of handling them, if one went to a universal card size engraved certificate, there would of course be handling problems and counting problems during the period of transition when you had both types of certificates that you were handling and filing, and so forth. But I don't know of any problems on the collateral point.

Mr. WARE. Do you have any comment with respect to the audit problem or lack of problem? Does anyone else in the panel ?

Mr. BEVIS. As a former auditor, if you are thinking in terms of perhaps outside auditors or internal auditors

Mr. WARE. Both.

Mr. Bevis. The machine readable certificate, if all of the certificates in bulk were machine readable, could be run through a reader, of course, much faster than they could be counted by hand.

However, to an auditor, to have a machine say that so many shares passed through is not quite enough because the machine will just be reading OCR characters and they could be on a plain piece of paper or any kind of fake certificate, so he would have to take some additional steps at least by test to check on the apparent authenticity of those certificates.

From the internal standpoint, running certificates through readers, if they are in bulk and don't have papers attached to them, would make inventories possible much more frequently than they can presently be done by hand.

Again the same safeguards would have to be set up against the complete reliance on the machine reading as to what the machine was reading.

Mr. KAESTNER. I would subscribe to that too, Mr. Ware.

Mr. PEAKE. Mr. Ware, I would comment that whether or not a certificate is machine readable I would certainly not suggest that the audit function be performed by the machine alone. However, I would also make the observation that those who count physical certificates today, the auditors, are not certain when looking whether a certificate is or is not genuine. I might add that on our own staff we have two certified public accountants examine those certificates which I presented to the committee, and they did not detect that they were not authentic.

Mr. Moss. Mr. Painter?

Mr. PAINTER. Mr. Chairman, with your permission, I would like to turn to the final topic of our panel, which is problems of theft in the securities industry and I have here in front of me a number of pieces of paper which purport to deal with lost or found securities. These have been papers that I received, having been put on the mailing list, I believe of the New York Stock Exchange.

I would like to hold them up here. I am sure you are familiar with these.

Mr. Howland, how many of these slips of paper indicating securities lost or securities found, how many of these would you say would be circulated in the course of an average day, through all of the brokerage houses in the country? Could you give any reasonable estimate?

Mr. HOWLAND. I wouldn't even hazard a guess. A significant number.

Mr. PAINTER. Do you think the brokers really pay any attention to these pieces of paper? Do they have time to look at them and read them? I have one here, for example, from Blythe & Co., and it tells me that $25,000 worth of Florida Gas Transmission has been lost, and $15,000 worth of Transcontinental Gas Pipeline, and $5,000 worth vi Clark Equipment Company, and it states:

We would appreciate your cooperation in examining the certificate numbers of any of the above securities now in your possession or those that may come into your possession in the future.

Do you think they really have time to read that notice and examine all the certificate numbers?

Mr. HOWLAND. I think possibly your broker might be put on notice as a result of the circulation of that notice.

Mr. PAINTER. Is it an effective notice to a broker?
Mr. HOWLAND. I think that is difficult to say.

Mr. Peake might be in a better position to answer how brokers use it but I have seen on occasions where those notices are posted and I have actually seen cashiers or clerks and cashiers refer to it, but how widespread, I think it is difficult to say.

Mr. PAINTER. Are these notices effective, either Mr. Peake or Dr. Kaestner?

Mr. KAESTNER. Mr. Painter, they are extremely important to the transfer agent of the stock. We have to set up reliable precautions to make sure that when those particular certificate numbers come across our windows that they are immediately detected and not processed as the real thing. So as far as the banking industry is concerned, they are extremely important and are put to good use whenever we are notified of the counterfeit or the loss.

Mr. PAINTER. Mr. Peake, do you consider that the brokers really read these notices and pay attention to them?

Mr. PEAKE. Mr. Painter, I think the banks have two functions; the broker really has only one. The banker is transfer agent and also functions as custodian. I don't know what Mr. Kaestner or other bankers do in terms of going to vaults and reexamining all of the certificates that may be there, in their role as custodian.

I say from a practical standpoint it would be, unless we had machine readable certificates, impossible to clerically verify and examine erery issue.

A couple of years ago the cashiers division of the Association of Stock Exchange firms published a printed bound volume of all of the certificates that had been reported missing in that year. It was a very impressive volume.

Mr. PAINTER. You would say these notices are relatively ineffective as far as the brokers are concerned ?

Mr. PEAKE. I would say they are certainly important notices and so captioned. We treat them as such because they do put us on notice for a certain period of time, but I don't think most brokerage firms consistently go to a certificate level control and examine each certificate.

а The key is knowing how certificates get into your system and that is knowing your customers.

Mr. PAINTER. Mr. Du Pont, do you have any observation to make at this point ?

Mr. Du Pont. Through studies we did in creating the securities validation system for both New York and American Stock Exchanges, we found that the average broker will accumulate between 5 and 516 inches in height of those documents in about a 2-year period. And it is virtually impossible for him to, or anybody to, memorize all of those numbers and types of certificates.

Our system that we developed lets any broker come in with teles, teletype, or telephone, with their present equipment to inquire against a data base which we are trying to build, and he can get in seconds or less the answer to as many as 20 listed certificates.

Mr. DELAHUNTY. Prior to my present position, I was director of operations for Lester Ryons & Co., a Los Angeles-based brokerage house, and my experience with these publications indicated that they served a very useful purpose. I am aware of a number of instances where we located missing certificates by reference to these documents.

Mr. KAESTNER. Mr. Painter, may I add something to my statement!

This is a burden that we are plagued with forever and a day until the securities are recovered or are detected, so we do have a problem. The more theft that takes place, the more recordkeeping and processing we have to do before we can accomplish a day's work.

Mr. PAINTER. Mr. Kaestner, Mr. Du Pont on page 5 of his statement referred to the difficulties which had been experienced in getting widespread adoption of his so-called SCI-TEK system, and he refers to some of the banks having mentioned that they will become subscribers when the system becomes mandatory, and then he ends by observing that adoption of the system will require the complete cooperation of the brokerage community and the banking industry.

The staff of this subcommittee has been informed that there are several banks which have hesitated to adopt the SCI-TEK system out of fear, that, if they become subscribers, they will lose the advantages of being holders in due course.

Now the question is, Are these fears, if they exist, justified? What can be done to implement a system such as SCI-TEK and yet safeard the interests of the banks? Can you explain a little bit for the Subcommittee what is meant by the term "holder in due course" as far as a bank is concerned when a bank gets a certificate?

Mr. KAESTNER. I am not a lawyer, but I assume a holder in due course who gave value for a stolen or found certificate would fall in that category.

As far as systems that are devised to detect these things, we have an elaborate computerized system whereby any certificate number presented to us for transfer, whether it be a bond or stock certificate, is entered into our mechanism and is searched out. If that number is Serched out and it corresponds with the account number and the registration on the certificate, we feel certain that that is a good certificate.

If there is a certificate that is presented to us that doesn't match out and we are aware there are forgeries around, these certificates are processed separately after we have a print-out of our day's work. So we have what we consider valuable safeguards built into our System for the certificates that we process and transfer.

Mr. PAINTER. Would a bank that was thinking of subscribing to a Sistem such as the SCI-TEK one have second thoughts about doing this if it might be legally in the position of having some type of constructive notice that there was something invalid about the certificate or that it was lost and thus it might not be a holder in due course?

Mr. KAESTNER. I would imagine, Mr. Painter, that there would be some benefits to be derived from it because particularly in large branch ystems where one is making a loan against collateral of listed stocks. You could be making it against a stolen certificate.

Off the top of my head I would say it would be a benefit to the banks in that regard.

Mr. PAINTER. Does your bank subscribe to this?

Mr. KAESTNER. I don't believe so. I am not too familiar with the inking area. I am associated with the trust side.

Mr. PAINTER. Is there any particular reason why it doesn't? Has it Kade a formal determination not to belong?

Mr. KAESTNER. Well, it could be from the legal aspect that being put notice you would be

Mr. PAINTER. So this may be a valid fear?
Mr. KAESTNER. It very well could be.

Mr. PAINTER. Do you have any comments to make on this Mr. Du Pont? Do you think the banks are justified in this concern they have about not being holders in due course?

Mr. Du Pont. With the full data base that we are accumulating and hopefully to get the complete data base from the FBI, which we are trying to negotiate, I would think that the banks would not be hesitant in joining.

One of the larger banks in New York just last week gave us some numbers which we put on the system of two bonds worth $1 million apiece that were removed from their bank.

They are joining the system posthaste.

Mr. PAINTER. In other words, the banks may stand to gain more by belonging to your system than they would lose?

Mr. Du Pont. Very much so. Å bank in the Midwest didn't make a collateral loan for $75,000 against the $125,000 of ITT stock because we had the stock listed. They managed to find that out through a broker.

Mr. PAINTER. Mr. Howland, Mr. Du Pont attaches to his statement an extract from the Wall Street Journal of Friday, July 24, 1970, where the Wall Street Journal reports that the New York Stock Exchange has endorsed the SCI-TEK system. Is this true? Has the New York Stock Exchange looked over this system and endorsed it!

Mr. HOWLAND. SČI-TEK actually. I think probably has progressed as far as it has because it had official endorsement of both stock exchanges, American and New York.

I think the problem now is that you have two systems. You have SCI-TEK which has private capital backing it up and then you have NCIC. I think I could make a good case as to why a bank would prefer to go the NCIC route rather than SCI-TEK route and I think this was pretty much brought out in the testimony before the McClellan committee earlier this year.

I think Mr. Du Pont testified also before that committee. I think there was unanimous consent from Donald Ragan of Merrill Lynch, and from our banker friends, that there is a need for a single system. One of the problems with NCIC system is that it suits the banks needs.

You have to go through the local police department to have access to the file, whereas SCI-TEK you can call in or have a touchtone phone. The NCIC system is much slower. We recommended at the McClellan hearings that there is need for one system which, as Mr. Du Pont says, has a good data base can be built up and it could be accessible both by banks and brokers or other financial institutions handling stock certificates or bonds.

Mr. Painter. Does this suggest then the need for Federal legislation along these lines?

Mr. HIOWLAND. I guess I better say yes.
Mr. PAINTER. I have no further questions, Mr. Chairman.

Mr. Moss. Are there further questions? Does any member of the panel have any further questions?

Mr. Rowen? Mr. Rowen. I have a couple of tag ends to clean up before we adjourn.

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