Mr. WARE. I am familiar with situations where stockholders may De scattered throughout a dozen States or maybe even some overseas, but there would not be a trade a week, for example. I would question the geographical limitation. Thank you, Mr. Chairman.

Mr. Moss. Mr. Painter.

Mr. PAINTER. Mr. Chairman, I have a question here which may be either overly complex or possibly somewhat on the theoretical side, but I still think it might be interesting to see if we could get any response from our panelists on this point.

As I recall, Mr. Chairman, at our hearing last week, Commissioner Needham made the observation that the Commission, in developing its views concerning the need for a national system of clearance and settlement, would also have to take into account very closely the interrelated problems which are involved in the question of what the market structure should be. As I recall, he said that these two points should be considered together because they are interrelated.

As you also know, Mr. Chairman, Mr. William McChesney Martin has suggested to the Board of Governors of the New York Stock Exchange a proposal which would result in a central market system, bringing into national focus the problem of what the structure of the market of the future should be.

Well now, when we come to consider the problem of developing a system which would eliminate the stock certificate, I suppose that, if Commissioner Needham is correct, we would also have to consider the problem of market structure.

In other words, the question-and possibly it is a rather difficult one to pose here is whether the system that we would design would be designed on the basis of the markets that we now have, or is it possible that we might design a system which would require the development of a particular market structure? Or, to put the question differently, will the system which we design follow the form of the market that we have today, or will the market that we will have tomorrow evolve from the system that we design today to deal with this problem of eliminating the stock certificates? I know it is a rather tall question, but I wondered if anyone would care to stick his neck out and try to respond.

Mr. Moss. Mr. Noyes seems to be ready, and then Mr. Maller.

Mr. NOYES. I have a couple of points. It is not particularly difficult to visualize an automated process for both trading and settlement. I think it rather unlikely that the settlement process would materially dictate the trading process, but the trading process could dictate to some degree how clearing and settlement occurred.

It is not at all clear what are the real differences between listed trading and OTC trading in terms of which securities are in the OTC market and which securities are listed.

We are also coming to the time when the physical distance between exchanges is not a particularly limiting factor. We are talking about electronics distance rather than physical distance, and while there are communication costs, they are not a tremendous factor in the total pattern.

I think we can look forward to the day-and I don't know how far away it is when we will use a device like the NASDAQ terminal, enter

an order, and the order will be executed at a central location, perhaps under manual observation or manual monitoring. Certainly the mechanics of the thing can be done, for most trades at least, by a pretty strict set of rules that can be established and can be executed mechanically.

The trade can be picked up then and passed into the settlement process. The settlement may not be at the level of individuals trading with each other, but it may be in a hierarchy as it is now with brokerage firms settling with each other and they, in turn, settling with their clients, or perhaps banks settling with each other.

I think, clearly, the capability is there now; the technical capability is there now. Our question should be, Should we utilize it? Does it achieve the objectives that we want to achieve?

And I think I would put in one further word of caution, that we should not develop a system which is too rigid. It must be flexible enough to accommodate change-in the securities, and way of trading, and technology, and so on. If we centralize everything and automate everything, there is a danger of inflexibility.

Mr. PAINTER. It should be flexible enough to accommodate possible change in the market structure itself as that evolves?

Mr. NOYES. Exactly, and in several other things. It should be flexi ble enough to accommodate significant changes in volume, the changes in the number of securities handled, changes in technology itself. communication systems, computer systems, and changes in the desire of the people in how transactions should be handled.

Mr. Moss. Mr. Maller and then Mr. Weinberg.

Mr. MALLER. In my opening summary questions, I indicated that I felt it would be particularly unwise to seek to automate the trading function and the settlement function simultaneously. The settlement function has been the problem from the workload standpoint. There are many other problems that are under review when it comes to the trading function; and any system, as Mr. Noyes has said, must be designed in a modular manner. It must be designed so that it can b readily changed. The one thing about the computer which is a little bit better in some respects than us as humans is that we resist the change but it does not. The computer provides us with an opportu nity to be totally flexible and to be able to have it do different jobs a different times by just changing what we tell it to do.

I think that the settlement process is the one that we must begin or I think it is the one we should get underway, and I think it is th one we are late in getting up and running. I do not see where an change in the market structures would hinder any settlement function In fact, some of the things, such as included in the Martin report such as the comprehensive tape, would be picked up as an adjung of a settlement system because every transaction would enter into thi system and could be reported in matters of seconds. So that there ar many advantages and many things that would benefit the industr that will come out of a settlement system.

Mr. PAINTER. Mr. Maller, do I sense that there is a disagreemen between you and Mr. Weinberg regarding the necessity of having national system for clearance and settlement? It is my recollectio

that Mr. Weinberg is of the view that a national system of clearance and settlement would not be desirable. Is that correct?

Mr. MALLER. Well, Mr. Weinberg does include in his statement the idea that there should be competition in the development of systems. My own feeling is that this would be adverse to the public interest. I think if we take the settlement process and have it on a single national system, it can interface with brokers, banks, insurance companies, and mutual fund systems.

The public, then, would be served through the competition of who can take the data and use it, the data from the national system, in the most efficient way to have the lowest cost and, with lowest cost, therefore attract the public business.

So yes, from this standpoint, we do have a disagreement on the means of getting to a settlement system.

Mr. Moss. Mr. Weinberg.

Mr. WEINBERG. Yes, I think, to elaborate perhaps, in my view the major point of difference is that we are concerned that to establish a single entity that actually runs and operates this huge clearance-settlement-transfer system, we think there is need for an entity to design it and decide how it should operate and to be sure it gets into operation; and the analogy we use is of the bank checking system where each bank has its own deposit system, which we think is a good analogy of what is likely to happen in stock certificates, and the points of similarity are the way the information comes in, the way the checks are coded, and the way the banks exchange information between entities.

We would not like to see either one computer or one computer system established by any one entity and that serve the whole country. We think the question of difference revolves around the operating entity. We don't think there should be one entity to do that.

Mr. SPORKIN. There are two points that I think are important here. We have to determine what it is you want out of such a system, and if you just go to a settlement and clearance system, you might not be getting two very important things. One is the locked-in trade. Namely, you want to make sure that you have a trade at the moment that you do have a trade, because if you don't you are going to foul up your settlement procedures because of the "DK" rate, or "don't know" rate. I think it is absolutely crucial that we someday get to same-day settlement. I don't think we should have this 5- or 7- or 10-day settlement. Instead, it ought to go down the other way. There should be instantaneous settlement.

Why do I say that? Because if there is exposure to the public, the exposure becomes magnified where you have a broker that has 5 days in which to settle a transaction. In other words, you have 5 days in which you are extending credit and, if he goes under, somebody has to pick up that amount for 5 days.

So I think that the objectives are to accomplish; if you are going to go through an elaborate system and spend up to as high as $300 million. I think you are being shortchanged if you don't get your locked-in trade and online settlement.

Mr. Moss. There is no disagreement, is there, on the need or derability of going to the same-day settlement? Mr. Noyes and then Mr. Maller.

Mr. NOYES. I agree with Mr. Sporkin. I think a system that does not include the trading process in its design is only half of a system. A locked-in trade is an element of any automated trading. It is a potential element, as Mr. Sporkin suggested yesterday, of the NASDAQ system.

The exchanges are well along now with automating the odd-lot trading. If you do have a locked-in trade, you have no clearing prob lems. The idea of clearing can be dropped from the whole process, and all of the problems associated with the clearing corporations themselves, and that part of the P. & S. departments of the brokerage firms that support clearing.

So I think that it is unwise to break these two things-trading and settlement-apart and say, "We will do this first and that second." They should be developed together.

Mr. Moss. Mr. Maller.

Mr. MALLER. Yesterday I made mention of the Kassenvereine. The Kassenvereine in Germany do have locked-in trades, although they do have trading in the normal manner. The trade is locked in right on the floor and then goes to, in the case of Frankfurt, the Frankfurt Kassenvereine, which does the producing of all of the informational tickets in the industry; so that this is completely possible without a change in the trading function.

In addition, Fastclear, which is a term that I have given to a system that I designed, does provide for overnight settlement. The overnight settlement is absolutely mandatory. I agree with both Mr. Sporkin and Mr. Noyes that it is extremely necessary if we are to do away with large parts of the problem, which include problem of dividends and who really is deserving of dividends.

Mr. Moss. Further comments? Mr. Painter.

Mr. PAINTER. With your permission, Mr. Chairman, I would like to turn the discussion to another topic, which may be of equal importance to the ones which we have been discussing. This topic concerns the possibility of systems failures and maintaining security in a system.

From the discussion that has been going on, I think all of us gather that the system that would be developed would essentially be a computerized system; and in any computerized system, obviously you are going to have the question of the reliability of the computer itself, the possibility that the computer might be tampered with in some way, either through vandalism or some other techniques, possibly sophisticated techniques of removing from one account amounts and putting them into dummy accounts or some other system. I am really not that familiar with automation to know the full possibilities here.

And then finally the problem of breakdown in the event of, say, a loss of electrical power or possibly a labor disturbance or even an atomic catastrophe of some sort.

I wondered if we could direct our discussion to some of these problems. Mr. Noyes, my first question is directed to you. In providing systems reliability and insuring continuous operations; is it a correct inference, from your statement, that you would feel happier if the operational facility were located outside of New York City in order to alleviate problems of possible power failure, sabotage efforts, labor

difficulties, and so on? What are your suggestions along these lines? Would you advocate, for example, regional dispersion of duplicate facilities or backup facilities of some sort?

Mr. NOYES. Yes, I think at least the backup facility and maybe the primary facility should be outside of the city. It would require some detailed analysis to determine exactly what the interfaces of the computer facility were with other elements of the industry. Exactly what are the communication links? What messages and what paper has to travel between them? And what are the labor requirements for the facility?

But, as a cursory look, it seems as though it is primarily an electronic interface; and, for the reasons you have mentioned, I think it might well be better to have it in an area where the power is more stable and the security is easier to establish and maintain.

Mr. PAINTER. Could you describe any precautions that might be taken to insure that the computer would be free from tampering or vandalism? For example, it is possible, at least in computers which operate with magnetic tape, that you can, through the use of a magnet, erase large amounts of the tape? How would you design your system so that it would be security proof in this respect?

Mr. NOYES. Computers are relatively delicate pieces of equipment, and there are several approaches that can be taken to minimize your chances of catastrophic failure.

Mr. PAINTER. I was thinking of tampering, intentional vandalism, and that type of thing.

Mr. NOYES. I think we would look to the experience that the military has had with this type of thing, protection against sabotage-physical security-control of who enters and who leaves the facility, what they bring with them, background investigations, perhaps, on the people. These are the kinds of things that the military has tried and are relatively successful, if not invariably successful.

Second, you always establish backup facilities-perhaps one, perhaps several-and beyond this, you establish means of protecting your files and of restarting the processing.

Now, the structure that I would suggest again is a layered structure. Each layer maintains its own records from which the other layers' records can be duplicated.

As an example, when an order comes in, it would go to a broker, say it came in through a branch office and would go to a central office of a brokerage firm. They would retain that order in their files. They would also pass it into the trading location, be it OTC or an exchange. And the record of that order is also maintained there; it is maintained at the exchange. The confirmation comes back, and the full order data is present now in at least two locations; the brokerage firm and the exchange. This is what I mean by keeping it at two different layers.

Mr. PAINTER. What precautions could be made against the outright theft? There is certainly such a thing as theft by computer. If you were sophisticated enough and took a course in computer technology and you were a thief, couldn't you very well manipulate a computer if you got access to it?

Mr. NOYES. Yes, I think you would have to try this out for awhile, think of ways you could cheat the system, and then see how you would