that such rates be eliminated over a reasonable period of time. In that brief we also supported the elimination of NYSE Rule 394. These positions were reiterated in another brief filed with the SEC in March 1970.

In November 1969, in connection with the NYSE proposed rules on public ownership, we filed a memorandum with the SEC arguing that exchanges were required under the antitrust laws to grant access to all qualified applicants, including institutional investors, but pointing out that competitive commission rates would largely solve the problem of institutional membership. In several speeches before securities industry associations, I have emphasized that competition in the securities industry would lead to a more efficient brokerage system and would benefit the public investor, and I have urged the industry to adopt needed reforms in its own interest.

The SEC has ordered an experiment with competitive commission rates on large transactions with a view to broadening the experiment if it should prove successful. More striking is the fact that an increasing number of prominent industry leaders have supported competition as a means of achieving efficiency and equity in the securities business. The President of the New York Stock Exchange, the President of the Investment Bankers Association, and the principal officials of two of the largest NYSE retail brokerage firms and of two of the largest NYSE institutional firms have supported competitive rates. In addition, purchasers of brokerage services, including mutual fund managers, the American Bankers Association, the national life insurance association and representatives of small investors, have testified before the SEC in support of competitive rates. What to many may have seemed a radical step when first proposed by the Department of Justice in 1968 has now received substantial and growing support. The SEC is now engaged in broad hearings on the future structure of the securities industry, and we expect shortly to submit a statement of our views to the SEC covering, among other things, the matters raised in your letter. We will, of course, be happy to furnish you a copy of that submission. We note that the SEC has promised prompt action on the matters it is now studying and, because of our responsibility for enforcement of the antitrust laws, we will follow developments with considerable interest.

Sincerely,

RICHARD W. McLAREN, Assistant Attorney General, Antitrust Division.

Mr. Moss. Before recognizing our next witness, I would like to recognize a member of the staff, Mr. Harvey Rowen, who has some unanimous-consent requests that material be placed in the record in order to dispose of some "housekeeping" matters before the subcommittee. Mr. ROWEN. Thank you, Mr. Chairman-there are two matters. In the course of our hearings we had some discussion on the FACS program of the American Stock Exchange. FACS is an acronym for feedback and analysis of control statistics.

The American Stock Exchange has some material it wishes placed in the record at an appropriate point, and I will make the request for them at this time.

Mr. Moss. Is there objection to the request? Hearing none, the material will be made a part of the record at the appropriate point, to be designated by the staff.

Mr. ROWEN. We also have received a letter from J. Charles Partee, adviser to the Board of Governors of the Federal Reserve System, Commenting on some testimony given by the New York Stock Exchange in our September hearing, and I ask that this letter of comment be placed in the record of our September hearings.

Mr. Moss. Without objection, the request is granted.

Our next witness is Mr. Morris A. Schapiro, president of M. A. Schapiro & Co., Inc.

STATEMENT OF MORRIS A. SCHAPIRO, PRESIDENT, M. A. SCHAPIRO & CO., INC.; ACCOMPANIED BY GEORGE D. REYCRAFT, ESQ., AND THOMAS A. RUSSO, ESQ., OF CADWALADER, WICKERSHAM & TAFT

Mr. SCHAPIRO. I am Morris A. Schapiro. I have been in the securities business since 1927. I am president of M. A. Shapiro & Co., Inc., and also president of Second District Securities Co., Inc., both located in New York City at One Chase Manhattan Plaza.

We have no branch offices. Both firms are members of the National Association of Securities Dealers and the Investment Bankers Bank Stock Quarterly.

Second District Securities is a dealer in U.S. Treasury obligations and other debt securities. M. A. Schapiro & Co., conducts a brokerdealer and underwriting business in bank securities. It publishes the "Bank Stock Quarterly."

Our business is primarily with financial institutions, such as banks and trust companies, insurance companies, public and private pension trusts, mutual funds, and various other fiduciary and institutional clients.

As marketmakers in bank securities, we have extensive dealings with brokers and dealers, many of whom are members of the New York Stock Exchange (NYSE). Our prices are net. We do not have giveups, and we do not operate under a fixed minimum commission rule. Mr. Chairman, may I introduce our counsel, Mr. George Reycraft, of Cadwalader, Wickersham & Taft, and his associate, Mr. Thomas A. Russo.

I thank you, Mr. Chairman, for the invitation to appear before this committee to discuss the question of self-regulation as practiced by the securities industry, whether self-regulation has worked, whether it should be continued, modified, or abandoned.

The principle of self-regulation was embodied in the Securities Exchange Act of 1934, which Congress enacted "for the protection of investors," to "insure fair dealing in securities," and "to insure fair administration" of national securities exchanges.

This law, which was passed to establish fair and honest markets, uses the term "protection of investors" more than 50 times. According to the House report, the 1934 act was based on the belief that "the exchanges are public institutions*** and are not private clubs to be conducted only in accordance with the interests of their members."

To administer the Act and attain its objectives, Congress-after much debate-relied on the principle of self-regulation, namely, that the exchanges would conduct their affairs in accordance with congressional intent under the watchful eye of the Securities and Exchange Commission.

Nevertheless, in December 1970, after 36 years of self-regulation, Congress created the Securities Investor Protection Corporation (SIPC) at the urgent plea of the New York Exchange. Investors were in jeopardy. Congress acted

To protect individual investors from financial hardship; to insulate the economy from the disruption which can follow the failure of major financial institutions and to achieve a general upgrading of financial responsibility requirements o brokers and dealers to eliminate to the maximum extent possible, the risks whicl lead to customer loss.

Your committee's inquiry into the question of self-regulation is therefore most timely. The importance of the issue is highlighted by the fact that Congress, by enacting SIPC, has conscripted the public credit-taxpayers' money-to protect investors from weaknesses on Wall Street.

The question which Congress now faces is whether self-regulation as practiced by the securities industry works. Obviously, the answer is "No." To make it work, Congress and the SEC must adopt reforms long overdue.

The weaknesses of self-regulation by national securities exchanges, particularly the New York Stock Exchange, essentially fall into two categories. The first concerns those monopolistic rules and practices which deny best execution for the investor. The second concerns the misuse by brokerage firms of cash and securities belonging to

customers.

The NYSE accounts for the lion's share of the common stock volume traded on the country's exchanges. Examples of its monopolistic agreements and conduct include:

1. The fixing of minimum commission rates.

2. The boycotting of competitive markets through its rule 394, which restricts a member from going off-board to get a better price for his customer.

3. The limitation on the number of exchange memberships, thereby maintaining the value of the monopoly for the privileged few.

4. The system of allocating listed securities to one market maker only, the specialist.

5. The commissions which nonmember broker-dealers must pay in order to trade on the exchange.

6. The ban on institutional membership.

7. The fact that representatives of NYSE member firms constitute the majority of the governing boards of the other major exchanges as well as that of the National Association of Securities Dealers.

8. The unwritten understanding by members that interest generally shall not be paid on free credit balances.

9. The unwritten requirement that members charge at least one-half percentage point above the prime interest rate on margin accounts. The Justice Department has repeatedly pointed out that the fixing of commissions and the boycotting of competition by the New York Stock Exchange contravene the Sherman and the Clayton Acts. To maintain its monopoly, the NYSE plans to ask Congress to exempt it from the antitrust laws.

Let me turn to the second weakness, which has priority over the first.

The second weakness of self-regulation involves the breach of the fiduciary relationship between Wall Street and the public investor through the improper use of customers' cash and securities in the day-to-day operations of brokerage firms.

In the securities industry a broker-a fiduciary-is free to use customer assets left with him in trust. At the beginning of 1970, NYSE member firms held approximately $3 billion of customers' free balances, funds withdrawable on demand.

According to the September 31, 1970, report of Senate Committee on Banking and Currency, these free credit balances are used by mem

ber firms "to maintain positions in securities, to finance margin purchases of other customers, and for other general purposes."

The total of cash and securities held in the custody of brokers for customer accounts was estimated at $50 billion. In many cases, these assets could be reached by creditors of brokerage firms where adequate segregation practices have not been followed.

Mr. Chairman, the need for basic reforms-highlighted by the events which led to the creation of SIPC cannot be satisfied by self-regulatory bodies, such as the NYSE.

In the past, when the system of self-regulation was under stress, the NYSE relaxed its rules to permit member firms to continue their operations at a time when customers' property was already endangered. Perhaps the best example of the weakness of self-regulation to uncover and limit the financial difficulties of member firms was demonstrated when the New York Stock Exchange, in May 1969, relaxed its rule on "short stock record differences." These differences represent securities which a member is supposed to have, but is unable to locate. A falling market eroded capital. The New York Stock Exchange abandoned its rule regarding short stock record differences. Previously, such differences, which for certain firms amounted to millions of dollars, were correctly charged to capital in the computation of their capital ratios. Without notifying the Securities and Exchange Commission, as it is required to do, the New York Stock Exchange suspended the rule, thereby, creating make-believe or phantom capital for many of its member firms.

Thus, in response to the back office crisis, the New York Stock Exchange camouflaged these problems by permitting record differences to be included as "good" capital, notwithstanding the fact that such record differences indicated serious back office problems, and constituted potential losses.

Another example of the weakness of self-regulation concerns the use of "restricted stock," which by law cannot be offered for sale to the general public. Restricted stock has never qualified as an admissible asset under the SEC's net capital rule.

However, to permit firms to stay in business, the NYSE allowed the use of restricted stock as a "good" asset for capital purposes; and, in the process, jeopardized further the accounts of their customers.

In a period of stress, the rules of the self-regulating NYSE became flexibily limp.

These are just two illustrations of how self-regulation operate under stress. There are numerous other examples.

No more authoritative and documented account of what transpired on Wall Street during the last 3 years has been given than that by Mr Hurd Baruch in his book "Wall Street: Security Risk." Mr. Barucl is Special Counsel in the Securities and Exchange Commission's Divi sion of Trading and Markets.

Though I have been in the securities industry for 44 years, the facts related by Mr. Baruch concerning the practices of the New York Stock Exchange, and his documentation of the misuse of customers property, surprised and shocked me. I urge every Member of Congres to read this book for the knowledgeable background it will give him t face the issue of self-regulation and investor protection.

Mr Chairman, I am in complete accord with your praise which appears on the cover of the book. Believing as I do in the urgent need for reform, I have today sent to each Member of the House and Senate a copy of the book, which describes and fully documents the behind-thescenes of Wall Street.

The answer to the problems of the securities industry lies not in selfregulation as we have known it, but in new rules to be established by Congress and the SEC, in which fiduciary responsibility and free competition have priority over the self-interest of the broker.

The fiduciary responsibility was defined by the SEC itself in a report mandated by Congress in 1936:

The relationship between broker and customer is fiduciary in its nature. The legal incidents of that relationship are well established in existing law. They are of the same character as those which pertain to any agent to whom money or other property is entrusted for the purposes of the agency.

In the performance of his duties, the broker is held to the same high standard of conduct as the law imposes upon attorneys, administrators, executors, guardlans, bankers, public officials, and other persons vested with fiduciary powers. He is required to exercise the utmost fidelity and integrity.

In that same year, 1936, Congress was wrestling with the misuse of customers' money by brokerage houses operating in the commodity markets. In enacting the Commodity Exchange Act of 1936, Congress decreed in section 4, with respect to trading in commodities, that the broker may not use customers' money to finance his own trading or general business operations, and may not use the funds of one customer to extend credit to another.

During the debate on the Senate floor, Senator George W. Norris of Nebraska stressed the importance of the provisions of section 4, and explained that the purpose of that section "is to protect money that is really a trust fund, sent to a commission agent and kept on deposit with him; to protect the margins of customers and to prevent the illegal use of money for such other purpose." Senator Norris further stated:

Heretofore, a great many frauds have been committed and a great many things have occurred by which the customer, innocent of all wrong, has been robbed of his funds which he has given to a commission agent for investment and which the agent has invested in some other enterprise.

Mr. Chairman, may I point out that securities firms who act as commodity brokers must live up to the 1936 requirements of the Commodity Exchange Act by segregating commodity funds and accounts belonging to customers. This is mandatory under Federal law, and not a matter for self-regulatory discretion.

Senator Norris' advice applies to the securities industry today just as it applied 35 years ago to the commodity markets. A customer who eaves funds with his broker for a transaction in corn futures is protected under the Commodity Exchange Act. A customer who orders Corn Products common stock on the NYSE has no such protection. The past 3 years have witnessed numerous insolvencies and liquidations of broker-dealers, including some prominent, long-established firms.

Despite these events, the fact is that the methods of doing business sentially have not been changed. Basic reforms have yet to be adopted.