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Washington, D.C. The subcommittee met at 10 a.m., pursuant to recess, in room 2318, Rayburn House Office Building, Hon. John E. Moss (chairman) presiding.

Mr. Moss. The subcommittee will be in order.

This morning, the subcommittee continues its hearings on the topic of self-regulation and the securities industry. The hearing will take the form of a panel discussion and we are pleased to have with us this morning as panelists: From the Securities and Exchange Commission, the Honorable William J. Casey, Chairman, the Honorable Philip A. Loomis, Jr., Commissioner, and Mr. Irving M. Pollack, Director, Division of Trading and Markets.

From the New York Stock Exchange, Inc.: Mr. Robert W. Haack, president, and Mr. Donald L. Calvin, vice president.

From the National Association of Securities Dealers, Inc.: Mr. Gordon Macklin, president, and Mr. Lloyd Derrickson, vice president and general counsel.

The Commission, the Exchange, and the NASD have been asked to present a brief summary of their views, and their written statements will be made a part of the record. The Chair, at this point, requests unanimous consent to include such statements in the record as they are presented.

Is there any objection?

Hearing none, the record will be held open to receive them.

In order to leave ample time for an interchange of views, both between the subcommittee and panelists, and between the panelists themselves-and, gentlemen, I certainly would encourage a maximum interchange between members of the panel-I ask that the summaries be confined to no more than 15 minutes.

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.

I am pleased to recognize the first member of the panel, the Honorable William J. Casey, Chairman, Securities and Exchange Commission.


Mr. CASEY. Mr. Chairman, it is a pleasure to be here again this morning and we are pleased to have this opportunity to discuss with your committee the very important and timely subject of selfregulation, how it has worked and—

Mr. Moss. Could we check that microphone?

Mr. CASEY. Is that better?

Mr. Moss. That is better.

Mr. CASEY. Mr. Chairman, we at the Commission feel this is a very vital and timely subject. We have submitted written response to the questions which make up the agenda of this hearing, and these responses confirm our belief in the self-regulatory process and our conviction that recent experience and new problems indicate a need to improve the process and a need for intensified oversight over that process.

Rather than restate the responses which have been submitted for your record, I would like to take a few minutes to express some reflections on some of the challenges which confront self-regulation as a result of changes which have taken place in the securities market.

As you know, at the Commission we have heard over the last 5 weeks some 20 days of testimony representing the views of substantially all elements interested in our securities markets, and I have from these views discerned substantial unanimity on certain objectives.

First, the desirability of developing a central market system featuring competitive market making; second, the desirability of full disclosure of price, volume, and quotations in all markets, and, third, the desirability of developing safeguards which give the small invester assurances that he is not at a disadvantage in a market in which large transactions by institutions account for an increasingly large portion of the trading.

The touchstone of these commonly accepted objectives, as I see it, is the importance of maintaining the broad public participation which has made our securities markets the best in the world, and I think that these objectives define the challenge which the self-regulatory process has before it today.

The fact is that today we do have a central securities market sysstem. It works by indirection, by dual membership, by reciprocity, by off-floor and sometimes undisclosed trading. I submit the challenge today is to make the working of this marketing system direct instead of indirect, to make it comprehensive and coherent so that we all understand it, to get all trading out in the open, to make competition in market making work for the public and to implement safeguards for the small investor.

This, in my opinion, constitutes a vital step for the self-regulatory process, and how rapidly, how effectively that test is met will be very important in determining what the interest requires.

I would like to conclude by expressing my opinion that if selfregulation is to meet these new requirements, it will have to do several things:

First, significantly broaden participation in the governing bodies to provide representation for the public and for those served by the


Second, show the flexibility to develop and operate the common facilities and arrangements necessary to achieve public disclosures of trading in all markets, and develop rules which effectively relate existing autonomous markets to each other, creating a common system in which competitive market making can flourish. Now, this may or may not require an intervening layer of self-regulation, and that is one of the subjects on the agenda which I will be glad to discuss further when we get to it.

Third, it seems to me, will be to develop new rules that would assure the small investor that his interests are being solicited and provided for, particularly with respect to participation in large transactions and the availability to the small investor of essential information and research.

Fourth, strengthen requirements and regulations dealing with financial responsibility, surveillance of financial condition, early warning systems, and the other steps which are necessary to show the harsh lessons of the 1968-70 period have been learned and profited from. I would submit that on this front a substantial and significant amount of progress has already been made, and I think there is a prospect of more progress to come.

That, Mr. Chairman, is my general introductory statement. (Material submitted by Mr. Casey follows:)


The Committee has asked the Commission to present its views on the questions contained in the Committee's letter to the Commission dated November 4, 1971, a copy of which is attached to this statement. Our views are set forth below in the order the questions are presented.


All broker-dealers are, of course, under the direct supervision of the SEC; many are also under the jurisdiction of more than one self-regulatory agency. It has long been recognized that this situation could result in an unnecessary and burdensome duplication of regulatory activities. Consequently, over the years efforts have been made to avoid this duplication by allocating regulatory responsibilities among the various agencies involved. In our opinion, this allocation of responsibility has, on the whole, worked successfully.

The New York Stock Exchange and the American Stock Exchange (for nonNYSE members) assume the primary responsibility for regulation of their respective members, regardless of whether they are also members of a regional exchange. The regional exchanges, however, generally assume responsibility for the activities of dual members to the extent that those activities take place on that regional exchange. This is also generally true where a broker-dealer is a member of more than one regional exchange but is not a member of a primary exchange, i.e., generally the larger of the two regionals will assume the primary regulatory responsibility for the member.

Most exchange members are also members of the NASD. The NASD has responsibility for all of the activities of its members, except activities involving

exempt securities (Sec. 15A (c) of the Exchange Act) and to some extent transactions taking place on exchanges (Article I, Sec. 3(c) of the NASD by-laws). Generally, it tends to defer to the exchanges on the responsibility for the financial surveillance of members, although this is not true with respect to the smaller exchanges that are not exempt from the Commission's net capital rule. In other regulatory areas, the NASD may, in some instances where an exchange is already working on a matter of mutual concern (generally in enforcement matters) choose to defer to those exchanges, again to minimize duplication of effort. Broker-dealers who are not members of the NASD are directly regulated by the SEC under its SECO program.

In fact, provisions of the recent SIPC legislation represent a Congressional desire to allocate responsibilities. Under this legislation, the self-regulatory organization of which a member of SIPC is a member is required to inspect or examine such member for compliance with applicable financial responsibility rules. With respect to SIPC members who are members of more than one selfregulatory organization, SIPC is required to designate one of such self-regulatory organizations to carry out the examining and inspecting responsibility, and I understand that SIPC is currently gathering information upon which to determine whether reallocation of existing inspection responsibilities should be made. The Commission's role in this regulatory scheme has traditionally been mainly one of oversight. These responsibilities are carried out in different ways, including (1) registration with the SEC of national securities exchanges and associations; (2) inspections of the exchanges and the NASD to determine the effectiveness of their regulation; (3) the opportunity to comment on proposed rules and rule changes of exchanges and the right to review and disapprove proposed rules or rule changes of the NASD; (4) review of disciplinary proceedings of the NASD; (5) formal and informal special studies, hearings and commission-industry conferences concerning particular regulatory problems; or (6) where it is felt that self-regulatory action is or would be inadequate, direct investigation of and proceedings against broker-dealers, primarily for violations of the registration, antifraud, net capital and other serious violations of the Federal securities laws.

An example of these types of oversight as well as direct Commission regulatory and enforcement action can be seen in the Commission's work during the operational and financial difficulties of the past three years. This is reviewed in detail in the Commission's letter dated January 12, 1971 to Chairman Staggers which is attached to this statement.


Self-regulation has worked, but not well enough. The events of the past three years have demonstrated this. Self-regulation should not be replaced, but it should be improved.

Congress, after considering the alternatives of more pervasive government regulation or self-regulation, recognized that self-regulation was a desirable recourse because the sheer magnitude of the job of securities regulation precluded direct, governmental controls in all aspects.1 Congress also recognized that selfregulatory agencies might act with less diligence than would the Government. Congress' solution was self-regulation supervised by the Government.

The self-regulators do have a genuine interest in effective regulation. The bankruptcy of one brokerage firm directly affects the financial and operational condition of other firms and the public image of the entire industry. It is to the advantage of everyone concerned that self-regulation prevent this from happening.

1 In discussing the alternatives at the time of adoption of the Maloney Act amendments providing for national securities associations, the Senate Report said: "The first [alternative of increased government regulation] would involve a pronounced expansion of the Securities and Exchange Commission; the multiplication of branch offices; a large increase in the expenditure of public funds; an increase in the problem of avoiding the evils of bureaucracy; and a minute, detailed, and rigid regulation of business conduct by law. It might very well mean expanding the present process of registration of brokers and dealers with the Commission to include the proscription not only of the dishonest, but also of those unwilling or unable to conform to rigid standards of financial responsibility, professional conduct, and technical proficiency. The second of these alternative programs, which the committee believes distinctly preferable to the first, is . . . cooperative regulation, in which the task will be largely performed by representative organizations of investment bankers, dealers and brokers, with the Government exercising appropriate supervision in the public interest, and exercising supplementary powers of direct regulations." S. Rep. No. 1455, 75th Cong., 3d Sess. 3-4 (1938).

In this regard, the Special Study concluded in 1963 that self-regulation was particularly effective in the areas of financial responsibility and the maintenance of books and records. Indeed, the Special Study suggested that greater surveillance responsibility be allocated to the self-regulatory authorities in these areas. However, this conclusion was based upon conditions as they existed in the securities industry at that time. Generally, whatever financial or operational problems did arise were of an isolated nature, and discipline by the self-regulatory authorities was able to effectively handle these problems as they occurred. The operational and financial difficulties of the past three years however, were of a scope and magnitude not encountered by the Special Study. The selfregulatory supervision that worked when one or only several broker-dealers encountered difficulties faltered when the problems became industry-wide. It became apparent that more comprehensive regulatory controls were needed-such as better reporting, early warning systems, and better settlement and clearance procedures. And it became clear that the existing self-regulatory apparatus was not geared to meet this situation.

We must recognize, however, that self-regulation was not completely ineffective during this period. Deficiencies did become painfully apparent, but the fact is that the situation could well have become much worse if it were not for the efforts of the self-regulators. Certainly, the SEC with its limited resources could not have done the job alone and a major disaster was averted through the combined efforts of the SEC and the self-regulatory agencies. For example, we must remember that the NYSE alone made available over 100 million dollars to cover customers' claims.

We must also recognize that while the financial and operational condition of broker-dealers is a major concern of the self-regulatory agencies, they have other significant responsibilities. The administration of trading markets and market facilities, fair dealing with customers of broker-dealers, and other measures relating to the integrity of the marketplace and their members are also important areas of self-regulatory responsibility. Self-regulation has made valuable contributions in these areas.

The question, then, is what have we learned about self-regulation from the experience of the past three years. In our opinion, nothing has happened that demands that self-regulation be replaced by Government regulation. It is more true now than in 1934 that the sheer magnitude of the job of regulation necessitates self-regulation. It is obvious that for the Government to undertake complete, direct regulation of the securities markets would require drastic increases in money and manpower.

On the other hand, I think we have learned that more effective governmental action is necessary. Whether you call this more governmental oversight or more governmental regulation is unimportant. I think that the problem should be approached on two fronts. First, the SEC's current oversight activities should be strengthened. Much more vigorous exchange and NASP inspection programs are needed. We are endeavoring to enhance our capability to review the financial reports and inspect the operations of broker-dealers more frequently and more intensively. Secondly, the SEC should take a more direct role in formulating and implementing major policies and necessary qualifications and standards for broker-dealers. In this latter regard we are already acting. Recently, the Commission adopted a rule requiring broker-dealers to conduct a quarterly box count of all securities in their possession and to verify securities not in their possession over thirty-days old. Also, we adopted a rule requiring a broker-dealer to immediately notify the Commission and any self-regulatory organization of which he is a member of a net capital violation and to file periodic reports with the Commission and any such self-regulatory organizations when his recorded net capital ratio exceeds 1200% or when his books and records are not current. And, we put out for comment a rule to increase capital requirements for entry into the business and to require a more conservative level of liquidity during the frst year of a new firm's operation. Also, we have developed rules requiring the Protection of customers' credit balances and segregation of fully-paid securities. We are working on measures to more effectively establish adequate operational and financial controls in order to enter the business. We are also working on rules which would require brokerage firms to give their customers periodic reports on their financial and operational condition.

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