The other twin, the segmentation of the industry, has resulted in the development of a multitude of self-contained processes. Even where automation has been applied, it is not uncommon to complete the process with a printout, hand-carry or mail the printout to the next organization in the process and then keypunch the data all over again. The results have been highlighted previously-fails, excessive transfer time, millions of dividend dollars in limbo, and armies of clerks grinding out their duties, in the warrens of Wall Street.

The Solution

There is a need to fully comprehend and accept the fact that the securities community is really that a community that includes brokerage firms, banks, transfer agents, the Exchanges, publicly held companies, institutional and individual investors. And the members of that community have a common interest and responsibility for making it work for the benefit of all.

In trading and marketing, it is essential that the members of the community be competitive. In operations—in settlement after the trade-cooperation must be the theme. This is not to imply that all systems must be the same or that each brokerage house and each transfer agent and each depository should not constantly strive to develop the best system. Requirements change, technology changes, and the systems must evolve with them. But the community cannot develop to its full potential until it begins to function efficiently as a total system.

Probably the most important specific action that the securities industry can take now is to begin the development of an integrated, viable clearance/settlement/depository system. The system should provide for a centralized automatic clearance and settlement based on compared trade reports from the exchange floors and from OTC Clearance houses. It should be an automated system. Certificates should be held in transfer agent depositories thereby curtailing their flow dramatically. Eventually all, or nearly all, certificates should be kept in these depositories. Collateral loans should be secured by depository segregation statements.

This report recommends the development of a National Clearing Service linked to Regional Clearing services in major population and market hubs and suggests how this goal can be reached. These services would handle clearance and settlement and maintain the records of security ownership for their members. Automatic stock loan and automatic buy-inprocesses would be developed to minimize the fail problem.

No certificates would be handled by the clearing services. Certificates would remain in the possession of Transfer Agent Depositories, who, linked directly to the clearing services would receive in, store, segregate for loan, and transfer out the certificates as required.

It appears to the NR team that, with the cooperative support of the leaders of the industry, this concept could be tested in 1970, implemented for a major part of the community in 1971 and be fully operational by 1975.

Conclusion

America's unique economic system-based on the concept of broad public ownership is made viable by the securities industry.

For years, the financial community has done its job well. But its operations have not kept pace with the technologies which can provide the means for it to grow and to better serve its many publics. 1968 demonstrated how fragile the system is.

Left alone, the industry will, no doubt, adapt itself to the changing environment. Such change, however, can come about most effectively when it is thoughtfully guided by the responsible leaders of the community.

CHAPTER 2

THE SYSTEM

This chapter provides a summary description of the securities community
and the processes it performs. The application of computer technology to
solve many of the operational problems is urged and an Exchange spon-
sored Member Firm System Advisory Organization to aid in this application
is recommended.

The securities community is composed of many members. They place orders—make trades in many types of securities-update accounts-handle certificates-transfer ownership-issue dividends-make loans-balance books—and make and correct mistakes. They make or lose money in different ways. Some benefit from the discontinuities and inefficiencies. But for most a smooth efficient system would maximize profits.

This chapter presents a brief summary of the more significant activities as they are being accomplished today and highlights some of the more obvious difficulties in the system.

While those activities which have recommendations for specific systems improvements are presented in more detail in subsequent chapters, it is important to review the whole system in overview prior to plunging in for a look at individual components.

The processing relationships of the primary members of the securities community are illustrated in Figure 2, page 11. This diagram is a broad-brush overview of the flow o orders and certificates in some typical security transactions. A narrative description of a more detailed flow from the point of view of the brokerage firm is presented in Appendix A

In a typical trade: A customer calls his registered representative (RR) at the membe firm's branch office. He asks for quotes and perhaps places a buy order. The RR writes up the order. It is telephoned or teletyped to the central office of the member firm for rela to a broker on the Exchange floor for execution. In wirehouse operations, the order is usually switched by computer to a teletype in the broker's booth at the stock exchange.

Frequent errors-some $100 million per year-are made in orders. The tempo is fas and the registered rep is, after all, not a clerk. Many errors could be stopped and correcte with a computerized order edit program that checks order format, account number, securit identification, type order and share quantity based on account data, and general price rang for limit orders.

At the Exchange, the floor broker picks up the order and within the trading crowd, a a designated location on the Exchange floor, checks the market with the specialist and make a bid to buy the ordered securities. If he finds a broker with a sell order in that security, the bargain and agree on a price, or the specialist in that security may offer the stock himself t help assure an orderly market. Each broker marks the price and the other broker's symbo on his ticket, then goes his separate way to return the ticket to his booth. The price is tele typed to the brokerage house for customer notification.

A floor reporter records the trade and relays the price to an Exchange clerk who keys into the ticker system.

Later, the executed order as annotated by the floor broker is handcarried to the broke age house. Punched cards are prepared from it for the clearing house to compare with a sim

ilar card from the selling broker and for preparation of customer billing. The cards are submitted to the clearing house daily for comparison of trades, netting of the day's trades in each security, and allocation to determine to whom the selling broker must deliver and from whom the buying broker will receive securities. Some ten percent of the cards do not match initially and are DK'd (don't know). Some are never resolved because of the inability to accurately reconstruct both sides of the trade.

For institutional investors, the confirmation may be sent to an investment advisory organization, which forwards it to the institutional investor, who then forwards it to a custodian bank, which in turn may have to send it to an agent bank in the Wall Street area. This is illustrated in the flow diagram as instructions-to-receive going from the buyer to the correspondent.bank-custodian to the representative bank. These instructions are usually handled by mail and frequently are not available at the New York bank by settlement date. It is estimated that unresolved brokers' deliveries which have been refused by banks because of late or inaccurate customer instructions represent a float averaging hundreds of millions of dollars.

Ten New York banks operate through the NYSE Stock Clearing Corporation to effect an intermediate settlement. This settlement is the delivery or receipt of securities against payment between the brokerage firm and his institutional customer's designated agent. The retail customer usually makes his settlement by mailing checks or certificates to the brokerage firm, or by leaving his cash and securities on deposit with the brokerage firm.

By the institutional customer providing his agent bank in New York City with standing instructions to receive securities based on a copy of his broker's confirmation it would not be necessary for the bank to receive separate instructions for each transaction. This would result in eliminating some 75% of the present delivery rejections.

The selling brokerage firm is supposed to obtain certificates and deliver them on settlement day whether it has received certificates from its customer or not. These certificates are usually obtained from the supply stored at the brokerage house by margin customers. On large block transactions, it is not always possible for the buying brokerage house to settle with his customer until the certificates are received from the selling broker(s). This usually causes a delay in settlement with the institutional buyer.

Present practice in most firms requires routine certificate deliveries to be held and reported on the next day's stock record. They are, therefore, not available for deliveries the same day as they are received. Large transactions are exceptions. Delivery is made to institutional customers the same day as the certificates are received.

The present operation of most brokerage firms cages has evolved as an essentially manual system with errors in the processing of certificates and accounts increasing almost geometrically as volume increases. Also, the manual system is slower than a well designed computer system. The location of securities is only known in general terms so it frequently takes excessive time to locate a security in movement. A security may have been delivered, used as collateral, loaned to another broker, sent to reorganization, sent to legal, sent to transfer, delivered to the box or misplaced.

In a few houses, automated cage systems have been developed so that all certificate movements within the cashiers' department are recorded within the computer, thereby providing a real time file of all securities. An automated system such as this can reduce the turn-around time of securities so that today's receipts can be today's deliveries. A segregation monitoring program can be included and made on-line so that the required securities can be released for delivery if they are not required in segregation.

The present systems utilize keyboard entries and cathode ray tube readouts, so that each station requires the entry of a certificate description by the operator. This requirement to read each certificate and instruction into the computer will be changed by the adoption of machine readable certificates and instructions and will, when readers are used with a computer system, provide faster and more accurate certificate processing. This will not only improve the delivery cycle but through very tight accounting control of each certificate make theft very difficult.

Figure 2 illustrates securities going to the transfer agent before storage at the custodian bank. The transfer agent transfers the certificates as directed, forwards them to the registrar for registration and then returns them to the submitter. Ownership of the securities represented by the certificates is now properly recorded so that all benefits (dividends, proxy statements, quarterly reports) will be sent to the rightful owner. During high volume periods, a transfer takes about six days making it a major bottleneck in the system. This time can be reduced through improved internal controls and the use of machine readable and machine preparable certificates.

Besides the netting and allocation previously described, the clearing corporation assists in security deliveries and monetary settlements. The brokerage house submits deliveries designated for other brokerage houses to the clearing house along with a list of monetary credits due for each delivery. The clearing house sorts out and places into messenger pickup boxes each firm's receipts for that day. These are retained for each brokerage house and a brokerage house messenger picks them up each day and returns them to the brokerage house. The deliveries are credited to the delivering broker and debited to the receiving broker. The dollar difference between credits and debits is settled between the brokerage firms daily via the clearing house.

The inner-relationships among virtually all important members of the securities community are everywhere evident. The corporations authorize the issuance of securities and determine what dividends are to be paid and when. They announce the dividend record and payable dates, pay the transfer agents and registrars and order and pay for certificates from the engravers. The certificate suppliers (engravers) design and produce certificates as authorized by the corporations. Banks lend money to the brokerage houses to supplement their capital. The brokerage houses usually borrow the money that they loan to customers in margin accounts. These loans are secured by collateral from margined securities. Other loans may be required to provide daily certified checks in payment of cash on delivery (COD) settlements.

In executing a single transaction for a customer, a typical brokerage house uses 33 different documents. Eighteen documents are required for each trade. They include such items as: an order filled out by the registered representative; a copy of the order received in the order room of the brokerage house; an exchange ticket; a balance order; a transfer instruction; etc. These documents are only those used by the brokerage firm in filling a customer's order and delivering the security to him. Fifteen more documents are used to provide summary records of the transaction. Not included in this count are various additional documents used at the clearing house, the transfer agent, and in the case of institutional customers, at various banks. The 33 documents are required for the normal (no error) transaction. Whenever an error is made or an other-than-normal transaction is executed, the number of documents increases. A simple error may double the number of documents usually required. Any deviation from the norm such as buying a split security after record date but before payable date, results in increased documentation and work.