SUMMARY The primary problems of the securities industry today arise from its labor intensiveness and its lack of system-wide control and audit information. The causes of these difficulties are the heavy reliance on paper for establishing and transferring records of ownership and the compartmentalization of activities within the industry. The problems become most visible in the large numbers of broker-to-broker Fails and the slow, expensive delivery of certificates to customers. Our proposed approach for solving these problems involves the development of a system of depositories, within which ownership records can be transferred by electronic bookkeeping entries. Associated with the depository system should be a nation-wide wire system to effect bank deliveries to customers - particularly institutional customers and a centralized infor mation and control unit. The overall securities handling system can be organized best in terms of three components or modules: A Broker component that services the brokerage in- A Banking component that services the banking com- A Custodian and Co-Transfer component, to control This organization will permit other markets to participate in an NYSE Broker component, if desirable, or to develop their own procedures if interfacing through the Custodian is preferable. A suitable Broker component for the NYSE, and for other exchanges wishing to use it, can be developed through expansion and evolution of the current Central Certificate Service (CCS). Additional features should include: Collateral Loans A Stock Loan System A Set of Fails Control Programs The preliminary design of a computer-controlled, nation-wide wire system for the delivery of securities has been prepared. It can serve as a basis for starting discussions among potential users and for study of the many serious legal and institutional barriers which must be overcome before such a system can be implemented. The CCS furnishes a natural base on which to build the future securities handling system. Essentially all the necessary components can be either built or simulated within the CCS. After these have been developed, and as legal and institutional barriers are overcome, the various functions should be split off into the three modules described above. The evolutionary characteristics of this approach permit effective action to be started without delay, and thus to obtain direct benefits as the various intermediate steps are taken. I. INTRODUCTION In April 1969, the New York Stock Exchange retained Arthur D. Little, Inc., to conduct a preliminary design study for a Securities Handling System that would meet the needs of the securities industry in the 1975 era. The assignment involved the development of concepts and general specifications for a system of services to cover all significant activities associated with securities that may arise between successive transactions involving the same ownership records that is, the activities of: clearing, broker-to-broker settlement, transfer, customer delivery, pledging and borrowing and custodial operations. The preliminary design was to provide an idealized goal and the development of this goal was not to be constrained by current legal requirements or by maintenance of the exact current roles of the many participants in various securities-related activities. Although the study was not to be restricted by current practices, it was expected to recognize that major departures could be justified only by major improvements. Similarly, while economic considerations were not to be treated explicitly at this stage, awareness of the need for eventual economic justification was an implicit consideration. Finally, although the needs of the NYSE provided the incentive for the study, the Exchange was not to be studied in isolation, but in terms of overall industry requirements. In essence, the preliminary design was to provide a starting point or framework, from which an operational system could be evolved. To perform this function, the preliminary design must be: Operationally effective in the sense that it overcomes Technically feasible – in that it be capable of implementa- Comprehensive in the sense that sufficient detail be provided to permit testing the design against a realistic set of industry operations. The last point is particularly critical; in a number of our interviews it was pointed out that: "the concepts for a new system are not difficult to develop - it is the details that kill you in this business." A preliminary design cannot be expected to have answers to all questions of detail. It should, however, cover the more obvious detail requirements and it must provide a framework for discussion and for testing and incorporating all other matters of detail as they are brought up. - The concepts and design elements presented in this report seek to provide such a framework to be used as a basis for further system development through a process of continuous interaction with the eventual users of such a system. II. THE BASIC PROBLEMS The difficulties of the securities industry during the past several years are well known and will not be reviewed here in detail. During a period of intense growth in activity, seldom if ever matched by any other industry, some components have maintained their capabilities to meet demand while others have been under intense pressure. While floor trading has kept up with the transaction rates imposed from the outside, the supporting services and paper work have formed a bottleneck. The subject probably receiving the most attention in this respect has been the problem of Fails. Even though the NYSE has suffered less than other markets in this regard, a survey in August-September 1968, indicated that only 35% of broker-to-broker deliveries were completed within the normal settlement period of five days, while 8% were still incomplete 10 days thereafter. These Fails amounted to the equivalent of several days worth of trading and exceeded one billion dollars in value. The NYSE and other markets have devoted major efforts to attempts to alleviate this problem; the NYSE, through the development of the Central Certificate Service and other markets, for the most part, through planning the development of continuous netting systems with associated securities depositories and stock lending facilities. When these plans come to fruition and all systems are fully and effectively operational, many of the current deficiencies may have been overcome. However, there will still remain areas where the needs of brokers and their customers impose requirements on the industry that cannot be met within the context of existing systems. Even if we ignore dissatisfaction associated with inefficiencies in the correct operation of existing systems, there remains a residue related to problems inherent in present techniques for securities handling. Our examination indicates that four key problem areas must be addressed if substantive long-term improvements are to be achieved: Industry Labor Intensiveness and Redundancy Lack of System-wide Audit and Control Prevalence of Broker-to-Broker Fails Slow and Inefficient Customer Deliveries The first two of the above are the underlying sources of industry difficulties, while the last two items are the operational elements where the impact of the primary problems becomes visible. |