4. Expedited Transfer The close relationship of the Broker and Custodian Modules should permit expedited transfer of securities to customer name; where practical this should be done at depository locations that will minimize the physical delivery problems thereafter. 5. Automated Participant Activity Auditing Current NYSE clearing and settlement activities were designed at a time when there was great variability in the level of automation and automation planning among its Clearing Members. We believe future system design should be based on the requirement that all Clearing Members use highly automated data processing techniques. Under these conditions, it should be possible for the NYSE, in cooperation with its Clearing Members, to develop a series of programs that will permit the Clearing Members to use automated procedures for checking and verifying the activity and position reports they will be receiving. Since the basic data employed in authorizing transactions originates with the Clearing Members, it should be practical to use independent automated methods to arrive at what should be identical records. While manual sampling or spot checking of records, even when they appear to be verified by automated procedures, will still be desirable, an enormous clerical burden can be removed by computer authentication programs. The mechanisms employed must, of course, be designed with great care but the process should leave Clearing Members much less vulnerable to errors by inexperienced personnel and should speed the discovery and correction of any errors that exist. We regard this feature as of major importance in the long term. C. OTHER BROKER SYSTEMS - CONTINUOUS NETTING During our work, we examined the potential benefits of a continuous netting system for clearing and settlement. This process involves having the Clearing Corporation act as the contra-side to each participant in each trade, and leads to a single daily settlement entry for each Clearing Member for each security in which he has dealt. Although deliveries on settlement date will still be expected, the system leads to a form of continuous Fails netting if deliveries are not made, with the expectation that such Fails will tend to balance out resulting in a need for less frequent deliveries. The system, therefore, accepts the existence of Fails, within controlled limits, for the sake of decreasing delivery requirements, and decreasing the impact which original Fails can have in producing secondary Fails. In this manner, it seeks to eliminate the "domino" effect. As a result of past work, ADL has recommended that the NASD adopt a continuous netting approach. We consider this procedure highly desirable for a situation where the geographical and size distributions of participants vary widely, where supplies of liquid stock in the securities traded are limited, and where a significant fraction of securities handled is not fungible and thus limits the effectiveness of bookkeeping entry systems. Under these conditions we consider continuous netting as the most desirable technique to employ. In the case of the NYSE, we do not recommend the adoption of continuous netting because: (1) We consider the establishment of an effective depository as a superior approach for the NYSE, with its centralized operations, more equal sizes of Clearing Members, large liquid supplies of securities, and a high degree of fungibility in its listed stocks. We believe the stock lending and Fails control procedures we are recommending will be adequate for handling Fails, and we believe participation in these activities will be greater and more effective if the NYSE retains traditional procedures than if it were to adopt a new set of relationships. (2) Accepting the contra-side position for each trade, as opposed to merely acting as a bookkeeping and monitoring agency, entails a considerable increase in NYSE liability. While the NYSE's liability will increase in any case, since its data resources will be improved and thereby its ability to act on its responsibilities for regulating its membership, this is a different and less direct form of liability. (3) If the NYSE were on the contra-side of each trade, it would become more difficult for it to equitably police its membership, because it would be an active participant in each operation as well as a “judge” and arbitrator. We believe equitable policing can be done more effectively under present procedures. It should be noted, however, that if effective stock lending and Fails controls are not adopted, continuous netting may become a necessity. Since we have not recommended continuous netting for the NYSE (although we believe it a necessity for some of the other markets) we have considered the implications of more than one clearing system, which implies a limit on the degree of standardization possible within the industry. As a result we note that complete standardization of input data is not feasible in any case; the NYSE, for example, must make provisions to accept data on $2 brokers, while the OTC market will be entering numbers associated with NASDAQ, etc. Settlement and position reports might be standardized if a single system were adopted. However, we believe the automated participantactivity auditing that we are suggesting is more important in reducing clerical checking, and should reduce clerical loads to a level where the existence of multiple systems is not unduly burdensome. In line with our basic philosophy, we consider the disadvantage of having more than one clearing system more than balanced by the opportunities offered the different markets to develop systems to meet their specific needs, and to express initiative in trying new procedures that can work to the long-term benefit of all markets. V. SECURITIES MOVEMENT OPERATIONS In the previous section we described the Broker Module, which employs a bookkeeping - entry system and associated services for controlling the level of broker-to-broker Fails, while simultaneously reducing broker clerical support requirements. The Broker Module, by itself, cannot handle effectively the movement of securities that involves transfer and customer delivery. A requirement of the Securities Handling System is to provide for rapid and efficient conduct of these functions. Here, however, the needs of the end customers the purchasers and sellers of securities will set constraints on possible procedures. We must start, therefore, by examining the characteristics of these customers. A. THE MARKET FOR DIFFERENT FORMS OF SECURITIES Table 1 shows certain characteristics for three categories of owners of stock during 1968, and as projected for 1975. The future estimates are based on direct extrapolations of recent trends. Although we consider these estimates to be reasonable for testing the general feasibility of a system design, more study would be required to develop estimates appropriate for detailed marketing or cost planning. The "Institutions" category in the Table is based on the usual NYSE definition of Institutions and Intermediaries and does not include personal trusts. The "Traders” and “Investors” result from splitting the normal NYSE category of Individual Owners to reflect the fact that a large fraction of all active trading is provided by a small percent of all share owners. Solid data on this subject are not available, so the Table was developed from the assumption that 20% of all share owners (the Traders) are responsible for 85% of all trading.* The implications of this assumption in terms of "activity rates" and "years held" could then be calculated, leading to the values shown in the Table. *The split is an arbitrary one. However, so long as a relatively large fraction of all trading is accounted for by a small fraction of traders (presumably including the NYSE Members among them) the market segments will have the general characteristics described herein. 67-228 - 72nt - 15 Some critical design features for a securities handling system can be derived by examining the needs of the market segments shown in Table 1: Investors: A large fraction (well over half) of all securities Traders: The most active component of the customer pop- |