significant advantages accruing to a member firm in being able to trade directly with a primary market specialist as contrasted with being able to trade with a third market dealer. Contrarywise, we feel that the public should have the right to deal with the third market or other non-exchange market makers through an exchange member just as the public currently has the right to deal with the exchange specialist through his member firm broker.

Question 12

We do not believe we are in a position to answer this question.

Question 13

The American Bankers Association submitted a statement to the Senate Securities Subcommittee in connection with the bills, S1164 and S3347. This statement concluded that membership on stock exchanges was not necessary for banks if competitive brokerage fees were reduced further.

One of the major reasons supporting this conclusion was the following excerpt:

"Banks owe undivided loyalty to their trust customers. It would be difficult, though not impossible, for a bank to reconcile that obligation with the potential conflicts which might arise from serving as a broker to a trust account. The hazard of choosing between themselves or an affiliated broker and an independent broker who may arguably possess special competence for a transaction would be considerable. A review of recent civil suits against institutional investors makes it clear that this problem is not limited to banks."

If this concern for fiduciary responsibility is followed to its logical conclusion, it is evident that any money manager whether it be a bank, insurance company, mutual fund advisor or broker would be confronted daily with the same potentials for conflicts of interest and with the same "opportunity" to use transactions from the management of capital funds in a manner to benefit others rather than the true beneficiaries or owners of these assets. While these interest conflicts are quite real to those who are acting presently in a fiduciary capacity, if proposed legislation affecting the management of pension funds is enacted, the definition of a fiduciary and therefore the legal responsibility for the management of these funds will be greatly expanded.

The problem of self-dealing between a money manager and a broker affiliate will then be of major concern from the strictest legal sense to not only the fund advisor, but under certain legislative proposals to those responsible for his selection.

The role of the money manager in the eyes of the public and in practice should be one of complete disinterest in any matter related to the funds under his care except for the professional management of these funds. There should be the avoidance of any appearance or possibility that this administration is not in the sole interest of the beneficiaries of these funds. The simplest and best method for achieving complete independence is to prohibit security transactions between money managers and a broker-dealer affiliate.

AMERICAN INSURANCE ASSOCIATION,

Washington, D.C.

Hon. HARRISON A. WILLIAMS, Jr.,

Chairman, Subcommittee on Securities, Committee on Banking, Housing and Urban Affairs, U.S. Senate, Washington, D.C.

DEAR SENATOR WILLIAMS: We appreciate the opportunity for responding to Part II of the questions prepared by your Securities Industry Study. Our answers to Part I of the questionnaire are set forth in our testimony and answers to questions before your Subcommittee on April 18, 1972 (see p. 9.)

The questions in Part II appear designed to explore why institutional membership is not in the public interest, and why exchange members should conduct a predominant portion of their business with unaffiliated customers. The experience of our members with brokerage affiliates on regional stock exchanges has been entirely favorable, and has revealed no situations not adequately covered by existing exchange regulations.

We demand that anyone alleging that institutional membership has a detrimental impact on the marketplace support his allegations with concrete, factual evidence. The absence of any such evidence convinces us that the arguments against institutional membership are nothing more than decoys to distract disinterested persons from discovering the fear of future competition in certain sections of Wall Street.

Until our members and other institutions organized their own brokerage subsidiaries, the business of executing orders for large institutions was monopolized by a small number of Wall Street houses which transact no business with small individual investors.1 During the past three years, new forces have emerged on the regional stock exchanges which can strengthen the inadequate market for institutional trading if they are not regulated out of existence by government officials who wish to preserve the old monopoly. As the central market system evolves, it is essential to increase the capital committed to our securities exchanges, and to strengthen their trading floors. The members of this Association presently carry over $4,250,000 worth of aggregate indebtedness, and have committed over $3,800,000 in net capital through their affiliates on the PhiladelphiaBaltimore-Washington Stock Exchange. This amount can be increased several times when it becomes clear that the regional exchanges will play an integral role in the central marketplace.

The Securities and Exchange Commission (SEC) bases the conclusions in its April 20, 1972 White Paper on Institutional Membership on the assumption that if institutional membership is not severely restricted, every institution in the United States will create a brokerage outlet for all of its trading, thereby causing the securities industry to lose 40 per cent of its gross revenue. Such assumptions are absurd. In our own Association less than ten of our 119 member companies presently operate affiliated broker-dealers. Those with brokerage affiliates execute a relatively small percentage of their total brokerage business through the affiliate. For example, one of our companies with an affiliated broker-dealer places only 11 per cent of its total securities business with the affiliate. All of our members are vitally interested in lowering the level of negotiated commission rates, but only a limited number have the capital surplus and investment expertise to compete as brokers in the securities markets.

The SEC also projects that institutions will use brokerage affiliates to speculate excessively in the market for short swing profits. Since insurance companies are prohibited from such activity by state insurance laws, we do not believe this is even a remote possibility. Our investment officers are cautious and conservative in their approach to stocks and bonds. Their function is to preserve their company's capital in a liquid form, and to provide a sufficient return on investment to protect against inflation.

We believe a broker affiliated with one of our members which executes transactions solely for the parent insurance company should not also be required at this point in time to transact business for unaffiliated customers. As competitive commission rates are implemented at lower levels it will become economically necessary for institutional members to transact business for unaffiliated parties in order to survive. In an environment of completely competitive rates, none of our companies will operate a brokerage outlet solely in order to save commissions for itself. The same cost savings could then be achieved by negotiating directly with any unaffiliatel broker.

It is impossible, however, for Congress, the SEC, or any of our members to forecast precisely what mix of affiliated and unaffiliated business will be necessary at any future time. This is especially true in light of the SEC's reluctance to require the exchanges to implement competitive rates by a certain date. Any requirement that exchange members must do a certain percentage of unffiliated business, or must not do more than a certain percentage of affiliated business. places certain exchange members at a competitive advantage over others. We are convinced that competitive pressures in the marketplace will resolve such problems, and that government action cannot be justified until facts prove it is needed. The same point of view applies to the question of whether rules can be designed

1 In his March 14, 1972 testimony before the House Subcommittee on Commerce and Finance, NYSE President Robert W. Haack stated that during a three-month period in 1971, 49% of all NYSE transactions over $500,000 were handled by five firms.

to prevent reciprocal arrangements. We believe that an absolute prohibition against rebating and recapturing commissions would create chaotic conditions in the industry at this time. If negotiated rates were available on all securities transactions, however, it would not be necessary to enter into reciprocal arrangements to save commission dollars. In our opinion, a subjective rule, involving questions of motive, intent, etc., would be impossible to administer, and could only be enforced in a discriminatory manner.

In considering what trading advantages are available to exchange members in transactions off the floor, it is essential to distinguish between an individual trading for his own account through a broker which handles orders for many different types of customers, and an insurance company which trades solely for itself through an affiliated broker. In the case of a broker affiliated with an insurance company, the individuals participating in market transactions are employed as professional money managers with no personal interest in their orders. Whatever profits they earn in the market are for the benefit of the parent insurance company, and are used to reduce the company's operating costs, thereby resulting in savings to millions of policyholders. In the case of a broker trading for many types of customers, there is no justification for individual partners or employees trading for their own account through the firm. All profits are solely for their own personal benefit. There is similarly no reason that the firm should be able to trade for its own account unless it is performing a legitimate marketmaking function. It seems to us difficult to remove the possibility of a conflict of interest where an individual or a brokerage firm trades for his or its own account at the same time the firm is trading for its customers. No conflict of interest is possible, however, when all trading is for the benefit of a broker's parent insurance company.

Among the brokers affiliated with members of this Association, only one has its own man on the floor of a regional exchange. The others deal through independent floor brokers. We know of no facts which support the view that a broker affiliated with an insurance company should not be permitted to trade through its own floor man. It seems to us that a broker executing orders solely for an insurance company is free of the possible conflicts of interest which are present in other situations, for the reasons discussed above. Floor personnel of a member firm are more likely to act improperly in handling an order for a large, unaffiliated customer, which could take its business elsewhere, than in handling orders solely for a parent institution. Past advantages, however, of having a man on the floor of an exchange will be reduced or will disappear altogether as the central market system evolves. The more competition develops among market makers, the less important will be direct access to a particular exchange floor. Our members hope to play an important role in strengthening the market-making function. Technological developments in data processing and communications will also make actual presence on an exchange floor less significant than it has been. The chief area of competition in the foreseeable future between insurance companies and institutionally oriented members of the New York Stock Exchange (NYSE) will be soliciting money management accounts from private pension plans. NYSE member firms, however, enjoy a tremendous competitive advantage because insurance companies have to position a broker between themselves and the principal securities markets in order to trade for managed accounts. It is not necesary for NYSE member firms to charge a management fee in order to profit from executing orders for large pension plans. The way to resolve this competitive dilemma is to allow our companies to develop their brokerage affiliates into fully competitive forces in the market for institutional business. If any restrictions are placed upon the development of our brokerage affiliates, then we will insist that NYSE member firms not be permitted to execute orders for managed accounts, regardless of whether they are managed on a discretionary basis or under contract. It seems more logical, however, to encourage the growth of competition, and to regulate any possible conflicts of interest through disclosure obligations rather than to require a separation of functions which will weaken the strength of the markets. This generally is our philosophy with regard to the issues under study by the Securities Subcommittee. We believe that our members can materially contribute to the strength of the central market system, and we urge the Subcomittee to adhere to a policy which will encourage this to happen. Sincerely yours,

WALTER D. VINYARD, Jr.,
Associate Counsel.

INTRODUCTION

The following are detailed responses to the 13 questions submitted to the American Stock Exchange by the Senate Subcommittee on Securities on issues relating to the issue of institutional membership on stock exchanges and related matters. Since these issues are, as the instruction sheet accompanying the questionnaire states, "complex and interrelated," it is not always possible to state fully the views of the Exchange in the form of the answers to specific, isolated questions. Therefore, while the responses given below attempt to answer each question as completely as possible, we believe that these responses must be read together with the Statement on institutional membership which the Exchange submitted to the Subcommittee in connection with the hearings currently being conducted and which, for the sake of convenience, is attached.

The questionnaire calls for responses concerning possible "abuses" and "problems" which may have arisen from institutional membership. In this regard, it should be kept in mind that institutional membership has never been permitted on the two major stock exchanges which provide primary markets for securities. Thus, the nature and extent of the problems which might arise from institutional membership can only be estimated, or inferred from the experiences of 1968-1970, when the activities of institutional investors had their sharpest impact on the markets, and when their activities were under the closest scrutiny. Beyond this, we believe that the issue of institutional membership must be decided not merely on the basis of whether specific "abuses," are likely to arise but also whether they can be regulated. It also appears that the far more important question which faces Congress, the SEC, the exchanges and the public is how the markets of the future should be shaped, whether they should be designed to serve equally the individual and institutional investor, and whether the overall effect of institutional membership will serve to help or to harm the markets in performing their functions for the benefit of the public investor and for the nation's businesses.