c. It is our opinion that institutional affiliates should have complete separation from their parents in regard to the brokerage business generated by such affiliates.

SPENCER TRASK & Co., INC.,

New York, N.Y., May 3, 1972.

SUBCOMMITTEE ON SECURITIES,

Committee on Banking, Housing and Urban Affairs, Washington, D.C.
Attention: David L. Ratner, Esq.

GENTLEMEN: This will acknowledge receipt of your "Questionnaire" recently relative to so-called "Institutional Membership" and a number of auxiliary questions.

This "Questionnaire" contains ten pages and some 100 varying complicated and complex questions, along with the request for various examples.

The question almost arises as to whether this massive, monumental request might have been subtly designed and concocted for some reason to immediately discourage, through its size and complexity alone, the average brokerage firm from even attempting to try to cope with it.

If this device of so-called "in depth" fact and view finding has the result of severely limiting the number of replies to the "Questionnaire" or leave many questions inadequately answered the Subcommittee could understandably point to an apparent lack of interest on the part of brokerage firms on this major question of "Institutional Membership."

On the other hand, those brokerage firms who have the time and talent available to research the voluminous data on hand and thus more fully reply to this investigation may find even their own data in some way turned against them by legal minds who through such training and/or a possible degree of bias can effectually maneuver facts and statistics to suit pre-conceived ideas and misguided convictions.

Briefly, our own position on "Institutional Membership" has been clearly and adequately expressed by an impartial and authoritative group more qualified to judge than we the Securities and Exchange Commission.

The views and recommendations of the SEC followed long and detailed hearings, much testimony from experts, with voluminous supporting data. All this was then interpreted and studiously appraised before the proposals for solving this question were submitted by this knowledgeable and informed government agency.

Actually it has been amply demonstrated that "Institutions" would gain relatively little on commissions related to their huge portfolios while their unlimited access to the "Exchange" would do great damage to the important securities industry. It is axiomatic tuat a neaitny securities industry is vital to the capitalistic system.

Moreover, our own views were expressed and furnished to your Subcommittee in detail by our representative, Mr. Charles Morin, a partner in the law firm of Gadsby and Hannah.

With regard to "negotiated commissions," there can be little question from the available figures provided by the New York Stock Exchange and others, that competitive rates on orders over $500,000. and then lowering this level to $300,000. significantly reduces the revenues to the brokerage firm on such orders.

For example, with regard to our own firm we negotiated our commissions on the portion of orders over $500,000, at half the regular commission, or less.

Now, on orders over $300,000. we begin negotiating the rate at 65% or less of the regular commission rate.

This may be over-simplification but I'm afraid it requires no ten-page Questionnaire and some 100 complex questions to recognize and demonstrate simple basic facts.

Our firm will do all we can to adjust to and live with the new negotiated rates and possible other industry changes but I sincerely urge the Senate Committee on Banking, Housing and Urban Affairs with its Chairman, Senator Sparkman, and the Subcommittee, with its Chairman, Senator Williams, to look at the situation broadly with a view to preserving and strengthening such an important segment of our domestic economy as the Securities Industry, rather than irreparably damaging it.

Again, in dollars and cents it has been fully demonstrated the full membership on an Exchange by institutions—such as the major insurance companies— means relatively little while, conversely, it would have a major adverse impact on the brokerage business, with all its manifold ramifications.

The SEC already has all the data, I believe, to support such a possible expectation.

Respectfully,

AUGUST HUBER, President-Chief Executive Officer.

P.S.-I believe it was Charles Caleb Colton who once observed-"Law and Equity two things which God hath joined, but which man has put asunder." This I must say is not true in all respects. I would suggest that in your factfinding and deliberations it be kept that way.

RESPONSE FROM UNDERWOOD NEUHAUS & Co.

PART I

1. Brokers should not be allowed to be members of stock exchanges for the sole purpose of handling transactions for institutional affiliates. In arriving at this evaluation we start by looking at two extremes. We consider it obvious and proven that an exchange membership composed solely of independent brokerdealers can serve the public interest in raising capital for governmental entities and industry, and in maintaining viable markets for issued securities. We see no way that any exchange membership composed solely of members trading for their own accounts, or solely for the accounts of their institutional affiliates, could effectively do the same job. Therefore, we conclude that incremental membership by such institutional affiliates reduces the effectiveness of the system and is undesirable.

To set up a privileged class of institutional members would be a discriminatory action unfair to smaller institutions. If memberships are limited to a fixed number, each institution that joins will mean one less membership available to brokers to serve the public. If memberships are limited by high cost of entry or large financial requirements, only the large institutions are favored at the expense of the smaller ones. If memberships are cheap and financial requirements are low, memberships will proliferate. Regulation will become an impossible task; financial risks of dealing with members will increase; members will need to monitor the financial responsibility of other members; and members may sometimes have to trade away from the best markets in order to be sure of completing their transactions. Further, if groups of investors can become members solely to make transactions for their own accounts, can individuals in fairness be denied the same treatment?

In many cases the supposed savings will not reach the supposed beneficiaries. For example, consider a pension account handled by a life insurance company. If the plan is an insured plan, will the commission "savings" be retained by the insurance company; will the result be reduced premiums to the employer; or will pension benefits, which are normally fixed by formula, be increased? If it is a trusteed plan and commission "savings" are realized in portfolio investments, will this result in smaller required payments by the employer or in increased benefits to employees? How will the "savings" be computed, especially in the negotiated rate area?

b. As to fairness of markets, we have already commented on the advantage that would be enjoyed by the large institutions over the smaller ones and individuals, beyond that which they already are realizing through volume discounts. If the institutional affiliates should wish to provide maximum savings they would have to execute and clear their own transactions. This could lead to their identification as a large buyer or seller and cause their execution to suffer by more than their savings on large orders. If they elected to pay more by going through another broker in order to conceal their identity, would this be considered a deception? Would the same people who are now critical of paying soft dollars for research, and who equate least commission with best interest and best execution, force them to go through their own affiliated broker?

Orderliness of markets can be expected to decrease if institutions are members. Independent brokers' business is creating supply and demand for securities. Members who only trade for their own accounts do not create additional supply and demand. Brokers serve individual public investors. Institutions do not. Individual investors and broker activity are both highly important to orderly markets. In appraising the impact of institutional membership, a common mistake made by those outside the industry is to think in terms of a single order, instead of the ability of the system to handle electively a large volume of such orders. For example, such a person might ask, "What difference would it make if a 10,000 share order came to the floor through an institutional member or an independent broker?" Obviously, one can't measure the impact by looking at one trade. One doesn't need a shelter to protect against one drop of rain. It is important that the system be able to handle large volumes of trades in an orderly way.

c. Undoubtedly there are more problems than we can foresee. Some that we can anticipate are:

1. Can exchanges regulate members effectively if they are controlled by institutions outside the regulatory authority of the exchanges?

2. If the affiliated broker participated in an underwriting for the sole purpose of acquiring stock for the institutions would the broker have made a bona fide public offering?

3. Could a broker-dealer confirm any new issue to an institution which was an affiliate of another broker?

4. Would the affiliated institution be subjected to the same restrictions and limitations now in effect at NYSE on member and member organization trading? 5. Would new insider information problems be created?

d. In view of the phrase "sole purpose" in the question, there is no real difference in the four categories.

e. We do not believe the public interest will be served at any level of commissions by creating a privileged class of membership for those who wish to serve only themselves. Total enmination of fixed commission rates might eliminate the incentive for some brokers to become or remain exchange members. Unless the broker wished to be represented on the floor, he might be able to negotiate as good a deal without membership as he could with it.

2. Exchange membership should not be open to any whose motive for joining is significantly affected by the opportunity to use the exchange for private purposes. Those who are members should not be permitted to remain members if private usage becomes a major factor in the mix of their business. Usage that is small percentage-wise and incidental should be permitted. For instance, in our view it would serve no useful purpose to require stockholders or partners of investment firms to execute their ordinary investment transactions through other brokerage firms unless such business in the aggregate was a significant proportion of total business. To require them to do business through other firms would also make supervision of their accounts more difficult for management. In our own firm, income from commission on the business of those stockholders who individually have more than 5% ownership in the firm aggregates on the order of 140 of 1% of the firm's gross income. Our firm very rarely buys or sells securities for its own account except in cases relating to underwriting, market making, or the correction of errors. Rule 348 of the New York Stock Exchange prevents payment of commissions to registered personnel beyond the ratio of 1 to 10 of private to public business-a primary purpose test at a ratio that we think is more related to public interest than the 1 to 4 test proposed by the SEC and the NYSE relative to institutional affiliates.

If a predominant test is to be used, business such as that listed in the subcategories might be considered "private" and aggregated for purposes of the test. However, if all "private" use were to be prohibited, some of these should be considered "public" in order not to subject certain business (see above) to ridiculous requirements which would create great amounts of paperwork and supervisory activity, yet contribute nothing to the public interest. Also, since the exchanges still maintain a fiction that seats are not owned by corporations or partnership (the owner of record must be an individual who has a repurchase agreement with the firm), individuals who are not actual owners should be considered no differently than other stockholders or partners except as to trading restrictions relative to initiating transactions on the floor.

Assuming the use of a primary purpose test, categories (i), (ii), and (v) should be included in the private category. In paragraphs (ii) and (iii) if the

party having the investment advisory contract were affiliated or in position to control the business it should be considered private, but if there is no affiliation and the contract is awarded on an arms-length basis, and if there is substantial other business of the same nature or public business done without contract, the business could be public.

b. As indicated under question 1, the principal danger would be destruction of a significant part of the securities distribution potential that now exists, and the displacement of members that create supply and demand by those who don't. Our ability to finance the economy of the country would be impaired. Also since only wealthier investors or larger institutions could afford to be members, those transactions that have been most profitable to brokers would be removed from their income mix, requiring increase of commissions or reduction of services or both to the smaller investors.

c. It depends on whether one "nit-picks” as to what is private use. Individuals in nearly every business enjoy some cost advantages in buying their own firms' wares or services. As pointed out above NYSE Rule 348 has operated as a primary purpose rule for registered representatives of brokerage firms. Also Rule 346 requires registered representatives to be full time employees of the brokerage firm. 3. Exchange memberships which permit the rebate or recapture of commissions directly should be eliminated, whether direct or indirect.

a. A rebate is the repayment to a customer of a part of a sum charged to him for a service for which other customers pay in full, resulting in the rebated customer receiving favored treatment. A rebative practice is an indirect method of making the same repayment.

(i) For purposes of Regulation T provisions relating to extension of credit, a broker arranging a stock purchase loan for himself is considered to wear two hats-that of broker while arranging and that of customer while borrowing. Similarly, a registered broker making personal investment transactions for his own account is exercising his professional abilities for himself as customer as long as he is a broker predominantly to serve the public. NYSE Rule 348 provides that he may not be paid commission on his own business if its ratio is more than 1:10 to his public business. Nothing would be gained by the public if brokers were forced to play "musical chairs" with their personal commission business. Such business should not be considered rebative.

(ii) This is not rebative if its firm meets the primary purpose test and pays the same commissions as public customers.

(iii) This s not rebative if the primary purpose test is met.

(iv) This is rebative.

(v) This is rebative.

(vi) In past practice most brokers have performed research services "free" for all customers, expecting to be rewarded solely by an amount of commission business determined by the customer based on his evaluation of the services. If the broker was not paid, or paid inadequately in his own opinion, he could stop providing the service. If research services were made available to only one customer in return for commissions, this would appear to be a rebative practice. b. Rebates should be prohibited because they create unequal treatment of customers. If or to the extent rebates are permitted there is no fixed commission rate.

c. We have already said we do not think it is in the public interest to open exchange membership to anyone willing to pay the price. We have already pointed out we think there would be practical limitations on membership that would result in evolution of a privileged or elite class of investors, with unfair advantages over those unable to become members.

d. There are no justifications for making discounts available to institutional customers that are not available to other customers. Under present conditions, there are justifications for making discounts available to non-member brokerdealers in the handling of their public business. The phraseology of this and other questions invites the interpretation that ownership in a member firm with whom one does business makes the business automatically rebative. We disagree, if such business is incidental and a minor part of the whole.

e. As pointed out above, we must infer the intended meaning of "rebate" from the phraseology of the question, since it is not defined in the instructions. As explained earlier there is justification for the owners of a brokerage business to handle their own business through their own facilities as long as their business is predominantly a public business.

4. Membership on exchanges should be limited to firms which either perform a market making function or do a specified percentage of their brokerage commission business for non-affiliated customers.

a. The purposes of such a limitation are to ensure that, to the maximum degree possible, all public investors, including institutions of all sizes, have equal access to the public auction market; to maintain a strong independent broker-dealer profession capable of creating supply of and demand for new capital issues and securities issued and outstanding.

b. As described earlier, to prevent the formation of a privileged class of large investors (private club?) entitled to trade for their own account at favored cost levels, without contributing to the market beyond satisfaction of their personal interests and who could gain control of and thus manipulate the market.

c. Since the major exchanges maintaining primary markets have not permitted institutional membership in the past, this apparently refers to PBW Exchange membership, or it is a veiled reference to individual membership which has existed at the exchanges. Neither of these activities has been of such size relative to the total market that it has drawn any attention, discernible to us, from the public.

Individual floor traders are a disappearing breed-a result of the public orientation policies of the major exchanges. It is our opinion, however, that the public would question whether exchange markets were operated fairly and openly if any sizeable segment of the membership were to develop whose sole purpose in membership was to trade for their own accounts, with advantages over public investors trading through their agents. See 4.b. above.

d. The percentage should be large enough to assure that membership is sought to permit operation of a business serving public investors and dependent on the public's business for profitability. Obviously, the larger the percentage of public business required, the more certain it is that the membership is sought for proper purposes. While 80% may be a sufficiently high percentage, it was previously pointed out that NYSE considers a ratio of 10:1 appropriate in compensation rules for registered representatives.

e. Commission rates and institutional membership, as indicated earlier, are separate areas and should be considered independently. Recurrence of this question may indicate that there is either some doubt that broker-dealers actually do create supply and demand, or doubt that this is a function important to our economic system. On the other hand it may indicate confusion of preservation of the independent broker-dealer system with protection of the individual brokerdealer from competition. Certainly the broker-dealer profession is highly competitive today, with many dealers aspiring to do the other firm's business. Could there be less competition than a situation in which a dealer exists solely to handle his own (or his parent's) business?

f. While we would favor numerical limitation of memberships, we would point out that requirements of entry into membership and maintenance of adequate financial strength by members would physically prevent smaller institutions, companies, and individuals from becoming members. Without the limitation there would still be a privileged class of members permitted to act only for their own accounts. A large number of members with small financial strength and responsibility would be highly undesirable as pointed out earlier.

g. A period of three to four years should be adequate, and those electing to conform by building up public distribution should fully conform to the predominant ratio by that time. This time interval should also permit sale of seats, if desired, under a favorable phase of the stock market.

h. Yes, see above.

i. See answer submitted by the American Stock Exchange Inc. as of May 18, 1972.

5. We subscribe to answer submitted in the response of the American Stock Exchange Inc.

6. See our answers to Question No. 1; also the response of the American Stock Exchange to this question.

7. As explained in answer to various previous questions, the premise upon which we believe any answer must be based, is that limitations be those which are necessary to assure that broker-dealers become and remain members for the predominant purpose of serving the public. This is now the policy of the two major exchanges both with regard to the firms, and to the personnel of the firms.