broker-dealer in his report to the Board of Governors of the New York Stock Exchange: The role of the small brokerage firm should not be overlooked. It has contributed to the health and strength of the economy, by raising capital to finance new ventures, and by serving the needs of small investors scattered across the nation. In short, by broadening economic opportunity. In the course of the many changes, which will inevitably take place in the securities industry, care should be taken not to cause the elimination of efficient, small firms.* The small broker works on a different scale and with different customers, yet plays a vital role in his community. Where, on one hand, the major brokerage house attempts to attract large volume customers and in many cases discourages the small investor, the small broker-dealer provides a different sort of service geared to his customer, of a more personalized sort, taking into account the limited funds available to the small investor. At a presentation held before the staffs of both the Senate and House of Representatives Select Committees on Small Business, Mr. George Steel of Planned Investment Company, itself a small broker-dealer, summed up the unique quality of service provided to the small investor by firms the size of his own: I started my business fifteen years ago because I could see there was a great void in the market for people to call on small investors. This is a nation now made up of people making eight to fifteen thousand dollars a year who never in the world will go into a bank or to Merrill-Lynch and ask for investment advice; but if you sit down over the kitchen table and talk to them, they can save ten, twenty, fifty, a hundred dollars a month.5 It is this willingness to assist and advise these investors and to handle their small accounts (all too often actively discouraged by large brokerage houses) which is one of the most valuable functions of the small broker-dealer. This aspect of their service takes on additional importance in a period when exchange officials decry the destabilizing effect the loss of the small investor has had on the securities industry. The scale on which the firms operate and their thin margin of profit is further emphasized in the statement of Mr. John H. Powers, treasurer of Gage-Wiley and Company of Springfield, Massachusetts, also given before the staff presentation held March 15, 1973; in it he described his firm's average transaction: a trade involving about $3,000, generating a gross commission of about $50, of which an additional $20 is the salesman's personal commission. The remainder of the gross commission must meet all additional expenses." One of the most vital functions of the small broker-dealer is his service to local business: in many communities, he is the only source of investment capital available to small businesses. The small investment firm will underwrite and market an offering for a local enterprise that larger financial institutions would never touch. This point was amply illustrated in the testimony of Mr. Raymond W. Cocchi, 'FPB Hearings, Op. cit., Part 4, p. 1415. FPB Hearings, Op. cit., Part 4, p. 1400. 'FPB Hearings, Op. cit., Part 4, p. 1394. president of the Independent Broker-Dealers Trade Association, an association composed primarily of small investment firms: Senator NUNN. One of our primary concerns is the small investor and the small business. How do you draw the line between the Wall Street broker and one who handles issues that your smaller broker firms would handle? What would be your rule of thumb on that? Mr. CoсCHI. I can tell you this, there is a very serious situation today in terms of what stocks are being sold. As you know, the volume on the New York Stock Exchange is made up primarily of institutional trades concentrated in probably fifty or one hundred major issues, and the other issues are being overlooked. Traditionally, the small broker not only raises capital for the businessman, but once it has become a public company, he will make a market to maintain and provide depth and liquidity to those shares which are ignored by the large firms. He often times will provide retail support merchandizing them. He will go out and merchandise a lesser known stock where a large firm would not do it. So, typically, he is dealing in issues that the New York Stock Exchange firms, because of size and budgets, will not get involved in. * Senator NUNN. In other words, this is your main service to the small businessman, trying to help them raise funds in the new issue market. Mr. COCCHI. Exactly, a small businessman who wants to go public, but needs only half a million dollars or a million dollars. If he went to Wall Street, they would laugh him right out of Wall Street . . . The small businessman today is really running out of places to turn when he needs a small amount of money.' B. The Problems Confronting Small Broker-Dealers Today The position of the small broker-dealer in the mid-1970's is a precarious one. The rate of failures in the past five years has increased substantially, and the testimony of witnesses before the committee indicates that the remainder are operating on increasingly narrow profit margins. One of the major causes of declining profitability of these small firms is an ever larger burden of regulatory and reporting functions engendered by the near disaster which overtook the securities industry in 1969 through 1971. During the decade of the 1960's, the volume of securities transactions increased at a rate unanticipated by the industry; the existing system became overburdened, and in some firms there was a resultant breakdown in accounting control which ultimately resulted in a number of brokerage house failures. In order to correct these instabilities, the various regulatory agencies, both public and private, which govern 1 FPB Hearings, Op. cit., Part 4, p. 1454. FPB Hearings, Op. cit., Part 4, p. 1569. the securities industry, instituted more stringent regulation. Professor James S. Mofsky testified before the committee: the self regulatory organizations, the Securities and Exchange Commission and, more recently, the Securities Investor Protection Corp. imposed additional and costly reporting requirements and recordkeeping procedures as well as increased minimum capital and tightened net capital requirements. As regulation was piled on regulation, little attention was given to the economic consequences of the increased burdens and the overlapping reporting and recordkeeping procedures . . .9 It was against this background of increased paperwork requirements and tightening regulations that the Subcommittee on Government Regulation convened hearings to determine the extent of the Federal paperwork burden on the small broker-dealers in the United States. III. THE PLIGHT OF THE SMALL BROKER-DEALER A. The Burden of Federally Engendered Paperwork The position of the small broker-dealer was made abundantly clear in both testimony before the committee and in letters submitted in response to the committee's request for comment on the effects of the Federal paperwork burden. Almost without exception they criticized the increasing amount of time and effort spent in servicing burgeoning reporting requirements imposed by the Federal Government, through the Securities and Exchange Commission (S.E.C.) and the industry's private self-regulatory organization, the National Association of Securities Dealers (N.A.S.D.). They cited in particular the requirements of the Securities Investor Protection Act of 1970.10 Although the Securities Investor Protection Corporation (S.I.P.C.) was depicted by its Chairman, Byron D. Woodside, as being "not an agency or establishment of the United States Government," the testimony of witnesses before the subcommittee reveal that S.I.P.C. has, at least in the opinion of small broker-dealers, resulted in the establishment of another level of Federally mandated bureaucratic reporting requirements.11 A number of specific complaints were aired before the subcommittee, in testimony, written statements and other materials submitted. One common complaint was the complexity of requirements, the amount of time necessary to meet them, and an apparent confusion even on the part of the regulatory agencies as to their interpretation. In the I.B.D.T.A. presentation held on March 15, 1973, which was inserted into the Record, Mr. Gerald A. Horwitz submitted a statement which dealt, in part, with this area of concern: We, at the present time, are inundated with Compliance Questionnaires from State and Federal Agencies, Associations and Exchanges, requiring thirty to sixty hours of our time each and every month. This to a great measure is a waste of time and money, draining us of competent personnel. The terminology used on these forms to seek information has a tremendous amount FPB Hearings, Op. cit., Part 4, pp. 1569-1570. 10 FPB Hearings, Op. cit., Part 4, p. 1388. 11 FPB Hearings, Op. cit., Part 4, p. 1683. of inconsistencies. For example, what is "net capital" for one, is not "net capital" for the other; what is "net worth" by general accounting principles, is not "net worth" on many of these forms; 12 The sheer volume of reporting requirements was consistently mentioned by witnesses and others submitting written statements. Mr. John H. Powers, treasurer of a small broker-dealer firm based in Springfield, Massachusetts, claimed that in the past calendar year, his firm had been required to submit thirty-eight different forms to a total of seven different agencies. He criticized the amount of time and effort needed to service the paperwork, and cited it as a major cause for the decreasing profitability of small dealerships. He mentioned a common complaint of witnesses and contributors to the hearings: The cost of meeting these new regulations has been an enormous burden to those of us (small broker-dealers) who survived; and considering the fact that they have utterly failed to restore investor confidence, I can't help but feel a little bit cheated. 13 As an appendix to his remarks, Mr. Powers went on to include a list of the major regulatory reports required of his firms: Form Q-filed quarterly with the NASD Form 17A-10-filed annually with the NASD, the Boston SIPC Income-filed quarterly with the NASD Form M-net capital and aggregated indebtedness filed Capital Report-net capital and aggregated indebtedness Certified Copy of Balance Sheet-Filed annually with the Form 17A-5-Statement of condition sent quarterly to customers. This list does not include reports on social security, un- Numerous additional comments on the volume of the Federal paperwork burden were received by the subcommittee in the form of letters received from small broker-dealers from many parts of the United States. These were entered into the record of the subcommittee's hearings and serve, collectively, as a useful barometer, gauging accurately the great concern these small businessmen have about the rising tide of paperwork that threatens to engulf them. One broker-dealer complained that the effect of increased regulation is not the intended one-protection of the investor-but rather, that the small investor continues to be driven from the market by reducing the broker-dealer's ability to give adequate service to his customers. He goes on to state that paperwork requirements and the cost of 13 FPB Hearings, Op. cit., Part 4, p. 1398. 13 EPB Hearings, Op. cit., Part 4, p. 1430. 14 FPB Hearings, Op. cit., Part 4, p. 1433. their completion comprise 50 percent of his overhead, seriously cutting into his profit margin." Another small dealer explained that paperwork was the largest single expense encountered by his firm. The expenses of audit and accounting came to $12 for each of the 22 trades his firm had completed during the month of June, 1973.16 It is these costs which continue to prove devastating to the small broker-dealer. The necessity of hiring additional secretarial help and retaining the services of an accountant are easily measurable, but it is almost impossible to gauge the costs to a small firm when the valuable time of its sales officers is consumed servicing regulatory requirements. In the face of the increasing difficulty inherent in complying with the regulatory agencies, many small firms are faced with the necessity of hiring a full time compliance officer, at a $15,000 to $20,000 a year salary." For many small broker-dealers this would be a hardship; for many more, it would be a financial impossibility. Certain specific paperwork requirements aroused comment by the various witnesses. Most often these were forms authorized by the National Association of Securities Dealers, the major self-regulatory organization within the industry. The fact that N.A.S.D., rather than the Securities and Exchange Commission is cited as a paperwork generator is illustrative of the complex nature of the relationship between Federal and private sector agencies within the securities industry. The S.E.C., N.A.S.D., and, to a lesser extent, the S.I.P.C., work very closely. In fact, the coziness of this relationship was one of the major complaints voiced by witnesses concerned with the regulatory burden. Senator McIntyre referred to this in a question directed to Mr. Raymond Cocchi, president of the Independent Broker-Dealers Trade Association: Question. Are small broker-dealers experiencing the same Answer. After listening to the testimony given by the SEC, All too often, the SEC adopts a rule or "requests" the NASD to adopt one-and then because it's the NASD's responsibility to enforce such rules, or collect such forms, it appears as you stated at the hearings, Senator, that the real culprit" is the NASD, not SEC. I would suggest the NASD be asked how many of the troublesome rules or forms they "invented"-absent a "request" from SEC, SIPC, or Congress. When testifying, the SEC simply hid behind the NASD when they found it convenient. 18 Mr. Cocchi's direct criticism of the relationships between N.A.S.D. and S.E.C. was echoed by other witnesses and was noted in several of the letters received by small broker-dealers inserted as part of the record. |