We have a lot of fast readers on this committee, and perhaps they can skip-read while I give you my undivided attention. Therefore, without objection, those pages will be included in the record. (Pages 12 through 25 of Mr. Budge's statement follows:)

STRUCTURE AND LEVEL OF COMMISSION RATES

Since formation of the NYSE in 1792, members have adhered to a schedule of fixed rates of commission charges to the general public. The system at present has three essential characteristics: (i) members must charge all non-members a fixed minimum rate for executing transactions; (ii) members are charged a considerably lower preferential rate of commission; and (iii) members are required to bring to an exchange market all their transactions, including prearranged trades, whether as principal or as agent, however with exceptions which vary among the exchanges.

At the time the Exchange Act was passed, the institutional investor was a relatively unimportant factor in the exchange market for common stocks, and the exchange rate structure was oriented to the concept that the normal unit of trading is 100 shares. This structure has continued except for limited "interim" changes effected December 5, 1968. Thus until that date, exchange commission rates contained no provisions for economies of scale. For a 10,000 share order the minimum commission was 100 times that on a 100 share transaction. One consequence was that mutual fund managers, whose advisory fees rise as the amount of assets they manage increases, found that the increasingly large volume of stock exchange portfolio commissions paid by the funds they managed could be used to supplement the sales load earned by broker-dealers for the sale of mutual fund shares. They negotiated with the funds' portfolio brokers the portion of the minimum commission the latter were to retain for effecting the funds' transactions. The balance of the minimum commissions was distributed or given up, at the direction of the fund managers, primarily to the many brokerdealers who sold fund shares and, to a lesser extent, to those who supplied research or statistical services. As a result, executing brokers would give away or "give up" most commonly 50-60 percent but as much as 80-90 per cent of the fixed commissions. The give-up rates generally were lower if the executing broker was a substantial seller of fund shares or had supplied research.

Give-up techniques were complicated by varying restrictions imposed upon their respective members by the different exchanges. The New York Stock Exchange, which is the primary market for most of the securities dealt in by the mutual funds, purported to permit commission sharing-or give-ups-only to its own members. If a mutual fund manager wished to make use of its control over portfolio brokerage to reward a fund seller who was not a member of the New York Stock Exchange, there developed a variety of techniques to accomplish this. A New York member who gets business from a regional member has traditionally been permitted to reciprocate by bringing business to the regional exchange and sharing commission earned on such business with the regional member. This practice was expanded to include reciprocation at the direction of the mutual fund manager who was responsible for originating the business done on the New York Stock Exchange. Under the rules of the regional exchanges, commission could be shared with their members and also to a limited extent with brokerage firms which were only members of the National Association of Securities Dealers, Inc. Placing of business on a rgional stock exchange was relatively easy to accomplish where a member of both the NYSE and a regional exchange had negotiated a trade between the fund and one or more institutional buyers. This trade (commonly known as a "cross") could be taken to any exchange where the firm was a member and the commissions could then be shared accordingly.

Accordingly, these practices cast considerable doubt on the appropriateness of rate levels and on the very existence of a minimum stock exchange commission rate structure.

On May 28, 1968, the Commission moved to correct some of the rate inequities produced under the then existing rate schedule. We formally requested the NYSE to adopt one of two interim rate structures. One proposal incorporated a volume discount as well as changes in commission rates which have narrowed the then existing discrepancies between orders which involve the same amount of money but different priced shares. Alternatively, the NYSE was requested to eliminate fixed rates of commission for the portions of transactions in excess

of $50,000. In addition, it was suggested that an appropriate review be made of existing intramember minimum rate charges. These requests were characterized as interim because at the same time, the Commission announced that it would institute public hearings to give more extensive consideration to various aspects of the commission rate structure of the exchanges. The hearings commenced on July 1, 1968.

On August 8, 1968, the NYSE advised the Commission that its Board of Governors agreed in principal with a need for an interim volume discount on large transactions. However, because of certain operational difficulties, the Exchange proposed a somewhat different schedule incorporating a quantity discount and providing a 7% reduction in intra-member rates.

The estimated overall reduction in commissions paid by investors were approximately the same as under the Commission's proposal. The NYSE also proposed to amend its constitution to bar customer-directed give-ups. The Commission agreed to the NYSE proposal and it went into effect December 5, 1968. The American Stock Exchange and the major regional exchanges have effected similar changes.

The New York Stock Exchange estimated that on the basis of 1967 trading volume, the interim schedule would result in a yearly commission saving to investors of approximately $150,000,000 or over $600,000 per trading day. These savings will accrue to the tens of millions of persons who invest in our securities markets through institutional media-mutual funds, insurance companies, pension funds which are aggregates of small investors. The ban on give-ups was subject to the understanding that traditional reciprocal practices between the regional and primary exchanges would not be disturbed. Whatever questions there may be as to the ultimate desirability of these practices, the Commission believed they should not be altered as part of the interim change.

The public hearing on the commission rate structure which began on July 1, 1968 is investigatory in nature. Its purpose is to develop evidence from interested persons on the following seven broad areas to which the Commission order of investigation refers: (1) commission rate levels for non-members and for exchange members (including intra-member rates); (2) the services for which commission rates pay and the costs allocated thereto; (3) give-ups and reciprocal practices among different categories of members and non-members; (4) membership for financial institutions on exchanges; (5) economic access to exchange markets by non-member broker-dealers; (6) competition among exchanges and other markets; and (7) the necessity for restrictions on access of exchange members to the "third market" (the over-the-counter market in listed securities in which market there is no minimum commission rate).

Testimony and statements on some of these issues have been received from numerous interested persons-the New York, American, Midwest, PhiladelphiaBaltimore-Washington and Pacific Coast Stock Exchanges; the National Association of Securities Dealers, Inc.; broker-dealers that are exchange members, third market makers, and representatives of trade associations; the Anti-Trust Division of the Department of Justice and economists who testified at its invitation.

MINIMUM COMMISSION RATES

In the course of the hearing, basically conflicting positions have been presented by the national securities exchanges and the Anti-Trust Division of the Department of Justice. In brief, the Justice Department has taken the position that a minimum commission rate structure on national securities exchanges-particularly as applied to large volume business-is inconsistent with the national policy found in the anti-trust laws. Its position is that in passing the Exchange Act the Congress did not mandate fixed rates for stock exchanges; that minimum rates are not necessary to make that Act work; that since workable standards of reasonableness of rates have not been developed and are difficult or, perhaps, impossible to develop for so diverse an industry, competition rather than regulation should prevail.

The exchanges, in their presentations, have sought to establish that a minimum rate structure is necessary for the proper operaton of the exchange markets and that if fixed rates were abolished, the centralized market would be impaired : brokers would no longer have the incentive to remain or become members and submit to the expenses of regulation by the exchanges; many firms could not remain in business, and that Congress, when it passed the Securities Exchange Act of 1934, mandated or permitted the existence of a fixed minimum commission rate structure for national securities exchanges. In addition, the NYSE has stated

its intention of conducting a study of what services may reasonably be included within a minimum rate structure, of the standards for determinging the reasonableness of rate levels, and to suggest specific rate levels under those standards.

The Justice Department, in its January 17, 1969, filing with the Commission, has submitted a plan for the gradual introduction of negotiated exchange commission rates.

ACCESS

I now turn to the problem of access to exchanges and other markets for exchange-listed securities. For Commission rate purposes, NYSE rules recognize only two types of entities, members and non-members. Non-member broker-dealers must pay the full public rate to execute trades on that Exchange. To make a profit on transactions in NYSE-listed securities, broker-dealers that are not members of that Exchange must either utilize the regional exchanges, the third market or rely upon reciprocity from member firms to recoup some of the minimum commissions paid.

Many broker-dealers have joined regional exchanges which trade in securities listed on the NYSE, so-called dually traded issues. Over the years, the regional exchanges' trading in such securities has come to account for all but a very small portion of their volume. To the extent that orders in dually traded securities can be executed on the regional exchange, sole members (that is firms which are members only of the regional exchanges) have the same advantages as they would obtain by membership on the primary exchange. Where an order or part of it cannot be executed on the regional exchange, it is forwarded to the primary exchange market. Though the sole member of the regional exchange pays the dual member (i.e., a firm which is a member both of the regional and primary exchanges) the full non-member NYSE commission, reciprocal practices of long standing enable him to recoup 40-50% on other trades effected by the dual member on the regional exchange. Unlike the NYSE, some regional exchanges also provide reduced commissions for orders off non-member broker-dealers which can be executed on the regional exchange.

Non-member broker-dealers also may execute in the third market customers' orders in several hundred of the most commonly traded exchange-listed securities. The broker-dealer buys or sells stocks at prices competitive to those on the Exchange and charges the customer a commission. If the security is not traded in the third market, the non-member will have to pay a full exchange commission, although we understand that some broker-dealers manage, through reciprocal practices, to recoup part of the commissions thus paid.

The New York Stock Exchange has argued that the diversion of any business from the NYSE market is undesirable. They call it "fractionalizing" the centralized auction market. On the other hand, testimony has been received from the regional exchanges and third market makers that these market places have produced competition which is in the public interest. Competition from the regional exchanges has included innovations such as centralized bookkeeping services and improved clearance methods for member firms which have enabled them to compete more effectively. The third market makers have offered price competition. Resolution of the commission rate structure questions may well require an assessment of the actual and potential benefits of competition from these market places.

Unlike fund managers who look to independent broker-dealers for the sale of fund shares, fund managers that rely on their own "captive" sales organizations have not had the need to utilize exchange commissions to reward broker-dealers for fund sales. Other institutions such as insurance companies, pension funds and college endowments also have not needed to use portfolio brokerage for such purposes.

Some of these institutions have indirectly joined regional exchanges through membership of their broker-dealer affiliates. They have thereby succeeded in returning to the small investors who comprise the institution all or part of the profits directly or indirectly obtained by the regional exchange affiliate from the institutions' portfolio brokerage.

The regional members affiliated with such institutions have in some cases limited their activity to obtaining reduced commissions on the fund's portfolio brokerage. In other cases such members have increasingly engaged in various aspects of the exchange brokerage business in competition with other member firms. Other institutions have been content to invest in an established regional exchange firm in the hope of realizing profits from business unrelated to the

parent company's portfolio brokerage. Still other institutions have indicated that they prefer not to enter the brokerage business provided they obtain concessions as to commissions on exchange portfolio transactions.

Reduced to its simplest terms, the question of non-member access is whether there should be preferential reduced commission rates for orders from brokerdealers who are not already members of an exchange. As I have previously noted, a few of the exchanges permit such access. The New York Stock Exchange does not. Moreover, the New York Stock Exchange, like other exchanges, has a fixed number of seats or memberships available for sale. Thus, the broker-dealer who desires to obtain the benefits of the reduced rates of commissions for members has to buy a seat from another member at the going rate. Seats on the New York Stock Exchange recently have sold in the neighborhood of $500,000.

Since the NYSE is the primary market for most securities listed on it, a nonmember broker-dealer cannot-though he may resort to the regional exchanges, the third market and various reciprocal techniques-obtain direct access to the primary market. Whether or not the indirect approaches are fully satisfactory from the standpoint of the public and the industry is one of the matters to be further considered during the course of the hearings. The regional exchanges and others have pointed out that if the New York Stock Exchange permits a substantial professional discount to broker-dealers who are not members of the Exchange, this could have a substantial effect on the attractiveness of membership on the regional exchanges.

The access problem has another aspect to it. So far, I have been discussing the issue of access of professionals to the exchange markets. In 1954, the New York Stock Exchange adopted Rule 394 which restricted access by its members to the third market. The Rule in effect required all members to execute all of their trades on the New York Stock Exchange or another exchange of which they were a member. Members were prohibited from dealing with third market makers unless they charged such market maker the minimum New York Stock Exchange rate. This provision made it impossible for the member firm to obtain for its public customers benefits from dealing in the third market. In 1966, at the Commission's request, the Exchange adopted Rule 394 (b) which allows members to go off-board and deal net with certain qualified third market makers, when they can thereby obtain a better price for their public customer. However, there has been testimony in the commission rate structure hearing by certain non-member firms that this new rule has not been achieving its objective because of the complex and cumbersome procedures required under it.

INSTITUTIONAL MEMBERSHIP

The issue of access also is related to the subject of institutional membership on exchanges. Simply speaking, the question is whether financial and other institutions such as mutual funds and insurance companies should be permitted directly, or through broker-dealer affiliates, to become members of national securities exchanges. There are at least two types of institutional membership. One is the case where the financial institution desires to use the seat to benefit from the reduced cost of commissions on its own transactions. The second is the acquisition of a seat by an institution for the purpose of engaging in the traditional brokerage business for others. A number of institutions through broker-dealer affiliates already have seats on some of the regional exchanges and use these seats for one or both of these purposes. Among them are some of the largest mutual funds, as well as insurance companies and other financial institutions. The NYSE prohibits such membership through a rule requiring that all partners or voting shareholders of a member firm be engaged full time in the securities business. However, there are certain members of the NYSE which are investment advisers to affiliated investment companies, some of which obtain indirect benefits in the form of reduced management fees as a result of the member firm handling their exchange transactions.

In one sense, institutional membership is purely a commission rate issue. In other words, an institutional member of an exchange may obtain the benefit of a discount in commission rates when executing transactions in its portfolio of commission stocks. In another sense, the question of institutional membership bears upon the future structure of the securities industry.

The objections to institutional membership are stated in terms of an inability of exchanges to regulate institutional members or their affiliates and a concern that a loss in commission revenue will impair the ability of the traditional brokerage community to service public investors. On the other hand, proponents of

such institutional membership point to the values of permitting increased competition in the securities industry resulting from the entry of new firms.

A very closely related issue concerns public ownership of member firms. I refer to a New York Stock Exchange requirement which has the effect of preventing ownership of member firms by the public or by publicly-owned corporations. There are less sweeping restrictions in the rules of other exchanges. By way of background, I should point out that it has only been in recent times that the question of the public ownership of firms, stock and bonds assumed significance. Not until 1953 were New York Stock Exchange firms permitted to incorporate their organization. Until then the Exchange took the position that corporations, with their ability to spread their ownership among numerous stockholders, would be less susceptible to Exchange control than would partnerships. In permitting incorporation, the Exchange specifically retained control over who could qualify as a stockholder.

In the past year or so, the New York and American Stock Exchanges, recognizing the need for more long-term capital to handle expanded business, have begun to reconsider their provisions on the question of public ownership. Removal of the restrictions on public ownership would force these exchanges to deal directly with the question of institutional membership since financial institutions are publicly owned. Institutional membership as such is, in turn, closely intertwined with the question of commission rates for institutional business since the prospect of commission savings is a major incentive to some institutions to seek Exchange membership.

The issues I have discussed are still being developed in our current commission rate structure hearings. Other issues which I have not discussed today are related to the matter of commission rate structure and will be the subject of further testimony in the hearing. These include the matter of intra-member commission rates, access to transaction and floor information by competing markets, the impact of automation on competition between markets in exchangelisted securities, the determination of what practices are developing under the interim rate structure that became effective on December 5, 1968, and related matters.

I wish to make clear that the Commission intends to proceed as expeditiously as possible with the commission rate structure hearing. While issues which are the subject of the hearing are interrelated in varying degrees and while some of them may of necessity be the subject of long-term studies, we shall give the complex issues our most careful consideration and we shall deal promptly with those issues which we find susceptible of separate and prompt resolution.

While we intend to deal with these matters promptly, I do not believe it would be appropriate for me or for any other member of the Commission now to attempt to reach conclusions concerning the issues as to which the record is incomplete and as to which we have not had the benefit of staff recommendations or the views of all interested persons.

Senator BENNETT. Mr. Chairman, may I ask questions for the record at this point?

Senator WILLIAMS. Surely.

Senator BENNETT. Mr. Chairman, do you have any impression as to when this hearing may be concluded and the report might be available?

Mr. BUDGE. Senator Bennett, I asked that question of the officer of the Commission who is conducting the hearing, presiding over the hearing and also of the Director of the Division of Trading and Markets this morning. They cannot give me an estimate as to the closing of the evidentiary hearing because of the nature of the seven elements that are imposed in the order of investigation. Some of those, obviously, are going to take quite some time. However, we do not intend to wait until we can wrap up the entire package, we intend to proceed with the commission rate structure and such other matters as we can determine in the relatively near future. Some of the other conclusions regarding some of the seven investigatory areas obviously will take some time, but we don't intend to wait for the completion of all seven