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Summary of Transcript of Proceedings in the Matter of Commission Rate Structures of Registered National Securities Exchanges

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SUMMARY OF TRANSCRIPT OF PROCEEDINGS IN THE MATTER OF COMMISSION RATE STRUCTURES OF REGISTERED NATIONAL SECURITIES EXCHANGES July 1, 1968 -- July 31, 1968 Office of Regulation Division of Trading and Markets Securities and Exchange Commission SCHEDULE OF WITNESSES MATTER OF COMMISSION RATE STRUCTURE OF REGISTERED NATIONAL SECURITIES EXCHANGES 1. Robert M. Bishop -- NYSE -- July 1, 1968 2. Pershing & Company -- July 2, 1968 3. Michael J. Heaney & Co. -- July 2, 1968 4. Jefferies & Co., Inc. -- July 3, 1968 5. Dominick & Dominick -- July 3, 1968 6. Reynolds & Company -- July 8, 1968 % Bache & Company -- July 8, 1968 8. Paine, Webber, Jackson & Curtis -- July 9, 1968 9. Salomon Brothers & Hutzler -- July 9, 1968 10. Donaldson Lufkin & Jenrette, Inc. -- July 10, 1968 11. Cantella & Company, Inc. -- July 10, 1968 12. A. I. Jablonski & Company -- July 11, 1968 13. Harry C. Dackerman & Company, Inc. -- July 11, 1968 14. A. G. Becker & Co., Inc. -- July 15, 1968 15. Ralph W. Davis & Company (Scott Davis) -- July 15, 1968 16. Mitchum, Jones & Templeton, Inc. -- July 16, 1968 1% Stifel, Nicolaus & Company, Inc. July 16, 1968 18. H. O. Peet & Company -- July 17, 1968 19. E. F. Hutton & Company, Inc. -- July 17, 1968 20. Dishy Easton & Company -- July 18, 1968 21. Weeden & Company -- July 18, 1968 22. Delafield & Delafield -- July 19, 1968 23. Maxwell Ohlman & Company -- July 19, 1968 24. Anchor Corporation -- July 22, 1968 25. Fidelity Management & Research 26. Keystone Custodian Funds, Inc. -- July 23, 1968 2% Tsai Management & Research Corporation -- July 23, 1968 28. Elkins Wetherill -- PBW -- July 24, 1968 29. INA Trading Corporation -- July 25, 1968 30. Putnam Management Company -- July 29, 1968 31. Waddell & Reed (Kansas City Securities Corp.) -- July 30, 1968 32. American Express Company -- July 30, 1968 33. Investors Diversified Services -- July 31, 1968 NEW YORK STOCK EXCHANGE: EXISTING MINIMUM COMMISSION RATE STRUCTURE July 1, 1968 -- pp. 16 -- 140 Introduction Mr. Robert M. Bishop, New York Stock Exchange Vice President and Director of the Department of Member Firms, testified concerning the operational aspects of the NYSE minimum commission rate structure, including the NYSE's past interpretations of rebative practices. Since the NYSE is the dominant exchange market, its minimum commission rate structure has proven to be the progenitor of the rate structures employed by all other exchanges, and, therefore, this testimony was intended to provide an introduction to the workings of the minimum commission rate structure in general. NYSE Membership A member of the NYSE is a person who owns one of the 1,366 Exchange seats (24-25). A member organization is a securities firm approved by the Board of Governors which has as a general partner or a holder of voting stock, one or more members of the Exchange (26). There are approximately 670 member organizations, many of which have more than one NYSE member. An allied member is any voting stockholder of a member corporation or a general partner in a member firm who is not a seat owner (31). Members and member organizations pay preferential commission rates; all others, including allied members, pay the full non-member commission rate. A prospective member is investigated and interviewed by the Exchange before the purchase of the seat is approved (26). According to Mr. Bishop, the Exchange has virtually no formal requirements for membership. Mr. Bishop indicated that prospective members should, in his view, intend to spend their full time in the securities business, but he admitted that some present NYSE members do not devote their full time to the securities business(27). Mr. Bishop was asked whether six people could band together as a member organization, finance the purchase of a seat for one of the group; the six intending to deal solely for their own accounts. The member would trade for his own account at preferential rates. The other five could place orders through the member; they would be required to pay the full non-member rate. At the end of the year, the profit derived from the allied members' own transactions could be returned to them in the form of a dividend (28-29, 33). Mr. Bishop stated at the time he could not answer the question on the facts presented (33). He then stated that he would frown on the admission of such a firm even though he knew of no constitutional prohibition (137). When asked whether a hedge fund -- which could have its own transactions executed, pay the full non-member rate, and divide the commission profits among the partners -- would be eligible for admission to membership, Mr. Bishop replied, "I will face that question when we get such an application" (138). In a letter of September 4, Mr. Bishop stated, "on reflection, I believe that Rule 318 would be a bar to the formation of such a firm. That rule requires every member organization to engage primarily in the transaction of business as a broker-dealer in securities or commodities. The hypothetical firm referred to, with all its partners trading for their own account, would probably be interpreted as not meeting the requirements of the rule." Present Non-Member Minimum Commission Rate Structure According to Mr. Bishop, the non-member commission rate is intended to compensate brokers for effecting securities transactions for customers, including execution and clearance of the order, and "the whole gamut of services which the broker normally gives for commissions" (67). Mr. Bishop at one point gave a partial list of allowable services: research; reasonable advertising and promotion; quotations; transmission of the order; execution and clearance; settlement; carrying the account; and custody of securities (113). Services may vary according to the customer's level of interest and investment (102). Since, however, the kinds and amounts of allowable services have never been completely spelled out, Mr. Bishop's determination of services covered by the minimum commission rate must be on an ad hoc basis (68). The minimum to be charged for execution and clearance, the mechanical aspects of a trade (see intra member rate structure, below). is approximately 21% of the total commissions. Theoretically, therefore, a maximum of 79% of the commission charged may be allocated to "services;" under the present rate structure, this 79% may be given up to other NYSE members or paid to a registered representative (139-140). The present non-member minimum commission rate schedule was adopted in 1947; it was last modified in 1958 (38). The commission is calculated as a percentage of the monetary value of one round lot (100 shares); this amount is then multiplied by the number of round lots involved in the transaction (34). Upon being questioned about the rationale behind this structure, Mr. Bishop stated, "We are not trying to rationalize and defend this; we intend to change it" (43). The Commission introduced four exhibits (attached) which give examples of computations of member and non-member commission rates. Outlined below are examples of commission rate charges discussed with Mr. Bishop, and his rationale for them: (1) The commission for 100 shares of an $80 stock is approximately 2 1/2 times the commission for 100 shares of a $10 stock. RATIONALE: The commission rate schedule was devised when the market was primarily a 100-share market. The schedule tried to strike a balance between the work involved to the broker and the value to the customer of the security traded (35). Mr. Bishop, elaborating, stated that although the work involved in trading 100 shares is the same, no matter what the value of the security, the broker gives the customer greater services "because the customer gets an equity of greater value converted to cash for him or vice-versa.. ." (36-37). Mr. Bishop analogized to percentage fees charged in the sale of houses (37). (2) The commission for 500 shares of stock is 5 times as great as for 100 shares of the same stock. RATIONALE: The commission rate was set when the market was primarily a 100 share market. "That is about it. You are well aware that that is not our position today" (37). (3) For a $10 security, the percent of value of the commission paid does not fluctuate between a $1000 order and a $10 million order. RATIONALE: Mr. Bishop's response was, "Why? No. 1947, I was not even in the securities business" (38). It was agreed, however, that this indicates there is no volume discount (39). (4) For a trade totalling $30,000, the commission charged depends on the price of the security involved, and varies from 1.7% to 0.49% of the money involved. RATIONALE: Mr. Bishop's response here indicated some confusion. He finally stated that as the percentage of commission increases, so do the number of shares involved, that there was a likelihood it would be more work to dispose of a greater number of shares, and that more work was entailed in clearing and delivering a larger number of stock certificates (39-41). Mr. Bishop was given the opportunity to submit for the record written comments concerning these examples (42). In his letter of September 4, 1968 Mr. Bishop declined further comment, stating, "In reviewing the transcript, I am satisfied that I explained clearly what I believe to be the philosophy which guided the authors of the present schedule, and I do not believe it is necessary for me to add to that explanation." Present Intra-Member Minimum Commission Rate Structure Intra-member minimum commission rates are markedly lower than non-member rates (see Exhibit 4, attached). There is a rate for execution only, one for clearance only, and one covering both execution and clearance. A. Execution "Execution" means the actual physical trade at the trading post on the floor of the Exchange; only a member may execute a trade (43).
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