tion, the SEC had, with certain exceptions, indirect oversight responsibility over exchanges and their members. The act simply required. exchanges to register, to file copies of their rules, and to enforce the explicit provisions of the act. Disciplinary power over its members was left to the exchanges. Direct rulemaking authority was given to the SEC in certain limited areas-by the antimanipulative section 10 and by section 14 which gave the Commission authority to make rules with respect to off-floor trading by members, the operations of specialists and odd-lot dealers. The power to require the exchanges (after hearings) to adopt rules was given by section 19 with respect to thirteen areas that included commission rates and other charges, financial responsibility of members, reporting of transactions, and "similar matters." The power to request changes in commission rates was not used until 1968 when SEC pressures forced the NYSE to adopt a volume discount (before a formal ruling became necessary). Until that time commission rate increases were accepted by the SEC without comment. As a result of commission rate hearings which began in 1968, congressional hearings and reports, the massive Institutional Investor Study, Department of Justice pressures, the SEC did use its rulemaking power for the first time to abolish fixed commission rates. The Rule 196-3 became effective May 1, 1975 and it is the principal purpose of this study to assess the effects of that rule. The Maloney Act of 1938 The Maloney Act of 1938 added to the 1934 Act section 15A which establishes rules for supervision of the OTC market. The act was adopted at the initiative and urging of the industry. It provided for the registration of any qualified association of broker dealers, and thus far the National Association of Security Dealers (NASD) is the only association to register under the act. One probable reason for industry support of the act is that the association may prohibit its members from dealing with nonmembers except on the same terms as is accorded to the general public. An important difference between regulation of the OTC market and the exchange is that the Maloney Act explicitly prohibits the NASD from imposing fixed minimum rates of commission. Securities Acts Amendments of 1964 The 1964 amendments followed the "Report of the Special Study of Securities Markets of the SEC" of 1963. The principal provisions were to extend corporate disclosure requirements to OTC stocks and to raise requirements for entry into the securities business and strengthen disciplinary controls of the SEC over brokers and dealers. Antitrust laws Since the rules of the exchanges and the NASD may be and have been in contravention of antitrust laws, the question arose as to whether the SEC rulings have limited anticompetitive behavior or condoned it. If condoned, the question of the jurisdiction of the SEC as opposed to the Antitrust Division of the Department of Justice arises. This issue takes on importance since (prior to the 1975 Securities Acts Amendments) "persons aggrieved by actions of securities exchanges have no avenue of obtaining judicial review of those actions 83-944--78-39 under securities laws, either by the SEC or the courts." Only actions taken or explicitly approved by the SEC were subject to judicial review. In an attempt to avoid this proverbial catch-22 aggrieved parties have, in a number of cases, sued the NYSE directly on antitrust grounds. The only case prior to the promulgation of Rule 19b-3 in 1975 in which the SEC acted to limit anticompetitive behavior was the Multiple Trading Case of 1940. The SEC abrogated a NYSE rule prohibiting exchange members from acting as odd-lot dealers or specialists in NYSE-listed stocks on other exchanges on the grounds that the rule was anticompetitive. In the intervening period the SEC, whether intentionally or unintentionally, served as a legal umbrella over NYSE actions which would normally have been held to be contrary to antitrust laws. The most important case bearing on the jurisdictional issue was Silver v. NYSE. Silver, a nonmember, sued the NYSE to gain redress for the severing of wire connections between Silver and a member firm. The Supreme Court rejected the NYSE argument that it was immune from antitrust laws and stated that immunity is "implied only if necessary to make the Securities Exchange Act work, and even then only to the minimum extent necessary." The Court noted, however, that it might rule differently in a case where there was explicit SEC jurisdiction which would be subject to judicial review. In other words, the ruling applied only to selfregulatory conduct and SEC review of such action, not to SEC exercise of powers explicitly granted under section 19 (b). Indeed, the Supreme Court ruled against a plaintiff who argued that fixed commissions were in violation of antitrust laws on the grounds that the SEC was granted explicit jurisdiction by section 19 (b) (9) and because to "deny antitrust immunity... would subject the exchanges and their members to conflicting standards." 8 The Securities Acts Amendments of 1975 These amendments, which became effective in May 1975. provide for a major overhaul of the Securities Exchange Act of 1934. They are the result of the SEC Commission Rate Hearings which began in 1968, the SEC Institutional Investor Study of 1971 which among other things examined the impact of institutional investors on the structure of markets, the position of the Department of Justice as reflected in submissions to the SEC, and underlying economic forces which were broadening and making more competitive the securities markets. Both the House and Senate held hearings, and reports of the House and Senate Committees effectively presented the major issues. The SEC presented its vews in two white papers in 1972 and 1973.10 The amendments mandate a national market system for securities in which competitive forces will play a much larger role. This is done U.S. Senate, Securities Industry Study (1973), p. 219. 7373 U.S. 341 (1963). Gordon v. NYSE (1975). U.S. House. Subcommittee on Commerce and Finance of the Committee on Interstate and Foreign Commerce, Securities Industry Study (August 1972). U.S. Senate. Subcommittee on Securities of the Committee on Banking, Housing and Urban Affairs, Securities Industry Study (February 1973). 10 Statement of the SEC on the "Future Structure of the Securities Markets" (Feb. 2. 1972) and "Policy Statement of the SEC on the Structure of the Central Market System" (April 1973). by obligating the SEC to abrogate rules of exchanges which are anticompetitive and not necessary for a legitimate regulatory objective [sections 6(b), 19 (b), and 19(c)]. Section 23 (a) prohibits promulgation of rules by the SEC which the SEC determines impose a burden on competition not necessary to achieve the purposes of the Exchange Act. The amendments explicitly mandate in section 6(e)(1) that .. no national securities exchange may impose any schedule or fix rates of commissions, allowances discounts or other fees to be charged by its members . . ."except that floor brokerage fees are exempt until May 1, 1976. The SEC is given "failsafe" authority to reimpose fixed commissions if it finds it necessary. 66 At the same time that competition was emphasized, the amendments gave the SEC more regulatory authority over exchanges and made. clearer the jurisdiction of the courts and the processes for judicial review. It also directs the SEC to facilitate the establishment of a "national market system" which is characterized by the absence of unnecessary regulatory restrictions, fair competition among brokers, dealers and markets, the availability to all of information on transactions prices and dealer price quotations, the linking of markets and the ability to execute orders in the best market. An important provision is section 28 (e) which explicitly permits. "paying up" for research. This section permits brokers to charge commission fees above those of other brokers in cases where research services are performed. "Brokerage and research services" are defined and the section implies that the services must be provided by the member firm receiving the commissions; i.e., the give-up 11 is not per mitted. In section 11(a) brokerage firms managing institutional type accounts are prohibited from executing orders for those accounts. This eliminates the possibility of any institutional investor joining an exchange to handle its own brokerage. Other provisions of the amendments deal with municipal securities, regulation of clearing agencies and transfer agents, and the disclosure of data on holdings and trading by institutional investors. CARTEL PRICING OF BROKERAGE SERVICES PRIOR TO MAY 1, 1975 CHARACTERISTICS OF THE NYSE CARTEL Prior to May 1, 1975, the rules and regulations under which member firms of the NYSE operated to provide brokerage services to the, public satisfied the classic definition of a cartel: (1) Prices of brokerage services were fixed. (2) Entry into the business was limited by the number of seats available which prevented new entrants from capturing the monopoly profits earned by members of the NYSE. (3) A panoply of rules and regulations prohibited price cutting and rebates by members and limited the output of brokerage services per seat so that monopoly profits would not be competed away by member firms. " The give-up, discussed in greater detail below, would allow the firm receiving commissions to compensate another firm for providing non-brokerage services by "giving up" to it part of the commission. Fixed commissions Prior to December 5, 1968, commissions per share or as a percent of value depended only on the price of the stock and were independent of the number of shares traded. On December 5, 1968, a volume discount on transactions over 1,000 shares was instituted at the urging of the SEC. Subsequent commission rate changes tended to reduce commissions on large transactions relative to small. Table 1 gives figures for commission rates on 100 shares of stocks of different prices since 1924.12 The time trend is clearer in Figure 1, which shows commissions on 100 shares of a $40 stock in cents per share since 1924 as well as larger transactions as of December 5, 1968. What the commission per share would have been had it risen by the same amount as the consumer price index is shown by the curve labeled "Consumer Price Index." TABLE 1.-COMMISSION RATES PER 100 SHARES BY STOCK PRICE AND TIME PERIOD Oct. 30, 1924 to Jan. 3, 1938.. 1 The NYSE rate schedule calls for negotiated commissions in orders less than $2,000. In fact, there was little change, and figures in the table represent commissions calculated on the same basis as commissions on higher priced stocks. Source: James Lorie and Charles McQuaid and NYSE "Fact Book." In regard to 100 share transactions a number of facts are worth noting. First, over the long term, commissions in cents per share increased somewhat more than the consumer price index. Commissions per transaction increased even more since the average transaction size increased over time. Second, there has been a sharp jump in commissions on 100 shares since April 6, 1970 when a surcharge was introduced. Between April 1970 and September 1973 commissions on 100 shares of a $40 stock rose from 39 cents to 63.8 cents, an increase of 64 percent. In part this reflects catching up after a long period of no change. A third fact is the importance of the price per share in the commission. The dollar commission earned on an $80 stock was 60 percent higher than on a $20 stock in 1924. In 1975 it was 79 percent higher. It is not immediately clear why brokerage costs (not dealer costs) should be higher on higher priced stocks. It may be that brokers take significantly longer to find the other side of transactions in higher priced stocks. The data as well as some analysis of the data were kindly provided by James Lorie and Charles McQuaid. |