securities were in "street name" were at considerable risk. The "box count rule" will focus the attention of firms and their auditors on this problem area as a routine practice, thereby lessening the chance that operational errors will cause serious financial exposure to the firms and their customers.

Rule 15c3-1 under the Exchange Act, commonly known as the Commission's "net capital rule", imposes minimum net capital requirements on brokers and dealers and limits the amount of indebtedness which may be incurred by a broker-dealer by providing that a broker-dealer's "aggregate indebtedness" (as defined in the rule) may not exceed 20 times the amount of its "net capital" (as computed under the rule). As such, the rule provides safeguards for the protection of customers of broker-dealers by requiring that at all times broker-dealers have sufficient liquid assets available to meet their current obligations.

The Commission recently took action to raise the standards for entry into the broker-dealer business, through proposed amendments to Rule 15c3-1.5 Under these, a firm would be required to have net capital of at least $25,000, instead of $5,000 as at present, and during the first year of its existence, a firm would be required to maintain an aggregate indebtedness to net capital ratio not exceeding 8:1, rather than the 20:1 ratio otherwise acceptable for firms subject to the Commission's net capital rule.

During the past 2 years the Commission has conducted inspections of the administration and interpretation of the New York Stock Exchange's net capital rule, the primary test of financial responsibility for member firms, and a series of conferences has been held between the two organizations. As a result the Exchange moved in August 1971 to strengthen the rule. It dropped the maximum permissible ratio of aggregate indebtedness to net capital from 20:1 to 15:1, and it made mandatory a charge against capital for short stock record differences 45 days after their discovery. Among the other amendments was one requiring the contraction or liquidation of a firm when its net capital ratio exceeds 12:1. Various parts of the revision are already in effect, and by August 1972, the new capital rule will be largely in force.

At the same time that the Commission was proposing and implementing measures for investor protection, it was engaged in studying the basic structure and functioning of the markets. Public hearings began on October 12, 1971 to help determine what changes are needed in the rules under which stock exchanges and

other market institutions operate. In a statement accompanying the announcement of the hearings, Chairman Casey noted that there had been a tendency for some of the most critical questions to be resolved, not as a duly deliberated matter of broad public policy, but as an expedient to effect short-run savings or to settle or avoid private law suits. Mr. Casey said the Commission would determine what the public interest requires in the way of rules governing the operations of various markets, the relationship between these markets, and the disclosure of quotations, prices and trading volume in these markets.

In a related area, the Commission held a conference with industry spokesmen in June 1971 on the subject of the stock certificate. Discussion centered on methods of improving the efficiency of securities handling systems. Presentations were made by proponents of different programs for evolving a satisfactory standardized, nationwide method of handling securities, including a presentation favoring the elimination of stock certificates altogether. Chairman Casey pointed out the need to develop a sound industry-wide operational system satisfying the need for the prompt consummation of securities transactions and resolving the diverse settlement practices of the various securities markets. Participants were requested to submit additional ideas for consideration by the Commission in its role of coordinating and furthering industry attempts to implement operational systems able to handle existing and foreseeable levels of trading.

STRUCTURE AND LEVEL OF COMMISSION RATES

As discussed in last year's report," the New York Stock Exchange submitted a new commission rate schedule to the Commission on June 30, 1970. Following extended public hearings, the Commission announced on October 22, 1970 that with certain modifications the new schedule would not be objected to. On February 11, 1971, the Commission announced that it would not object to the Exchange's commencing competitive rates on portions of orders above a level not higher than $500,000.7 These competitive rates became effective on most exchanges on April 5, 1971. Intra-member rates for floor brokerage and clearance on portions of orders above $500,000 also became subject to negotiation at the same time.8

6 See 36th Annual Report, pp. 5-8. See also 35th Annual Report, pp. 6–7, and 34th Annual Report, pp. 1-2.

7 Securities Exchange Act Releases Nos. 9079 (February 11, 1971) and 9105 (March 11, 1971).

The Commission also requested the Exchange to present on or before June 30, 1971, a new rate structure based on a percentage scale of the money involved in an order, a proposed revision of the intra-member charges for floor brokerage and clearance, and a proposal for reasonable non-member access.

On June 28, 1971, the Exchange presented a new commission rate structure, a proposed revision of intra-member rates for floor brokerage and clearance, and a proposal for a 30 percent discount from the public commission rate for certain broker-dealers who are not Exchange members. In accordance with the Commission's announcement on August 31, 1970, a temporary commission rate surcharge was continued until such time as circumstances warranted its termination."

On September 24, 1971, the Commission informed the New York Stock Exchange that it would not object to implementation of the Exchange's proposed new minimum commission rate schedule subject to a number of conditions, including compliance with the President's restrictions on price increases. 10 Other conditions included: the elimination of the commission surcharge; an increase to 40 percent in the discount for broker-dealers who are not Exchange members; a requirement of continued unrestricted service to small investors in the case of firms which traditionally have served such investors; the development of uniform reporting by member firms of income and expenses; the adoption of rules permitting member firms to enter into cooperative executing and clearing arrangements; re-examination by the Exchange of the necessity for fixed intra-member commission rates; and an adjustment of the rate schedule to eliminate a pricing anomaly that would have required investors to pay more for execution of odd-lot purchases than for the next higher round-lot purchase.

PUBLIC OWNERSHIP OF BROKER-DEALERS

In March 1970, the New York Stock Exchange amended its rules to permit the public ownership of member firms provided

9 Securities Exchange Act Release No. 8969 (August 31, 1970). 10 Securities Exchange Act Release No. 9351.

11 See 36th Annual Report, p. 67. In commenting upon this rule change, the Commission reserved its comment on the "primary purpose" limitation. In a September 24, 1971 letter to the Exchange dealing with the commission rate schedule, the Commission stated that it was reserving its determination regarding the "primary purpose" limitation until after the market structure hearings scheduled to begin October 12, 1971. See Securities Exchange Act

the member and any parent are primarily engaged in business as brokers or dealers in securities.11 Since then, the National Association of Securities Dealers, Inc., after reviewing the recommendations of a specially formed subcommittee on self-underwritings, abandoned its position that members could not participate in distributions of their own securities and published proposed regulations and procedures to govern such distributions. Pending the adoption of these regulations, the Association determined to review, on a case by case basis, proposals by its members to participate in distributions of their own or an affiliate's securities.12 These actions by the Exchange and the NASD cleared the way for Merrill Lynch, Pierce, Fenner & Smith to register with the Commission and distribute primarily to its customers a $112,000,000 offering of its securities. Subsequently, several other NYSE members filed registration statements with the Commission, which became effective, covering public offerings of their equity securities.

Generally, under the NASD proposals, which were submitted to the Commission in September 1971, an Association member would be permitted to "go public" if: (1) specified financial statements were submitted with the registration statement; (2) no more than 25 percent of the equity interest of the owners of the member was offered as a part of the issue; (3) the amount of the offering did not exceed three times the member's net worth; and (4) the member's aggregate indebtedness to net capital ratio, as computed under Rule 15c3-1, would not exceed 10:1 at the termination of the offering. Additionally, a member would be prohibited from making a subsequent public offering for at least one year and would be required to send to each of its shareholders a quarterly statement of its operations and an annual independently audited and certified financial statement. Finally, in addition to the above requirements, if the member participated in the distribution of its own securities or those of an affiliate, it would have to obtain two independent underwriters with at least 5 years experience in the underwriting business, three of which were profitable, to certify to the fairness of the offering price. These seasoning and profitability requirements would apply to the member-issuer as well. If the member recommended the securities to a customer it would have to have reasonable grounds to believe that the recommendation was suitable and would also have to maintain a record in its files showing the basis upon which it

12 For the previous two years such participation had generally been pro

reached its suitability determination. As of the end of October, the Commission had these proposals under consideration.

SECURITIES QUOTATIONS WITHOUT SPECIFIED INFORMATION The Commission has always been concerned with the problem of brokers and dealers publishing quotations for a security when there is no current information available to them or to the public concerning the issuer of the security.13 The publication of quotations for such securities subjects the investing public to a situation having a great potential for fraud and manipulation. In order to protect public investors, the Commission adopted Rule 15c2-11 under the Exchange Act.14

With certain exceptions, the rule prohibits brokers or dealers from submitting or publishing quotations respecting a security in the absence of publicly available information concerning the issuer and the security. In general, the rule prohibits a broker or dealer from submitting any quotation for a security to a quotation medium unless (1) there had been a recent public offering pursuant to a registration statement or a notification under the Regulation A exemption from registration, or (2) the issuer is subject to certain reporting requirements of the securities laws and the broker or dealer has no reason to believe that such reporting requirements are not being complied with, or (3) the broker or dealer has specified information concerning the issuer reasonably believed to be correct and reliable, which must be made available to any person interested in a transaction in the security with the broker or dealer. The rule does not prohibit quotations for a security which had been the subject of quotations at least twelve days within the previous thirty calendar days, or for a security which is listed on an exchange and has been traded on the same day or on the day before the submission of the quotation.

NASD AUTOMATED OVER-THE-COUNTER QUOTATIONS SYSTEM (NASDAQ)

On February 8, 1971, the National Association of Securities Dealers, Inc. (NASD) formally commenced public operations of the NASDAQ automated quotations system with approximately 2300 over-the-counter securities. The system, which is operated by Bunker-Ramo Corporation for the NASD, has three levels of operating service. Level I service provides a current representative

13 See Securities Exchange Act Release No. 8909 (June 24, 1970). 14 Securities Exchange Act Release No. 9310 (September 13, 1971). See the discussion of the rule as proposed in 36th Annual Report, pp. 86-87.