niques are not sufficiently refined to deal adequately with certain important aspects of the specialist's role and obligations. Among needed improvements on this Exchange as well as the Amex are the following, which should be developed promptly by the exchanges in conjunction with the Commission:

(a) For many routine surveillance purposes it would be invaluable, but it has not heretofore been practical, to have a means of preserving or reconstructing a specialist's book for a given period; modern automation techniques may well remove the practical difficulties and should be promptly explored.

(b) Surveillance of overparticipation as well as underparticipation should be strengthened; as a basic check, regular reporting to the respective exchange of income of specialists, segregated between brokerage income and dealer income, should be required.

(c) In general, surveillance should be directed toward assuring that each specialist is performing his obligation to maintain a fair and orderly market in each security, with appropriate procedures and sanctions for enforcement and with the ultimate purpose of allocating and reallocating securities where required to assure high standards of performance with respect to all securities.

(d) In addition to present tests to evaluate performance, tests for evaluating specialist purchases, sales, and positions in relation to price movements should be evolved, with the object of determining the market effects of specialist dealer activities.

E. ODD-LOT DEALERS

1. INTRODUCTION—THE SIGNIFICANCE OF ODD LOTS, AND THEIR HANDLING

The unit of trading in most stocks on the exchanges is the "round lot" of 100 shares. Trading in the regular auction market on the floor of an exchange is conducted in round lots, or multiples thereof.371 An order to buy or sell a security on an exchange in any amount less than the round lot is an "odd-lot" order. Under this system, odd-lot orders do not enter the flow of buy and sell orders in the regular auction market. The business of the odd-lot dealer consists of filling odd-lot orders by buying or selling for his own account as principal. He transacts business exclusively with other brokerage firms, and not with the public.

The conduct of the odd-lot business is nevertheless very significant for the public investor, particularly the small investor, although odd lots also include any portion of a larger order that is not a multiple

The minimum trading unit of 100 shares was adopted shortly after the Civil War, as a result of increased volume. (See note 380, below.) The minimum unit for the auction market has been justified on the ground that it fits that market's needs for a unit involving a sum of money adequate to represent a reasonable appraisal of a security's worth and, at the same time, conforming to the physical and mechanical limitations of the trading floor. It is also said that the trading of small units on the floor might result in a material increase in the cost of doing business and clogging of the ticker tape with reports of insignificant transactions. However, see p. 202, below.

For a relatively small number of securities traded at "active" posts on the NYSE, the round-lot unit is 10 shares. This is apart from 198 securities traded at Post 30 and known as "Post 30" stocks, all of which are considered inactive and handled differently from normal Exchange procedures.

of 100. The total odd-lot volume on the New York Stock Exchange during 1961 was 214,018,834 shares, or 9.1 percent of the total volume of shares traded on that exchange.372 Odd-lot transactions, however, form a much higher percentage of total transactions than of total volume; in the same year, the two principal odd-lot firms on the New York Stock Exchange handled about one-half of the total number of round-lot and odd-lot public transactions on the Exchange. On the American Stock Exchange, odd lots constituted 3.7 percent of total volume for the year 1961.373 On the principal regional exchanges too, odd lots constitute a substantial portion of the total volume, especially in dually traded stocks. In 1961, odd lots constituted 11.7 percent of total volume on the Pacific Coast Exchange and 19 percent of total volume on the Midwest Stock Exchange. Thus, although odd-lot dealers do not deal directly with the public, the conduct of their business affects a large proportion of all public transactions, so that they are critical figures in the exchange markets.

374

Almost all odd-lot orders are executed at prices determined automatically by round-lot sales in the same securities. The odd-lot buyer pays a fraction of a point more per share and the odd-lot seller receives à fraction of a point less per share than the controlling round-lot price. This fraction is called the "odd-lot differential," and the oddlot dealer's compensation is derived from it. A public customer purchasing or selling an odd lot pays, in addition to the differential which is passed on to him, a standard commission to his brokerage firm.

On the New York Stock Exchange, where the price of an odd lot is determined by the next ("triggering") round-lot sale,375 the differential for stocks in which the round-lot unit is 100 shares is % of a point (122 cents) if the controlling round-lot sale is at 39 or below, or 1/4 of a point (25 cents) if the round-lot sale is at 40 or above ("quarter stocks"). Almost 99 percent of the volume of odd-lot transactions on that exchange is handled by two member firms, Carlisle & Jacquelin and DeCoppet & Doremus, who engage exclusively in handling odd lots. Both firms handle odd lots in every listed security except those inactive stocks traded at Post 30. The remaining 1 percent of odd-lot transactions on the Exchange is handled by the firms specializing in "Post 30" stocks, and by two specialist firms, in stocks traded at the posts where members of such firms are specialists.376

On the American, and most regional stock exchanges, odd-lot transactions are handled by the specialists in their respective stocks; most

372 See table VI-49 for the relation of odd-lot trading to total trading on the New York Stock Exchange during the period 1936-61.

It should not be overlooked that, to an unascertainable extent, brokerage firms receiving odd-lot orders may (if the customers approve) accumulate them in order to make up round lots, so that odd-lot volume is in fact somewhat larger than the figures show. These transactions do not involve the odd-lot dealers.

378 See table VI-50 for the relation of odd-lot trading to total trading on the American Stock Exchange during the period 1937-61.

374 These figures are derived from a sample of trading on these exchanges, based upon figures supplied by the respective exchanges.

In calculating the ratio of odd-lot volume to total volume, the odd-lot dealers' odd-lot Volume can be included or excluded. The regional exchanges have provided the Special Study with ratios that include these figures. The NYSE, which regularly makes its figures public, does not include these figures; nor does the Amex. The study has adjusted the regional exchange data to make them comparable with those of the NYSE.

375 Instead of waiting for the next round-lot sale, the odd-lot customer may enter an order to buy at the round-lot offer or to sell at the round-lot bid. Also, limited price orders or stop orders may be placed by specifying the price at which, or price range within which, the odd lot is to be bought or sold.

376 Some odd-lot business in listed securities is also conducted in the over-the-counter markets. See ch. VIII.D.

exchanges have no dealers handling odd lots exclusively. The specialist odd-lot dealer fills all odd-lot orders in the securities in which he specializes, by taking for or supplying from his own account the stock involved in such orders. On the American Exchange, like the New York Stock Exchange, odd-lot orders are filled at a fraction of a point above or below the next round-lot price for active stocks,377 and on the American and regional exchanges, the differential is the same amount as on the New York Stock Exchange.

2. SCOPE AND METHODS OF STUDY

The following discussions of odd-lot dealers and brokers concentrates on the activities of the two principal odd-lot firms on the New York Stock Exchange, with particular attention given two aspects of their business where regulation by the Exchange and the Commission has been at a minimum. The first of these concerns the setting of the odd-lot differential; the other relates to the modernization of the facilities for odd-lot transactions. The Special Study was not able to undertake an intensive study of specialist odd-lot dealers on the American Stock Exchange or the regional exchanges, and this report contains no evaluation of those dealers' performance or of their regulation by their exchanges. The report does, however, describe the relationship between the regional exchanges and the New York Stock Exchange dealers with respect to the setting of the odd-lot differential in dually-traded stocks.

In the course of this study, New York Stock Exchange officials and members were interviewed, and testimony was taken from partners and employees of the firms and their associate brokers, and from officials of certain regional exchanges. The Special Study staff also studied documents from the files of the odd-lot dealer firms and the files of the New York Stock Exchange and certain regional exchanges relating to odd-lot dealers.

3. ODD-LOT BUSINESS ON THE NEW YORK STOCK EXCHANGE

a. Structure and mechanics

Although the firms of Carlisle & Jacquelin and DeCoppet & Doremus handle almost 99 percent of the volume of New York Stock Exchange odd-lot transactions, they do not themselves handle executions on the floor of the Exchange. Each firm uses approximately 50 associate brokers to execute their transactions on the floor. These associate brokers are in effect floor brokers who work on a full-time and exclusive basis for one of the two firms. Each associate broker is a member of the Exchange, owning his own seat, but none of them are partners of the firms whose transactions they handle, and their relationships with those firms are terminable at the will of either party. Each associate broker is assigned a specific number of stocks located at his post and maintains a "book" in such stocks.

A public investor wanted to purchase or sell an odd lot on the New York Stock Exchange does not deal directly with an odd-lot firm and

377 The regional stock exchanges, in trading dually traded stocks, which represent the major portion of their odd-lot business, employ what is known as the 3-minute rule, described in ch. VIII.E.

its assocate broker, but places his order with a commission firm, which transmits it to the NYSE floor.378 An Exchange clerk prepares an order slip which is then sent through pneumatic tubes to the post at which the stock is traded, where it is received by another Exchange clerk who time-stamps the order and places it on a clip at the associate broker's post. The associate broker removes the order from the clip and places it in his "book," to be executed as soon as the triggering round-lot sale in the security takes place.379 When that occurs the associate broker executes the order by selling or purchasing the shares for the account of the firm he represents. After the execution, the associate broker reports it on a slip of paper handed to the tube operator at his post. The report is then sent back through the pneumatic tubes to the booth where the telephone or teletype of the commission house is located, for communication to the office of the commission house and thence to the customer. One commentator on odd-lot procedures has noted that each transaction involves 19 different steps.380 In all cases the execution of an odd-lot order is a purely mechanical operation, usually based upon a round-lot transaction; in many cases it is in fact handled by the associate broker's clerk.381 In the course of buying and selling odd lots, the associate brokers may accumulate long or short positions for their odd-lot firm's account. In order to adjust such positions, the associate brokers make offsetting round-lot transactions on the floor; these constitute about 25 percent of the total share volume of the odd-lot firms.

In 1961, the average income of an associate broker was approximately $50,000. They are paid by their firms the standard floor brokerage commissions on round-lot transactions, and from the odd-lot differential they earn 1% cents per share on each transaction in securities with a price of less than $10 per share and 24 cents per share on transactions in securities at $10 per share or more.382

By contrast with the associate brokers, the partners in each odd-lot firm who hold Exchange seats execute no transactions for the firm, although many of them utilize the membership privilege to station themselves on the floor and supervise the activities of the associate brokers. The 2 firms had a total of 42 general partners (not all holding seats) as of February 1963, and about 100 associate brokers. Together, the floor partners of the two principal odd-lot firms and their associate brokers constitute about 10 percent of the Exchange's membership.383

Carlisle & Jacquelin and DeCoppet & Doremus, the two major odd-lot firms, trace their origins to a common ancestor, Jacquelin & DeCoppet Brothers, which in 1874 became the first dealer to make

a78 On mechanics of the market, see pt. B of this chapter.

370 The associate broker may observe the round-lot sale himself or may hear of it from an exchange employee, part of whose job it is to call out the sales.

380 Hardy, "Odd-Lot Trading on the New York Stock Exchange," pp. 15-16 (1939). 381 For details of the method of handling various types of orders and variations in the differential for low-priced, 10-share units, and called stocks, see DeCoppet & Doremus, "Buying and Selling Odd-Lots," pp. 22-42 (1962.)

382 This is 12% percent more than the minimum rate prescribed in the New York Stock Exchange Const, art. XV, sec. 2(c) (4).

383 Two of the Exchange's largest commission firms, Merrill Lynch, Pierce, Fenner & Smith and Bache & Co., together had a total of 20 seats, as of February 1963. This constituted 1.5 percent of the membership.

For further data on the composition of the membership and a discussion of its significance, see ch. XII.B.

a market in odd lots on the floor of the New York Stock Exchange.384 In the intervening years there have been various changes in the composition of the odd-lot industry, but no significant change has occurred since 1941, when a merger reduced the number of major odd-lot firms from three to two. Total gross income received by these two firms during the prosperous year of 1961 was over $35 million, and after deducting expenses (not including partners' compensation) their combined income was just over $12 million.385 For 1959 the firms' total net income was over $9 million, and for 1960, over $7 million. During 1962, they stated that their 1962 profits would not equal those of 1961. As of January 1, 1962, their combined capital exceeded $14 million, not including 20 seats capitalized at $4,100,000.

Each odd-lot firm maintains an order service department which provides last sale service, sales recording service and adjustment service to the brokerage firms who are its customers. The cost of these services and the others rendered by the odd-lot houses is covered by the differential paid by the public odd-lot customer, although, as discussed below in section 3.d, the services are provided less for him than for the benefit of the commission houses, themselves. The order service department employs about 139 persons at DeCoppet and 106 at Carlisle, or 20 to 25 percent of all of their employees. In each firm the order service department is divided into three sections. In one section, clerks record all transactions appearing on the tape, separating them by security and noting the time of each transaction. This section supplies specific information about individual round-lot transactions to the firm's clerks working on the floor with the associate brokers; to the firm's adjustment section, described below; and to the commission houses. A second section, a battery of telephone operators seated in front of a large Teleregister board, supplies the commission houses with the last sale prices, volume, market averages, and other similar information. The average number of calls per day handled at Carlisle in 1961 was over 18,000, and at DeCoppet, as of mid-1962, the average number per day was 21,000. Finally, the section handling claims and adjustments processes errors and mistaken claims of errors in the firm's transactions. During 1961, DeCoppet adjusted 177,363 trades at a net cost of approximately $286,000; although strictly comparable figures are not available, Carlisle made 145,643 adjustments at a net cost of approximately $36,000 for all adjustments of $100 or more during the same year.

Neither firm regularly breaks down its costs by departments, although, as will emerge later in this report, the matter of these costs is significant. It can be assumed, however, that a substantial part of Carlisle's 1961 "overhead expenses" of over $6,300,000 and DeCoppet's "administrative expenses" of over $6,400,000 are attributable to the

384 Before the 100-share trading unit was adopted after the Civil War, odd-lot trading was conducted off the floor of the Exchange on an over-the-counter basis, and in 1874 when odd-lot trading moved to the floor of the Exchange, it was handled substantially in the same manner. Brokers buying or selling odd-lots had to negotiate each transaction with the odd-lot dealer. This method later changed to a system whereby the odd-lot dealers offered to trade on the bid and offer, with the result that brokers could have their transactions automatically executed by sending them to the odd-lot firms. Ultimately the method evolved of executing odd-lot orders based upon the price of the next round-lot transaction, plus or minus a standardized differential. See Hardy, note 380, above at pp. 161-163; DeCoppet & Doremus, "Odd-Lots," pp. 5-6 (1961); Carlisle & Jacquelin, "Odd-Lot Manual," pp. 9-11 (1961).

385 The figures cited are arrived at from the firms' income statements. No examination of their accounting methods has been made.