were among the top 25 percent of active stock days, and approximately 50 percent of all stock days in which floor traders dealt were among the top 13 percent of active stock days over the 3 weeks.435 As measured by share volume, over 80 percent of all floor trading was concentrated in each of the 3 weeks in less than 11 percent of the stocks traded on the Exchange, which stocks accounted for between 22 and 37 percent of total reported round-lot volume (tables VI-55 to VI-57). These were the approximately 110 to 150 stocks in which floor traders accounted for more than 2.5 percent of total purchases and sales. The data also show that between 35.8 and 51.5 percent of all floor trading in each week was concentrated in less than 38 issues, and that in each of these issues floor traders accounted for more than 7.5 percent of all purchases and sales. That is, approximately onethird to one-half of all floor trading each week was concentrated in less than 3 percent of the issues traded on the Exchange, which issues accounted for between 7 and 10 percent of total Exchange volume. On the other hand, in a majority of the issues which they traded at all, floor traders accounted for less than 2.5 percent of total volume in hose stocks. These issues represented in the 3 weeks respectively 15.7, 19.5, and 10.7 percent of the total number of issues traded on the Exchange, and accounted for 38.8, 29.1, and 30.2 percent of total reported round-lot volume. Concentration of floor trading in the 25 most active stocks was very high in each of the weeks studied (tables VI-58 to VI-60). For the week ended January 27, 1962 the 25 most active stocks accounted for 19.6 percent of total Exchange volume, but 42.2 percent of all floor trading. For the weeks ended March 24 and June 16, the 25 most active stocks accounted for 22.1 and 19.7 percent of total Exchange volume, but 50.4 and 39.6 percent of all floor trading, respectively. Whether measured by stock days or share volume, floor traders tend to concentrate their activities to a far greater degree than any other class of Exchange member. Specialists traded less than 16 percent of their total volume in the 25 most active stocks, and odd-lot dealers less than 21 percent, in each of the 3 weeks. These lower rates of participation are due largely to the fact that the functions of such members require broader participation in the market. However, floor-trader concentration in the 25 most active stocks in each of the 3 weeks was at least 9.9 percent greater than that of members off the floor,436 who are under fewer restrictions with respect to their trading than any other class of members.437 Testimony taken from 19 Exchange specialists confirmed this statistical evidence of floor trading concentration in the more active stocks, and contributed additional insights into floor trading patterns. Thirteen of the specialists concurred in the view that floor traders generally trade in the more active stocks. Four of the remaining six did not feel that floor trading was generally concentrated in active stocks, but did testify that they rarely saw floor traders in their inactive stocks. 435 See also chart VI-4, which shows a slightly greater concentration of floor trading in active stock days when stock day activity is measured by number of transactions rather than by share volume. 430 Trading by members off the floor is described in pt. G, below. 437 For the weeks ended Jan. 27, Mar. 24, and June 16, 1961, respectively, members off the floor did 27.9, 36.1, and 29.7 percent of their trading in the 25 most active stocks (tables VI-77 to VI-79). For comparisons of member classes' concentration by stock days, see charts VI-3 and VI-4. Another characteristic of floor trading is that it often develops or increases in a given stock when the stock experiences unusual activity. The specialist in Sperry Rand Corp., when asked why that stock attracted "very heavy floor trading during the early part of 1962," testified: Sperry Rand has a big market. It had a rise up to 35% after doing nothing for years. It was one of the few electronic stocks that did nothing for a long, long while and then it suddenly went up as high as 35. Since that time, it has gone down quite a bit and maybe that activity-I can't answer that, why it is. I don't know why people buy stock. Another specialist, when asked whether he had experienced any concentration of floor trading in any of his stocks, answered: I hadn't lately. Before, when Ampex was active over the last 4 years, we had floor traders; also in General Tire. They generally go to stocks that are active and that have had a break or rally. They go to the glamour-type stocks. The specialist in Reynolds Metals Co. noted that this stock "occasionally" attracts floor traders. Asked when this happens, he stated: "***it could probably happen when the so-called aluminum group became active in volume. Some specialists, however, testified that floor traders are sometimes active in relatively inactive stocks, if such stocks are volatile. One, for instance, testified that floor traders are active in Spartans Industries, Inc., a relatively inactive stock that he described as "very volatile." The specialist in Beckman Instruments, Inc., a somewhat more active stock, testified that floor traders become most active in Beckman "when the stock is most volatile." The specialist in U.S. Smelting, Refining & Mining Co., noted that this stock is attractive to floor traders, an attraction he explained as follows: Because it has a very thin market. It is one of these stocks that is worth a hundred dollars a share in book value. There are only 500,000 shares of it outstanding, and it has got gold, lead, zinc-everything under the sun. It has great speculative value, but it has a quick move, and then everybody comes dashing in and buys it, and then nothing happens, and it goes down again. They only trade it when they see something like that going on. They get in and out very quickly. It appears, however, that unless the volatility is of a type that will sustain a rally or break for at least a period of time, floor traders will not participate in the trading. This was clearly expressed by the specialist in a very inactive stock marked by what he described as "wicked movements." He was asked whether these moves attract many floor traders, and the testimony continued as follows: A. No; *** just as if we were floor traders we would shun it like the plague. Why trade in something of that character? You would not do it and I wouldn't do it. 438 This testimony, given in late July of 1962, has been borne out by subsequent events. Between July 9 and Dec. 27, 1962, the price of U.S. Smelting increased from 26% to 42% (touching a high of 43%) on a total published volume of 355,600 shares or a daily average of 2,988 shares over the 119 trading sessions. During this period, floor trader purchases and sales totaled 40,500 shares, or 5.7 percent of the total purchases and sales in the stock. On Dec. 28, 1962, the daily volume jumped to 43,500 shares, exceeding the total trading in the stock over the 15 preceding trading sessions. Between the opening on Dec. 28, 1962, and the close on Feb. 21, 1963, the price increased from 42% to 70% (down from a high of 88%) on a total volume of 1,526,200 shares, or a daily average of 39,133 shares over the 39 trading sessions. During this period floor trader purchases and sales totaled 467,300 shares, or 15.3 percent of the total purchases and sales in the stock. See table VI-61. Q. Because of the A. There is no possible chance of having a sustained move or a percentagewise it is a stock that can be invested in, I think, very attractively, but certainly no trading in it. * ** Q. You rarely see floor traders in a stock like that? A. We have seen them, but our comment is that they ought to have their heads examined. Q. Whatever you buy you can always sell? One may conclude, therefore, that even in the relatively inactive stocks in which floor traders trade because of the volatility, in most cases the stock must be sufficiently active to sustain a moderate price trend and provide opportunity to cover a short position or liquidate a long position rapidly. 3. OBJECTIONS TO FLOOR TRADING The objections to floor trading that have been most frequently advanced are: (1) floor traders enjoy a competitive trading advantage over all other traders, and (2) floor trading accentuates price movements.439 a. Competitive trading advantages of floor traders All members of the Exchange have a trading advantage over nonmembers by virtue of their lower commission costs. The floor trader enjoys two further advantages which stem from his ability to represent himself in all trades: elimination of the costs of floor brokerage and an opportunity to observe and act upon floor developments instantaneously. The cost advantage of the floor trader may be illustrated as follows with respect to trades which are made and reversed during the course of a single trading session, a form of trading-described as "in and out" or "daylight" trading-which accounts for a large percentage of total floor trading. If a nonmember purchases 100 shares of a $25 stock in the morning and sells the same 100 shares later in the day, he must pay a commission of $63 ($31.50 on the purchase, $31.50 on the sale). A member trading off the floor can effect the same purchase and sale at a commission cost of $7.30 in floor brokerage plus a clearance fee (if the member is not a clearing member) of $2.75. The member trading on the floor does not incur floor brokerage costs, and may therefore effect the transaction at a total commission cost of $2.75, the cost of clearing the purchase and sale. The commission costs of the nonmember, member trading off the floor, and the member trading on the floor are therefore $63.00, $10.05, and $2.75, respectively. Adding Federal transfer taxes of $1, New York State transfer taxes 4 Because many floor members act as both floor traders and floor brokers, it has also been argued that a potential conflict of interest exists; such members may compete as principals with orders they hold for customers, or allow concern for their own trading to interfere with prompt and careful performance of their broker functions. Although these problems cannot be dismissed, evidence that they do exist is lacking. The former objection appears to be met by rule 92 of the Exchange, which provides that members may not purchase stock for their own account while holding a customer's market order to buy stock, and may not sell stock while holding a customer's market order to sell. of $4, and SEC fees of $0.05 to each of these transactions produces total costs of $68.05, $15.05, and $7.80, respectively. The price rise necessary to offset these costs is therefore $0.68 or more than 5% of a point per share for the nonmember, about $0.15 or slightly more than 1% of a point per share for the member trading off the floor, and less than $0.08 or less than 1/10 of a point per share for the floor trader. It is evident, therefore, that a member trading for his own account on the floor is able to trade with greater frequency, assume commitments at smaller cost, profit from smaller price changes, and incur less risk of loss than a nonmember or a member trading off the floor.440 The floor trader's "place" advantage was described as follows by an early Commission report: 441 He sees instantly the outbreak of activity in a stock, the nature of the trading, and the direction of prices. He is in a position to discount or revise his market appraisals almost instantaneously. Upon the basis of information which he derives while on the floor he can increase, decrease, or cancel his orders more rapidly than a nonmember to whom the same information is only made available at a later time. This is particularly true when the "tape is late," i.e., when reports of transactions which are conveyed to the outside world by means of a ticker system are delayed because of unusual activity on the floor. During such periods the member on the floor has immediate knowledge of the latest prices while the nonmember must rely upon prices which may no longer be current. Since there are no news tickers on the floor, members contend that important developments in industry, finance, or politics affecting the course of security prices are revealed more expediously to persons outside the trading premises. It should be noted, however, that such tickers are found immediately adjacent to the trading premises, that news of this character may be relayed to members on the floor by their office partners or employees almost as quickly as it appears and that the reaction of the investing public as expressed in increased buying or selling orders is quickly manifest to members on the floor. The Exchange has denied that floor traders enjoy any "significant" trading advantages, stating, for example: There has been a tendency, on the part of some people in the past, to try to spell out "advantages" a Floor Trader may have over the public. On analysis, it appears that there are differences-but they do not amount to significant advantage. For example, it has been said that the Floor Trader has a cost advantage. But this ignores his costs: capital investment in membership; initiation fee; interest on investment; annual dues; contribution to gratuity fund; office space; clerical help; clearance charges; Federal and State transfer taxes; SEC fee; value of time spent in conducting his business; and, Federal and State income taxes. It has also been said that the Floor Trader may gain an advantage by reason of his presence on the Floor. This ignores the fact that there are no news tickers on the floor. It is true that a Floor Trader may obtain a bid and offer or observe a transaction occurring on the Floor, thus learning of that quotation or transaction before someone who must depend upon the quotation system or the tape for such information, but such knowledge on the part of the Floor Trader is extremely limited as to the number of stocks at any one given time. He must watch the tape for information concerning transactions in stocks not in the particular locality where he may be at the moment, and must go to the Post 440 Adding the floor trader's "fixed" costs-interest on investment in membership (approximately $11,000 per year), annual dues ($1.500 per year), a "floor privilege fee" ($500 per year), the initiation fee ($7,500, or $750 per year over 10 year amortization period), and small incidental costs-does not diminish the floor trader's cost advantage to any significant extent. Placing the average number of purchases and sales for the average member account engaged solely in floor trading at roughly 14,000 shares per week or 728,000 per year results in a fixed cost per share of less than $.02, or less than $2 for each purchase or sale of a round lot. 441 SEC, "Report on the Feasibility and Advisability of The Complete Segregation of The Functions of Dealer and Broker," pp. 16-17 (1936). (Hereinafter cited as "Segregation Report.") where the stock in which he is interested is traded in order to obtain the bid and offer. Another fact which is most important is that THE FLOOR TRADER HAS NO MORE KNOWLEDGE THAN ANYONE ELSE OF WHAT IS GOING TO HAPPEN IN THE MARKET IN A STOCK AFTER HE MAKES A PURCHASE OR SALE. Floor Traders do not get rich over night. They take calculated business risks and certainly they are not always right.442 [Emphasis in original.] These Exchange views appear to be inconsistent with those of certain members with intimate knowledge of floor activities. In 1956, for instance, one of the odd-lot firms, protesting Exchange consideration of a plan to remove associate brokers from the floor, argued: Under our present system of trading the broker develops an intangible quality called a "feel of the market." At the post his eyes and ears become attuned to the sights and sound of the marketplace. Here he picks up information regarding the stocks he is trading in. Here he can act with split-second speed and reflect in his own trading the action of the tape. Here he makes friends with the specialists and other brokers and traders who impart to him their combined thoughts and advice and who are helpful to him in the execution of his round-lot trades made for the purpose of offsetting his positions. The fact that our broker would no longer be able to remain at the place of auction *** would, in our opinion, cost our firm many hundreds of thousands of dollars in the effectiveness of his round-lot trading. When you consider that last year our firm traded 20 million shares in round-lots, the importance of this factor becomes immediately apparent. Even the minimum variation of one-eighth poorer on these transactions would result in a loss of $2,500,000. Members on the floor have access to much greater and more current market information than individuals relying on tape reports and quotation systems. Floor members see and hear what is going on and they can react immediately. They know in many instances that a given broker represents certain institutional investors, and may follow his activity closely as he begins to buy or sell large amounts of a stock. They appreciate the trading patterns that generally prevail during acquisition or disposition of large blocks of stock. They are familiar with the trading techniques of different brokers or specialists. They may obtain from fellow brokers or traders general or specific evaluations of investor tenor, in terms of limit or stop orders placed, short sales effected, or orders cancelled. These and other factors that are not reflected on the tape contribute to the "feel" of the market development by floor members. Most certainly factors such as these account, at least in part, for the following testimony given in a nonSEC proceeding by a prominent floor broker: I would not want any people *** to think that I am a prognosticator of the market. I never have been. But I do think that I know fairly well what the market will do from hour to hour. * That is quite essential for a person handling discretionary orders. A. * As your business builds up and your customers become convinced of your ability as a broker, they more and more lean on you to execute the orders in your fashion, because let's face it, they're upstairs and I'm downstairs, and many times I know things that my customers do not, and that is why they will give me discretion. Q. When you say they are upstairs, you mean they are off the floor and you are down there? A. They're in their offices and I'm on the floor. 44 Prepared statement of the NYSE, submitted to the Commission and apparently circulated to members, dated May 20, 1959. |