erally speaking the clarification provides that a 15-minute "freeze" is initiated if floor traders effect "long" purchases of offered stock on a plus or zero-plus tick above the prior close (1) at two different prices within 15 minutes, or (2) of 500 shares or 50 percent of an offer, whichever is greater (up to a maximum of 7,500 shares), at one price, or (3) of 500 or more shares of an offer, and the remainder of the offer is purchased by other than floor traders. The "freeze" that follows such purchases does not prohibit all floor trading in the stock involved, but rather prohibits, subject to certain exemptions, additional purchases on plus or zero-plus ticks. In addition to the above limitations, if a floor trader purchases stock on his own bid on a plus tick, a 15-minute freeze is initiated during which no floor trader may purchase on his own bid on a plus tick or a zero-plus tick at a different price. Numerous shortcomings of this clarification may be noted. First, the clarification, like the rule itself, places no restrictions whatever on floor trader sales.492 The significance of this omission is best illustrated by the floor trading in Sperry Rand Corp. described in section 3.a, above. Asked why the Exchange does not restrict floor-trader sales, Vanderbeck testified as follows: Well, the whole aspect of floor trading, as worked out with the SEC back in the year 1945, was concentrated on the buy side, because of the fear that the SEC had that floor traders would mark stocks up and dump them on the unsuspecting public and walk away with a bundle of money. That is why, ever since then, the direction of thought has been toward the buy side. Also, I think that behind the fact that we have not ever thought in terms of their selling, are two things: first, with respect to the sale of long stock; that it certainly should be the democratic right of any citizen or investor, whether he be a floor trader or not, to be able to dispose of stock at a price when he wants to do it. Otherwise, you may be infringing, I think, unduly, upon the rights and privileges of a man who wants to participate in the market. Secondly, with respect to short selling: he has to keep within the bounds of your short-selling rule, and sell short only at prices which are higher than the last given price. However, the Commission minutes and press release quoted in section 6.c, above, refer quite clearly to "market movements" or "fluctuations," without regard to their direction. Moreover, the rule originally adopted by the exchange applied the "lock in" device to both purchases on plus or zero-plus ticks and "long" sales on minus or zerominus ticks. Vanderbeck's reference to the "democratic right *** to be able to dispose of stock" is hardly in accord with earlier thinking of the exchange, or indeed with the general concept of regulation of the conduct of members. Thus it seems most anomalous that the specialist, whose admission to the floor is earned by obligations assumed, is restricted in his selling while the floor trader is not. In any event, the restrictions set forth in the clarification of rule 110 are limited to the purchase side of the market, but even here the restrictions apply in only a limited number of situations. No restrictions whatever, for instance, apply on purchases made at prices below the prior day's closing price, on the theory that any such purchases tend to have a stabilizing effect on the price. Under this view floor 402 The Commission's short-selling rule prevents all persons, including floor traders, from selling short on minus or zero-minus ticks. traders may sell unlimited amounts of a stock experiencing a decline, and then purchase unlimited amounts of the stock as the price recovers. In selling on the decline and buying on the recovery, floor traders may thereby trade with the price trend and accentuate the price movement or fluctuation. Even as to purchases above the prior close the restrictions are limited in nature. No restrictions, for instance, apply to purchases effected to cover short sales. Also, no restrictions apply to purchases made above the previous close on a minus or zero-minus tick, on the theory that purchases on minus or zero-minus ticks are stabilizing, regardless of the general trend of the stock price. As noted in the discussion of the "tick" measure of stabilization in section 4.c, this permits floor traders to be heavy purchasers on balance in a stock that experiences a price rise, simply by purchasing on the minus or zerominus ticks that appear from time to time over the day. Even purchase on plus or zero-plus ticks above the prior close are permitted within the 500-share (or 50 percent of the offered amount) limitation. Although these prohibitions to some extent limit floor trader opportunities to drive a price up, it is equally obvious from net balance studies conducted by the Commission that they have not prevented floor traders from trading with rising price movements. Because they are based on the tick system, they fail to meet directly the question of trend rising, and ignore altogether the problem of directing floor trader liquidity into its most useful channels. In addition to these fundamental defects in the structure of the rule, the Exchange's administration and enforcement of the rule falls noticeably short of what may be justifiably expected. Effective enforcement of the rule depends in the first instance upon prompt and accurate reporting of floor trades by each member effecting such trades, but several instances of late or inaccurate reporting were found by the Special Study in a spot check.493 Moreover, even with prompt and accurate reports, it is often impossible to reconstruct the market in sufficient detail to establish clear violations of the floor trading rules. It is virtually impossible, for instance, to prove that a floor trader took more than 50 percent of an offer when no written record of offers in the crowd exists. Finally, although the Exchange expends many man-hours daily reviewing reports received, and thereby detects violations of the rule with some frequency, only one member has been formally disciplined for violation of the rule since January 1, 1957. These matters, treated in more detail in part B of chapter XII, point up the difficult and costly administrative problems created by opening the floor to members for their personal trading purposes. 494 7. THE AMERICAN STOCK EXCHANGE Regulation of floor trading on the American Stock Exchange has followed a pattern almost identical to that on the New York Stock Exchange. Until 1959 the rules of the two exchanges were very similar. In June of 1959, however, the Amex adopted a rule that prohibited members from initiating bids on the floor at a price higher than the last sale, limited plus tick purchases to 300 shares or 30 percent of 403 See ch. XII.B. 404 For details on the nature and extent of floor trading on Amex, see app. VI-H. the amount offered (whichever is greater), and limited zero-plus tick purchases to 500 shares or 50 percent of the amount offered (whichever is greater). Such purchases initiate a 15-minute "freeze." In April of 1960 this rule was amended in several respects, the major change being that all restrictions on purchases below the prior close were lifted. 195 The effect of this rule is difficult to assess. Floor trading data covering the periods in question are unreliable, due to deficiencies in the Amex reporting system. 496 For what it is worth, recent studies based on this data, noted in appendix VI-A.3.h, reveal a sharp drop in floor trading as a percentage of total exchange trading in the 45 stocks in which floor traders were most active over selected 2-week periods. The most recent study, however, was during a period of very high total volume in these stocks which prompted the chairman of the board to issue a notice to floor traders to reduce their purchases until further notice. Total floor trading in recent years, as indicated in appendix H.1, has declined as a percentage of total exchange purchases and sales, but the number of shares traded by floor traders each year has remained relatively constant. In any event, as noted in the "Staff Report on Organization, Management, and Regulation of Conduct of Members of the American Stock Exchange," floor trading on the Amex still posed serious problems as of January 1962. 8. REGIONAL EXCHANGES Floor trading on the regional exchanges must be evaluated in a different light than floor trading on the New York exchanges. More than 80 percent of the dollar volume on regional exchanges is in dually traded securities, which are customarily executed against the NYSE or Amex tape. Regional members who floor trade in such securities, therefore, do so without the time or place advantage of NYSE or Amex floor traders and, in addition, cannot influence price movements in the primary market. On some of the smallest exchanges, however, significant member trading appears to occur in solely listed securities, a finding only recently established by the Division of Trading and Exchanges. Further study of this type of trading is required, however, before meaningful conclusions or recommendations can be formulated. 9. SUMMARY, CONCLUSIONS, AND RECOMMENDATIONS Of all classes of exchange members on the floor, the floor trader stands alone in having no fiduciary status, no duty to execute transactions, and no market responsibilities or obligations in relation to the operation of the market as a public institution. He is, in short, the only type of member granted access to the floor without being required or expected to participate in the handling of securities transactions. The floor trader's presence on the floor is simply a matter 495 Although the specific "tick" restrictions of the Amex rule 110 apply (as on the NYSE) only to purchases, the general provisions prohibiting congregating, dominating, etc., as written apply (unlike the general NYSE provisions) to both purchases and sales. 498 SEC, "Staff Report on Organization, Management, and Regulation of Conduct of Members of the American Stock Exchange," pp. 42-43 (January 1962.) of his desire to trade for his own account. That any individual who purchases a seat thereby becomes entitled to do his personal trading on the floor of an exchange without having any special function or undertaking any obligation in relation to the operations of the market raises, in itself, a fundamental question of public policy as to the extent to which a public market may be permitted to maintain this vestigial "private club" aspect, even apart from very serious questions as to the net impact of floor trading on the orderly functioning of the market. The privilege of access to the floor provides trading advantages of a substantial nature; the commission cost of trading on the floor is appreciably lower than for off-floor trading, trading activity may be observed minutes before it appears on the tape, and bids or offers may be entered or withdrawn in a matter of seconds. In addition, presence on the floor carries with it the benefit of what has been termed a "feel of the market"-a heightened sense of market tenor and trend. In part this "feel of the market" is attributable to the constant exchange of observations among floor members, either with respect to general market conditions or, more specifically, to such factors as the volume and type of orders or cancellations coming to the floor. More subtle factors also add significantly to the floor member's awareness; familiarity with the trading techniques of specialists or floor brokers, for instance, in many case combined with knowledge that a large block of stock is being accumulated or distributed, is a factor that facilitates the trading activities of the floor trader. 497 Section 11 of the Exchange Act vests the Commission with broad powers to regulate or prevent principal_transactions by exchange members on the floor of an exchange. It is clear that one of the major legislative concerns underlying this broad grant of power was that benefits derived by the public from member trading on exchange floors were not in balance with the advantages derived by the preferred groups.* Viewed in this light the broad scope of the section is thoroughly consistent with one of the dominant themes running through the series of statutes administered by the Commissiondenial of special advantage in the public interest and for the protection of investors. The equality of access to full and accurate corporate information sought to be guaranteed by these statutes is complemented by the specific provisions of the Exchange Act which seek to provide open and honest markets in which investment decisions may be acted upon. In its administration of the statutes the Commission has shown that the guiding concepts are dynamic and not static. If anything, there has been an increasing emphasis of fairness and equality. A recent case, for example, has made it clear for the first time that a broker in possession of important nonpublic corporate information is under severe limitations as to the use of his knowledge in the marketplace.* In a disciplinary proceeding within the last few months the NYSE found it contrary to acceptable business practice for a broker 498 497 Early drafts of sec. 11 would have turned exchanges into pure auction_markets, banning all except brokers from access to the floor. See "Hearings on Stock Exchange Regulation Before the House Committee on Interstate and Foreign Commerce," 73d Cong., 2d sess., pp. 116-117 (1934). 408 In the Matter of Cady, Roberts & Company, Securities Exchange Act release No. 6668 (Nov. 8, 1961). This case held a broker-dealer in violation of secs. 17(a) of the Securities Act and 10(b) of the Securities Exchange Act, for selling stock for his own and customer discretionary accounts, upon learning-one-half to three-quarters of an hour before the public-that the issuer had cut its dividend. (See ch. III.F.) to trade on similar information. Although the content and quality of floor information and the "leadtime" of a trader on an exchange floor may be different from the information and advantages noted in these cases, the principle remains the same. Only some strong demonstrable, countervailing public benefit can justify the special advantages enjoyed by the floor trader. Absent such a balancing consideration, floor trading is an anomaly-a special advantage in a public market which can be enjoyed by purchasing access to the floor of an exchange. The anomaly becomes more disturbing in light of the fact that floor traders tend to have a destabilizing influence on prices. On at least 15 separate occasions since 1934, studies conducted by the Commission and the Division of Trading and Exchanges, confirmed by studies made by the Special Study, have shown that floor traders are generally buyers in rising markets and sellers in declining markets, with respect to both the market as a whole and to individual stocks. Their trading, as a result, is inimical to the orderly functioning of the market, tending to accentuate rather than to stabilize price movements. Apart from its effect on price stability, floor trading has been defended on the grounds that added market liquidity and continuity are its beneficial byproducts. There is no doubt that floor trading, as does any kind of trading, adds liquidity to the market. The same may be said, however, of transactions effected in error, pool operations, wash sales, or other transactions generally acknowledged to be undesirable elements of a sound market. That is to say, added liquidity standing alone cannot justify trading that in other respects is deleterious. In addition, floor trading is heavily concentrated in the active stocks where added liquidity is needed least. Finally, to the extent that floor traders improve liquidity; they may on occasion fulfill a specialist's function but they remain totally free of the specialist's responsibilities. Much the same considerations deprive the continuity defense of floor trading of much of its weight. Because floor traders concentrate their trading in the active stocks, the continuity they add is limited for the most part to the stocks that suffer least from lack of continuity. Such continuity, moreover, is obtained at the expense of permitting a type of floor activity that has an adverse impact on price stability. Again, in adding continuity they perform a specialist function without incurring specialist obligations. In at least one respect, the continuity defense of floor trading is definitely less persuasive than the liquidity defense; whereas floor trading may never be said to detract from liquidity, there are occasions on which floor trader participation in the market has a negative impact on price continuity. Due to the tendency of floor traders to trade with price trends, their participation in auction proceedings often adds to the imbalance of buyers and sellers and thereby encourages more rapid and sizable price changes. Floor trader contributions to market liquidity and continuity, in short, are not of sufficient magnitude or importance to warrant retention of this vestigial "private club" aspect of the exchanges. If the exchanges feel problems of market liquidity or continuity exist, solutions should be sought which provide greater assurance of these |