a change and, if necessary, public hearing, to compel amendment or adoption of a different rule. The Commission has no authority to suspend a rule prior to completion of an administrative proceeding, nor does it have power to compel retroactive adjustments. Again, the legislative history does not reveal any special concern with the treatment of rules relating to commission rates as distinguished from other exchange rules.545

(3) The nature of the securities commission business differs sharply from that of the typical public utility commonly associated with fixing and regulation of rates. Thus no single firm has a franchise conferring upon it special monopoly rights-commission rates are set uniformly for all member firms. Moreover, no substantial capital investment in fixed plant equipment is normally required, and volume characteristics of the securities business are markedly different from those of the typical public utility.

(4) Finally, the commission rate is designed to provide compensation not only for a service performed in all cases-execution and clearance of agency transactions-but also for such ancillary services of various kinds as are performed by the different member firms competing with one another.

These points are further elaborated below.

2. STRUCTURAL ASPECTS OF THE PUBLIC RATE SCHEDULE

This section singles out certain aspects of the structure of the public or nonmember commission rate schedule because of their distinctive repercussions not only upon public customers but also on professionals in the securities business who are not members of the NYSE, on the regional exchanges and their members, and on both mutual funds and their shareholders. The next section examines structural aspects of the members' rate schedules. While these structural aspects involve issues of basic importance, many of which have been the subject of numerous studies and differences of view within the Exchange community, they have only in limited respects received the formal attention of the Commission.

a. Nonmember professionals pay the same rate as other customers Under the public commission schedule of the NYSE, a nonmember broker must pay a member the same commission that his customer would pay if he were to place the order directly with a member. Yet the nonmember incurs, in addition to the commission cost, overhead and other expenses incident to securing and transacting the business. Since competition normally prevents the nonmember from charging his customer any more than the rate charged by a member, his gross income from the transaction generally equals the commission he pays to the member, notwithstanding his other costs. Yet unless he accepts such NYSE business placed with him by his customer, he runs the danger of losing both customer and business altogether.

Such business is important to the NYSE. Its studies conducted between 1952 and 1960 show orders from nonmember brokers to the NYSE for public individuals, institutions, and others accounting for 11 to 24.3 percent of total share volume effected for the account of

545 A provision of the original bill (sec. 18(c) of S. 2693, 73d Cong., 2d sess.) empowered the Commission to fix rates directly, just as it was authorized to deal directly in most of When the present machinery of sec. 19 (b) the other areas now covered by sec. 19(b). was substituted, no attention appears to have been given, at least on the record, to its impact on the review of commission rates.

institutions and intermediaries, which during this period represented about 20 percent of the Exchange's total volume.546 Such transactions at full commission rates are obviously profitable to the NYSE member, and there is incentive for him to make it attractive for the nonmember professional to forward it to him. But the constitution of the Exchange provides that commissions paid to the member shall be-*** net and free from any rebate, return, discount or allowance made in any shape or manner, or by any method or arrangement, direct or indirect." Member and nonmember must then devise some other means of both reimbursing the nonmember and attracting the business to the member. Attempts to bypass this NYSE antirebate provision have been the single most important cause of the development of what are generally referred to as "reciprocal business arrangements" and "special" services among member and nonmember firms.

(1) Reciprocal business arrangements

The member desiring to reciprocate for commission business given him by a nonmember professional can do so by returning commission business to the nonmember. There are several methods, only the most important of which can be mentioned here: he may place business on a regional exchange with a nonmember who is a member of that exchange even though (a) the member is also a member of the regional exchange (dual member) and could have placed the business there directly or (b) the security is traded on the NYSE as well as the regional exchange (dual listing) so that the dual member could have effected the transaction directly on the NYSE. He may place orders for unlisted securities with the nonmember to be transacted over the counter, even though the member firm may have a trading department capable of effecting the transaction directly. This reciprocal commission business is generally placed under arrangements involving "reciprocal ratios" of 2 to 1, 3 to 1 or similar ratios; that is, the NYSE member will direct $1 in commissions to the nonmember for each $1.50, $2, or $3 of commissions received.548 The ratio always favors the NYSE member.549

A variation of the basic type of reciprocal commission arrangement is cited in the testimony taken by the Special Study of a partner in a member firm of both the NYSE and the Philadelphia-BaltimoreWashington Exchange and himself an active specialist on the latter exchange. Many of the firms which are members of the regional exchange but not of the NYSE give this firm orders to execute on the NYSE. When asked what his firm gives, by way of reciprocity, to such regional members, the partner answered:

A. We eventually will give that man clearance 50 to the extent, we will say, of roughly 50 percent. It would not be in excess of that. That will net him about 40 percent, after he pays floor brokerage and clearance charges.

Q. What kind of clearance business will you give him? Where will it come from?

A. If Laird, Bissell & Meeds [an NYSE member firm] will sell us 500 General Motors, instead of giving up our name on the transaction we will give up the name of a local member to whom we wish to give clearance business.

548 NYSE, "Ninth Public Transaction Study," p. 11 (1959); "Tenth Public Transaction Study, Pt. II,” p. 10 (1960). 547 NYSE constitution, art. XV, sec. 1.

548 See pt. E of ch. VIII.

540 Apparently as a result of reciprocal arrangements of all kinds, one nonmember firm advised the study that despite the antirebate provisions of the NYSE constitution the firm ultimately receives in return the equivalent of approximately 40 percent of the commission on NYSE business forwarded to member firms.

650 The term "clearance" here seemingly refers to both execution and clearance of a transaction.

If a bank, for instance, gave us 500 Pennsylvania Railroad to sell, we would give up the name of some local broker on that transaction. He would act as clearance agent on that. Therefore, it would come both from firm trading and from customer business.

Q. What is the ratio here?

A. I do not know, possibly 60 to 40; 60 percent firm and 40 percent customer, in our case. In other cases it might all be the customers.

Upon first impression, one might regard a practice such as this as typical of reciprocity in many industries in which a firm reciprocates for orders from a customer by placing business with him for goods or services it cannot provide itself. Thus, securities commission firms commonly receive brokerage business on a reciprocal basis from commercial banks in which they maintain sizable accounts.551 is a fundamental difference in reciprocal commission arrangements between brokers, however, because the NYSE member is generally able to handle directly, and at least as effectively, the business he places with his reciprocal partner.

There

The extent of these reciprocal commission arrangements is revealed in the returns to the Special Study's questionnaire EX-4. Of 447 members of the four largest regional exchanges not members of the NYSE (i.e., "sole members"), 298 reported participation in such arrangements in ratios ranging up to 3 to 1, but with 2 to 1 most popular. Of the 285 members reporting on the income received from such arrangements, 41 attributed to them at least 40 percent of their income, and 175, or 61 percent, attributed a minimum of 20 percent of their income to this source. (Tables VI-z to VI-bb.)

TABLE VI-Z.-Number of sole regional exchange members having reciprocal arrangements

TABLE VI-aa.-Nature of reciprocal arrangements of sole regional exchange

Excludes 18 members who have reciprocal arrangements but did not furnish complete information

See ch. VIII.C.4.c.

TABLE VI-bb.-Proportion of total exchange income received from reciprocal business by sole regional exchange members

1 Excludes 13 members who engage in reciprocal business but did not furnish complete information.

Return by an NYSE member of cash to his reciprocal correspondent for commission business would violate the antirebate rule cited above, but the return of a cash equivalent in the form of profitable security commission business which might have been transacted directly by the NYSE member is permissible. The distinction is obviously a fine one and it has produced a fertile field for administrative interpretation. The Exchange's published constitution and rules have never officially recognized a need to regulate reciprocal commission arrangements. Its rule 369 outlaws 10 specific commission practices either outright or under specified conditions, but does not mention reciprocal arrangements with nonmember professionals. An NYSE interstaff memorandum illustrates that the problem is present and is a perplexing and demand one:

In general, the Exchange does not object as a matter of policy to the existence of reciprocal arrangements, per se, even when they are based upon a ratio, such as 2 for 1, 1 for 3, etc., provided any business directed to the nonmember is bona fide business, and does not involve so-called "generated" business or "allocated" trades, and further provided any ratio is not guaranteed and no deficiency in the amount of business given by the member to the nonmember is paid or made up in cash. If a member firm has a well-organized and wellstaffed department for handling, as an example, over-the-counter business, the Exchange probably would object to that firm's directing all of its over-thecounter business to a nonmember under a reciprocal arrangement.

Testimony to the Special Study by NYSE staff officials Frank Coyle and Walter Coleman served to point up the problems of interpretation. Coyle and Coleman confirmed that the first sentence in the quoted paragraph still represents the policy of the Exchange. They noted that an "allocated" trade "would be a transaction which is a bona fide trade but, as an example, might have been executed by me as a broker and I would give bookkeeping credit to someone else for having executed when in fact they would not." An example of "generated business" was given by Coleman as "*** a transaction which I originate as principal, not as customer. I might as a broker give you an order for which I had no particular need." Coyle defined the term as "an order created solely for the purpose of paying you a commission for executing it in a stable security where the risk is not high and where I would reverse the transaction again giving you another com

mission." The witnesses were asked "* * * does it matter if the ratio is a firm one or not?" and the testimony proceeded as follows:

A. [By Coyle] To my way of thinking it makes no difference at all what the ratio is. If the reciprocity is merely on a business basis that I give you business because I think you can execute it, and I hope you give me business for the same reason, and we will try to keep even with each other, and so long as I have sufficient on your exchange to match what you give me on my exchange, and the rates I pay for that are proper, I see no objection to it whatever.

Q. The paragraph goes on to say that if a member firm has a well-organized and well-staffed department for handling, say for example, over-the-counter business, the Exchange probably would object to that firm directing all of its over-the-counter business to a nonmember under a reciprocal arrangement. Is that the present policy of the Exchange?

A. Well, I have got to add a little explanation with it, yes, with this explanation. By agreeing to give all your business in over-the-counter securities to one broker, you may not be servicing your customers properly because he may not properly cover the waterfront. An unlisted market is not the same as a listed market where there is a central point and policies, and records of the transaction. We think it is the duty of the broker to do the best for his customer and by promising to give all the business to one person willy-nilly might violate that.

Q. The policy refers to a "well-organized and well-staffed department." How many member firms of your Exchange meet this test, percentagewise?

A. Again you are reading from a memorandum, an interstaff memorandum, which was not written with the idea that it was going to be a legal matter for all time and it is one member of the staff telling another member of the staff in general terms broad policy. I think I would have to get a definition from you as to what you mean by a well-organized and completely staffed department to answer your question as to how many firms have them.

The complexity of the problem becomes apparent. Reciprocity arrangements representing "generated" or "allocated" business violate the antirebate rule; reciprocal business based on the member's "hope" that he can secure return business is legitimate. The arrangements referred to above actually fall somewhere between the extremes. The member normally directs business to his reciprocal correspondent with something more than "hope" that his correspondent will reciprocate. Members' reports of such agreements filed with the Midwest Exchange under its commission rules indicate the firmness of the understanding on which they are founded. This general recognition of the existence of reciprocal ratios elevates the basis of these arrangements from the level of "hope" to that of reasonable expectation based on informal agreement, often crystallized by years of business relationship and always subject to the sanction of cancellation if the correspondent fails to maintain the agreed ratio.

The NYSE's task of policing the antirebate rule in this field extends beyond its own floor. Because its members often discharge their reciprocal obligations by placing business with reciprocal correspondents for transaction on the regional exchanges, the question is presented concerning the Exchange's power to prohibit a member from engaging in a practice permissible under the rules of a regional exchange but constituting a rebate under its own rules.

A prime example of this conflict is the problem discussed at a Toronto meeting of top officers of the NYSE and the presidents of some of the regional exchanges in October 1952. At issue was the question of the amount of the commission to be paid by a dual member to a regional-only member on reciprocal business. At that time most of the regional exchanges either provided that the member "execu