Simplify and make cheaper transactions in large blocks of stock on the New York Stock Exchange. c. Services covered by the commission rate As already pointed out, a security transaction on the Exchange involves two basic components: (a) Execution of the order on the floor; and (b) clearance of the order, i.e., completion of arrangements for the transfer of the stock certificate and payment for it. Exchange members generally perform, however, a variety of other services for customers in connection with the brokerage business. Certain of these services may precede the transaction, such as rendering investment research or advice, obtaining quotations, or providing a "customers' room" where customers may watch the tape. Some services may follow the transaction, such as the safekeeping of a customer's securities. Other services may be only remotely connected with the transaction, such as the collection and delivery of dividends, rights, and warrants on securities which the customer has left in street name with the broker. For purposes of simplicity, all these regular services are referred to here as "ancillary services. Since the public schedule of minimum commission rates precludes direct price competition, these ancillary services constitute the most significant area of competition among members of the Exchange. And to the extent that such competition tends to improve the scope, depth, and quality of those services which are useful to the public, this would appear to be a desirable characteristic of the rate schedule. It has other effects, however, which may require further evaluation. One is the condition described in the previous subsection. Members' competition for the business of block and volume investors, coupled with the frequent nonutility of normal ancillary services to such customers, has led to the substitution of special services, which may involve substantially more cost than the usual ancillary services. But for a customer lacking the leverage to negotiate such an arrangement, inclusion of the cost of ancillary services in the commission rate may have another effect. Such a customer may well be paying for services he does not want. Nor does he enjoy the usual remedy of taking his business to another member who neither performs the unwanted services nor charges for them. Regardless of where the customer goes to trade in securities listed on the Exchange-unless perchance in the over-the-counter market for listed securities-he must pay the same minimum rates.577 This characteristic of the rate structure may also tend to promote the expansion of ancillary services as a means of maintaining business and attracting new customers. Chapter III.C describes, for example, the development of research and investment advisory services of varying quality, as a competitive measure. This development is beneficial for those who use the ancillary services, but to those who do not, it represents an increase in cost without any corresponding increase in value. 578 The problem of special charges for some types of services has perplexed the Exchange membership for many years. The 1938 rate in 577 The pricing practices in the over-the-counter market for listed securities are discussed in ch. VIII, pt. D. 578 The question here discussed is, of course, closely related to those considered in the preceding subsections. In the case of the nonmember broker-dealer, it is he rather than the member who is likely to provide the ancillary services included in the minimum commission received by the member. In the case of the block or volume customer, the lack of need or desire for usual ancillary services is most likely to be present. crease included a charge on inactive accounts that was rescinded shortly after its adoption.579 In the same way, a schedule of fees adopted in 1940 to apply to dividends, rights, transcripts of statements, etc., was rescinded 26 days after its effective date. A split in the 1958 special committee points up a basic difference in the attitude of its members. The majority pressed a recommendation for both higher commission rates and special service charges: The performance of services requested by certain customers, apart from the complete components of the ordinary commission transaction, is a normal function of a good brokerage business. However, these additional services do result in increased costs and, in the opinion of the Committee, should be paid for by the person requesting them. The establishment of mandatory service charges at reasonable rates will not endanger the competitive position of member firms with respect to other types of financial institutions. The Committee feels * * * that certain mandatory service charges should be imposed which will permit the commission increase to be lower than otherwise would be necessary. A single member of the committee dissented, arguing that— * * * adoption of mandatory minimum service charges would narrow the area of competition among member firms ***. It would be a big step toward making ours a noncompetitive, price-fixed business, a paradoxical step when one considers the free and open auction securities market we jealously guard and the type of economic system we all espouse. * The proposed service charges and the proposed higher commission rates, if adopted, will result in driving more of our customers and potential customers into the eager arms of our over-the-counter competitors." 580 Whether because of the minority report or for other reasons, the board of governors withheld from its membership the majority's proposals on service charges and announced "that the subject should receive further study." The NYSE's present Income and Expense Report does not attempt to determine the cost of ancillary services (or, for that matter, of special services), as distinguished from the basic brokerage function. Despite the Exchange committee's finding in 1958, the Exchange's Special Cost Study reported in 1961 that the identifiable cost relating to "certain traditional services to customers; namely, security custodianship, proxy service, transfers, dividend claiming, etc., appears to be minimal for the test firms and "does not seem disproportionate to that of other sales and services industries." *** More detailed data on the costs of these and other ancillary services might prove them nominal, as the Special Cost Study indicates with respect to those enumerated, thereby reinforcing the present practice of absorbing the costs in the basic nonmember commission rate. A showing of relatively high expenditures for these services, on the other hand, might raise the question whether customers not using them ought to be required to subsidize those who do, and might suggest the possibility that the basic commission rate should cover solely the execution and clearance of security transactions, with all other services being 679 Rate changes since passage of the Exchange Act are discussed in sec. 4.a. below. 580 The dissenting member also objected that service charges would diminish the value of rights and similar offerings, penalize the small investor, cause a loss of revenue to firms already imposing service charges, create difficulties in policing the schedules, render it impossible for margin accounts to effect their own exchanges of securities (1.e., they are "captive" to the mandatory charges), and create additional bookkeeping problems and clerical work. charged for and billed separately. Such a structure would tend to allocate charges among customers on the basis of costs incurred on their behalf. To the extent that this might lead to a reduction of commission rates for customers who do not use these services, it could discourage practices resulting from the rigidity of the present schedule and encourage large block and volume customers to trade on the NYSE. In other words, this might be an alternative and broader approach to the question of providing special rate treatment for the latter category. Still another approach to the problems discussed in the preceding pages, but even more far-reaching in its implications, would be to depart completely from the practice of setting minimum rates in favor of setting maximum rates or establishing minimum-maximum ranges, within which member firms could set their own rates with appropriate regard to services performed. Obviously so drastic a step could not be taken, or even proposed, without much more exhaustive examination of its potential advantages and disadvantages than could possibly have been undertaken by the Special Study, and the reference to it here is not intended as a suggestion for action but only as a course of further study. Yet it is appropriate to point out that many of the knottiest problems of rate structure and establishment of "reasonable" rates, as discussed in this part, might be enormously simplified if "reasonable" rates were not necessarily conceived of as minimum ones. d. Commission rates related to round-lot value One of the thorniest of the problems of the commission rate structure is the scaling of rates to the standard employed as the basis for the schedule, at present the dollar value of each round lot. The application of this principle under the present nonmember commission schedule is illustrated by the following examples of commissions payable on a round lot at various price levels: TABLE VI-CC.-NYSE nonmember commission per round lot The $54 commission cost of a round-lot transaction in a $150 stock is little more than three times the $17 cost of a transaction in a $10 stock. But when expressed as a percent of total value of the transaction, the 0.36 percent factor of the $150 stock is roughly one-fifth the relative cost of the 1.7-percent commission on the $10 stock. Schedule is thus a compromise between a "pure" round-lot type schedule of the kind in effect on the Exchange from 1877 to 1919, and a strict percentof-value type schedule relating the commission to the value of the total transaction. Even as so adjusted, the commission schedule creates an incentive for the broker and his sales staff to sell lower-priced rather than higherpriced stocks. An investment of $15,000 in one round-lot of stock priced at $150 produces a commission of $54; the same investment in 15 round-lots of a $10 stock produces a commission of $255.581 From this point of view, a direct relationship of commissions to dollars involved might be indicated. But in terms of the cost of the brokerage function, quite a different result might seem preferable. In the absence of actual cost figures, it may be assumed that the cost of executing and clearing a round-lot transaction in a $10 stock is substantially the same as it is for a $150 stock, and it might seem to follow from this fact that the number of units should control without substantial adjustment for dollars involved. Yet the present schedule imposes a substantially higher dollar commission rate on the high-priced stock than on the low. There is thus a dilemma. Each of the two approaches avoids one of these two problems but aggravates the other. A percentage schedule would eliminate sales bias since the commission would be the same for a $15,000 transaction whether consisting of one round lot or 15, but the rate might then have only a remote relationship to underlying costs. A straight round-lot schedule would presumably relate the commission rate more closely to costs, but at the expense of a stronger sales bias. Also, the problem is complicated by another consideration-the impact of the commission schedule on the small investor. Thus, one of the principal revisions to the 1958 schedule, recommended by the Commission in 1959 and accepted by the NYSE, was a reduction in the commission rate for transactions involving $100 to $2,400 in amount. This recommendation combines with the policy of inhibiting sales bias to hold down the commission rate on low-value transactions both in dollar amount and a percent of transaction value. This dilemma in the rate structure was the second of the two major problems analyzed by the Exchange's 1953 special committee, the other being the graduated rate for volume transactions. As shown above, the committee's majority has sought to resolve both problems by a fundamentally new commission rate formula. It would have reduced the spread between round-lot transactions in high- and lowpriced stocks, lowering the 1.5 percent charge on round-lot transactions in $10 stocks to 1.24 percent and raising the 0.33 percent for $150 stocks to 0.89 percent, so that the net difference would have been cut from more than 42 times as great a charge on the $10 stock to less than 12. The committee predicted that the narrowing of the spread would correct the "lack of incentive for salesman in higher-priced stocks," and that the reduced dollar rate at the lower end would "encourage the small investor to buy shares." Perhaps in no area of the public commission rate schedule are the factors which have been referred to as the "social principles" of ratemaking as influential as they are here. If a specific level of rates is assumed to be "reasonable" and the dollar value of the round lot is accepted as the basis for the rate structure, there is still an infinite number of possible schedules allocating a "fair" share of the burden. between stocks of different prices. Present resolution of the problem appears to rest on the general acceptance of the principles that (1) investors dealing in high-priced stocks are able to pay a larger share of the cost than those dealing in low-priced stocks, at least on a single round-lot basis, (2) the rate schedule should discourage sales bias, and 581 Cf. ch. III, pp. 253-261 (pt. 1). (3) it should not discourage participation in the market by those who may be in the relatively least advantageous position to pay a pro rata share of the costs involved in that participation. The quantitative expression of these principles is obviously far more difficult than their statement as generalizations. e. Odd-lot commission rates The treatment of commission rates on odd-lot transactions, i.e., generally those involving less than 100 shares, has also been a vexing problem through the years. Special committees of the Exchange reviewed it at great length in 1938, 1942, and 1947, and it was the sole matter for Commission comment when the 1953 rate increase was permitted to become effective without objection. 582 It should be explained preliminarily that the odd-lot customer is charged a so-called odd-lot differential in addition to the commission. Discussed fully in part E of this chapter, the odd-lot differential— 122 cents per share on shares priced up to $40, and 25 cents per share on shares priced at $40 or more-is, in the case of a purchase, added to a price determined by the next round-lot transaction and deducted from it in the case of a sale. The distinction between the commission and the differential is important to the members involved since the customer's broker earns the former while an odd-lot dealer realizes the latter. But to the customer, whether classed as commission or differential, the total of the two constitutes his cost of effecting an odd-lot transaction. The Exchange's special committees in the early years expressed concern with the disproportion between the revenues produced by odd-lot transactions and the relative number of such transactions. It was a major issue in the 1937 report. Ten years later another special committee reported that odd lots contributed 19 cents of each commission dollar but incurred 38 cents of each expense dollar. Its remedy stemmed from its recommendation of a fundamental change in the public commission rate schedule from a charge per share to a charge on money involved per round lot, the basis today. The effect on odd-lot commissions may be seen in the increase for a 25-share transaction in a $50 stock from a $6.25 commission under the 1942 schedule to $16.25 under the schedule proposed by the 1947 committee. The report of the 1953 special committee made no special reference to this question but provided a $2 discount for odd lots. While acquiescing in the proposed rate increase, the Commission entered a caveat as to odd-lot rates, but took no subsequent action to modify them either as proposed or as finally approved. The report of the 1958 special committee is also silent on this subject and, except for the $2 discount per transaction, odd-lot commission rates today are the same as round-lot rates. The operation of the present schedule may be illustrated by a specific case. In a $3,750 transaction involving 75 shares of a $50 stock, the commission is $35.75 and the differential $18.75, for a total of $54.50. In comparison, the commission on a round-lot transaction in the same $50 stock is $14, while a round-lot transaction involving $3,750; i.e., 100 shares of a $37.50 stock, would involve a commission of $37.75. 582 See sec. 4, below. 96-746-63-pt. 2- -22 |