but stresses that it shall be "in confidence." In any case, it is not clear that the letter or the rule assures an adequate interval of time for the Commission to review the specific forms of a proposed change before it may become effective.

The need for a more adequate procedure to allow an orderly review of commission rates presumably can be met without statutory amendment, by the Exchange's exercise of its original powers to adopt rules governing commission rates or by the Commission's exercise of its secondary power to compel the adoption of such rules by appropriate order under section 19(b). Of prime importance would be a rule assuring the Commission of more ample notice before institution of a specific change of rates. In addition, consideration should be given to the feasibility of a rule providing for the refund or adjustment by Exchange members of any interim "excess" payments if a rate increase is to be put into effect before the Commission formally acquiesces.

Whether the time permitted for review of specific rate changes is measured in weeks or months, however, a further prerequisite for full discharge of the Commission's reviewing functions in the future would be that the Commission's staff include qualified persons with the responsibility of keeping abreast of relevant data and advising the Commission of changing conditions or needs. In light of changes that have occurred in the past and may be expected in the future in respect of the general economics of the business, the methods of doing business, and the costs of performing particular functions, income, cost-and-profit relationships may also be expected to undergo change from time to time. The whole subject is too complex for occasional, ad hoc attention at the time of a proposal to change a rate schedule. A program of continuous compilation and analysis of data is essential.

5. SUMMARY, CONCLUSIONS, AND RECOMMENDATIONS

Stock exchange commission rates-the fees paid to a member of an exchange for effecting transactions on the exchange-are established by rules of the respective exchanges, subject to review by the Commission. Section 19 (b) of the Exchange Act authorizes the Commission to review, and if "necessary or appropriate for the protection of investors or to insure fair dealing in securities traded in upon such exchange or to insure fair administration of such exchange"-to alter or supplement, the rules of registered exchanges with respect to the "fixing of reasonable rates of commission ***." In examining the subject of commission rates the Special Study has been concerned, first, with the structure of rates and the impact of that structure on the securities markets generally and, second, with the procedures and standards involved in the setting and review of rate levels. It has not considered or evaluated specific commission rates, past or present. The NYSE nonmember rate schedule has been followed, with few variations, by the Amex and the regional exchanges. Since 1947 commission rates have been based on the money involved per round lot. The amount of the commission per round lot varies with the value of the stock, but the schedule omits other possible differentiations: -11 nonmembers, whether or not professionals in the securities business, pay the same public commission rate (the Amex and some of the regionals provide important exceptions here); the rate per round lot is the same regardless of the number of round lots involved in a trans

action; and the rates include the cost of various services provided by members to customers, ancillary to the basic brokerage function.

Among the consequences of these characteristics have been the establishment of a variety of ad hoc practices designed to temper the rigidity of the schedule without violating the letter of the NYSE's rule prohibiting members from granting commission rebates to nonmembers. Some are aimed at special treatment of nonmember professionals. Most important are the reciprocal arrangements between NYSE members and nonmembers who are regional exchange members (i.e., sole members) which permit NYSE members to reciprocate for commission business given them by the nonmember by referring other commission business (often for stocks traded on both the NYSE and the regional exchange) on an agreed ratio, for transactions by the nonmember on the regional exchange. Of the 447 sole members of the 4 largest regional exchanges who reported to the study, 298 participated in such arrangements, 175 attributing a minimum of 20 percent of their income to this source. Nonmember professionals forwarding business to NYSE members may also receive substantial special services, extending beyond the usual services performed by Exchange members for their public customers.

The absence of a block or volume discount in the schedule has given rise to similar arrangements between NYSE members and some of their larger customers, generally institutions. Members also perform a wide variety of special services for such customers; these include special research projects, installation and maintenance of wires, and the development of sales and promotional services for mutual funds. In addition to these services, block and volume investors-chiefly mutual funds (see also ch. XI.C)-are permitted to direct reciprocal give-ups of commissions. This practice allows the mutual fund to instruct its broker to give up a portion of the commission to another broker in return for services which it has rendered to the fund or, more usually, its underwriter or adviser. The regional exchanges have been employed to channel such give-ups of commissions to their members and, in the cases of three of the regionals, to certain classes of nonmembers who are members of the NASD.

The various practices designed to ameliorate or avoid the impact of the Exchange's commission schedule have produced a variety of questionable consequences. They have greatly complicated the administration of the commission schedule, requiring subtle and shifting lines of distinction between prohibited rebates and permissible arrangements. They have involved not only the NYSE's regulation of the practices of its own members but also its relationship to other exchanges. They have, to some extent, clouded the cost data used to support changes in commission rates. Two of these practices, the reciprocal commission arrangements and the give-ups of commissions, have created delicate conflict-of-interest questions. Despite these consequences, the practices have not fully met the underlying needs, and their failure to do so has spurred a diversion of trading volume from the NYSE to other markets. 620

Another structural characteristic of the NYSE's nonmember commission schedule is its coverage of services performed by brokers in addition to the execution and clearance of transactions. Such ancil

620 See ch. VIII, pts. D and E.

lary services are generally not charged separately, and their cost is included in the basic commission rate. The practice encourages competition among brokerage firms in the area of service, but it also aggravates the impact upon institutional investors of the absence of a volume or block discount since they often do not require ancilliary services provided by brokers to other public customers.

From time to time the NYSE has considered possible solutions to these major problems of rate structure but has rejected them. In 1953 a thorough overhaul of the rate structure proposed by a special Exchange committee was repudiated by the membership (after revision by the Exchange's board of governors). In 1959 the Commission announced that the Exchange had agreed to initiate study of a block or volume discount, but the latter study was not commenced until late 1962. It is essential that studies of the rate structure proceed with dispatch and that attention be given to the many facets of the problem affecting competitive markets as well as the Exchange, not from the limited view of the Exchange (or groups of its members) but of the greater public interest involved.

Review of the level of commission rates presents at least equally complex problems as those of rate structure. The unique character of the security commission business precludes any blanket adoption of standards employed in reviewing rates in other industries. Factors shaping that character include (1) the multiplicity of firms (even though the total is limited), (2) an erratic and largely uncontrollable volume factor, and (3) competition with other markets and other media of investment.

The various changes in commission rate level which have taken place since enactment of the Exchange Act have been explained on the basis of a relationship, variously stated, between commission rates on the one hand and income, costs, and profits on the other. Important questions are presented at every stage of the determination. Thus, the basic operating data for the individual firm are reported on an Income and Expense Report, which was revised in 1961 as a result of a cost study undertaken by the Exchange at the instance of the Commission 2 years earlier. The present form is a notable improvement over its predecessor but its ultimate usefulness in the review of rates will depend on its being supplied by all firms rather than on a voluntary basis and also on its adaptability in relation to criteria and standards that remain to be more clearly articulated.

While the "profit" of the member firm from its security commission business, as derived from the Income and Expense Report, has been considered relevant to the setting of "reasonable" rates, its significance has not been made clear: changes in the content of the term (for example, including or excluding interest earned on customers' debit balances in margin accounts) have given it different meaning at different times, and dollar amounts have been converted to percents of commission income without an indication of the significance of the result in relation to professed objectives of "fair return" or the statutory standard of reasonableness.

The multiplicity of firms complicates the determination of "reasonable" rates in relation to income, cost, and profit data. One type of question relates to whether data are to be combined in respect of all firms, "efficient" ones (however that term may be defined), or

any other grouping. Another relates to the types and amounts of costs to be recognized, in a context of competition among firms and with other markets and in light of the public interest in promoting a high level of performance in the securities commission business. Further, characteristic fluctuations of volume and the relatively high proportion of fixed costs in the securities commission business add complexities to the determination of "reasonable" rates applicable to a multiplicity of firms.

Both the nature of the problem of arriving at "reasonable" rates and the manner in which the rates are initially set by exchange rule point to the importance of the Commission's role of oversight to protect the public interest in this area. Improvements appear to be called for in three respects. First, there is need for more complete data to be gathered on a continuous basis, relating not alone to the securities commission operation but to its place in the economics of the securities business generally. Unit cost and transaction data would be useful for a proper understanding and evaluation of the rate structure. The Income and Expense Report should generally provide the information necessary for application of such criteria of reasonableness as may be adopted.

The second major desideratum is the public articulation by the Commission of such criteria. This appears to be one of those "basic matters" which calls for the "need of a more carefully articulated enunciation of *** views *** in the interest of clarifying policy not only to outsiders but to the Commission itself." 621 The goal is not to strive for exactitude in satisfying a specific rate formula, but to adjust divergent interests in accordance with reasonable, objective standards. A clear articulation and public expression of such standards by the Commission must be considered a major objective.

Finally, the procedure for the review of commission rates requires strengthening. Under section 19 (b) of the Exchange Act, which defines the relationship of the Commission and exchanges in this area, it is possible for the Commission to be confronted by a commission rate change, without previous notice, as an accomplished fact. This has been ameliorated by agreement after the 1958 increase, but the importance and complexity of the Commission's role require strengthening of procedural arrangements with the exchanges and of the Commission's internal arrangements for fulfilling its role. The Special Study concludes and recommends:

1. The present nonmember commission schedule of the New York Stock Exchange does not take account of important distinctions such as (a) whether the nonmember is or is not a professional in the securities business, (b) the effect of volume of a particular customer's business (whether measured by size of single orders or volume of orders over periods of time) on the cost of serving that customer, and (c) a particular customer's use or nonuse of ancillary services covered by the commission rate. Each of these aspects is far too complex in its own right and too involved with other complex questions to be the subject of specific recommendations of the study-indeed they are probably not capable of simple answers after longer study. The broad conclusion can be

13-B Sharfman, "The Interstate Commerce Commission." p. 764 (1931–37), quoted in Friendly, "The Federal Administrative Agencies," p. 142 (1962).

reached, however, that they involve important questions of public policy to which the Commission should address more positive and continuous attention than it has heretofore given.

2. Under the present rate structure of the New York Stock Exchange, members are required to charge the same minimum commissions to all nonmembers including nonmember broker-dealers, with the result that a nonmember broker-dealer has no incentive to bring business to the Exchange except by resorting to one of several complicated, and often artificial, devices that have been created to provide indirect compensation. The Amex and various regional exchanges, on the other hand, have forms of associate memberships or special commission rates for specified categories of nonmembers (including non-broker-dealers in some instances); and the availability of these measures on regional exchanges has been the basis of some forms of reciprocity and the source of some business on such exchanges. The advantages and disadvantages of associate memberships and/or special nonmember commission rates, from the viewpoint of the NYSE and its members and of the public interest, should be a subject of joint Commission-Exchange study, particularly with reference to problems of competition, depth of markets, and reciprocity.

3. The absence of any volume discount in the commission rate structure of the NYSE has had the effect, among others, of inducing mutual funds and their brokers to adopt various arrangements to channel a portion of commissions paid by them for portfolio transactions to other members and nonmember brokerdealers as extra compensation for selling mutual fund shares. The Commission announced in 1959, in connection with its consideration of other aspects of NYSE commission rates, that the Exchange had agreed to undertake a study of a volume discount, but it appears that such study was not begun until late in 1962. In view of the public importance of the subject and the complexity of the issues involved, the Commission itself should undertake a broad study with the aid of or in conjunction with the exchanges and other affected institutions and parties.

4. The present nonmember commission rate of the NYSE does not provide any reduction in commission for customers not desiring or using the ancillary services usually included under the commission schedule and thus gives added incentive to various forms of reciprocity. As part of its general and longer range studies in respect of commission rates, with the aid or in conjunction with the Exchange and other interested parties, the Commission should consider the feasibility and desirability of (1) a separate schedule of rates for the basic brokerage function and for ancillary services, or alternatively (2) a schedule of maximum rates, or minimum-maximum rates, covering all services.

5. In relation to the brokerage business-a service business-the term "reasonable rates" cannot have the same meaning as in utility rate regulation involving a property base, yet there have been no official expressions of its significance in the present context. While the determination of "reasonable" rates of commission is an extremely complex matter at best, objective standards for measuring reasonableness could and should be more clearly