Retail quotations are compiled and supplied to newspapers by or under the supervision of NASD quotations committees. The national list is the responsibility of the National Quotations Committee,257 and the regional lists are under 4 of the 13 district quotations committees. There are also about 65 local quotations committees, in market centers in each of the NASD districts. In general, the committees use the following procedure: The first step is to obtain wholesale bid and asked quotations from one designated dealer for each security on the particular list; there is no practice of obtaining quotations from several dealers for purposes of comparison or selection. The dealer supplying the quotation always knows the purpose for which it is to be used. The dealers are selected with a view toward equalizing the burden of supplying quotations. Although some attempt is made to use as sources those dealers making a market in the particular security, quotations may be supplied by dealers who are not making a market at all. In these last cases, the supplying dealer obtains the quotation from another dealer.

The national and eastern lists are compiled in New York, the mechanics and computations being performed for the NASD by the National Quotation Bureau, which has a separate department for this purpose. The Bureau collects dealer quotations twice a day by messenger; in most other cities, quotations are collected by telephone. After the wholesale quotation is received, it is used as the basis for computing the retail quotation. This computation and attendant problems are discussed below.

The NASD then supplies the retail quotations to newspapers and wire services. The national and regional lists appear only in the New York Times and Wall Street Journal and their regional editions, and a few other New York newspapers. The NASD has considered replacing the one national and several regional lists with a single expanded national list as has already been done by the Wall Street Journal. In the few other cities that have an NASD committee compiling a regional list, the local newspapers carry most of the issues on such list and may also carry quotations on more local issues. For all the other newspapers throughout the country which carry over-thecounter quotations, the NASD local committees supply the quotations on all industrial securities. Quotations on banks, insurance companies, and mutual funds are usually obtained from the Associated Press; but the Associated Press carries no quotations on industrials, and the United Press International's over-the-counter coverage is even more restricted. The NASD has recently been conducting discussions with the Associated Press concerning possible expansion of its coverage.

The NASD's local committees do not confine themselves to quoting securities that appear on the NASD national or regional lists; ordinarily they furnish quotations on many securities actively traded in the area. Each local committee collects quotations from dealers in its area, even for those securities which it quotes that are carried on the national or regional lists. Members of the local committee may submit quotations for any securities in which they make markets, but the acceptance of such quotations usually is determined by the local committee. In some cases, the full local committee may consist of

257 The National Committee has a paid staff of five whose function consists almost entirely of administering the national and eastern lists. See also the discussion of the National Committee in ch. XII.G.

only one or two members, usually those dealers most interested in the publication of quotations. Each local committee, though appointed by the district committee, itself decides which securities to quote and how to operate. Standards vary widely, and there is little supervision over the local committees.

Various committees of the NASD quote approximately 1,000 issues which do not appear on the national or any regional list. Although the NASD's policy is to quote both bid and asked prices in the national and regional lists, quotations provided by local committees are frequently on the bid side only.

One of the major concerns of the NASD has been that some newspapers carrying retail quotations of over-the-counter securities receive them directly from individual dealers rather than from an NASD committee.258 As a result of the efforts of the NASD, this practice has diminished substantially. Local committees are often formed, at the suggestion of an NASD district committee chairman, by a dealer who has been submitting his own quotations to a newspaper. Probably fewer than 40 newspapers throughout the country now receive quotations independently of the NASD.

The NASD opposes and discourages the independent submission of quotations because it feels that the dealer furnishing the quotations and having a byline attributing them to him gets an unfair competitive advantage over other dealers. Moreover, it is argued that the practice may cause confusion among investors, for quotations furnished by different dealers may vary. In Hartford, Conn., for example, two different newspapers accept quotations from individual dealers and the prices for the same security sometimes vary between them as well as varying from quotations on NASD lists. It is also argued that there may be no standards of selection of securities quoted independently. Lastly, according to the NASD's executive director, in some of the cities where local committees were established there formerly had been publication of wholesale quotations.

The NASD has recently considered adopting a rule which would restrict the publishing or circulating of retail quotations by members without prior clearance by an NASD quotation committee.

(2) Nature of retail quotations

The retail bid price involves no computation: it is supposed to be simply the wholesale bid.259 The retail asked price is found by adding to the submitted wholesale asked price an amount determined from a suggested but not uniformly applied NASD schedule called the Rule of Thumb.260 In brief, stocks with wholesale asked prices up to $25 a share are converted to retail asked prices by adding about 5 percent to the wholesale asked price; those selling between $25 and $70 are increased by a markup ranging from 5 to 3.6 percent; those selling between $70 and $100 are increased by a scale ranging from 3.6 to 2.5 percent; those selling between $100 and $135 are increased by a

258 The NASD's Statement of Policy on quotations is: "The Board of Governors believes that the interests of the investing public and the securities business can best be served when published quotations are supervised by NASD Quotation Committees. The supervision of quotations representing the over-the-counter market is properly an industry obligation and responsibility. The Board of Governors urges all members to assist in this important work by releasing quotations for publication only through an NASD Committee." [Emphasis in original.] NASD Manual, G-53.

200 A few local committees reduce the wholesale bid to arrive at a retail price.

200 The Rule of Thumb schedule was last revised in October 1962. For stocks priced above $25, the old schedule provided slightly higher markups.

scale ranging from 2.5 to 2 percent; and those with a wholesale asked price at $135 and higher are increased by approximately 2 percent. In summary, the published retail bid price of a security is the inside bid price supplied by one designated dealer, and the published retail "asked" price is the inside asked price supplied by that dealer, increased by an amount related to the NASD markup policy.261

In some newspapers, the quotations appear under this masthead suggested by the NASD:

262

The following bid and asked quotations," from the National Association of Securities Dealers, Inc., do not represent actual transactions. They are a guide to the range within which these securities could have been sold (indicated by the "bid") or bought (indicated by the "asked") at the time of compilation.

The NASD states that, to the public, NASD quotations mean "objective, accurate retail price ranges within which members of the public could have expected to do business at the time the prices were recorded." 263 To insure accuracy, clerical employees check insertions in the national and eastern lists to see whether the quotations vary substantially from the preceding day's quotations, and a member of the National Committee's staff spends part of his time checking on the dealers submitting the quotations by comparing the newspaper bid against the best "pink sheet" bid, at the rate of about 50 issues every day. Thus, every issue is checked about once a month. If the newspaper bid is lower than the best "pink sheet" bid, subsequent days' insertions are watched and the dealer is warned; if the low newspaper bids continue, the source of that quotation is changed.264 A change of source may occur as a result either of the periodic check or of complaints which prove valid. In 1962, there were about four changes of source, three of which were attributed by the NASD to the uncertainty caused by the May "market break."

The NASD, besides taking a position on the meaning of retail quotations "to the public," states this as their meaning "to the business": Retail quotations designed (1) to give recognition to the fundamental fact that the over-the-counter market is a negotiation market, and (2) to assist retail dealers in selling securities as principal. [Emphasis in original.] 265

Since the meaning for the public is stated to be not only accuracy but also objectivity, the question arises whether retail quotations "designed *** to assist retail dealers in selling *** as principal" can be "objective." As described earlier, the published retail asked prices include a spread over the wholesale asked price, consisting in whole or in part of an unrevealed markup.

In order to determine whether retail quotations provide an accurate guide for retail price ranges, the study analyzed and compared the information in the published retail quotations, the sheets, and the actual trading for randomly selected stocks on a single day. This examina

201 The markup policy itself is discussed in sec. b, below.

262 The Wall Street Journal's masthead over the new combined national list speaks of "prices" rather than "quotations." 203 NASD Manual, G-53.

264 The same procedure applies to newspaper quotations that are higher than bids in the sheets.

In a recently undertaken operation to check on quotations in NASD District No. 10, the NASD staff found that in approximately 5 months, in every case in which a quotation in the sheets differed from that supplied to the NASD for publication, the lower bid quotation was that given to the NASD.

Similar checking procedures have been followed by some local committees.

205 NASD Manual, G-53.

tion also provided data for determining the accuracy with which retail quotations represent underlying wholesale market prices, and revealed the range within which public transactions in fact take place.

Table VII-31 summarizes information comparing wholesale and retail quotations for 73 securities appearing on the NASD national list in the Wall Street Journal on January 19, 1962. These 73 securities are all that appear in the national list, of the 200 randomly selected securities (excluding the exchange-listed ones) for Questionnaire OTC-3. The retail quotations were prepared on January 18, 1962, and represented quotations for that day.

As the table's columns 1 and 4 indicate, the inside bid submitted by the designated dealers to the NASD was reported without adjustment in the newspapers as the retail bid for all 73 securities. The inside asked price, or, offer, generally was then increased pursuant to the NASD's Rule of Thumb. Thus, securities with the same inside offer were marked up identical amounts; the amount of the markup may be seen by comparing columns 2 and 5.

To determine the accuracy with which the retail quotations represent the underlying wholesale markets, the retail quotations published on January 19 are measured against the wholesale quotations which were collected at roughly the same times and which appeared in the sheets received by dealers on the morning of January 19. For this purpose, the NASD Rule of Thumb markup is added to the inside offer of each dealer appearing in the sheets. The results appear in the last four columns of the table. These results show that in many cases the published quotation was not as good-from the public customer's point of view-as one or more quotations appearing in the sheets so adjusted. It must be recognized, however, that the different quotations may have been submitted at different times by the different dealers involved.

On the bid side, for 46, or over 60 percent of the securities, the wholesale bid of at least 1 dealer appearing in the sheets was higher than the retail bid appearing in the newspaper. In 20 of the securities, 5 or more dealers were appearing in the sheets with higher bids.

On the offer side, in 38, or about one-half of the securities, at least 1 dealer appearing in the sheets had a lower adjusted offer than the published retail offer. In a few securities, including Bank of America and Boston Capital Corp., virtually all of the dealers appearing in the sheets had a lower adjusted offer than the retail offer.

In 26 of the securities, the median bid of all dealers who quoted a particular stock in the sheets was higher than the bid which was given to the NASD for inclusion in the newspapers; and in 20 of the securities the median adjusted offer was lower than that which appeared in the newspapers.

Moreover, for 20 securities, or 27 percent of the sample, the dealers who supplied quotations to the NASD did not even appear as market makers on January 18 in the sheets.

This analysis tends to indicate that the foundation of the retail system-the wholesale quotations supplied by designated dealers—is often something less than the best and in a significant number of instances is not as good as the median adjusted market quoted by other wholesale dealers in the sheets.

As shown by column 3, the retail quotations themselves generally contained a spread of from 7 to 10 percent, with some considerably

factors which should be considered and were thus unable to furnish information to support their actions.a

312

Confusions and misunderstandings about its interpretation and application are not, however, the only difficulties with respect to the markup policy. Although its enforcement has added to the protection of investors against the abuses and manipulations of marginal firms and "boiler rooms," it cannot supply (nor is it designed to supply) material facts to investors about the over-the-counter trading

markets.

c. Commission regulation of the over-the-counter retail markets

Regulation of the conduct of broker-dealers in the over-the-counter markets by the Commission has been bottomed primarily upon the fraud provisions of the Securities Act and the Exchange Act.313 On the basis of these provisions, the Commission has developed a number of fraud concepts particularly applicable to the over-the-counter markets, and through the use of these concepts the Commission has articulated standards of conduct concerning the relations of brokerdealers to their public customers.

The first of these concepts is the so-called "shingle" theory. Under this theory, a broker-dealer doing business with the public impliedly represents that he will deal "fairly and in accordance with the standards of the profession." It is based on the premise expressed in the Hughes case that

[t]he essential objective of securities legislation is to protect those who do not know market conditions from the overreachings of those who do.31

The shingle theory was first applied by the Commission to markups charged by over-the-counter dealers 315 and over the years it has been extended to failure to deliver stock certificates promptly,316 unauthorized transactions in a customer's account,317 pledging of customer's securities without authority from the customer,318 acceptance of customer's funds and securities while insolvent 319 and other situations in which the pertinent facts known only to the professional have not been disclosed to customers. Perhaps the most significant extension of the shingle theory has occurred recently in a line of Commission cases dealing with selling practices in connection with high-pressure tele

812 This statement was made to the NASD board of governors in September 1958 in connection with a recommendation to review the markup policy. The recommendation was adopted and culminated in a revision and condensation of the policy in 1960. 313 These fraud provisions are sec. 17(a) of the Securities Act and secs. 10(b) and 15(c) (1) of the Exchange Act (and the rules thereunder). The Commission also has power under sec. 15(c) (2) of the Exchange Act to prescribe means reasonably designed to prevent acts of fraud, deceit, or manipulation in the over-the-counter markets. In addition to powers stemming from the fraud provisions, the Commission's regulatory power with respect to the over-the-counter markets includes the requirement of registration of brokerdealers engaged in an interstate over-the-counter business; rulemaking powers with respect to the financial responsibility of broker-dealers, fictitious quotations and broker-dealer books and records; and a visitorial power over broker-dealers. See secs. 15(a), 15(c) (2) and (3), and 17(a) of the Exchange Act. Except for the areas of financial responsibility, fictitious quotations and books and records, the Commission's power over substantive rules of broker-dealer conduct in the over-the-counter markets are related to standards for the prevention of fraud, deceit, or manipulation in lieu of the general standards of the public interest or protection of investors as in the case of exchange markets under sec. 11. The fraud powers are themselves quite broad but not necessarily as broad as "the public interest or the protection of investors."

314 Charles Hughes & Co. v. S.E.C., 139 F. 2d 434, 437 (2d Cir. 1943). See ch. III.B. 815 See, e.g., Duker v. Duker, 6 S.E.C. 386 (1939).

310 See Securities Exchange Act release No. 6778 (Apr. 16, 1962) and ch. IV.B.3 (b). 317 See, e.g., First Anchorage Corp., 34 S.E.C. 299 (1952).

318 See, e.g., Richard A. Sebastian, Securities Exchange Act release No. 5876 (1959). 10 See, e.g., C. H. Abraham & Co., 186 F. Supp. 19 (S.D.N.Y. 1960).