taken whether or not such a system is established. Likewise, although developments in automation would tend to facilitate some of these reforms and might tend to make others academic, the reforms can and should be undertaken regardless of the manner or pace of applying automation in the over-the-counter markets. These reforms are of various kinds but most of them have essentially the same objective, in response to essentially the same need. The need is one arising out of the multiplicity and heterogeneity of markets and professional participants that have been apparent throughout this discussion of overthe-counter markets. The objective is to meet this need by means of disclosure providing more reliable and more readily available information about markets and prices than exists under present rules and practices.

It has been seen that the securities and markets constituting the broad over-the-counter category range from well-known, established companies with a substantial number of dealers making a close and competitive market at one extreme, to obscure, recent issues with a single dealer dominating the market, quoting widely spread bid and asked prices, and combining wholesale and retail trading at the other extreme, and with many variations and gradations between the two extremes. An investor's reasonable expectation when he buys an over-the-counter security necessarily depends on where in the broad spectrum the particular security falls. Just as he needs basic disclosures about over-the-counter securities themselves, he needs basic disclosures about their markets. He should be afforded information about the depth of dealer interest and the identity of the dealers making the market,339 so that he may have some conception as to the prospect for continuous marketability. He should have access to information about price spreads in the interdealer market so that he may have some conception of the level at which a sale may be expected to occur in relation to the level at which a purchase can be made. He should have access to information about prices in the interdealer market-on which the retail market in which he deals is ultimately dependent in a most fundamental sense-so that, in addition, he may have a basis of knowing how good an execution was obtained, and what cost of execution was charged by his own broker-dealer. Such disclosures are not only needed for intelligent investment decision by the customer, however; as in all other areas of disclosure, they serve the important prophylactic purpose of silently policing the performance of the broker-dealer himself.

One such reform, or set of reforms, relates to the reliability and informativeness of the wholesale quotation system. Such a system provides information that is basic to everything else because it tells at any given time and over spans of time what dealer interest exists,

One NASD official described the importance of the identity of dealers making markets in this way: "I had been on the Business Conduct Committee now for the past year and come to grips quite frequently in the markup cases. I do not want to sound ethereal, but I think there are several abstractions that I have looked to and I suspect others have.

"No. 1 is the security question. If I see the Bankers Trust, First National City Bank, Dun & Bradstreet, large, reputable companies, that is a factor in my judgment. I know I can trust the market. I look to the people who are making the market, if you please. Are the firms reputable; are they knowledgeable; what is the background of their interest; do they have traditional underwriting relationship, and so forth and so on; or are these firms part of a group which are known in trade as to operate on the fringe and go hand-in-hand and work in concert with each other and what not?

"These are all factors that I have tried to utilize to determine what I think is one of the pivotal things; the validity of this market."

the basic price levels at which particular securities are capable of being bought and sold, and the spread between these levels. In its present form, however, it fails to reveal important information that can and should be readily disclosed. In particular, it fails to differentiate in any way the quotations of an independent market maker from those of another broker-dealer who may, for convenience or with insidious purpose, be quoting merely a carbon copy of someone else's market. Other significant improvements in the wholesale quotation system are recommended below but unquestionably the most important single reform would be to impose a requirement for clear differentiation of quotations entered for correspondents and quotations representing multiple expressions of the same market.

Another needed change, of especial value after the quotation system has been made more reliable and informative but independently useful apart from that, is to make the wholesale quotation system publicly available. Of all the mechanisms of the over-the-counter markets it is the most crucial. It is crucial because everything else that occurs in the over-the-counter market ultimately depends on what that system most clearly and conveniently shows the number of interested dealers and the prices at which they are willing to buy and sell. Although reflecting the wholesale level, it is the most reliable indication of what can be done at the retail level, and thus the best measure of the quality and fairness of what happens there. Some non-broker-dealers now have access to the sheets although it is denied to most, a form of discrimination that itself seems highly dubious in a fair market or a free and open one. But apart from this, under a regulatory system founded on disclosure as basic to the protection of investors, the policy of nondisclosure of the most vital single source of information about over-the-counter markets should no longer endure.

The same conclusion, for similar reasons, applies to the retail quotation system of the NASD. This system starts with a selection, out of the welter of over-the-counter securities, of those commanding sufficient public attention to be included in what must necessarily be a more selective newspaper (or electronic) listing. The present retail system provides a convenient source of information beyond what is available for most over-the-counter securities, but it has the effect of masking the interdealer market rather than disclosing it. As a result, it provides no means of testing the quality of execution or ascertaining the service charge imposed for the execution at the retail level. It may be granted that the range of variation in the handling of transactions is kept within limits by the NASD's markup policythe variation would not ordinarily be a matter of several points but perhaps a point or two at the most-but in buying and selling securities the latter range, or even fractions of points, may be the all-important difference between a favorable and an unfavorable result. The investor should not be denied, through the retail quotation system or otherwise, the ability to perceive such differences.

Both for securities in a retail quotation system and for the larger mass of securities not so quoted, certain disclosures are so important that they ought to be regularly made in confirmations of transactions or, where practicable, at the time of solicitation. Of particular consequence, for reasonable investor awareness of what he buys and how

his transaction is handled, is knowledge of whether the broker-dealer is executing a retail transaction out of its own inventory or another firm's and whether an independent market does or does not exist. Where the executing broker-dealer is in reality acting as agent as in a riskless transaction, in the sense of buying or selling in the interdealer market to accomplish the customer's transaction, the agency form should be required so that the price and commission will be disclosed. The problems of disclosure and fair dealing are more difficult where the broker-dealer has an inventory through which the customer's transaction is handled, but it is precisely here that the markup policy is most difficult of application and in greatest need of supplementation through disclosures. The investor should have the means of appraising the quality and cost of execution, even though merged in a single net price charged by the integrated broker-dealer, through knowledge of the approximate level at which the transaction might have occurred in the interdealer market if it had been executed on an agency basis.340

In these and other respects specified below, the full disclosure philosophy needs to be given new meaning and vitality in over-thecounter markets. It seems quite inconsistent with that philosophy that broker-dealers, whether or not making a market or having an inventory position in a security, may engage in principal transactions with public customers but not disclose whether they are dealing with their own inventory, whether and what kind of an independent market exists, or the amount of their markups in relation to the independent market.

Quite paradoxically, the NASD has resorted to a theory of direct regulation rather than disclosure in this area, in the form of its markup policy. This approach, as supplemented by the Commission's use of its fraud powers in regulating over-the-counter markets, sets important outer limits of conduct and undoubtedly precludes gross overreaching. These limits are still wide enough to be important, however, and within such limits, as in other areas of the securities markets, there is no satisfactory substitute for full and reliable disclosure to investors of facts essential for intelligent appraisal and self-protection.

The merchandising character of the securities business is recognized at various points in this report, and it is a necessary corollary that selling and other costs as well as entrepreneurial profit must be adequately provided for in any pricing system.341 Nothing herein is intended to contravene these facts of business life or to suggest that any particular level of commissions or markups, equivalent to stock exchange commission rates or based on a "5-percent policy" or otherwise, is appropriate or inappropriate for over-the-counter transactions generally or any particular type of transactions, security, broker-dealer firm or geographical or other circumstance. Whatever the appropriate level of markup or commission for a particular transaction and assuming that it may vary in different circumstances, it is difficult to see why

340 It has already been seen that many firms in the entire volume spectrum now use agency executions (with disclosed commissions) for many securities of varying degrees of activity. See 2.a, above.

341 Carrying out the recommendations of ch. IX to provide regular reporting data for over-the-counter securities should considerably reduce the dealer's burden of research which has often been cited as a reason for higher costs of doing business in such securities.

it should be necessary to conceal what elsewhere in the securities business is considered essential to be disclosed. It is a standard requirement, for example, that there be complete disclosure of the spread in underwritten offerings, often amounting to as much as 10 percent or more on common stock issues, and of the sales load on mutual fund shares, typically amounting to 812 or 9 percent. Disclosure in these situations has not discouraged merchandising activity or successful selling, and it is not apparent why it should do so in the over-the-counter markets generally.

6. CONCLUSIONS AND RECOMMENDATIONS

The Special Study concludes and recommends:

In view of the heterogeneity of over-the-counter securities and markets and the need for categorization of components, as emphasized in the above discussion, the following program is put forth with recognition that the measures recommended are not necessarily equally applicable to all securities, broker-dealers, or markets, so that the appropriate scope and limitation of particular measures may require a more exact definition in the process of implementation. It is also recognized that, while the following recommendations are designed as a total integrated program, the form and timing of the implementation of certain of them might have the effect of lessening the need for others.

1. In the over-the-counter markets, there is a dichotomy between interdealer (wholesale) and public (retail) markets in many important respects, but there is a close and continuous relationship between wholesale and retail markets for any particular security. Interdealer and public quotation systems are vital to the operation of these markets and, whether handled by private enterprise or by a self-regulatory agency, they are vested with a public interest and should be brought under appropriate supervisory control of the Commission. At the same time, the operator of any such system would be vested with authority and responsibility to regulate the use of its system by broker-dealers through appropriate rules and procedures consistent with the rules of the NASD and the Commission.

2. Broker-dealers, although entirely free to change their interdealer quotations in the course of trading as at present, should be positively obligated to buy or sell 100 shares (or other indicated "size") of a quoted stock at their prevailing quotations, unless clearly designated as not firm, and should be required to keep a timed record of changes in quotations. All quotations entered in an interdealer quotation system should be firm, unless otherwise designated, when supplied. The NASD should establish appropriate programs for surveillance and enforcement of these obligations. The NASD and/or the Commission should have the power and responsibility to deny or temporarily suspend any broker-dealer's right to enter quotations in an interdealer quotation system with respect to a particular security or all securities, for willful abuse of a quotation system (e.g., by entering other than bona fide quotations) or willful violation of any special rules applicable to interdealer quotations.

3. Other rules applicable to interdealer quotation systems and/ or to broker-dealers using such systems should require (a) that quotations entered by one broker-dealer on behalf of another be so designated by appropriate symbols, with clear differentiation between correspondent arrangements and other arrangements involving this practice, and with clear indication where two or more quotations in different names respresent a single quotation; (b) that "OTC listed" securities (see ch. IX) 842 be differentiated from all other securities by appropriate symbols, and that securities eligible for extension of credit (see ch. X) be designated by separate symbols; and (c) that, consistent with the recommendation in paragraph 9, persons other than broker-dealers be eligible to become subscribers to interdealer quotation systems, and that broker-dealers be required to make available to their regular public customers, upon request, any quotation system to which they may be subscribers. In addition, upon establishment of a system for identification of "primary market makers" as recommended in paragraph 4, consideration should be given to a further rule providing that primary market makers for a particular security should have the exclusive right (subject to possible defined exceptions) to enter two-way quotations in any interdealer quotation system; whereas any other broker-dealer, although free to enter one-way or OW or BW quotations, should be permitted to enter two-way quotations only as correspondent for an identified primary market maker.

4. Because of the large numbers and varieties of securities and participants involved in the over-the-counter markets, the quality and depth of the market for any particular security and the reasonable expectations of investors in such security are intimately related to the number and identity of dealers making an interdealer market. As a foundation for various immediate or longer term improvements in the operation and regulation of over-the-counter markets, a system for official identification of the "primary market makers" in each security (tentatively defined for this purpose as "any broker-dealer who, with respect to a particular security, holds himself out, by entering two-way quotations in any interdealer quotation system or otherwise, as being willing to buy from and sell to other broker-dealers for his own account on a continuous basis") should be established by the Commission or the NASD as promptly as necessary mechanical arrangements can worked out. Such a system would contemplate that each primary market maker in a particular security would file, prior to or promptly after becoming such, a data card showing the name of the security and the dealer's relation to the issue or issuers (as underwriter, director, optionee, etc.); that a primary market maker ceasing to act as such, either permanently or temporarily, would give notice to that effect; and that the Commission or the NASD would maintain, for public inspection or circulation, an official "primary market list" of those dealers who are primary market makers for each security at any given time.

343 See note 338, above.