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dips downward; during the May-June decline, the ratio increased to more than 6 percent.

Specialists do the greatest amount of short selling, partly because their obligation to maintain fair and orderly markets frequently leads them to make short sales. In recent years, their short selling ordinarily has represented 40 to 70 percent of total short sales. As a percentage of their own total sales, specialists' short selling is predominantly between 15 and 20 percent, and has a tendency to decrease on market advances and to increase in market declines. Off-floor members' short sales represent 10 to 25 percent of total short selling, and range predominantly from 8 to about 25 percent of their own total sales. More markedly than specialists, they tend to decrease their short activity on advances and to increase it on declines. Floor traders’ short selling accounts for only 2 to 10 percent of total short selling. However, as a portion of their own total sales, floor traders' short sales range predominantly from 5 to 15 percent, and—at least relative to other members' short sales-appear more volatile in their rising in weak markets and falling in strong ones.

The number of stocks with relatively large short positions tends to rise as the market declines and to fall as the market advances. In general, however, the large short positions tend to be concentrated in no more than 100 stocks including both the so-called "market leaders” and the "trading favorites.” This strong concentration of short selling in a relatively small number of stocks suggests that the aggregate data used above, although useful to portray broad patterns, tend to obscure the true significance of short selling. It is well established that the price action of these stocks has a wide-ranging effect on stocks in general. Because of the concentration of short selling in such stocks, therefore, the practice has a more telling influence on the market than is indicated by the aggregate statistics. Accordingly, it is important to examine short selling with respect to individual stocks and to pinpoint this selling, as much as possible, to specific instances of time. For that purpose, reference was made primarily to short selling in eight selected stocks during 14 selected days prior to, and during the 3 days of, the market-break period in the last week of May 1962.

Most of the eight stocks experienced a declining trend during the period of the 14 selected days prior to the market break, and all of them showed a decline during the latter part of the period. Yet short selling in a number of instances rose to over 8 percent of total reported sales, and in two stocks to over 30 percent. Contributing to this large volume of short selling were varied factors, such as in the case of U.S. Steel, the dispute with the Government about steel prices, in a stock such as Korvette, a general speculative interest, and in the case of Avco, the specialized transactions of a few members.

Of the total short selling in the eight stocks during the May 28–31 market-break period, over 75 percent occurred in four of them, A.T. & T., Avco, Korvette, and U.S. Steel, with the bulk of such selling taking place on the second and third days. Nevertheless, on the day of the actual break, May 28, over 10,000 shares were sold short in each of 3 stocks and some short selling occurred in each of the remaining 5. In the cases of both U.S. Steel and Korvette, short sales constituted over 16 percent of total sales. A detailed analysis of each of the eight

stocks on May 28 reveals that much of the short selling came during spells of decline. Creation of this extra supply of stock when the market already was under heavy selling pressure undoubtedly contributed to the downward movement. In addition, an awareness of this augmented supply may wel! have tended to cause professionals on the floor of the Exchange, including the specialists, to diminish and withdraw their buying.

This emerging picture of a substantial volume of short selling in prominent stocks during intervals of price weakness indicates the inadequacy of current rules to cope with the harmful effect of short selling which they were devised to prevent. The presence of extra selling burdens during a market which is generally weak may be a contributory factor during a period of market break. An important aspect of the inadequacy of the current rules is their reliance upon a "tick test,” which goes on a “trade-to-trade” basis making short selling permissible at prices above the last preceding different price. There is need for a rule of broader perspective, focusing not upon the “trade-to-trade” situation but upon the underlying trend, so as to be an effective limitation on short selling in a security when its market is under extraordinary selling pressure. Before enactment of such a rule, its effects should be thoroughly explored to insure that it meets its intended purpose without limiting the use of short selling in other market conditions. There is need also for the Commission's rules to provide for rapid action to prohibit short selling in a particular security or in general, in emergency situations.

As has been indicated, the primary objectives of the current rules are to prevent the use of short selling either to effectuate a "bear raid” or to accelerate a declining trend. While the Special Study has not uncovered any evidence of the use of short sales to spearhead a “bear raid”, it has concluded that short sales may contribute importantly to accelerating the trend of a falling market. The present up-tick limitation, complemented by one or some combination of changes such as those suggested, would preserve those features of short selling that are in the public interest.

The Special Study concludes and recommends:

1. The two series of data on short selling presently compiled by the New York and American Stock Exchanges are inadequate for regulation. The series are neither compatible nor are they useful in indicating the degree of short selling in individual issues, the effect of such selling on the price stability of a security, or whether the provisions of the Commission's rules are being observed. Accordingly, the Exchanges should initiate systems of reporting that will provide more frequent information on the volume of short sales in particular stocks classified as between the public and the principal classes of members. Monthly data on the short interest should show corresponding information in the selected individual stocks. In addition, consideration should be given the feasibility of indicating exempt short sales and furnishing information on the other types of short sales such as "against the box,” arbitrage, and hedging. The Commission also should consider the extent to which short sales data should be reported by other exchanges. The Commission should designate the information to be furnished to it on a regular basis, and should also determine the extent and type of short selling data to be made available to the public.

2. It is difficult to determine the extent to which short sales are being made on "minus” or “zero-minus” ticks in the guise of exempted arbitrage transactions, but there is some indication that advantage is being taken of this exemption. The stock exchanges should examine current procedures for marking transactions as "short-exempts" and institute checks to insure that this marking is accurate, and thereafter the Commission should review and evaluate the procedures adopted.

3. Present rules appear inadequate to relieve the added pressure that short selling may create during a severe decline in the general market or a declining price trend in a particular security. Despite the rules, a relatively large volume of short selling occurred in particular stocks, including “market leaders” and “trading favorites," during the period of decline preceding the market break of May 28, 1962, and at critical junctures on that day, and many additional opportunities existed when short selling could have occurred. Accordingly, the present up-tick limitation

should be supplemented by a rule or rules designed to cope more effectively with the potentially depressing effects of short selling during price declines. While the Special Study is not prepared to suggest the exact form of such rule or rules of general application, among the possibilities to be considered would be: the prohibition of short selling in a particular stock whenever its last sale price was below the prior day's low; or alternatively, whenever the last sale price was a predetermined dollar amount or percentage below a base price (e.g., the prior day's close or low or the same day's opening) as specified in the rule; or instead, given the circumstances of such a decline, a limitation of short sales in any particular stock to a predetermined proportion of the amount of stock available at the prevailing market. As a further precaution for times of general market distress, the Commission's rules should provide for temporary banning of short selling, in all stocks or in a particular stock, upon an appropriate finding by the Commission of need for such action.

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Part I. COMMISSION RATES

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: all 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 transaction; 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 NYŠE 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 NĂSD.

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.

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 ancillary 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 ancillary 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

+ See ch. VIII, D and E (pt. 2).

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