14. With an already strong communications network, there is on the horizon the likelihood of a computer system that would assemble all interdealer quotations and instantaneously determine and communicate best quotations for particular securities at any time. If such a system were established, the further possibility of using it in connection with executions and to compile actual price and volume data for over-the-counter transactions would exist. Any such automated system would clearly be affected with a public interest and should be under regulatory supervi sion. The NASD is the natural source of leadership and initiative in dealing with matters of automation in respect of over-thecounter markets. It should actively carry forward the very limited study of automation possibilities applicable to over-thecounter markets that the Special Study has been able to undertake and should report to the Commission from time to time as to the progress and programs of the industry in this area. The Commission and the NASD should jointly consider possibilities for developing and coordinating automation programs in such manner as to fulfill their respective regulatory needs, as well as operational needs of the markets, with maximum effectiveness and minimum duplication and expense.

15. In the absence of a completely automated system for recording transaction data, consideration should be given by the Commission and the NASD to the feasibility of establishing a reporting system designed to obtain maximum price and volume data, without undue burden, for actual transactions in over-the-counter securities or for specified categories of transactions and/or securities.

16. Interdealer or retail over-the-counter transactions in exchange-listed securities present special problems because of their actual or potential interaction with auction markets. In implementing the recommendations in this chapter for over-the-counter markets generally, appropriate exceptions and/or special requirements should be provided for over-the-counter transactions in exchange-listed securities. Other recommendations on this subject appear in chapter VIII.D.

CHAPTER VIII

TRADING MARKETS-INTERRELATIONSHIPS

[Part A (Introduction-Scope of Chapter) summarizes the contents of the remainder of the chapter.]

PART B. THE BASIC ALLOCATION BETWEEN EXCHANGES AND OVER THE COUNTER (AS PRIMARY MARKETS)

The allocation of securities among trading markets, including the determination of the primary market and the establishment of dual or multiple markets for a particular security, is determined by a number of interacting factors and forces. A crucial concept in allocation as between exchange and over-the-counter markets is that of "listing," the process by which securities are first admitted to trading on an exchange. Securities may also be admitted to trading on an exchange through "unlisted trading privileges" but this now applies primarily to securities already listed on another exchange. There is no corresponding gateway to trading in over-the-counter markets, either primary or multiple.

The most stringent listing requirements are those of the New York Stock Exchange. These include "yardsticks" as to minimum amounts of net tangible assets, net earnings, share distribution, and market value of stock. Delisting standards, while paralleling the listing standards, are far less stringent. Listing and delisting standards of the Amex and other exchanges tend to reflect similar factors but at substantially lower quantitative levels.

There is a broad tendency for securities traded in a particular market or category of markets to show generally similar characteristics; yet there are wide diversities within each category and considerable overlapping among categories. NYSE-listed stocks generally are in the highest size ranges, and stocks in the "OTC inactive" category (defined by the study as those showing fewer than four dealer quotations in the February 1962 Monthly Stock Summary) are in the lowest. The bulk of Amex issues lie between these two categories, while the "OTC active" category (stocks showing four or more dealer quotations in the Monthly Stock Summary) is spread broadly across the whole spectrum with a slight concentration below the Amex issues. Stocks listed solely on the major regional exchanges tend to fall between the active and inactive OTC groupings. Only in assets is this pattern broken-stocks in the OTC-active categories show a range of assets generally no higher than those that are inactive. Most NYSE stocks have characteristics considerably in excess of the Exchange's minimum yardsticks for original listing, but about 10 percent do not meet these requirements. While stocks not listed on the NYSE generally are smaller in relation to those yardsticks, significant percentages of

stocks listed on the Amex or solely on regional exchanges and of stocks in the OTC-active category substantially meet all NYSE listing requirements.

A generally similar pattern appears in respect of trading activity. Thus, in 1961, the central two-thirds of common stocks in the NYSE were in a range higher than the Amex and considerably higher than the major regional exchanges. While no direct comparision with overthe-counter securities is possible, it would appear that the central twothirds of OTC-active stocks show a range of trading volume higher than that of most stocks listed solely on major regional exchanges and only moderately below the range of the central two-thirds of the shares traded on the Amex. Notwithstanding these general patterns, the differences in volume within each market category are exceedingly wide, even for the NYSE (where trading activity is most evenly distributed), and there is a considerable overlapping among market categories.

For a security to be well suited for trading in a continuous auction market, spontaneous meeting of buyers and sellers must occur on a reasonably continuous basis without undue reliance on specialist participation; the market in other words must have adequate "depth." The degree of market depth in this sense is affected not only by transient variables with respect to given securities or markets but also by a number of long-range tendencies and forces. Listing and delisting standards should be designed to admit and retain securities capable of being successfully traded in the kind of market that a particular exchange is and purports to be. The wide discrepancy now found between listing and delisting yardsticks seems questionable in light of these considerations, particularly with respect to the NYSE. The depth of buying and selling interest reflected in the auction market is directly affected by the round-lot unit of trading, presently 100 shares for most stocks, since odd-lot transactions are largely handled through dealers and not directly in the auction market. Thus, a reduction in the round-lot trading unit would tend to add to the flow of buy and sell orders constituting the depth of the market at any given time and should receive consideration for all or some securities. Since exchange markets, as continuous auction markets, are more demanding in terms of depth than are over-the-counter markets, a primary public concern is to assure that each security admitted to an exchange market is suitable, in such terms, for the kind of market that the exchange purports to conduct. Indeed, the best clue to appropriate allocation between exchange markets and over-the-counter markets may lie in the difference in warranted expectation on the part of public investors. An exchange market is generally regarded and frequently advertised as assuring a high degree of continuity and fluidity through the continuous auction process. It follows that each exchange should reasonably live up to the expectation created by its image and should not maintain listings that are incompatible.1 There

1 The same kind of point was made by the Commission in 1936, in relation to unlisted trading:

"Admitting a security to trading privileges on an exchange amounts to a representation by the exchange that an appropriate and adequate market for that security exists on that exchange. It does not necessarily amount to a representation that the best market from the standpoint of buyer or seller exists on the exchange, but it is a representation that an adequate and an appropriate market may be found upon the exchange."

SEC, "Report on Trading in Unlisted Securities Upon Exchanges," p. 10 (1936).

nevertheless remains room for a degree of variation and experimentation, as discussed in part E of this chapter, with certain of the regional exchanges perhaps operating under a modified set of assumptions intermediate between those of continuous auction markets in the fullest sense and over-the-counter markets.

The legitimate expectation for over-the-counter markets is quite different from that of the classic auction market. It is not and need not be the opposite; it is simply more kaleidoscopic. What the sophisticated professional expects, and the public investor is entitled to expect, is only such degree of depth, continuity, and fluidity for a particular security traded over the counter as is implied by the number of dealers making a market at any time or from time to time. This may range from 20 or more on a continuous basis to 1 or 2 on a more spasmodic basis. The over-the-counter markets have room for all of them and there need be no disappointment of legitimate expectation as to any of them, since the range of difference is ascertainable and expectation can be adjusted to particular facts. What is essential, in these terms, is that there be clearer recognition and identification for public investors of the wide variations that necessarily exist within the broad over-the-counter category, and better adaptation of regulatory measures to suit the varying needs.

For the considerable category of securities that would be suitable for an exchange or over-the-counter markets, there appears to be no reason of public policy why an issuer should not have freedom to decide, as at present, either to remain entirely in the over-the-counter sector or to seek an exchange listing. This necessarily presupposes, however, that public investors in either type of market are afforded, through requirements of fair trading practices and disclosures, the maximum protection consistent with the character of that type of market. Chapters VI and VII contain both immediate and longerrange recommendations as to trading practices and market disclosures to meet this objective, and chapters IX and X contain recommendations for greater equalization of disclosure and credit requirements for securities traded in the two types of markets. Implementation of the chapter VI and VII recommendations is imperative if each type of market is to provide, within the assumption in which it operates, appropriate safeguards for investors and the public interest. Implementation of the chapter IX and X recommendations, on the other hand, will eliminate discriminations that may now affect market allocations artificially and arbitrarily.

The Special Study concludes and recommends:

1. Continuous auction markets are, by their very nature, more. demanding than over-the-counter markets in respect of the depth of public interest and activity required for the degree of continuity and fluidity generally associated with them. Since various factors affecting depth are dynamic rather than static, listing and delisting standards and practices of the several exchanges require reexamination from time to time to assure that the entire list of securities being traded is in keeping with the kind of market that the particular exchange purports to provide and is capable of

In this connection, see ch. IX, pp. 56-57 (pt. 3), on the recommended repeal of sec. 12(f) (3), under which proposed change all "OTC listed" issues would not automatically be eligible for unlisted trading.

providing. Present delisting standards and practices appear disproportionately low in relation to listing standards, particularly in the case of the NYSE, and should be strengthened.

2. Reduction in the round-lot unit of trading would significantly add to the depth of auction markets by bringing a portion of present odd-lot trading directly into the balance of available supply and demand. Technological advances, as of the present or the foreseeable future, may well be found to have obviated what were previously felt to be practical impediments. A Government-industry study of the feasibility and desirability of reducing the roundlot unit for all or some securities should be undertaken in the near future.

3. Over-the-counter market mechanisms are generally more adaptable than exchange market mechanisms in their capacity to provide for the heterogeneous types of securities that are traded over the counter, including some that would be suitable for continuous auction trading but a great many more that would not. On the other hand, the very heterogeneity of over-he-counter securities makes it impossible to assure markets of the same quality (in depth, continuity, or otherwise) for all such securities. Hence a pressing and continuing need is to provide more specific identification of crucial facts about individual markets, so as to assure more realistic understanding on the part of public investors as to the kind and quality of market that may be expected for any particular security. Reference is made to certain recommendations of chapter VII directed to this end.

PART C. INSTITUTIONAL PARTICIPATION AND BLOCK TRANSACTIONS

Although institutions are still considerably less important than individuals as holders and as buyers and sellers of stocks, their importance is increasing. In addition, institutions have special importance to the trading markets since their unit holdings and buying and selling programs tend to be larger than those of individuals; and decisionmaking, for the bulk of institutional holdings and transactions, is concentrated in relatively fewer investor units.

Because of the increasing importance of the institutions in the trading markets, the Special Study conducted a survey among 91 different institutions concerning their procedures for executions and their transactions in common and preferred stocks. The major specific results of this survey may be summarized as follows:

1. The transactions of the institutions sampled showed a concentration in NYSE-listed issues, with a minor amount of activity on the Amex, and negligible activity on the regional exchanges in stocks listed only on such exchanges.

2. Most of the transactions executed on regional exchanges involved NYSE-listed issues, and most of them were by the open-end (load) investment companies. The other institutions made considerably less use of the regional exchanges. Such higher use of regional exchanges by the investment companies may well be related to the investment companies' desire to give "reciprocal business" to regional exchange members and, in some cases, to nonmembers.

3. For transactions by the institutions in NYSE-listed stocks, the NYSE is the most important market channel (except for preferred