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The Exchange has thus undergone a major constitutional and organizational reform. In contrast to the prior breakdown of selfregulation described in the staff report, the accomplishment of this reform appears to be an excellent demonstration of the effectiveness of self-regulation under responsible Exchange leadership and active Commission oversight.
PART D. THE MIDWEST STOCK EXCHANGE AS A SELF-REGULATORY
As one of the largest regional exchanges, the Midwest Stock Exchange occupies an important position in the securities markets with the potential for an expanded role in future years. In assessing the MSE's self-regulatory performance it should be emphasized that its regulatory efforts are directed principally at sole members and securities traded only on that Exchange. The MSE does not examine firms that are also members of the NYSE, and it leaves market surveillance of dually traded stocks to the primary market.
The government of the MSE is vested in the board of governors; the executive committee performs board functions between board meetings. The Exchange's organizational structure also includes regional and standing committees; the regional committees represent the cities whose exchanges were merged into the MSE, and the standing committees have regulatory and other responsibilities in specified substantive areas.
The Exchange staff plays a crucial role in the administration of the MSE and in regulating member conduct, again highlighting the importance of a paid staff, with sufficient authority and responsibility, to accomplish effective self-regulation. The important role played by the MSE president in the Exchange's disciplinary machinery and in its total administration contributes to the efficient performance of the Exchange's role as a self-regulatory agency,
The impact of the public advisers on MSE affairs appears to be minimal, thus giving the appearance of public representation in Exchange affairs more than the actual fact. The public advisers rarely attend board meetings, do not have the right to vote at these meetings, and are more involved in matters of listing than in the regulatory process.
The MSE has taken leadership in various significant ways including qualification examinations for members, centralized automated bookkeeping for member firms, and clearance of transactions by mail. Its self-regulatory program devotes considerable effort to the enforcement of its net capital rule, but seemingly inadequate attention to the supervision of member firm selling practices. The Special Study concludes and recommends:
1. Certain recommendations in other parts of chapter XII, especially part B, may apply directly or with appropriate adaptation to the MSE; e.g., the recommendation as to publicizing disciplinary actions. Commission and Exchange representatives should undertake to determine the possible applicability of such recommendations and the Exchange should proceed to implement
6 See ch. VIII.E (pt. 2).
such recommendations or adaptations as may be found appropriate.
2. The Exchange should undertake a reassessment of the institution of public advisors to determine whether it can become a more effective instrument for representation of the public in Exchange affairs.
PART E. THE PACIFIC COAST STOCK EXCHANGE AS A SELF-REGULATORY
The Pacific Coast Stock Exchange is important as a securities market because of its present business and its potential for future growth. As with the Midwest Stock Exchange, some of the larger NYSE commission firms are also members of the PCSE and a substantial percentage of trading on the PCSE take place in securities that are also listed on one of the New York exchanges. The primary thrust of the PCSE's regulatory effort is directed at sole members and securities traded only on that exchange.
The PCSE is the product of the consolidation of the Los Angeles and San Francisco Stock Exchanges. Considerable effort is expended in keeping the two divisions on an equal basis in the government of the Exchange. Each division has control over its own finances and has its own traditions and procedures. Although there has been progress in recent years toward making the regulatory practices of the two divisions uniform, there are still areas in which varying practices exist.
The government of the Exchange is vested in its board of governors. However, because of the geographic distance between the two divisions the division management committees (consisting of the governors from the respective divisions) have considerable authority over the affairs of their respective divisions.
The PCSE is unique among the four largest exchanges in the degree to which its board and committees participate directly in the self-regulatory operation and management of the Exchange. In addition to assisting in the formulation of policy, the division management committees and the standing committees exercise important regulatory and administrative functions. Disciplinary and policy matters are channeled through the committees whose decisions are generally adopted by the board, whereas the paid staff occupies a less important position in the regulatory structure than in the NYSE, Amex, or MSE. It acts in a factfinding capacity under the direction of the board and the various committees and is responsible not only to the president of the Exchange but also directly to the board. The president does not have the right to vote at meetings of the board or division management committees.
Experience has demonstrated that, in an exchange of substantial size, this kind of arrangement is of less than maximum effectiveness and has within it the potential for abuse. The reforms adopted by the NYSE in 1938 and those adopted by the Amex in 1962 incorporated the concept of a paid staff with the authority to operate the exchange. The report of the Levy Committee, the industry group that studied the Amex, concluded that the standing committee system, among other things, resulted in an absence of well-defined responsibility and the assumption by the committees of greater powers than
the president or the board, and was an obstacle in the development of necessary staff initiative. A reorganization of the PCSE in the direction taken by other important exchanges seems highly desirable in light of their experience.
In its surveillance and enforcement of off-floor requirements, the Exchange puts most emphasis on its net capital rule. Members' selling and advisory activities receive inadequate attention, and the Exchange's handling of public complaints should be strengthened.
The Special Study concludes and recommends:
1. The PCSE, under the supervision of the Commission, should undertake a thorough examination of its organizational structure with a view to providing a paid staff of adequate size and authority for self-regulatory functioning in lieu of the present reliance on a committee system.
2. Consideration should be given to the elimination of those constitutional provisions which may unduly restrict the board in the exercise of its authority, for example, the constitutional provision which bars the board from acting on a matter that "solely concerns the internal affairs or assets” of a division and the one which permits a member expelled by the board to appeal the expulsion to the membership.
3. Certain recommendations in other parts of chapter XII, especially part B, may apply directly or with appropriate adaptation to the PCSE; e.g., the recommendation as to publicizing disciplinary actions. Commission and Exchange representatives should undertake to determine the possible applicability of such recommendations and the Exchange should proceed to implement such recommendations or adaptations as may be found appropriate.
PART F. THE OTHER EXCHANGES AS SELF-REGULATORY
With respect to the registered national securities exchanges apart from the NYSE, Amex, PCSE, and MSE, the study's inquiry was generally confined to a limited review of their constitutions and rules. Since no study was made of their surveillance and disciplinary procedures, it is impossible to draw conclusions as to the effectiveness of their regulatory activities.
Despite wide differences among these eight exchanges, certain organizational similarities exist. Operation of the exchange is generally vested in a governing committee and in standing committees with authority in specified substantive areas. The role of the paid staff is relatively minor and, except for the larger of these exchanges, the staffs are quite small.
On numerous occasions since the passage of the Exchange Act the need of registered exchanges for qualified staff personnel with sufficient authority has been demonstrated. The developments at the Amex in 1962 are but the most recent illustration. The paid staff affords continuity of administration as well as the critical element of objectivity. To the extent this is not economically feasible for some of the smaller exchanges, there is a corresponding limit on what may be expected of self-regulation, and the Commission's direct regulatory activity must be adapted accordingly.
Other parts of this chapter, particularly those dealing with the NYSE, contain recommendations pertaining to the organization and regulatory performance of that exchange. It is not possible within the confines of this report to indicate the applicability of each recommendation to each registered securities exchange, nor has it been possible to analyze the special circumstances of each exchange to determine in what respects changes are desirable. Consequently, on the basis of an assessment of the applicability of the recommendations to the particular exchange, each exchange should make such changes in its rules, practices, and procedures as may be appropriate.
PART G. THE NASD AS A SELF-REGULATORY INSTITUTION The NASD began as a somewhat unique experiment in supervised self-regulation and, at the outset, had relatively small overall influence in the regulatory pattern. It has emerged 24 years later as an established part of the regulatory scheme exerting a substantial influence on numerous phases of the securities industry.
While this report is in many respects critical of its performance, the NASD has many important accomplishments to its credit, and its history evidences a clear desire to expand the role of self-regulation in the total regulatory scheme and to make self-regulation work. Some of the problems of self-regulation on the part of the NASD such as delays in administrative proceedings, backlogs in investigations, and inadequate staff have, of course, had their counterparts in the Commission's performance of its regulatory role.
Over the years, the NASD's policies and rules have multiplied and now deal with many aspects of the securities business. In enforcing its standards of conduct, the association makes over 1,700 special and routine examinations of its members annually, covering a wide variety of subjects relating to the business of its members, and it institutes more than 450 formal complaint proceedings in a year. It also engages in various other activities of a regulatory nature, such as review of underwriting compensation and mutual fund selling literature. Another significant function of the NASD, outside of the strictly regulatory sphere, is the dissemination of retail quotations.
In spite of this record of accomplishment and expansion, or perhaps because of it, the NASD now appears to be at a crossroads. This report points out many important respects in which its activities should be further expanded or its performance of existing activities should be strengthened, yet even without these added burdens it is clear that its capacity to do its job is overtaxed.
The causes seems to lie in its fundamental organizational concepts and arrangements, as related to the responsibilities imposed upon it. The NASD's job of self-regulation is an enormous one in every dimension, but from the beginning it has sought to adhere to a concept of selfregulation with maximum emphasis on "self”—members in the securities business regulating themselves—and with minimum reliance on a full-time paid staff. This concept is applied in every aspect of the association's work, not merely in areas of policy but also, and most pointedly, in the area of complaints and disciplinary actions against members.
The latter area is a uniquely difficult one in both quantity and quality. Its uniqueness stems from the fact that the association is virtually
all embracing—there is practical economic compulsion on most brokerdealers to join and legal compulsion on the association to accept them. From the association's point of view this means, unless and until standards for entry into the securities business are substantially raised, that it must take self-regulatory responsibility for the conduct of members of diverse standards and competence. From the members' point of view, on the other hand, the compulsory feature calls for scrupulous fairness when members' conduct is called into question; in practice this has meant that, although proceedings are handled locally in the first instance, appeals may be carried to the highest national level, i.e., the board of governors.
At all levels, although staff assistance is used, hearing and decision is by members, i.e., part-time volunteers serving this and other needs of the organization. At the district level this has produced severe strains, delays and compromises. At the national level it threatens a breakdown in the capacity of the organization to act promptly and—an even more serious problem-its capacity to deal adequately with important questions of policy and program. There is now such preoccupation with disciplinary matters, in addition to matters of internal administration, that little time is left for the top governing officials to perceive and solve large questions.
“Time” is the key word, the time of volunteer members. There are limits on the amount of time that any individual in the securities business can afford to devote to association affairs. The chairman is called upon to make the greatest sacrifice, and the demands of the office have been such that, even apart from other reasons, a single 1-year term has been the pattern. The demands on other members of the board of governors are obviously less and they have 3-year terms, but here another limitation applies: the organization is nationwide and the board has nationwide representation. Thus it is necessary to assemble the governors from their several places of business in order for them to meet as a board. In recent years this has occurred three times a year, for 3 days at a time, a total of 9 meeting days annually,
The problem of time also has another aspect; namely, that the many small member firms ordinarily cannot afford to allow their principals to take major roles in NASD affairs. This is reflected in the composition of district and national committees and the board of governors, particularly the latter; for example, a majority of members of the board are from large NYSE member firms, not as a result of any constitutional provision and apparently not by design but largely on the practical ground of their relative availability. Another factor affecting composition of the board that is of constitutional origin may be mentioned here: Because governors are elected by districts, with only the three largest ones having more than one governor, and the remaining districts selecting a representative only once every 3 years, it has been difficult to have continuing representation of the various important types of business conducted by members.
As the organization has grown and its business has expanded, the association has endeavored to keep pace by bringing more individual members into active participation in its affairs, especially at the district
& For example, in 1962 the board decided 115 disciplinary cases, 75 of which had been appealed by respondents and 40 of which had been called up by the National Business Conduct Committee. In that year, the association closed a total of 486 cases. See ch. XII, G, 3.b (2) (b) (pt. 4).