B. THE STRUCTURE AND GROWTH OF THE SECURITIES INDUSTRY The securities industry in the United States is a complex structure of many disparate elements. Some of its separate aspects are described and analyzed in detail in the succeeding chapters of this report. The present part, briefly sketching a picture of the industry and its recent growth, is intended as a framework to facilitate an understanding of the particular aspects that are considered subsequently. 1. THE SECURITIES MARKETS The broad term "securities markets" encompasses both the markets for distribution of securities into public hands and the markets for continuous trading in outstanding securities. Both kinds of markets are elaborate structures geared to bringing buyers and sellers together. Trading markets consist of both a limited number of organized stock exchanges and a greater, fluctuating number of far less organized over-the-counter markets. Distribution markets are essentially over the counter. Since shares of corporate stock once distributed may subsequently change hands many times, the volume of trading is substantially larger than the volume of distributions. For example, the Special Study estimates that in 1961 the dollar volume of stocks traded in exchange and over-the-counter markets was almost 30 times as great as the cash proceeds received by corporations from the sale of stocks. Speaking broadly, distributions are the main concern of the Securities Act and trading markets are the main concern of the Exchange Act. a. The public interest in the securities markets Securities markets in the United States are, in contemplation of law and in fact, public markets. They are public both in the sense that large numbers of people are directly or indirectly involved in owning and trading securities, and in the broader sense that the performance of securities markets affects the general economy and well-being in important ways. The former sense was recently expressed, for example, by the president of the New York Stock Exchange as follows: The sole purpose of a modern marketplace is to provide the public with an efficient and dependable mechanism through which securities can be bought and sold." The latter sense is expressed by section 2 of the Exchange Act, which succinctly states various reasons why securities markets are "affected with a national public interest." In the following paragraphs some of the more important impacts of securities markets on investors and the general public are very briefly noted. First, in a capitalistic society in which the corporate form of enterprise prevails, securities are an important form of private property, constituting an integral element of the resources, and materially influencing the long-term financial security, of a large segment of the population. Thus, on December 31, 1961, individuals had accumulated net financial savings of approximately $900 billion, of which direct holdings of corporate securities represented more than one Funston, letter of comment on James, "Disputed Role of the Stock Exchange Specialist," 40 Harv. Bus. Rev. 7, 8 (September-October 1962). 96746-63- 3 half, almost all of which was common and preferred stock; these holdings were more than twice as large as the deposits and currency of individuals.10 Another indication of the widespread importance of securities is the New York Stock Exchange estimate that in early 1962, over 17 million individuals held shares in publicly held corporations."1 Potentially affecting an even larger segment of the population, private retirement and insurance programs for individuals depend considerably on investments in corporate securities. This has been historically true as to corporate bonds and in recent years has become increasingly true as to corporate stocks. As of December 31, 1961, holdings of corporate securities by life insurance companies and private pension funds were estimated at $93 billion, of which corporate stocks represented about 30 percent.12 Personal trust funds held $57 billion in corporate securities, mostly common and preferred stocks. Turning briefly to the general public interest in securities markets, as distinguished from the direct and indirect interests of public investors, it may first be noted that the state of the trading markets unquestionably has an important bearing on the flow of new capital into private enterprise, and thus on the country's rate of economic growth. During the 5-year period 1957-61, as an illustration, corporations in the United States made expenditures for plant and equipment of $148 billion plus $38 billion for other investments and increased net working capital.13 Of this total expansion, $39 billion came from the issuance of stocks and bonds representing the additional funds needed beyond reinvested earnings and depreciation. Without doubt, original distributions of securities are facilitated by the confidence of investors that they can later dispose of their purchases in a trading market. Conversely, companies' plans to sell securities may be significantly affected by current market behavior. Indicative of this relationship, during the 4 months following the market break of May 1962, new effective registrations for the issuance of common stocks (excluding investment company shares) decreased over 60 percent in dollar amount and 40 percent in number from the corresponding months of 1961, a period of substantially higher prices. The securities markets' vast resources for marshaling the capital of individual and institutional investors all over the world give corporate enterprise access to large sources of funds that would not otherwise be available. At the same time, by providing liquidity to investments, the markets make possible the accumulation of aggregates of capital with the assurance that they can be converted to cash or readily valued when they may be needed for planned uses or to meet maturing liabilities. Apart from their direct bearing on the flow of savings into private enterprise through distributions of securities, the actual state of the markets and the public's attitudes toward the markets are widely believed to have important bearing on the state of the economy. Thus, the potential impact on individual and corporate spending was 10 SEC, Statistical Bulletin 11 (April 1962). 11 New York Stock Exchange, "1962 Census of Shareowners in America," 4 (June 1962). 12 SEC, report to staff of the President's Committee on Pension Plans, tables 9 and 11 (1962). 13 SEC, "Source and Uses of Corporate Funds" based on SEC and Department of Commerce data. a matter of concern and comment in the wake of the sharp market break in mid-1962.11 Finally, surely not the least important way in which the securities markets may affect the general economy and well-being is that described in clause (4) of section 2 of the Exchange Act: National emergencies, which produce widespread unemployment and the dislocation of trade, transportation, and industry, and which burden interstate commerce and adversely affect the general welfare, are precipitated, intensified, and prolonged by manipulation and sudden and unreasonable fluctuations of security prices and by excessive speculation on such exchanges and markets * * It is to be remembered that the Congress that made this recital had fresh in its memory the market debacle of 1929 which preceded the great depression of the 1930's. The emphasis on the public interest in this and other clauses of section 2 is echoed repeatedly in the substantive provisions of the statute. Over and over again Congress proclaimed that the regulatory authority conferred on the Commission was to be exercised "in the public interest" and "for the protection of investors." Thus, while the private ownership of exchanges was not disturbed, the Exchange Act, in the words of the House of Representatives committee report preceding its enactment, proceeded on the theory that "the exchanges are public institutions which the public is invited to use for the purchase and sale of securities listed thereon, and are not private clubs to be conducted only in accordance with the interests of their members. The great exchanges of this country upon which millions of dollars of securities are sold are affected with a public interest in the same degree as any other great utility." 15 Similarly, "the public interest" and "protection of investors" were established as the dominant considerations in the operation and regulation of over-the-counter markets. b. The stock exchanges In reviewing the trading markets, consideration initially is given to the stock exchanges, of which there are at present 14 registered exchanges and 4 exempt exchanges.16 Of dominant importance among the exchanges is the NYSE, which in 1962 had $47.4 billion of transactions in stocks, rights, and warrants, representing 86 percent of the total dollar volume on registered exchanges. Ranking far below, but nevertheless well above the others, is the American Stock Exchange (Amex), which in 1962 reported $3.7 billion of transactions or 7 percent of the total. The rest, the "regional" exchanges, account for only a small share of total exchange trading; three of them, the Midwest, Pacific coast, and Philadelphia-Baltimore-Washington, produced 6 percent of the dollar volume of all exchange trading in 1962, while the remaining registered exchanges accounted for only 1 percent. The leading role of the NYSE is also shown in its percentage of the aggregate market value of shares available for trading on all ex 14 See, e.g., First National City Bank of New York, Monthly Economic Letter, July 1962; on the 1937 decline, see Roose, "The Economics of Recession and Revival," at pp. 219-222 (1954) and on the 1920's and early 1930's, see testimony of Federal Reserve Board official E. A. Goldenweiser, hearings on H.R. 7852 and H.R. 8720, on "Stock Exchange Regulation," 73d Cong., 2d sess., at p. 65 et seq. (1934). 18 H. Rept. 1383, 73d Cong., 2d sess., p. 15 (1934). 16 Included in the registered exchanges are the National Stock Exchange and the Chicago Board of Trade, the former having 10 listings at the end of 1962, and the latter having RO Securities transactions. The exempt exchanges are of minor significance and omitted from this report, except as specifically noted. changes, which rose from 83 percent in 1940 to 93 percent in 1962 (table I-1). The aggregate market value on all exchanges increased over seven times during this period, with over 90 percent of that increase occurring in NYSE stocks and practically all the rest in Amex stocks. The preeminence of the NYSE is much less striking, but nevertheless clear, when gaged by the number of stocks listed on exchanges. Its share of one-third of the listings on all exchanges in 1940 has increased to one-half (table I-2). The number of listings on the Amex declined from 1940 to 1950, but then the trend reversed itself and in 1962 there were almost as many listings as there were in 1940. During this period a sharp decline occurred in the stocks exclusively traded on the other exchanges. While each exchange has its own operating characteristics, the pattern of the NYSE sets the pace for the rest of the industry. Only individuals can hold seats or be "members" of the NYSE. However, the exchange sets up categories of "member firms" and "member corporations" for partnerships or corporations in which a member is a general partner or a director holding voting stock. Other general partners or holders of voting stock of these member firms," who are not actual members of the exchange, are denominated "allied members." At the close of 1962 the NYSE's membership was 1,366, which included 1,101 individuals affiliated with 672 firms. The remainder were not affiliated with any firm or were inactive (table I-3). In general, there has been a tendency for the number of nonaffiliated and inactive members to decline. The most striking change in the membership of the exchange, however, has been the rapid expansion in the number of allied members. This group has doubled over the past decade to reach a peak of 6,238 in 1962. The members of the NYSE perform various functions in connection with the market and may be classified on the basis of their principal activity (table I-4). As of December 31, 1962, there were 350 specialists, who play a focal role in the market's operations; in the securities in which a specialist is registered, he executes public orders generally forwarded to him by other members and also deals as principal, thus "making" markets in those issues. There were 666 members, affiliated with member firms, who were either "office partners" or were on the floor of the exchange handling orders transmitted to them by their firms. Another 150 members are floor brokers, commonly known as "$2 brokers," who were unaffiliated with member firms dealing with the public but executed orders for them. There were 119 members involved in handling odd-lot orders, most of them brokers working on the floor exclusively for the odd-lot dealer firms, executing odd-lot orders and buying and selling round lots to meet the demands of oddlot customers. There were approximately 28 individual members primarily engaged in floor trading; that is, buying and selling for their own accounts. Finally, there were 53 inactive members. Compared with 1950, the number of floor brokers and inactive members have declined while the other categories have grown modestly. 17 The NYSE uses the phrase "member organization" to cover both partnerships and corporations. In this report, unless specific qualification appears, "member firms" and "member organizations" are used interchangeably. c. The over-the-counter markets for outstanding securities Transactions in securities outside the organized securities exchanges are described as taking place in the over-the-counter market. The over-the-counter market is actually a group of markets, in which broker-dealers transact business with the public as principals or agents, dealing for the most part in securities not listed on any exchanges. Some dealers may maintain inventories in one or more over-the-counter securities and be willing to both buy and sell them to other brokerdealers, in which case they are known as "market makers" in those securities. The bulk of the over-the-counter broker-dealers are members of the NASD. In trading with nonmember broker-dealers, NASD members must charge the same price as they charge the general public, whereas member broker-dealers may be given a "wholesale" price. Thus, there is an important economic pressure on all broker-dealers doing business in the over-the-counter markets, including member firms of the exchanges, to join the NASD. Because of the differences in the mechanics of executing a transaction over the counter and on an exchange, it is difficult to compare activity in the two markets. Normally in the over-the-counter markets, two or three sales of a security may take place between brokerdealers before a security sold by one public customer is bought by another. Even if all of these dealer sales are included in over-thecounter volume, however, activity in the over-the-counter markets, in terms of value of shares traded, is not as large as on the Nation's securities exchanges. For example, based on the Special Study's OTC-3 questionnaire, it is estimated that in 1961 the dollar volume of trading in stocks over the counter was equal to about 60 percent of that on exchanges.18 If over-the-counter activity is measured in terms of share volume, the picture is quite different. Reflecting the low prices of a large number of over-the-counter stocks, share volume in the over-the-counter markets tends to be higher than that on exchanges. In 1961, it was probably 25 percent greater than the volume of trading on all exchanges.19 In the ordinary course of events, corporations issue new securities through underwriters in the over-the-counter market or through private placements. Unless or until an issue may become listed on an exchange, the trading in the security takes place in the over-the-counter market. If the issuer grows sufficiently, it may decide to list its securities on an exchange, in which case further trading in that issue will ordinarily be handled on that exchange. 2. THE SECURITIES TRADED Securities traded in exchange and over-the-counter markets represent many different transferable evidences of debt or equity interests, and broker-dealers may handle a number of different types or specialize in one or a few. The securities range from those issued by the Government, including Federal, State, local, and agency bonds, to 18 For a further description of this survey and a detailed description of its results, see ch. VII. 19 Syndicated distributions and sales of open-end investment company shares have been excluded from over-the-counter volume. |