Modernizing the Market

Wall Street is more than just a seven-block thoroughfare in Lower Manhattan: it is also a marketplace for 17 million investing Americans, a worldwide symbol of capitalism, and a national pool of money from which American business draws its financial sustenance. The Street has meant profit for many investors and grief for some, and since World War II has raised $43 billion for the expansion and modernization of U.S. industry. Any man can buy a piece of what Wall Street offers with a down payment of as little as $2, but the men who really run the Street, says the Securities and Exchange Commission, are a small and clubby circle of insiders.

Last week a group of investigators for the SEC reported that these men often overcharge and insufficiently protect the small investor, and called many of the rules by which they work outmoded, ineffective, and in need of reform. This was the essence of 2,100 pages of findings in the second report of a three-part series on the financial markets, it followed a thorough, 1 1/2-year study by a team of 65 lawyers, economists and SEC staffers under Milton H. Cohen, 51, a sad-eyed and careful Chicago attorney.

The SEC group found few outright abuses of the stock market's rules, but its recommendations struck deeply at five major areas (see box on next page) that make up the very heart of the market, promised the most sweeping overhaul of Wall Street since the Pecora investigation set up the SEC 30 years ago. The SEC recommended that trading in stock issues that are "unlisted" on any exchange be automated and perhaps made cheaper for the investor, and that the cost of trading in "odd lots" of fewer than 100 shares be lowered. It asked for closer regulation for the stock exchange specialists and bearish "short sellers," and suggested that the exchanges' anachronistic floor traders be abolished altogether.

Long Overdue. Having been relieved last spring at the relative mildness of the first part of the SEC report (TIME, April 12), Wall Streeters were shocked by the sharpness of Part 2. Some grumbled that the criticisms and suggestions were "wild" and "unknowing." Said Floor Trader Edwin H. Stern: "The other floor traders think what I think. They don't know what to think." But after the first shock, many close observers of the market acknowledged that the proposed reforms are long overdue, would bring the market up to date and raise investor confidence.

Speaking with the slow deliberation of a man who does not want to rouse the bears, Investigator Cohen conceded that the proposals are "quite controversial" and said that the SEC commissioners might find some "alternative solutions." SEC Chief William L. Gary and the four other commissioners already have the power to order most of the changes, but Gary, a tough and even-tempered former Columbia law professor, does not intend to take any action until Wall Streeters get a chance to speak their piece at public hearings.

Illusory Value. The SEC investigators were disturbed most that the market's safeguards for small investors seem inadequate and that its devices for moderating market swings often sharpen them instead.

The "highest priority" need for reform, said the SEC group, centers in the "over-the-counter" market in unlisted issues, where the investigators accused some brokers and order clerks of "indifference, incompetence and venality." Prices on this market are published by the privately owned National Quotation Bureau, Inc. in daily "pink sheets" that brokers and bankers see but small investors generally do not.

While praising the "conscientious" bureau, the SEC report said: "In case after case, broker-dealers have abused the system by inserting fictitious quotations in connection with worthless securities to give an illusory value." One broker-dealer firm, for example, arranged to list fictitious quotes for the shares of Diversified Funding, Inc., while trying to push those shares to its own customers.

Because O-T-C quotes are vague and controls loose, brokers' commission markups vary greatly: on one selected day in January 1962, this variance alone caused Bank of America common stock to range in price from $61 to $64.25 and Pacific Power & Light to range from $56.25 to $60, depending on where the investor tried to buy the stock. The SEC group wants to put the National Quotation Bureau under SEC control, open its reports to the general public and let investors know the wholesale prices that dealers are paying.

No Immunity. Turning to the haven of the small investor, the SEC group charged that the odd-lot market is controlled by a "duopoly" of two Wall Street wholesalers, Carlisle & Jacquelin and DeCoppett & Doremus. In 1951, said the SEC, the two got together and fixed the extra charges that small investors have to pay above and beyond the regular commission for buying odd lots--1210 per share on stock priced up to $40 and 250 per share on costlier stock.

There are still 19 agonizing steps involved in every odd-lot trade, and the report charged that the two firms have resisted automation because it would "reduce their profits and make it easier for competition to develop." Added the SEC dryly: "Securities markets are not inherently more immune from featherbedding than any other business." The SEC wants the exchanges to regulate and moderate the price markups in odd-lots and push for automation.

Frightened Like People. Even tougher was the SEC group's criticism of professional floor traders, exchange members who pay no commissions and have no responsibility to the public. The SEC has been trying to run them off the floor for a generation; it says that they enjoy special inside advantages and only accelerate the markets' swings by buying on rises and selling on falls. Floor traders claim that they perform a function by pumping cash into the market at strategic moments, but the SEC group contends that they only follow the trends--and thus accelerate the markets' runaway booms and shattering breaks. Proposed: an end to all floor trading by 1965.

"Serious problems" were also uncovered among stock specialists, those professional risk takers who are supposed to soften swings in prices by buying or selling "against" the market trend. The SEC group says that specialists are not always willing to go out on a limb, that they profit on about 88% of their transactions, and that their inside information on how the market is trending gives them a leg up on other investors. During the 1962 market crash, some specialists cushioned the slide in General Motors, Jersey Standard and Brunswick, but those handling A.T. & T., IBM and Korvette did not. "Specialists are like all people," testified one specialist to the SEC. "They get frightened." Recommended: closer SEC supervision of specialists and new rules forcing them to have more capital, to buy when stocks are dropping and not to interfere in market opening prices, which the SEC feels should be determined by public supply and demand.

The SEC study also accused short sellers of aggravating last year's market break by dumping shares that they hoped to buy back later at a lower price. On "Blue Monday," May 28, 1962, short selling accounted for more than 16% of the sales of U.S. Steel and Korvette shares and, said the SEC, "undoubtedly contributed to the downward movement." The SEC proposes a ban on short selling in times of "general market distress."

For Strength. Just as U.S. business itself has modernized, the SEC believes, so should the financial markets. Nothing in its report suggests any basic change in the share-capital system that U.S. finance is justly jealous of. In fact, most of the reforms--though they may be hard on some individual professionals--are designed to make the market more fluid and to attract the greater number of investors needed by growing U.S. business. "This report," said Chairman Gary, "should not impair public confidence in the securities markets but should strengthen it as suggestions for raising standards are put into practice."

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