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  • 92d Congress, 1st Session - - House Document No. 92-231

    STUDY OF UNSAFE AND UNSOUND

    PRACTICES OF BROKERS AND DEALERS

    REPORT AND RECOMMENDATIONS OF THE

    SECURITIES AND EXCHANGE COMMISSION (Pursuant to Section 11 (h) of the Securities Investor

    Protection Act of 1970)

    DECEMBER 1971

    Printed for the use of the Committee on Interstate and Foreign Commerce

    71-109

    U.S. GOVERNMENT PRINTING OFFICE

    WASHINGTON : 1971

  • CONTENTS

    Letter of transmittaL _____________________________________________ _ Preface __________________________________________________________ _

    Chapter I-Introduction, Summary, Conclusions and Recommendations: Introduction _________________________________________________ _ Nature of report ______________________________________________ _ Summary ____________________________________________________ _

    1. Composition of the 1968-70 reverses ______________________ _ A. The 1967 paperwork crisis ________________________ _ B. The 1969-70 market downturn ___________________ _ C. Capital structure weaknesses _____________________ _ D. Inadequacies of management _____________________ _ E. Concentration on sales ___________________________ _ F. Excessive trading _______________________________ _ G. The conditions of books and records _______________ _

    2. The regulatory policy __________________________________ _ 3. The need for an early warning system ____________________ _ 4. Ease of entry into the business __________________________ _

    Conclusions and recommendations ______________________________ _ Corrective action taken by the Commission under Securities Investor

    Protection Act of 1970 and other existing law __________________ _ 1. Protection of cnstomers' funds and ~ecurities ______________ _ 2. Perfection of early warning systems ______________________ _ 3. Improvemellt of clearance, delivery, and transfer procedures __ 4. Financial information for customers ______________________ _ 5. Improvement of entry standards _________________________ _ 6. Commission enforcement activities _______________________ _

    Industry activities encouraged by the Commission ________________ _ 1. Net capitaL ___________________________________________ _ 2. Operational area _______________________________________ _

    Additional measures for the Commission and the industry _________ _ 1. Regulation of the process of effecting transactions __________ _ 2. The transfer, registry, and depositary functiollS ____________ _ 3. Self Regulation ________________________________________ _ 4. Improvement of adequacy and permanency of capitaL _____ _ 5. N~e.d for increased protection of customers' funds and secur-Itles ________________________ . _______________________ _

    6. Measures to curtail thefts of securities ___________________ _ 7. Improvement of auditing standards ______________________ _ 8. Improvement of management practices ___________________ _ 9. Changes in entry standards _____________________________ _

    10. Improved disclosure to investors of broker-dealers' financial and operational condition ____________________________ _

    Chapter II-Nature and Use of Broker-Dealer Capital: Introduction _________________________________________________ _ Financial data employed ______________________________________ _

    1. NYSE member firms' general financial position for 1968-70 __ A. Cnstomers' security account balances ______________ _ B. Proprietory positions in securities and commodities __ C. Money borrowed ________________________________ _ D. Securities failed to deliver and securities failed to receive _______________________________________ _

    E. Securities borrowed and securities loaned ___________ _ F. NYSE monitored firms 1969-70 ___________________ _

    2. Temporary nature of capitaL ____________________________ _ A. Goodbody& Co ________________________________ _ B. F.!. DuPont Glore Forgan & Co _________________ _

    (III)

    Page

    1 9

    11 12 13 13 13 14 14 17 18 18 18 21 24 27 27

    30 30 qp 32 32 32 32 34 35 3.'>

    GV 39 42

    43 44 4.5 4.5 47

    47

    49 49 nO 50 5:3 5:-\

    53 53 54 54 61 63

  • IV

    Chapter II-Nature and Use of Broker-Dealer Capital-Continued Financial data employed-Continued Page

    3: Methods employed to counteract flight of capitaL _ _ _ _ _ _ _ _ _ _ 63 A. Walston & Co___________________________________ 64 B. Bache & Co __________________ . _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 65 C. McDonnell & Co_________________________________ 65

    4. Relationships among the components of capitaL____________ 66 A. Variation in the capital structure among firms_ _ _ _ _ _ _ 68 B. Securities contributed for capital purposes_ _ _ _ _ _ _ _ _ _ 70

    5. CaJtital structure of non-members of the New York Stock xchange____________________________________________ 73

    6. Leverage available to broker-dealers_______________________ 74 7. Trends in financial structure______________________________ 78

    A. NYSE member firms 1965-70_____________________ 78 B. Return on capital: NYSE monitored firms__________ 79

    Conclusion_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 80

    TABLES CONTAINED IN CHAPTER II

    Table 1: Summary balance sheet statement for all NYSE member firms carrying public customers' accounts (year end 1968-70)______________ 51

    Table 2: Summary balance sheet statement for 68 NYSE monitored firms (year end 1969-70) _ _ _ __ _ _ _ _ _ _ _ __ _ _ _ _ _ _ _ __ __ _ _ _ _ _ _ _ _ _ _ _ _ _ 52

    Table 2A: NYSE monitored firms as of ]\,Iay .5, 197L_________________ 52 Table 3: Equity capital as a percentage of total capitaL _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ .57 Table 4: Subordinated loans and accounts as a percentage of total capitaL_ 57 Table 5: Secured capital demand Hotes as a percentage of capitaL______ 58 Table 6: Accounts of partners subject to equity or subordinated agreements

    as a percentage of total capitaL _________________ -_________________ 58 Table 7: Statement of capital and subordinated aCC01lnts for N YSE mem-

    ber firms carrying accounts of public c1lstomers (year end 1970) __ _ _ _ _ _ _ _ 66 Part 1. Corporations___________________________________________ 66 Part II. Partnerships__________________________________________ 67

    Table 8: Market value of securities as a percentage of total fnnds available in selected capital and subordinated accounts of NYSE member firms (year end 1970)_________________________________________________ 71

    Tables 9 and 10: Selected financial data for 761 broker-dealers filing X-17A-I0 reports with the NASD (year end 1970)__________________ 73

    Table 11: Concentration of assets among N YSE member firms carrying accounts of public customers (year end 1970) ________ . _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 76

    Table 12: Concentration of equity capital among NYSE member firms carrying accounts of public customers (year end 1970)________________ 76

    Table 13: Concentration of total capital among NYSE member firms carrying accounts of public customer~ (year end 1970) __ ._____________ 78

    Table 14: Capital and subordinated accounts for 284 NYSE member firms carrying accounts of public customers (year end 1965-69) _ _ _ _ _ _ _ _ _ _ _ _ 78

    Table H(A): Capital and subordinated accounts for 324 NYSE member firms carrying accounts of public customers (year end 1969-70)________ 78

    Table 15: Return on total capital funds of overall business based on the experience of 6 months, October 1970-March 1971 at annual rate for 69 NYSE monitored firms versus that of 357 NYSE firms in 1967 (the highest of the 5-year period 1965-69) ._________________________ 79

    Table 16: Comparison of balance sheet data for NYSE member firms carrying accounts of public customers (year end 1965-70)____ ________ 81

    Table 17: Statement of capital and subordinated accounts for NYSE member firms carrying accounts of public customers (year end 1969) _ ___ 82

    Part 1. Corporation .___ ____ __ ___ __ _ _ __ ______ __ _ ___ _ __ _____ __ _ _ _ 82 Part II. Partnership_ _ _ __ _ __ _ _____ _ _ _ _ _ _ _ ___ __ _ ___ _ ___ ___ _ ___ _ _ 82 Part III. Statement of financial condition for NYSE corporations

    carrying accounts of public customers (year end 1969)____________ 82 Part IV. Statement of financial condition for NYSE partnerships

    carrying accounts of public customers_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 83 Table 18:

    Part 1. Statement of financial condition for NYSE corporations car- rying accounts of public customers (year end 1970)_______________ 84

    Part II. Statement of financial condition for NYSE partnerships car- rying accounts of public customers (year end 1970)_______________ 85

  • v

    Table 19: Composition of the capital structure for NYSE member firms carrying accounts of public customers (year end 1970):

    Part I. Equity capital as a percentage of total capitaL _ _ _ _ _ _ _ _ _ _ _ _ _ 86 Part II. Subordinated loans and accounts as a percentage of total

    capital_____________________________________________________ 86 Part Ill. Secured capital demand notes as a percentage of total capital ________________________________ c____________________ 87 Part IV. Accounts of partners subject to equity or subordinated agree-

    ments as a percentage of total capitaL_________________________ 87 Table 20: Composition of capital struct

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