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By Root 2674 0

a century or more that such a thing has happened, and it is startling for more than one reason. For many decades the New York Stock Exchange has been moving in the direction of closer and stricter controls over the operations and financial condition of its members—including minimum capital requirements, surprise audits, and the like. Besides this, we have had 37 years of control over the exchanges and their members by the Securities and Exchange Commission. Finally, the stock-brokerage industry itself has operated under favorable conditions—namely, a huge increase in volume, fixed minimum commission rates (largely eliminating competitive fees), and a limited number of member firms.

The first financial troubles of the brokerage houses (in 1969) were attributed to the increase in volume itself. This, it was claimed, overtaxed their facilities, increased their overhead, and produced many troubles in making financial settlements. It should be pointed out this was probably the first time in history that important enterprises have gone broke because they had more business than they could handle. In 1970, as brokerage failures increased, they were blamed chiefly on “the falling off in volume.” A strange complaint when one reflects that the turnover of the NYSE in 1970 totaled 2,937 million shares, the largest volume in its history and well over twice as large as in any year before 1965. During the 15 years of the bull market ending in 1964 the annual volume had averaged “only” 712 million shares—one quarter of the 1970 figure—but the brokerage business had enjoyed the greatest prosperity in its history. If, as it appears, the member firms as a whole had allowed their overhead and other expenses to increase at a rate that could not sustain even a mild reduction in volume during part of a year, this does not speak well for either their business acumen or their financial conservatism.

A third explanation of the financial trouble finally emerged out of a mist of concealment, and we suspect that it is the most plausible and significant of the three. It seems that a good part of the capital of certain brokerage houses was held in the form of common stocks owned by the individual partners. Some of these seem to have been highly speculative and carried at inflated values. When the market declined in 1969 the quotations of such securities fell drastically and a substantial part of the capital of the firms vanished with them.2 In effect the partners were speculating with the capital that was supposed to protect the customers against the ordinary financial hazards of the brokerage business, in order to make a double profit thereon. This was inexcusable; we refrain from saying more.

The investor should use his intelligence not only in formulating his financial policies but also in the associated details. These include the choice of a reputable broker to execute his orders. Up to now it was sufficient to counsel our readers to deal only with a member of the New York Stock Exchange, unless he had compelling reasons to use a nonmember firm. Reluctantly, we must add some further advice in this area. We think that people who do not carry margin accounts—and in our vocabulary this means all nonprofessional investors—should have the delivery and receipt of their securities handled by their bank. When giving a buying order to your brokers you can instruct them to deliver the securities bought to your bank against payment therefor by the bank; conversely, when selling you can instruct your bank to deliver the securities to the broker against payment of the proceeds. These services will cost a little extra but they should be well worth the expense in terms of safety and peace of mind. This advice may be disregarded, as no longer called for, after the investor is sure that all the problems of stock-exchange firms have been disposed of, but not before.*

Investment Bankers

The term “investment banker” is applied to a firm that engages to an important extent in originating, underwriting, and selling new issues of stocks and bonds. (To underwrite means