WALL STREET: TROUBLE IN THE PRIVATE CLUB

LIKE all his predecessors, Robert Haack, president of the New York Stock Exchange, speaks proudly of the Big Board's "preeminent position in the securities industry." Then he utters what his predecessors would surely have deemed blasphemy--the thought that this dominance is not part of the order of nature but could be lost if the exchange does not adapt itself to "a totally new set of conditions." Largely because it has so far been highly resistant to just such a basic change, the Big Board is in trouble today.

It must resolve at least three basic problems. They concern not only market professionals but also the 26.5 million Americans who own shares directly and the 100 million who participate in stock trading through mutual funds, pension funds and trusts. First, the 642 brokerage firms that are members of the exchange have not yet cleaned up the back-office paperwork mess that since last June has kept the Big Board from conducting a normal 271-hour trading week. In addition, commission rates that member brokers charge to stock traders are under attack by the Justice Department, the Securities and Exchange Commission and institutional investors. All of them contend that the cuts made in some rates last December did not go far enough. Finally, some member firms are clamoring for repeal of an exchange rule that prevents them from raising needed capital by selling their own stock to the public.

The troubles are coming to a head now because there has been an enormous growth in trading volume. An average of 13 million shares daily changed hands on the Big Board last year, or 21 times the total that exchange officials once expected to be reached in 1980. A rising proportion of the trading is done by institutions, for which the exchange's trading mechanisms and commission structure are ill adapted. Haack estimates that institutional trades now generate 50% of all commissions on his New York Exchange. Whether the exchange can hold this business against rising competition from other markets, such as regional exchanges, and whether it can handle the still greater trading volume that is sure to come in future years, will depend heavily on the progress it makes toward solving its present difficulties.

--CUTTING THE PAPER. This is the most pressing problem at present, but also the one that the exchange, under Haack, has gone farthest toward overcoming. It is slowly phasing into operation a Central Certificate Service, which will transfer stocks from one brokerage account to another by making electronic bookkeeping entries. That will end the archaic system under which messengers now lug bags of stock certificates between brokers' offices in the Wall Street area. This week the exchange also will show off to the press a new computerized system for matching the institutions' big buy-and-sell orders. Next month the exchange will relieve crowding by increasing space 20%, opening up an extension to the trading floor. Exchange officials are asking SEC permission to lengthen trading half an hour to a 2:30 p.m. daily close--still an hour earlier than normal.

As for automation on the exchange, that still has a long way to go. Haack figures that the brokers can now "comfortably" handle a daily volume of 10 million shares. That is 23% less than the average volume they actually had to struggle with in 1968, and 72% less than the average daily volume of 36 million shares that Exchange Economist William Freund now predicts may be achieved by 1980.

--THE COMMISSION FIGHT. This is the issue with the greatest impact on investors' wallets, and one that the exchange must resolve in the next year or so to appease Government regulators. Under intense pressure from the SEC, it enacted a 7% volume discount on big block trades last year, but the cut was too small to please anyone. The Justice Department advocates scrapping the brokers' jealously guarded system of fixed minimum commission rates --which now range from $6 to $75 for every 100 shares traded, depending on price--and letting every broker charge whatever he can persuade customers to pay. The idea horrifies Haack. He contends, probably rightly, that it would discriminate in favor of institutions, which have the bargaining power to drive down rates, and against individual investors, who do not.

Haack is no defender of the tradition of setting commissions so high that they enable even inefficient brokerage houses to make money and the most efficient ones to make barrels of it. Donaldson, Lufkin & Jenrette, a house that specializes in institutional orders, has consistently had a profit margin of 50% before taxes under this system. Individuals can make more money with less work on Wall Street than almost anywhere else in the economy. Some neophyte brokers earn commissions at a $50,000 annual rate within six months after graduating from a training course, and veterans fairly commonly make $100,000. Haack generally advocates a new commission schedule under which efficient firms would continue to make large profits but inefficient ones might make none. The theory sounds fine, but he has not given details as to how the schedule would actually work. Brokers already speculate that any such system would drive some inefficient firms out of business or force them to merge.

-- WHOM TO LET IN. Public ownership of the exchange's member firms is the prospective change with the greatest long-range potential for reshaping the structure of Wall Street. The need is clear. Despite the rich commissions, member firms lack capital for long-term needs such as back-office automation, and several recently had trouble complying with an exchange rule that capital must equal at least 5% of debts. They must now rely on internal growth and borrowings.

Besides that, it would be desirable to open the "exchange community" to the new ideas that new brokerage owners would bring, and to let the public share in Wall Street's profits. Donaldson, Lufkin is threatening to leave the exchange if the constitution is not changed to let it go public (TIME, May 30). Haack seems sympathetic, but he predicts that a forthcoming vote on public ownership among the exchange's seat holders will be "close."

Voting Against Themselves. Beneath the debate over these issues, one factor more than any other has held back fundamental change at the Big Board: though its operations profoundly affect the public interest, the exchange is a private club. It is an association of brokerage-house partners who buy memberships entitling them to trade on the exchange floor at commission rates and under basic rules that can be changed only by the club members themselves. The number of seat holders has been fixed at 1,366 since 1953; new members can come in only by buying the seats of old members as they die or retire. As a result, voting power in the exchange bears no relation to the amount of business a member firm does. Merrill Lynch, the biggest brokerage house, holds only 17 seats, and some seat holders are partners of firms that consist mostly of themselves.

This system gives power to those who have the greatest interest in preserving the status quo. A seat holder who voted to cut commission rates, for example, would be consenting to at least a temporary reduction in his own income. The system recently defeated its own reform. Exchange leaders considered increasing the number of seats early this year, but decided against making a formal proposal after a poll of members disclosed a lack of interest. It would have been astonishing had matters been otherwise. The scarcity of seats for brokers who want to participate in the Big Board's rising volume has driven seat prices up to $515,000 each; an increase in the number might have lessened their value. Obviously, the exchange must act less like a private club and more like a public institution if it is to change as rapidly as Haack believes it must.

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