"I know that all of the persons that think we are wrong are not greedy or lazy or antediluvian. Some of them are the most statesman-like thinkers and figures in our whole financial community. I have to say to such concerned and thoughtful persons that I think they are wrong and that we are right."
- February 12, 1974 "A Look Ahead at the World of Competitive Commission Rates" – Address by SEC Chairman Ray Garrett, Jr. to the Midwest Stock Exchange Conference
In 1974, the SEC issued regulations that provided that membership in the securities markets should be open to those who have the "primary purpose of serving the public as brokers or market-makers."(13) The SEC adopted the definition of "primary purpose" proposed by the Martin Report, using the "80-20 rule" which required a firm to do at least 80 percent of its commission business with unaffiliated customers in order to be eligible for membership in any exchange.(14) In addition, no more than 20 percent of an exchange member's trading volume could be executed on behalf of such affiliates if they also engaged in money management activities, including managing or advising mutual funds.
The reforms addressed the concern over the discounts and deals that large institutional investors often received from brokers and affiliated exchange members. The SEC believed that these types of arrangements hurt overall investor confidence in the markets by creating special status for larger investors that, despite the importance of scale economies for the cost of stock transactions, was perceived by critics as unfair to smaller public investors.
Several smaller exchanges, most notably the Philadelphia-Baltimore-Washington Stock Exchange, considered the 80-20 rule a death blow to its members and its continued operation. Nearly half of their business derived from institutional investor transactions.
While the SEC had reached a compromise with the smaller exchanges in 1973 that incorporated a three-year grace period, formally promulgated as Rule19b-2, all parties realized that the issue of fixed commission rates and their effect on the markets remained central to solving the problem.(15)
(13) 1934 Securities Exchange Act Release 9950 (1972)
(14) August 6, 1971 The Securities Markets – A Report, with Recommendations, by William McChesney Martin, Jr.; Seligman, 470
(15) Seligman, 470-472
