Looking for More Money

For more than a year, savvy Wall Street insiders have feared that the back-office paperwork tangle in brokerage houses might lead to a major scandal. Now those fears have been heightened. Several firms have failed, some others are in obvious financial trouble and the top officers of the New York Stock Exchange are desperately asking Washington for emergency help. Nobody expects a repeat of the classic 19th century panics, when brokerage houses went under in domino fashion, trading was suspended on the Exchange and Wall Street was crowded with frantic depositors trying to get their money from failing banks. But if the situation gets much worse, it could hurt some investors, scare others and provoke selling that would drive stock prices still lower.

Taking a Beating. Two weeks ago, McDonnell & Co. announced that it would close because of insufficient capital. Three smaller houses have liquidated in the past two years, but McDonnell is the best-known one to have shut down since 1963. One problem was that McDonnell had invested some of its capital in the sagging stock market. Investing capital reserves in stocks is a common though risky practice on Wall Street. Many of the larger firms, including Merrill Lynch, refuse to chance it. But McDonnell did, and so does Francis I. du Pont, among others.

Last week's news was also disconcerting. Bache & Co., the second largest brokerage house, announced an $8.7 million pretax loss for last year. Goodbody & Co. reportedly had a $1.5 million operating loss in the first two months of this year. Hayden, Stone took a $17.5 million loan from a group of investors in Oklahoma. And Kleiner, Bell & Co. announced that it was getting out of the brokerage business, but will continue as an investment banker.

No Profit in Trades. The trouble with Wall Street is that the securities business, which fattens on the managerial prowess and high technical competence of others, is itself poorly managed and technically backward. Though the Stock Exchange has started a centralized certificate clearing service, millions of dollars worth of stock certificates are still moved back and forth each day by aged messengers. Office automation came to the brokerage business relatively recently, and only because the Street was strangling in its own paper work. In 1968, brokers stepped up hiring expensive new talent and adding office equipment. All of this added greatly to the brokers' costs. At the same time, their income was reduced because of a cut in commission rates on large trades and the shortening of trading hours, a change imposed to give back offices time to catch up. On top of that, the market started its long decline in December of 1968, and volume tumbled. Costs could not be cut enough to prevent last year from being a disaster.

According to the Exchange, half of its member firms that serve the public lost money on their stock-trading business last year and continue to do so. Even Merrill Lynch, the largest and most efficient brokerage house, made most of its 1969 profit from underwriting and from its commodity and bond-trading activities. Institutional houses--which deal with mutual funds, insurance companies and pension plans--do well by comparison. Such institutions account for more than 40% of the current 11 million-share daily volume. That leaves the retail firms to scramble for the remaining 6,000,000 shares per day, the level of trading that prevailed in the mid-1960s before the recent spurt of expensive expansion took place. One good index of the malaise in the market: the price of a seat on the Exchange dropped from $515,000 last May to $300,000 this month.

Emergency Fund. In a semicrisis atmosphere last month, Robert Haack, Bernard Lasker and Ralph DeNunzio, the three top officers of the New York Stock Exchange, went to Washington to ask the Securities and Exchange Commission for an increase of 17% in brokerage commissions, the first raise since 1958. At the time, the plan was criticized because the heaviest burden would fall on small investors, and the public would be asked to support some sloppily managed firms. Last week, with a real crisis on their hands, the Exchange's trio went back to Washington to ask permission to impose an interim surcharge on all trades up to 1,000 shares. The surcharge would be $15 or 50% of the regular commission, whichever is lower. That would help keep some brokers solvent while the SEC studies the February proposal.

The Exchange maintains a trust fund to cover customers against losses if their broker fails. It has committed $6,000,000 to the orderly liquidation of McDonnell. The money will enable McDonnell to repay bank loans and reclaim customers' stock that had been pledged as collateral to secure the loans. Investors who buy stock on margin must agree to let the brokerage firm use the stock as collateral. McDonnell's clients stand to get their cash or stock, though margin customers may have to wait some time for the paper work to be unscrambled. One result of the McDonnell failure could be a decline in margin speculation because there is always the chance that the stock could be tied up indefinitely if more brokerages fail.

The Exchange has also committed $6,000,000 from its trust fund to the liquidation of two firms that failed last year. It has only $3.3 million left to handle other emergencies, though it does have a $15 million line of credit from banks. If several big houses should go under, the Exchange would assess the membership, and some institutional firms might well decide to leave the Big Board rather than pay up.

The latest tremors show that shareholders need more protection than the Exchange's trust fund provides. Maine's Senator Edmund Muskie has introduced a bill that would set up a Broker-Dealer Insurance Corp. similar to the Federal Deposit Insurance Corp., which protects bank depositors. Congress might be wise not to wait for the kind of disaster that brought FDIC to fruition before acting on the proposal.

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