Believing that such restrictions “act as a burden on competition,” the SEC has announced plans to remove Rule 390 and all similar remaining restrictions on the freedom of exchange members to trade listed equities off national securities exchanges. Unfortunately, the viability of national exchanges, hence the commission brokerage business, rests on some minimal degree of centrality in the exchange system, which depends in turn on the off-board trading restraints the SEC is proposing to eliminate.
In the event of the demise of the present agency-auction market system, pure agency brokers can, of course, assume dealer functions. But this will require more capital. Since no new capital is currently entering the business, the capital will have to come from within—i.e., from further concentration of the industry.
The firms most likely to survive are the largest, most diversified ones. Since 1973, the largest 25 firms have continuously increased their market share. Through mid-1977, their share of the capital increased from 50.9 to 64.5 per cent, their share of commissions from 40.9 to 56.4 per cent and their share of total revenues from 47.8 to 63.8 per cent. As of June 30, 1977, the 10 largest firms had over 40 per cent of the industry’s capital in gross revenues and roughly one-third of its commission revenues. The conditions for market making in listed equities to become concentrated in the largest brokerage firms are now in place.
In a world of a limited number of large full-service firms—similar, as Charles Ellis has pointed out, to the leading money center banks—corporate issuers will be competing with each other for their share of the market makers’ capital. Dealers will aim to maximize profit and limit risk by exposing their capital only to those stocks in which they can expect to hold an edge over potential competitors—i.e., the less risky and more liquid larger stocks. As secondary markets for securities of smaller enterprises suffer, primary markets will become less accessible to them. In this way removal of Rule 390 will concentrate economic power, hence lessen competition, not merely within, but beyond, the securities industry.