"INVESTOR INTERESTS AS THE COMMON INTEREST:
         THE SEC'S CAMPAIGN FOR FAIR TRADING PRACTICES"

                REMARKS BY CHAIRMAN ARTHUR LEVITT
        UNITED STATES SECURITIES AND EXCHANGE COMMISSION 
                    ECONOMIC CLUB OF CHICAGO
        WEDNESDAY, APRIL 24TH, 1996 -- CHICAGO, ILLINOIS

     I'm honored to address this distinguished audience.  It's a
special pleasure to be in "the city that works."  That epithet is
undoubtedly a tribute to the creative, can-do spirit that
epitomizes Chicago.  Long home to major securities and commodities
markets, this city pioneered options, financial futures, and other
derivatives.  It has always been a major player in the financial
markets of our nation: In 1914, when the New York markets had been
closed because of financial panic for four and a half months, it
was the Chicago Exchange that reopened first.  More recently, when
floods closed the Chicago markets, the New York Stock Exchange
experienced the second slowest trading day of the year.  

     I've long known of the great contribution the financial sector
makes to the vitality and prosperity of Chicago.  But only from the
perspective of Washington does one realize the extent of the
contribution Chicago makes to the vitality and prosperity of our
nation.  Chicago matters.

     I therefore find it remarkable that SEC Chairmen have appeared
before this audience only six times in the agency's 62 years. 
Perhaps we're trying not to overstay our welcome.  

     The truth is, this is among the most esteemed forums in our
nation, and we only come when an issue is worthy of the audience.

     I believe the fairness of our markets is such an issue.

     Each day, when an SEC Chairman enters our building in
Washington, he is, in effect, vouching for the fairness of American
capital markets.  By the simple fact of his presence, he is saying
that, in those markets, investors can be confident that their
interests are held supreme. 

     It seems to me that, should any Chairman have the slightest
doubt about this, he has a responsibility to speak out.

     I am here to speak out.  I want to talk to you tonight about
conflicts of interest in the way orders are handled in our markets,
and how these conflicts work against you as investors.  The SEC has
proposed rules to address these conflicts and, toward the end of
my remarks, I'll discuss those, too.  But more than any particular
rule, I want to focus on a fundamental truth that underlies all of
the laws and all of the rules, and that is that, in American
capital markets, the interests of investors come first -- and that
is in the best interest of everyone.

     I've been talking about this issue in various contexts since
I came to the Commission.  

     We've addressed the conflicts created when an underwriter uses
political campaign contributions to open the door to  municipal
bond business.  

     We've encouraged a fresh look at how compensation and contests
can put brokers at odds with their customers' best interests. 
Internal promotions, extra compensation for "in-house" products,
and trips to Hawaii for selling a single product can force the
investor's interests to take a back seat.  As a result of our
efforts, an industry panel published a series of "best compensation
practices" for firms to aspire to.

     In the over-the-counter market, we pressed Nasdaq to prohibit
brokers from "trading ahead" of their customers' orders.  This
means that the broker-dealer entrusted with your order can't trade
for his own account before you trade.  The customer must come first
-- not just in theory, but literally.

     The NASD, at our behest, has just completed a sweeping re-
evaluation of its governing structure that saw representation of
the public interest grow to an all-time high.  In fact, I've talked
with all the exchanges about the need to enhance public
representation on their boards.

     And as I speak, we are engaged in a dialogue with the
governing body of the Financial Accounting Standards Board to
strengthen and safeguard the independence of financial accounting
standard-setting.  

     This sounds innocent enough, but it is one of the most
important issues we've had to face.  Accounting standards have been
set by the private sector for more than sixty years.  This is a
huge responsibility, for our system of securities regulation is
only as good as the numbers on which it rests.  If they go wrong,
we go wrong.  If standards are drawn, or even seem to be drawn, to
favor corporate interests over those of investors, faith in our
markets will erode.  

     While tension between the business community and standard-
setters is inevitable, farsighted leaders over six decades have
supported the independence of the process and accepted even those
standards that may have worked against their short-term interests. 
The positive economic consequences of a visibly independent process
far outweigh any potential disclocations it may cause.  

     I'm not persuaded that our government should take over this
reponsibility.  A better way to strengthen both the substance and
perception of FASB's independence would be to increase public
representation among the trustees of the Financial Accounting
Foundation, which oversees the standard-setters.  Yesterday I wrote
to the head of the Foundation and asked him to move quickly toward
this goal.

     These initiatives all bear a common message:  In American
capital markets, conflicts of interest are out, because the
interests of investors are supreme.  

     It hasn't always been that way.  Long ago, when he was
Chairman of the SEC, former Supreme Court Justice William O.
Douglas used the metaphor of a poker game to describe the capital
markets before the SEC.  "The feeling that one member at the table
has a mirror strategically located behind the other players is not
conducive to confidence," said Douglas.  "It does not create an
eager desire on the part of others to become participants."  In his
dry way, he hit the nail right on the head.

     Seventy years ago, not only were our markets tilted against
investors, but the very notion that they ought to be fair was
scoffed at.  Wall Street held most of the cards, made most of the
rules, and took most of the profits.  Investors had almost no
defense, short of holding on to their money -- an option they
exercised freely in 1929. 

     This systemic tilt against investors was remedied in 1934 with
the creation of the SEC.  The history of our markets since then is
a history of increasing fairness.  The invisible hand has become
a more even hand.

     And no one has welcomed this more than the securities industry
-- for business has thrived as investor confidence has grown.

     There have been times, however, when the industry has needed
a push to do the right thing.  That was the case in 1938, when
Chairman Douglas came to Chicago to address this forum.  He was
engaged in a huge battle to reform the New York Stock Exchange,
which until then had been run more as a club for the benefit of
its members, than as an institution in the public interest.  Stock
prices were still manipulated.  The financial statements of firms
were kept secret, so insolvency could strike investors suddenly and
without warning.  Specialists, who buy and sell shares in specific
stocks, dominated the board of the Exchange and ran it for their
own benefit -- to the detriment of brokers and the public.

     Douglas demanded that the Exchange be placed under the control
of a disinterested, paid president and professional staff, and that
its Board of Governors be representative of all the Exchange's
constituencies.  He came to Chicago to talk about this partly
because the Chicago Stock Exchange had already reorganized itself
along these lines, before New York, and without being ordered to
do so.  Another Chicago first.

     Douglas won that battle, while still preserving the New York
Stock Exchange's independence -- to the benefit of investors, to
the benefit of the nation, and perhaps most of all, to the benefit
of the Big Board itself.  

     I'm here this evening on a similar mission.  Today, our
capital markets stand among our nation's most spectacular
achievements.  They are the deepest and most liquid of any market
in history -- the envy of the world.  They've raised more than
capital: they've raised the quality of life.

     And yet, there are still places in those markets where
investors aren't getting an even break.  The industry is in need
of another push to do right.  I'm speaking of the way orders are
handled in our stock markets.

     In the 1960s, both Wall Street and LaSalle Street used to shut
down on Wednesday afternoons to give the markets a chance to catch
up with the paperwork.  Technical innovations have since brought
dramatic new efficiencies in the way trades are executed.

     Equity trading is no longer concentrated exclusively in New
York.  Stock is increasingly bought and sold on computer screens
away from the established markets.  These electronic trading
systems today attract more business than many exchange floors. 
And brokerage firms now execute many of their customers' orders
internally, from their own inventory, rather than sending the
orders to an exchange floor or wholesale dealer for execution.

     These innovations have brought about the almost instant
execution of orders, and they've driven down the costs of executing
trades.  But they've also made possible certain practices that call
into question whether investors are being well served.

     In certain markets today, brokers can trade with you at one
price publicly, while quoting a better price privately on a hidden
network.

     The quotes you do see may not accurately reflect the real
price of an issue, because limit orders, which specify the price
at which customers will buy or sell a stock, are not included in
the quote.  

     And brokers are able to route trades for execution based not
on the lowest cost to you, the customer, but on the highest payback
to the broker.

     A recent trade confirmation from a brokerage firm told its
customers that, in seeking to obtain best execution, the firm may
consider other factors, including whether there is an opportunity
for in-house execution, and whether it will receive cash or other
payments for order flow, as well as reciprocal business
arrangements with other firms. 

     In other words, in deciding where to get the best price for
the customer, the firm considers where it will make the most money.

     These practices debase the pricing mechanism on which our
markets depend.  They raise the cost of capital for issuers.  They
stack the deck against investors.  And they strike at the heart of
the relationship between a broker and customer, because they
violate the understanding on which it rests.  

     That understanding bears repeating, because it's fallen out
of focus in recent years.  It hinges on the distinction between
the two roles broker-dealers assume, that of a principal and that
of an agent.  

     A principal buys and sells for his own account.  His only
obligation is to himself.  

     An agent buys and sells on behalf of someone else.  His only
obligation is to the customer.

     When you go to a dealer in exotic Oriental carpets, not for
a moment do you assume that the dealer has your best interests at
heart.  You automatically suspect the prices you're quoted, and
you know you'll have to haggle.  

     When buying stocks, however, you don't haggle with your broker
over prices.  Unlike the rug dealer, whose quotes reflect only the
prices at his store, brokers undertake to provide their customers
with the best available market price -- even if they will
ultimately be trading from their own inventory.  In agreeing to
provide its customers with the best execution of their orders, the
broker assumes the responsibilities of an agent.  

     Brokers who trade with their customers out of inventory must
make a clear distinction between when they are representing their
customer and when they are acting as dealer.  Brokers can act in
only one capacity at a time: if they're holding a customer order,
they are required to step out of their dealer role and work solely
to represent their customer -- even where zealous representation
of the customer may hurt the firm's bottom line, at least in the
short run.

     Unfortunately, the line between these two roles has slipped,
leading to some of the problems I mentioned earlier.  We're
responding by placing a renewed and robust emphasis on a broker's
agency obligation.  Simply put, where it is possible to obtain a
better price for a customer, the Commission expects that a broker
will do so.  Indeeed, many firms have already begun to do this
today. 

     A second challenge the SEC faces is to restore fierce
competition based on prices -- a competition that takes place
between and among investors, brokers, and dealers.  Last fall, we
proposed new order handling rules intended to achieve this goal.

     I've managed to get three-quarters of the way through a speech
on those rules without actually discussing them.  This is a special
skill one learns in Washington.  

     The rules would promote competition in three main ways: 

     First, by asking firms to publicly display limit orders, so
that the prices at which customers are willing to trade are widely
advertised.  This will ensure that the quoted price reflects as
much buying and selling interest as possible.

     Second, by addressing the problem of so-called hidden markets. 
Twenty years ago, Congress directed the SEC to facilitate a
"national market system" that displayed all buying and selling
interest or activity across all markets to all investors, to ensure
that everyone got the best price.

     Today, however, to take just one example, Nasdaq market makers
often quote prices in private, "hidden" markets that are better
than the prices they quote on Nasdaq.  Retail customers don't have
access to these other markets, which go by such names as Instinet
and SelectNet, and have to trade at the prices on the Nasdaq
screen.  This is exactly the situation that Congress wanted to
avoid.  In order to make the prices in these hidden markets public,
our rules would require market makers who quote their best prices
in these hidden markets to quote the same prices on Nasdaq. 

     The third way our rules would promote competition is by
increasing opportunities to obtain a better price.  Ordinarily,
customers who want to buy or sell stock will have their orders
executed at the best bid or offer prices currently being quoted in
the market.  Our rule would require specialists and market makers
to offer customers an opportunity to get better prices for their
orders.  

     These proposals come not from the ivory tower, but from the
trading floor -- in fact, they would codify for all markets some
of the best practices already being followed by broker-dealers
today.

     Whatever their fine points, the rules arise from two very
basic principles:  Prices should be set by open competition.  And
when you trade in our markets, there is one person you should never
have to compete against, and that's your own broker.  

     What would be the positive results of these rules? 

     Institutional investors would benefit from a market that
showed clearly the best price.

     Issuers would have a lower cost for raising capital.

     Market participants, including some of Chicago's most
innovative, competitive businesses -- options markets and
derivatives traders -- would be better able to compete on the basis
of price.

     And at a time when their participation in our markets stands
at record levels, individual investors would see their orders
handled with the fairness they expect.  Let's remember that, in
the 1990s, for the first time in history, mutual fund assets have
surpassed commercial bank deposits.  Americans today have more
household wealth invested in stocks than in real estate.

     These investors rely on their brokers to do right by them. 
They depend the most on the agency relationship I've described
today.  They deserve an even break.

     If a lawyer had a hidden arrangement with the other side for
his own benefit, none of us would tolerate it.

     If a doctor performed the wrong procedure on a patient because
it paid more, none of us would tolerate it.

     If an architect designed a building made of a certain stone
not because it served the client's needs, but because he happened
to own the quarry, none of us would tolerate it.

     Neither must we tolerate it any longer if a broker puts his
own interests ahead of his client's.

     The truth is, in almost every instance, what's good for
investors is good for the market.  SEC regulation is not a zero-
sum game in which every new advance for investors brings an equal
and corresponding loss for the firms.  Most people recognize that
it's quite the opposite -- every new improvement for investors
makes a better marketplace, one that's likely to attract more
investors and more capital. 

     This is an enlightened view.  The fact that so many brokers
and firms share it today is a remarkable tribute to an industry
that, by and large, is willing and able to look beyond short-term
profits at long-term interests.

     I see our relationship with the industry as a partnership,
with responsibilities on both sides.  The process is not without
its tensions -- but together, we've created a regulatory framework
that has helped make American markets the most innovative and
successful in the world.  We must preserve that.

                          *     *     *

     In 1938, William O. Douglas came here and declared that, at
the New York Stock Exchange, the public interest must come first.

     This evening I've come before you to say that the same
principle applies to every market and every broker-dealer in
America: the investor's interest must come first.  

     This is not an article of faith -- it is more like a natural
law of markets.  Whether through good fortune, divine plan,
uncommon wisdom, or some combination thereof, the United States
has recognized that markets prosper only by preserving the good
favor of investors.  That insight has rewarded us with a growing
supply of jobs for our citizens; educational institutions that keep
us at the forefront of almost every endeavor; a cultural
environment that is among the richest in history; and a standard
of living that the whole world seeks to emulate.  And let me say
that to this material, intellectual, and cultural bounty, the great
city of Chicago has contributed far more than its share.

     But the whole thing begins to unravel the moment we take it
for granted -- the moment we stop working zealously to earn the
trust and good graces of investors.

     Our markets are a legacy you and I have inherited, but do not
own.  They are a national asset we hold in trust for America.  We
owe it to those who will come after us to leave those markets
stronger, sturdier, more productive, and more prolific than we
found them.  And looking out upon this extraordinary array of
civic-minded people, I have no doubt that we will.  Thank you.

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