oversight

Improvements Needed in the Federal Reserve Reporting System for Recognized Dealers in Government Securities

Published by the Government Accountability Office on 1971-10-06.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

0
i-c
z     OF THE JOINT ECONOMIC COMMITTEE
%
?     CONGRESS OF THE UNITED STATES




      Improvements Needed In The
      Federal Reserve Reporting System
      For Recognized Dealers In
      Government Securities 8.1699o5




      BY THE COMPTROLLER GENERAL
      OF THE UNITED STATES


                          OCT. 681971
                     COMPTROLLER     GENERAL     OF      THE   UNITED   STATES
                                   WASHINGTON.    D.C.     20548




       B- 169905




       Dear   Mr.   Vice    Chairman:

                This is our report   on the improvements       needed in the Federal
       Reserve      reporting  system for recognized     dealers   in Government
       securities.      Our review was made pursuant       to your request    of May
       1970.

              As agreed, we discussed        our report      with officials of the Fed-
       eral Reserve     Bank of New York.         Although    they agreed with our find-
       ings, they felt that formal     comments        should come from the Informal
       Treasury-Federal      Reserve     Steering     Committee    which has overall
       ?e spons ibility for the reporting      system.

              We plan to make no further      distribution     of this report   unless
       copies are specifically  requested,     and then we shall make distribu-
       tion only after your agreement      has been obtained        or public announce-
       ment has been made by you concerning            the contents    of the report.

                                                                    Sincerely    yours,




                                                                    Comptroller      General
                                                                    of the United    States

       The Honorable      Wright  Patman
LP 2   Vice Chairman,      Joint Economic     c                _    .
  /       Committee                       -,I
       Congress     of the United States




                           50TH, ANNIVERSARY              1921- 1971
COMPTROLLERGENERAL'S REPORT TO                               IMPROVEMENTSNEEDED IN THE FEDERAL
THE VICE CHAIRMAN OF THE                                     RESERVE REPORTING SYSTEM FOR RECOGNIZED
JOINT ECONOMIC COMMITTEE                                     DEALERS IN GOVERNMENTSECURITIES
CONGRESSOF THE UNITED STATES                                 B-169905



DIGEST
--w--m


WHY THE REVIEW WAS MADE                                                                                             h

  --
    I   The Federal Reserve Bank of New York operates    a voluntary    reporting                           sys- "‘lIp$L
        tern to accumulate statistical and financial  data‘Ktbe      activities                            of
        private  dealers in Government securities.

        Participating    dealers report statistical  data daily and financial      data
        annually.     In 1970 the total transactions  reported  were $738 billion,
        or more than three times the value of transactions      on the New York Stock
        Exchange.

        At the request of the then Chairman of the Joint Economic Committee,   the
        General Accounting  Office (GAO) reviewed the reporting system to determine
        whether

          --good       accounting       practices   were being   followed       in preparing        the reports
             and

          --the reporting       system afforded    the Committee and the public with an
              accurate  picture     of the operations   and profits of the dealers  as a
              group.
                 --_.
        GAO examined into the procedures   and methods of report   preparation   employed
        by six of the 20 dealers  in Government securities   recognized    by the Federal
        Reserve System.


FINDINGS AND CONCLUSIONS

        The daily statistical           information     furnished      by the dealers was reasonably
        reliable.       This information         is published     regularly   for the use of Govern-
        ment officials,       financial       analysts,    and the public.       (See p. 18.)   GAO
        does not believe,        however, that financial            data which is reported    annually
        can be relied       upon because

             --sound       accounting    methods    were not followed       consistently,

             --numerous       errors    were made, and

             --different        accounting     bases were used by the dealers               in preparing      the
                reports.



Tear Sheet
                                                         1
    The Federal Reserve Bank of New York made reviews of the reported   data;
    however, these reviews were not effective in ensuring that the information
    was reliable.  (See pp. 9 to 17.)

    As a result   of errors    and inconsistencies, the annual financial       data   is
    not published   and little    use is madeof it.    (See p. 24.)


RECOMWENDATIONS
             OR SUGGESTIONS
    The reporting    system functioning     as it does on a voluntary  basis is a
    commendatory achievement.        Substantial  improvement in the accuracy of the
    annual financial     reports,  however, could be madeby correcting      some of
    the problems which GAO found.         (See pp. 26 to 28.)


AGENCYACTIONSAND UNRESOLVED
                          ISSUES
    Officials  of the    Federal Reserve Bank of New York told GAO that,         although
    they agreed with     GAO's findings   and conclusions,  the Informal     Treasury-
    Federal Reserve     Steering  Committee which has overall   responsibility       for the
    reporting  system    would have to decide what corrective     action would be taken.
    (See p. 28.)                                                                               I
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                                                                                               I
                                                                                               I
MTTERS FOR CONSIDERATIONBY THE                                                                 I
VICE CHAIRMAN,JOINT ECONOMICCOMMITTEE                                                          I
                                                                                               I
                                                                                               I
    This report   outlines   some measures that the Federal Reserve System could               I
    take to correct     the inadequacies  in the reporting systems. GAO is includ-             I
                                                                                               I
    ing these measures for such action as the Vice Chairman may deem appropri-                 I
    ate.                                                                                       I

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                         Contents
                                                             Page

DIGEST                                                         1

GLOSSARY

CHAPTER

  1       INTRODUCTION                                         3
              Background                                       3
              Nature of GAO review                             7

  2       FINANCIAL REPORTS                                    9
              Income                                          10
                  All gains and losses not reported
                      in the right reporting        period    10
                   Different     methods used to calculate
                      unrealized    gains and losses          11
              Expenses                                        12
                   Questionable     allocations               12
                   Different     methods of accounting
                      used in reporting                       13
                   Other                                      13
              Net worth allocation                            15
              Review of financial        statements           16

   3      DAILY STATISTICAL REPORTS                           18

   4      OTHEROBSERVATIONS                                   20
             Problems in analyzing net income                 20
             Need for refining    financial reports           24
             Use made of reports                              24
                  Financial  reports                          24
                  Daily reports                               25

   5      SUGGESTED  CORRECTIVEMEASURES                       26
             Strengthening    controls    over preparation
                of reports                                    26
             Improving review function                        27
             Refine financial     reports                     28
             Distribution   of aggregate report data          28
             Agency comments                                  28
APPENDIX

      I    Letter dated May 1970 from the Honorable
             Wright Patman, the then Chairman, Joint
             Economic Committee, Congress of the
             United States                               .31
 II       List of financial   report deficiencies   by
             type and primary cause                      32
                                                                     -1
              1,.   .




                                  GLOSSARY

Accrual     accounting        recording of financial    transactions
                              in the accounts as they actually       take
                              place (that is, as goods and services
                              are purchased or used and as revenues
                              are earned) even though the cash in-
                              volved in such transactions     is paid or
                              received at other dates

Borrowings                    funds borrowed to maintain     positions

Cash accounting-              recording  of financial transactions
                              only at the time that cash is received
                              or paid for goods and services

Commitment basis              recording  of securities transactions
                              in the accounts on the date agreement
                              to purchase or sell is made

Delivered     basis           recording  of securities  transactions
                              in the accounts on the actual date the
                              securities  are delivered

Margin requirements           difference between market value and
                              the maximum loan value of securities

Market value                  estimated selling  or purchase price of
                              security  based on bid and ask quote of
                              dealer

Position                      the total value of the securities           that
                              a dealer holds for resale

Recognized          dealers   Government security      dealers who--the
                              Federal Reserve Bank of New York con-
                              siders--have    established     a satisfac-
                              tory financial    credit    standing and can
                              handle a large volume of trading and
                              accordingly    are permitted     to deal di-
                              rectly with the trading desk
Repurchase agree-      arrangement for borrowing money
  ment                 whereby securities   are "sold" by the
                       dealer with a commitment to buy iden-
                       tical  securities  back at a specific
                       price
Settlement     basis   recording    securities transactions   on
                       the date agreed upon for delivery      of-
                       the securities
System open market     the Government securities     held by the
  account              Federal Reserve System
Trading   desk         the personnel who buy and sell secu-
                       rities  for the Federal Reserve Bank of
                       New York
Transactions           purchase   or sale of securities
COMPTROLLERGENERAL% REPORT -TO ..              ..:.       :,- IMPROVEMENTS
                                                                       NEEDED IN  THE FEDERAL
THE VICE CHAIRMAN'OP THE                                   RESERVE REPORTING SYSTEM FOR RECOGNIZED
JOINT ECONOMIC COMMITTEE                                   DEALERS IN GOVERNMENTSECURITIES
CONGRESSOF THE UNITED STATES                               B-169905



DIGEST
------

WHY THE REVIEW WAS JddDE-

     The Federal Reserve Bank of New York operates    a voluntary reporting                              sys-
     tem to accumulate statistical  and financial  data on the activities                               of
     private dealers  in Government securities.

     Participating    dealers report statistical  data daily and financial      data
     annually.     In 1970 the total transactions  reported  were $738 billion,
     or more than three times the value of transactions      on the New York Stock
     Exchange.

     At the request of the then Chairman of the Joint Economic Committee,   the
     General Accounting  Office (GAO) reviewed the reporting system to determine
     whether

       --good    accounting       practices    were being     followed       in preparing        the reports
          and

       --the reporting      system afforded    the Committee and the public with an
           accurate picture     of the operations   and profits of the dealers  as a
           group.

     GAO examined into the procedures   and methods of report  preparation employed
     by six of the 20 dealers  in Government securities   recognized by the Federal
     Reserve System.


FINDINGS AND CONCLUSIONS

     The daily statistical           information     furnished     by the dealers was reasonably
     reliable.       This information         is published     regularly  for the use of Govern-
     ment officials,       financial       analysts,    and the public.      (See p. 18.)   GAO
     does not believe,        however, that financial           data which is reported    annually
     can be relied       upon because

       --sound       accounting    methods    were not followed          consistently,

       --numerous       errors    were made, and

       --different        accounting    bases were used by the dealers                   in preparing     the
          reports.



                                                      1
    The Federal Reserve Bank of New York made reviews of the reported   data;
    however, these reviews were not effective in ensuring that the information
    was reliable.  (See pp. 9 to 17.)

    As a result   of errors    and inconsistencies,  the annual financial      data   is
    not published   and little    use is made of it.    (See p. 24.)


RECOMi'dENDATIONS
               OR SUGGESTIONS
    The reporting    system functioning     as it does on a voluntary basis is a
    commendatory achievement.        Substantial  improvement in the accuracy of the
    annual financial     reports,  however, could be madeby correcting     some of
    the problems which GAO found.         (See pp. 26 to 28.)


AGENCYACTIONSAND UNRESOLVED
                          ISSUES
    Officials  of the    Federal Reserve Bank of New York told GAO that,         although
    they agreed with     GAO's findings   and conclusions,  the Informal     Treasury-
    Federal Reserve     Steering  Committee which has overall   responsibility       for the
    reporting  system    would have to decide what corrective     action would be taken.
    (See p. 28.)


MlTTERS FOR CONSIDERATION
                        BY THE
VICE CRAIRMAN,JOINT ECONOMICCOMMITTEE
    This report outlines    some measures that the Federal Reserve System could
    take to correct   the inadequacies   in the reporting systems. GAO is includ-
    ing these measures for such action as the Vice Chairman may deem appropri-
    ate.
                             CHAPTER1

                           INTRODUCTION

       In May 1970 the Chairman of the Joint Economic Commit-
tee requested that the Comptroller      General look into the re-
porting system established     by the Federal Reserve System
for dealers in Government securities       and advise him as to
whether the reporting    system was likely    to afford the public
and the Joint Economic Committee an accurate picture of the
operations   and profits  of these dealers as a group and
whether the accounting practices      used in reporting  were in
accord with good accounting     standards.    A copy of the Chair-
man's request is included as appendix I.

BACKGROUND

       The Federal Reserve System, among its other functions,
is responsible    under the Federal Reserve Act for maintaining
a flow of credit and money that will foster orderly economic
growth and a stable dollar.     This function  is, in part, ac-
complished through the public sale and purchase of Govern-
ment securities    (U.S. Government and Federal agency securi-
ties).

       To carry out this function,        the Federal Open Market
Committee of the Federal Reserve          System has the responsibil-
ity of determining    the policy to       be followed in the purchase
and sale of Government securities.           The objective   of the
Federal Open Market Committee is          to protect the monetary
machinery from undue stress and         to influence    the economy by
affecting   the cost and availability        of credit.

      The Federal Open Market Committee has delegated the
responsibility   for executing its policy for all Reserve
banks to the Federal Reserve Bank of New York (Federal Re-
serve Bank).    Each year the Federal Open Market Committee
appoints a senior officer     of the Federal Reserve Bank to
manage the system open market account.       The manager main-
tains a trading desk at the Federal Reserve Bank to handle
all purchases and sales of Government securities.




                                  3
      Marketable Government securities      are traded daily in
an over-the-counter     market by dealers in Government securi-
ties.    Certain dealers,   called recognized dealers,   are per-
mitted by the manager of the system open market account to
trade directly    with the trading desk and are expected to
respond to the trading desk's needs for buying and selling
these securities.      This procedure is designed to ensure that
dealers admitted to trading have the resources and ability
to undertake large volumes of trading.

      The number of recognized dealers varies from year to
year.   As of March 31, 1971, there were 20 recognized deal-
ers, of which 11 were nonbank business enterprises    and nine
were banks.   They form a security   market which is the largest
in the country in terms of dollar volume and which is heav-
ily vested with the public interest.     The market is not reg-
ulated by either the Government or a private association.

     The volume of purchases and sales by recognized dealers
in Government securities    increased steadily     from $573 bil-
lion in 1966 to $738 billion     in 1970. A comparison of the
1970 volume of Government securities     traded with purchases
and sales of the New York Stock Exchange and the American
Stock Exchange is shown in the following       chart.
      TRANSACTIONS REPORTED BY GOVERNMENT SECURITIES DEALERS
                               COMPARED
               HllTH ACTIVITY ON RECOGNIZED EXCHANGES
  BILLIONS                                                                                     BILLIONS
OF DOLLARS                                                                                IF     DOLLARS
         75Of                                                                             750

                       $738
         700 -



         650 -



         600 -



         550 -



         500 -



         450 -



         400 -



         350 -


         300 -



         250 -                                                                            250

                                               $215
         200 -



         150 -



         100 -



             50 -



              0
                                    CALENDAR          YEAR   1970

       GOVERNMENT  SECURITIES DEALERS   REPORTiNC
       TO THE FEDERAL RESERVE BANK                              AMERfCAN STOCK EXCHANGE


       NEW YORK STOCK EXCHANGE




                                                    5
       Because statistical         and financial     information       about
the dealer market was scarce, a formal reporting                    system was
established    in 1960. The reporting            program was aimed at
providing   current information          on the functioning         of the mar-
ket in Government securities           to the public,        to students of
the market,    and to market participants,             including     the Federal
Reserve System and the Treasury Department.                    Reports in-
clude, in addition      to annual reporting          of balance sheet and
income data,     daily  statistics       covering securities         positions
and borrowings and volumes of transactions.                    No,legal or
regulatory   requirements        exist to enforce reporting;            the
dealers have reported voluntarily.
NATUREOF GAO REVIEW

      Our work was done at the Federal Reserve Bank and at
business offices   of six dealers in Government securities     lo-
cated in New York.    The dealers included in our review were
selected with a view toward obtaining     representation  from
each of the three types of dealers which are categorized       as
specialist,   bank, and multioperation.

       In the case of financial   reporting, we reviewed the
requirements   imposed on dealers by the Federal Reserve Bank
instructions.    At each dealer's   office we obtained reports
submitted to the Federal Reserve Bank for the year ended
December 31, 1969. We determined whether the figures on
these reports were taken from the dealers'     books of account
or financial   statements or whether the amounts in the ac-
counts or statements had to be revised to satisfy      Federal
Reserve Bank instructions.

       In those instances in which revised figures had been
reported to the Federal Reserve Bank, we identified     the
procedures and methods used to make the changes.      We re-
viewed some of these adjustments,    calculations,  and other
transactions   to determine whether sound accounting princi-
ples and practices    were followed and whether the results
were reasonably accurate.

      For the daily reports,       we reviewed the detailed    proce-
dures followed by the six dealers to accumulate, record,
and report information      required by the Federal Reserve Bank.
We selected a few transactions        and traced them through the
dealers'   systems to determine whether the transactions          had
been handled in accordance with dealer procedures,           sound
trade practices,      and Federal Reserve Bank instructions.        We
observed the preparation       of daily reports for one day at
each dealer's    office and traced the information       through the
Federal Reserve Bank processes into its computer file.

       Our work was done principally   through discussions  with
the Federal Reserve Bank and dealer officials;      onsite ob-
servations   of operations;  and reviews of a limited number
of transactions,    accounting  records, and other data.   The
cooperation    and courtesies  extended to us by the Federal
Reserve Bank and dealers were excellent.

     Our review did not cover the activities      of the System
Open Market Account.

        The confidential   nature of the data relative  to opera-
tions of individual      dealers was maintained in accordance
with rule 23 of the Joint Economic Committee which places
limitations     on the disclosure  of data obtained from individ-
ual dealers.




                                 8
                              CHAPTER2

                         FINANCIAL REPORTS

      We found that the financial       reports submitted by the
dealers had not been prepared in accordance with sound ac-
counting methods.      Further,   the dealers used different      bases
in preparing    the reports and made substantial        errors in
compiling the information       in the reports.     Consequently we
have little   confidence that these reports provide accurate
information   on the operations      and profits   of the dealers as
a group.    A list of the deficiencies       in the reports we ex-
amined is included as appendix II.

        The deficiencies    in the reports we examined occurred
primarily    because the dealers did not use sufficient       care
in preparation      of the reports and because the Federal Re-
serve Bank reviews failed to detect them. The inconsisten-
cies in the data contained in reports prepared by the par-
ticipating    dealers are attributable     to the wide latitude    in
reporting    practices    permitted under the Federal Reserve
Bank instructions,

       Before describing      some of the major deficiencies      af-
fecting   the reliability      of the reports,   it is important to
mention the factors       that complicate dealer reporting.        The
Federal Reserve Bank instructions         provide for submission of
reports on a calendar-year        basis, whereas seven out of 20
dealers operate their accounting         systems on a fiscal-year
basis.    Their closing of accounts can be at different           dates
during the calendar year.         Thus their normal year-end ad-
justments are not made for the period covered by the Federal
Reserve Bank reports.

       Also 14 are engaged in activities     other than trading in
Government securities     and their accounting    systems and nor-
mal financial   statements relate to the entire operations,
As a result of both these factors,       many adjustments had to
be made to the information      in their formal accounts to pre-
pare the Federal Reserve Bank reports.        It is in this con-
version process that most of the problems existed,




                                   9
INCOME
      We found two major problems which affected       income--
namely, all trading gains or losses were not reported in the
right reporting     period, and dealers used different     methods
to calculate    unrealized  gains or losses.
All gains and losses not reported
in the right reporting period
         The dealers included in our review used three methods
of recording        security     transactions     (1) the commitment basis,
recording       transactions       on the date that the purchase or sale
is made, (2) the settlement              basis, recording     transactions     on
the agreed-upon date for delivery,               and (3) the delivered        ba-
sis, reporting         transactions      on the actual date that the se-
curities       are delivered.        For 1969 the Federal Reserve Bank
required       dealers to report on a commitment basis in their
income statements all unrealized               gains or losses on posi-
tions as of December 31.
         Included in our review were three dealers who were on
other than a commitment basis and who did not make the nec-
essary adjustments for reporting.                Thus one dealer reported
unrealized        gains and losses on $649 million           of securities
but did not report in that reporting                 period unrealized
gains and losses on an additional               $330 million     of securities
that should have been included in his computation                   if it were
made on a commitment basis,
      The second dealer, with a position        of $313 million,
omitted from his computation about $44 million          of securi-
ties;  the third omitted $6 million       from his calculation     on
$54 million   of position.     In addition,   these   same dealers
did not compute the realized      gains or losses on securities
which were purchased and sold prior to January 1 but which
were not settled until     after December 31.
      Although the dealers knew that they were required to
report on the commitment basis, they did not do so because
they said that too much effort      was required.      The dealers
did not provide us with data on what the cost of reporting
on the commitment basis would be and we did not make our own
study of such costs; however, we believe,         with proper plan-
ning, the report could be prepared on the commitment basis
without an unreasonable     amount of effort.


                                       10
        Early     in our study,       we advised   the Federal    Reserve Bank
of our findings          regarding     the use of other than the comrnit-
ment basis of reporting.               On their own initiative,      bank of-
ficials      revised     the instructions       to permit dealers     to com-
pute profits         on their     own accounting     bases.  We doubt the
merits     of this revision         because it could have a material         ef-
fect on the reported            gains or losses.       This would occur
when there are large variances               in opening and closing      posi-
tions    on a commitment          basis which would not be reflected        by
the dealer's         accounting     basis.

        Further,     in the case of interdealer       trading,   there
could    be significant     transactions   lost     to the reporting        sys-
tem.     For example, if     a dealer reporting on the commitment
basis    sold securities     on December 31 to another dealer re-
porting   on the settlement     method,    these securities         would    not
be reported    in the positions     of either   dealer.

Different     methods used to calculate
unrealized     gains and losses

      The Federal Reserve Bank also instructs   the dealers to
compute their unrealized   gains or losses on year-end posi-
tions  at market value and allows   the dealers to choose their
own methods of determining   market values.

       The dealers whose records we reviewed used four meth-
ods of determining   market values for their positions.     Three
dealers used their own judgment of prices.      One used pub-
lished composite prices;    one used last sale; and one dealer
used a combination of his own judgment and price quotes of
another dealer.    Thus the same class of securities    held by
each dealer may be valued at different    prices for computing
unrealized   gains or losses.

       When we advised the Federal Reserve Bank of this prob-
lem, they again issued new instructions        requesting     dealers
to use the Federal Reserve Bank composite closing quota-
tions.    This, however, did not fully     resolve the problem be-
cause closing quotations    only include'securities        issued by
the Treasury and do not include securities          issued by other
Government agencies.     Agency securities     can represent       sig-
nificant   sums. For example, one dealer's        position    included
$121 million    in Government agency securities.

                                       11
EXPENSES

      The major problems in reporting expenses were the nu-
merous errors made by dealers in allocating   them and the dif-
ferent methods of accounting  for them,

Questionable    allocations

       The Federal Reserve Bank instructs    dealers to allocate
expenses between their Government operation and other opera-
tions.     The five dealers who had to make allocations    at-
tempted to comply with instructions;      however, they did not
follow sound accounting     practices or were not careful    in mak-
ing distributions.

       In pooling their expenses for allocation,           some dealers
did not follow the accepted practice            that there must be some
relationship     between the expenses and the operation         to which
they are allocated.       For example, one dealer overstated         his
reported expenses by about $900,000 because his pool included
commissions and dividends       not related to Government opera-
tions and interest      on partnership     capital,   which is not an
expense but a form of profit        distribution.       Another dealer
did not reduce his reported expenses by $84,000 because he
did not allocate     to other operations        the cost of services
performed for those other operations            by his Government opera-
tions.

       Also Government securities     are used to borrow funds for
all of the dealers'    operations.      In allocating     the related
interest   expense, two dealers charged their Government opera-
tions with the total interest       on borrowings made with Gov-
ernment securities    without regard to how much was relatable
to non-Government operations.        Since interest      on borrowed
funds is the dealers'     largest expense, this could have a
material   impact on reported net income.         To illustrate     the
impact that this allocation      can have when done properly,          one
dealer who did allocate      such interest    costs, instead of re-
porting all of it under Government operations,            showed only
$8.1 million    out of a total of $10.3 million        as relatable     to
Government operations.

       In addition,   dealers used various bases for making al-
locations.      One dealer  arbitrarily allocated administrative

                                    12
expenses on the basis of the number of people employed in
Government operations    to the total number employed and did
not establish   that this ratio was commensurate with the ben-
efits obtained by the Government activities.     Another dealer
merely had his staff estimate the amount of expenses to be
allocated   to Government operations  without any supportable
basis except judgment.

Different methods of accounting
used in reporting

       The Federal Reserve Bank instructions      are silent as to
whether reports should be prepared on an accrual or cash ba-
sis; this is one of the reasons for the lack of uniformity
in reporting.      Three dealers prepared their statements on
an accrual basis and three dealers submitted their state-
ments on a combination of accrual and cash basis.           For ex-
ample 3  one  dealer  reported   interest earned,  prepaid   insur-
ance, and interest      on borrowed funds on an accrual basis but
reported general and administrative       expenses on a cash basis.
We did not make a study to determine the difference          in
profit   and loss that would result from the use of the ac-
crual basis for general and administrative        expenses; how-
ever, in view of the size of such expenses, we believe the
difference    could be substantial.

Other

       The following paragraphs illustrate other        questionable
methods employed by dealers in the preparation          of financial
reports.
       Some dealers' Government securities    positions  were fi-
nanced with funds borrowed from their other operations.          The
Federal Reserve Bank requires     these dealers to apportion     a
part of these funds as interest      free because they represent
allocated   capital.  Interest  is includable    on the remaining
portion as part of reportable     expenses.

        One dealer has been using an estimated amount of
$7.5    million     since 1965 to represent his allocated    and there-
fore    interest-free       capital and has been reporting  the inter-
est    on the remainder as expense.        We were told that this
$7.5    million     estimate was based on a comparison of the


                                  13
relationship  between capital  and total Government positions
of several other New York City dealers.       We believe that
more exact methods of determining   allocated    capital should
have been employed.

       Another dealer made no allocation      in 1969 and reported
interest     expense on the total borrowings.     He reported
interest-free     borrowings in 1965 of $5 million.      Assuming
the same apportionment      for 1969, the reported interest     costs
for borrowed funds would have been reduced by about $429,000.

       The dealers told us that they could not make a realistic
apportionment    unless the Federal Reserve Bank gave them more
guidance.     These same dealers,  in computing interest     on
funds borrowed to finance Treasury bill positions,         used par
value of the securities    as a base rather than the amount
borrowed.     In addition, one of these dealers used the wrong
interest   rate to make the calculations.     As a result,    the
interest   expense reported by one dealer was $175,000 too
high whereas the other reported a figure that should have
been $9,000 higher.

        Also, the Federal Reserve Bank instructs      dealers to
report profits      both before and after income taxes and spe-
cifically     states that   income taxes are not to be included
as an expense.       We found that three dealers reported cor-
rectly.      One of the remaining three dealers included the
New York City income tax as an expense, and two dealers ig-
nored the city tax altogether        in preparing their reports.




                                 14
NET WORTHALLOCATION

       The Federal Reserve Bank requires nonbank dealers to
estimate net worth allocable     to Government activities    for
use in its profit    studies on return on capital.      The methods
used for allocation     did not appear to provide reasonable re-
sults because the Federal Reserve Bank has not given dealers
suitable   guidance.

        A Federal Reserve Bank study in 1967 indicated    that it
was aware that dealers were having problems and were using
various methods to allocate    net worth.  The report also dis-
cusses various concepts of net worth allocation     and the dif-
ficulties    encountered in applying them. It was silent,     how-
ever) as to which method would be preferable     or what guide-
lines should be followed.

      The dealers are apparently     still   having problems in
complying with this requirement     and are still    using various
methods in preparing   the reports.      In some instances the re-
sults appeared questionable.      The following    examples illus-
trate some of these conditions.

       In determining  the amount of net worth used for his
position   in Government securities,     one dealer included
$4 million    of Government securities     held for his own invest-
ment purposes plus $2 million       of Government securities    de-
posited with clearing     corporations   for handling other than
Government transactions.       The $6 million   should have been
treated as applying to his other operations         since these
funds were not used in maintaining       his position.

       Another dealer using a ratio of positions       to all com-
pany assets reported a net worth allocation         to Government
operations    of $2.4 million.    This dealer did not retain the
details    of his calculations.     We used the method he de-
scribed in his report to the Federal Reserve Bank to com-
pute--an allocation    of $1.9 million   as applicable   to Govern-
ment operations,     or $500,000 less than reported.      Although
the dealer agreed with our computation,       he was unable to
determine what caused the difference.

     In allocating  net worth, a third     dealer used a ratio
of Government securities  to his total     position,  This method

                                 1.5
appears inequitable      because considerably       less of the com-
pany's own capital     is needed to maintain        Government secu-
rities positions    since

      --large     positions of Government securities need less
          borrowings owing to their margin requirements   which
          range from less than 1 to less than 6 percent, whereas
          25 percent margin is necessary on corporate bonds and
          65 percent for stocks and

      --the low amount of positions    kept by the dealer's un-
         derwriting  activities  (which handles other than Gov-
         ernment issues) required substantial   resources to op-
         erate.

Under such circumstances,    a disproportionate amount of net
worth can be allocated    to the Government securities opera-
tion.

REVIEW OF FINANCIAL
            --      STATEMENTS

     The   Federal Reserve Bank reviews of dealer reports
were not   effective  in ensuring that the reported financial
data was   reasonably reliable   because the group responsible
for such   reviews did not

      --visit  dealers to examine the supporting             data and re-
         view report preparation practices,
      --have   staff   with   professional    accounting     expertise,
         and
      --have the authority       required    to obtain     dealer   coopera-
         tion.
      Among its other duties,        the Market Statistics     Division
of the Federal Reserve Bank is responsible          for processing,
reviewing,    and distributing     dealer reports.      Its reviews
consisted essentially        of checks for mathematical     accuracy,
completeness,    and consistency      with other reports.      They told
us that they also made certain analyses of the financial
data but did not rely too heavily on them because they felt
that the information       was unreliable,     These reviews were
done at the Federal Reserve Bank. According to the Market

                                     16
Statistics    Division,  visits were not made to the dealers'
offices    to examine into the reports in more depth because
it did not have the authority     to do so.
      Another problem in making such reviews was that the
Market Statistics    Division did not have any professional       ac-
counting expertise    on its staff.   The Market Statistics      Di-
vision had about 32 individuals     on its staff comprising
11 professional    and junior economists,   16 statistical    clerks,
and five typists    and messengers.   About eight of these staff
members were assigned to processing,      reviewing,and    distribu-
ing the financial    reports.

      The Market Statistics      Division    had no authority   to
correct errors found in dealer reports or to enforce            im-
provements in dealers'      reporting    practices.

      If the staff of the Market Statistics         Division obtained
professional     accounting expertise    and were permitted   to re-
view dealers'      accounting procedures at the site, they could
more effectively       identify  errors and inconsistencies   in the
dealers'    reports.      They could also encourage dealers to
make changes and improvements in the data reported.




                                  17
                                CHAPTER         3

                        DAILY STATISTICAL REPORTS

        The Federal Reserve Bank requires the dealers                    to submit
daily    the following statistical  information.

        Type of report                        Description
          Positions        The amount of securities held
                           for trading valued at par by
                           type of security

          Borrowings       The amount borrowed to maintain
                           positions by source and type of
                           security

          Volume           The amount of sales and purchases
                           at par value by source and type
                           of security

      We found a marked contrast     in the procedures and con-
trols covering the processing and reporting         of transaction
data when compared with those used for reporting          financial
information.    The transaction   reports usually came directly
from the dealers'   day-to-day   operating   systems.     The need
to have up-to-date    and accurate data for trading operations
undoubtedly   had an influence   on the reliability      of those
systems.

       Although we found that two dealers had reported certain
repurchase agreements incorrectly,        the Federal Reserve Bank
told us that in two instances the incorrect         data had not
materially    affected  the data as a whole and in another the
Federal Reserve Bank had issued corrected        instructions     for
future reporting.      On the basis of our observations,       it
seems that the dealers have adequate internal          control proce-
dures for processing     daily transactions.     Accordingly     we
believe that the information      furnished   to the Federal Reserve
Bank in the aggregate is reasonably reliable.

        The following    paragraphs        illustrate       the errors   found.



                                      18
       The Federal Reserve Bank and the dealers regard repur-
chase agreements as loans secured with collateral.            The then-
current instructions    requiredthat   repurchase agreements be
reported as borrowings at the actual amount borrowed.             We
found that two dealers were valuing their outstanding           repur-
chase agreements at par value of the securities          pledged as
collateral    instead of at the amount of funds borrowed.          As
a result,   these dealers were overstating      from 3 to 4 percent
the amount borrowed in the daily transaction         report.    Al-
though this practice    was contrary   to instructions,      Federal
Reserve Bank officials     said that they were aware that some
dealers were doing this but they believed that the aggregate
borrowing statistics    were only slightly    affected by it.

      We found also that one of the dealers discussed in the
preceding paragraph had, in accordance with a 1966 instruc-
tion, reported a certain type of repurchase agreement as a
sale.    Although the total amount was substantial,         about
$148.6 million,    the transactions     occurred rather infre-
quently.     After discussing    this situation  with Federal Re-
serve Bank officials,      they rescinded the 1966 instruction
and advised the dealer to follow then-current         instructions.




                                  19
                              CHAPTER4

                        OTHEROBSERVATIONS

      During our review, we noticed conditions    which we con-
sider important to the subject of the review and which may
be of interest  to the Committee.   These conditions    deal with
problems in analyzing net income, improved disclosure      of
matters that would significantly   affect the reports,    and the
lack of 'use made of the financial  reports.

PROBLEMSIN ANALYZING NET INCOME

       Except for information    relating    to    net profit    and net
worth, data permitting     analysis    of the     profitability     of mar-
ket operations    in Government securities         was limited.      This
situation    stemmed essentially    from the      Federal Reserve
Bank's inability    to obtain information         on certain    sources of
income and factors affecting       profits.

      For the period 1966 through 1970, the aggregate of
earnings reported by all dealers,   before taxes, ranged from
a loss of $8.6 million   in 1968 to a net profit  of $188.2 mil-
lion in 1970. The chart on the following     page shows the re-
ported profits   for each year and the 5-year average.

        In discussing the difference     in the 1969 and 1970 fig-
ures,    a Federal Reserve Bank official      told 'us:

       The sharp swing in dealer earnings between 1969 and
1970 stemmed from the turnaround       in interest   rates.    In 1969
interest   rates were rising    and they reached record levels.
Dealers maintained relatively      small positions     and had to
finance them at negative yields.         In 1970 interest   rates de-
clined and dealers increased their positions         in anticipation
of further    reductions.   Also the drop in short-term       money
market rates outpaced declining      yields on long-term securi-
ties and allowed dealers to finance their positions           at favor-
able rates.     The trend toward higher prices enabled the deal-
ers to earn substantial     trading profits.

        A more detailed analysis  of these factors was not pos-
sible    because the net income information   obtained by the


                                   20
      DEALERS
           IN GOVERNMENT
                      SECURITIES
                              REPORTING
                                     TO THE
          FEDERAL
                RESERVE
                      BANKOF NEWYORK
            DEALER
                 PROFITS
                       (BEFORE
                             TAXESI
                                                                                 $188.2




MILLIONS OF DOLLARS                                                                       MILLIONS   OF DOLLARS
                                                                                                              20




                      NONBANKS
1OC                                                                                                           00
                      BANKS

                      TOTALALLDEALERS




                                                                                                              80




                                                                                                              60




                                                                                                              40




                                                                                                              20




                                                                                                               0



                                               $8.6




-20               I              I                    I               I               I                       .20
         1966          1967             1968                   1969       1970                S-YEAR
                                                                                             AVERAGE


                                                          21
Federal Reserve Bank did not provide,       in all cases, for
dealers to segregate trading profits      from interest   earned on
Treasury bills.     Such information  is furnished    only if the
dealer normally makes such a breakdown.        Althaugh bills   con-
stitute  the largest volume of securities      sold, three of the
six dealers that we visited     did not separate interest     earned
from trading profits    but lumped these factors together.
Thus the extent of trading profits      in the aggregate was un-
determinable.

       An analyst of the Federal Reserve Bank stated that
another important factor influencing       profits  was the inter-
est paid on funds borrowed by the dealers to finance their
positions.      We noted that in 1970 the Federal Reserve Bank
entered into about $34 billion       worth of repurchase agree-
ments with nonbank dealers.       The Federal Reserve Bank enters
into these transactions      in performing  its function   of main-
taining    a flow of credit and money. The interest       rate paid
by the dealers on these borrowings is almost always less
than if they obtained the funds from other sources.

       For example, during July 1970, the Federal Reserve rate
was as much as 2 percent less than the New York City bank
loan rates for dealers.    Thus these transactions     enable
dealers to finance their securities      at lower costs,    Finan-
cial data that would readily    allow assessment of these trans-
actions on nonbank profits    is unavailable.

      The rate of return reported on net worth        by the nonbank
dealers for the 5-year period is shown below,

                        Rate of Return on
                     Net Worth Allocated    to
                Government Securities    Operations
                     Net income     Net worth    Percentage
         Year        (millions)    (millions)     of return

        1966            $ 25           $ 76            33
        1967               25            97            26
        1968              -5            101           -5
        1969              -5            104           -5
        1970             116            129           90
        5-year
           average        31            102           31

                                  22
       We obtained profit       and net worth data on the profitabil-
ity of other industries         and operations.       The First National
City Bank of New York monthly economic letter               of July 1971
showed composite rates of return on net worth, after taxes,
for more than 3,700 leading corporations.               These included
manufacturing,    transportation,      and financial      institutions
(commercial banks, investment trusts,            etc.).     To put the
economic letter     figures on the same basis as those of the
dealers, we adjusted the profits,           after taxes, to arrive at
profits,   before taxes, by assuming a tax rate of 50 percent.
The economic letter       figures as adjusted are shown below.
                                         Percent of return
                                             on net worth
                                         1969           1970
           Manufacturing                  25             20
           Transportation                  8               2
           Financial                      12              13
           Composite                      21              18

       We also obtained from the New York Stock Exchange re-
ported statistics    covering the financial  results  of member
firms.    This information   showed that more than‘300 firms
made a return on net worth, before taxes, of 16 percent in
1969 and 19 percent in 1970,

      A General Accounting Office profit  study showed that,
for 74 large defense contractors  in 1969, the average return
on net worth, before taxes, was 17.4 percent on work for the
Department of Defense, 24.8 percent on work for other de-
fense agencies and 20.4 percent on commercial work.1
      These figures are shown not for the purpose of assess-
ing the reasonableness   of earnings by the dealers but merely
to provide some information   on how they compare with other
business enterprises   in the economy.




'Defense   Industry   Profit   Study,   B-159896,   March 17, 1971.


                                   23
NEED FOR REFINING FINANCIAL REPORTS

   In addition    to the incomplete     disclosure   of income data,
we observed:

    1. Federal Reserve     Bank instructions      did not require as-
sertions  to the effect      that financial    statements were or
were not prepared on      a basis consistent      with that of the pre-
ceding year.    In our    opinion,   such an assertion      should be
required to disclose      any accounting procedural        changes that
would produce results      differing   materially     from-past years.

     2, Some dealers adjusted their security      positions     each
month to market values and record the unrealized          gains or
losses in the income accounts.      Under these circumstances,
the more acceptable method of financial       data presentation
requires    that disclosure  be made of the amount of unrealized
profit   which accumulated over the year and is still         in the
position   values at year-end.    Such disclosure     is  not   specif-
ically   required by the Federal Reserve Bank.

USE MADEOF REPORTS
    The expressed doubts about the reliability  of the finan-
cial reports have limited  their usefulness.   We understand
that the daily reports were meaningful to officials    of the
Federal Reserve Bank.

Financial   reports
    We found practically      no use made of the financial    re-
ports and therefore      discussed this matter with officials     of
the Federal Reserve Bank, the Federal Reserve Board, and
the Treasury Department.        Some of their comments follow.

    An official of the trading desk, Federal          Reserve Bank,
told us that the financial    reports were not        necessary to
its operation.   Such information,    however,       could be useful
to observe broad trends in the market if it           were not for        i
the problems in allocating    income, expense,        and net worth.

    A Federal Reserve Board staff member stated that the re-
ports were used for (1) identifying     changes in dealer oper-
ations,  (2) evaluating dealer profits,    and (3) determining


                                   24
those dealers that may have financial  difficulties.   He
added that the reports would be more useful if the alloca-
tion methods for expenses and net worth were improved.

    Treasury officials   were concerned with whether there were
enough dealers to handle the volume of trading and were also
interested   in such other matters as dealer profits.    They
believed that the reports were necessary but that they could
be more useful if improved.

   We  also found that the financial       data, in the aggregate,
was not regularly     distributed    to the Congress or to the pub-
lic.   An official    of the Federal Reserve Bank told us that
this was not done because the reports were considered unre-
liable  and therefore     meaningless.

Daily   reports
    Each day the trading desk at the Federal Reserve Bank re-
ceives position    data for each dealer and aggregate data on
positions,   dealer borrowings,  and volume of transactions   to
assist it in its open market operations.      In addition,  se-
lected data in the aggregate is sent daily to all the Fed-
eral Reserve Bank presidents,    to the Federal Reserve Board,
and to the Treasury Department.

    Only aggregate statistics   are released to the public
through weekly press releases and the monthly Federal Re-
serve Bulletin.    The volume of transactions   is publicly re-
leased weekly and position    and borrowings after a 4-week
time lag.

     Federal Reserve Bank officials   who operate the trading
desk have told us that the data is useful for several pur-
poses.     The data is used to determine the amount of secu-
rities   available  for purchase from dealers and to determine
the amount of money borrowed and the source of borrowings.




                               25
                             CHAPTER5

                  SUGGESTEDCORRECTIVEMEASURES

       Considering   the highly sensitive    nature of the Govern-
ment security     market operation    and how little  was known
about it in 1960, we believe that the progress made toward
developing and operating       a financial  and transaction   re-
porting   system merits commendation.       The fact that this
progress was made without regulations        and achieved through
the Federal Reserve Bank and dealer cooperation          also war-
rants recognition.

        Even so, we believe that our findings         show a need for
the Federal Reserve Bank and dealers to improve the reli-
ability    and usefulness     of the financial    data accumulated
under the reporting       system. This will require special ef-
fort by them if improvement is to be achieved.             In the re-
mainder of this chapter, we are suggesting some corrective
measures that we believe could be taken by the Federal Re-              '
serve System to achieve appropriate          improvements.

STRENGTHENINGCONTROLSOVER
PREPARATIONOF REPORTS
       In chapter 2 we pointed out major problems that were en-
countered:     (1) all income was not being reported for the ac-
counting period because some dealers were not on a commitment
basis and (2) some dealers reported,some        accounts on an ac-
crual basis but reported others on a cash basis.          It is gen-
erally recognized     that the accrual method of accounting more
accurately   shows the financial    position   of a concern and mores
precisely   measures the results    of operations   for specific
periods.    Accordingly   we believe that the financial     reports
should be prepared on an accrual basis if a significant          dif-
ference might result.
      Another problem discussed in chapter 2 was the reason-
ableness of expenses allocated      to the Government securities
operation.     The inequities  found were mostly attributable
to mistakes made by the dealers and the need for more spe-
cific   guidance by the Federal Reserve Bank. We believe
that the following     steps could be taken by the Federal


                                  26
Reserve System to build     a greater     degree of assurance      into
the reporting system.

     --Develop criteria       for the dealers to follow in al-
        locating     expenses with special emphasis on the suit-
        ability    of the basis used to allocate    costs and the
        relationship     of expenses to Government securities
        operations.

     --Require    dealers to retain the working papers support-
        ing such items as adjustments,   allocations,   and cal-
        culations   in preparing reports so that questions   in-
        volving the data submitted can be properly resolved.

      --Establish  methods for increasing awareness on the
         part of top management officials of the dealers that
         complete and accurate data is to be provided.

      --Establish    and require dealers to use uniform quota-
         tions to determine market value of Government agency
         securities.

      Chapter 2 also covers the question of obtaining          real-
istic  allocations     of net worth which has been a continuing
problem.    Essentially    theri! is a lack of guidance in this
area.    We believe that problems in such allocations        could
be overcome through the development of specific        criteria      on
the method to be used in allocating        net worth.

IMPROVINGREVIEW FUNCTION
     To strengthen     the Federal    Reserve Bank review       function
we believe that
      --the Market Statistics   Division      should   obtain    profes-
         sional accounting expertise,

      --the review procedures of the Market Statistics       Divi-
          sion should be modified to provide for examinations
          of financial     data and supporting workpapers at the
         dealers'    offices,   and

      --the authority   of the Market Statistics     Division       could
         be broadened to provide for visits      to dealers'       of-
         fices and enable it to make changes necessary

                                     27
        to improve the accuracy       and usefulness   of financial
        reports.

REFINE FINANCIAL REPORTS

      In chapter 4, we show the advantages that can be gained
by refining   the financial reports particularly   with respect
to more complete disclosure   of income data.    The following
steps could be taken to provide for better reporting.

      --Require    dealers to segregate Treasury bill  trading
         profits   from interest earned in the net income analy-
         sis.

      --Require dealers to indicate whether reports were pre-
         pared on a basis consistent    with that of the prior
         year.   If changes in accounting   procedures were made,
         the dealer should describe the nature of the change
         and the effect on the data.

      --Require dealers to disclose    the unrealized   gains and
         losses for all Government securities     using cost as a
         base. The balance sheet should show the amount of
         unrealized gain or loss included in reported posi-
         tions.

DISTRIBUTION OF AGGREGATE
                        REPORTDATA

        To ensure distribution      of financial    data to the Con-
gress and the public,        we believe that consideration      should
be given to inclusion        of the dealers'     aggregate data in the
annual report of the Federal Reserve Board.              To accomplish
this, we suggest that the Federal Reserve Bank establish
reporting    dates to coordinate       with the date of the annual
report.
AGENCYCOMMENTS
       We discussed the report with officials       of the Federal
Reserve Bank who gave us their informal comments. Although
they agreed with our findings   and conclusions,        they told us
that the Informal Treasury-Federal        Reserve Steering Commit-
tee,which has overall responsibility,,for        the reporting   sys-
tem,would have to decide on what corrective         action would be
taken.

                                 28
 APPENDIXES




29
                                                                         APPENDIX I




                                   Nay         1970

The Honorable Elmer B. Staats
Comptroller  General of the United         States
Washin:$on,  D. C.

Dear Mr. Staats:

             Eleven years ago, at my recrxest,         the staff    of the Joint
Economic Committee developed a set of reportin               forms and account-
in? standards     to use in obtaining     information     on tie operations       of
the dealers who make a market in Government securities.                   At that
time there were seventeen such dealers.             The results     were published
by the Committee in 1960 in a pioneering            staff   study of this market.
Subsequently     a system of regular    reporting      on this market was devel-
oped by.the Federal Reserve System in cooperation               with the dealers.
This system now produces a regular          flow of data about transaction           in
the market and on revenues,       expenses, and profits          of dealers,   both
bank and nonbank.

             Now that this system has been operating         for several years,
it would seem appropriate       to review the basic accounting       standards
that are employed to make sure that these are in accord with the
best practices.      This would insure that we could have confidence
in the data, particularly       as to the profits    of the dealers,      With
this aim in view, I am attaching         a set of the forms and instructions
used by the Federal Reserve Bank of New York in operating             this system
of reporting     and I request that your accounting        experts go over this
system and advise me as to whether or not:           (1) the accounting      prac-
tices are in accord with the best accounting           standard;   and (2) such
a system is likely     to afford   the public and our Committee an accurate
picture    of the operations    and profits   of these dealers as a group.

           Mr. James W. Knowles, Director     of Research for the Joint
Econom$ Committee,    has been involved   with this system from the
beginn+&   in 1959, and is available    to work with you in
needeg'5.n the course of your review.

                                                      Sincerely,     _




                                          31
 APPENDIX II


              LIST OF FINANCIAL REPORTDEFICIENCIES
                     BY TYPE AND PRIMARYCAUSE
                 Statements    of Financial    Condition

                                                                    Primary
                                                                     cause

 1. Adjustment    of securities    positions from the
       dealer's basis of accounting to the commitment
       basis was made incorrectly.       UP                            D2
    2. Various methods were employed for determining
       the market value of securities positions.     (6)               F

 3. Net worth     allocated to Government securities
    activities     was not adequately supported.     (1)               D

 4. Securities borrowed and the offsetting              liabil-
    ity were not reported.  (1)                                        F

 5. Liability     for outstanding repurchase        agreements
    reflected     par value of the securities        instead
    of actual     money borrowed.   (1)                                D

 6. Securities     purchased but not yet received             un-
    derstated     due to a footing error.   (1)                        D

 7. Accrued interest receivable           and accrued    inter-
    est payable were inaccurate.            (2)                        D

 8. Nonreportable  securities       were incl;ded       in fi-
    nancial statements.      (2)                                       D

 9. Securities    sold but not yet delivered         were im-
    properly   stated.    (2)                                          D

10. Securities     positions    were overstated.        (2)            D
11. Repurchase agreements were improperly classi-
    fied as to maturity  and type of security.    (2)                  D

1
  See page 34.
2
  See page 35.
                                     32
                                                                      APPENDIX II

                                                                          Primary
                                                                           cause

12. All contingent     liabilities          were not re-
    ported.    (1)                                                           D

13. Required explanations            of data were not submit-
    ted.   (2)                                                               D

14. Positions  in agency securities were errone-
    ously classified  as "other securities."    (1)                          D

15. The reported increase            in net worth was not
    accurate.   (1)                                                          D

16. Related asset and liability              accounts were off-
    set even though the Federal              Reserve Bank in-
    structed otherwise.    (1)                                               D

                        Net Income Analysis

17. Trading profits    were not reported on the com-
    mitment basis, as required by Federal Reserve
    Bank instructions.      (3)                                               D
18. Unrealized gains or losses not reported in the
    right   reporting   period.   (1)                                         D
19. Unrealized gains on Government securities                    in-
    cluding Treasury bills were not properly                   clas-
    sified.   (1)                                                             D
20. Unrealized   loss was erroneously            reported      as
    unrealized   gain.  (1)                                                   D
21. Income was not reported on a calendar-year
    basis as required by the Federal Reserve
    Bank. (1)                                                                 D
22. Certain interest       income was offset         against        in-
    terest expense.        (3)                                                n
23. Expenses on certain transactions              were offset
    against interest   income instead            of being re-
    ported separately as required.               (1)                          D!

                                       33
APPENDIX II

                                                                         Primary
                                                                          cause
24. Required explanations         of data were not submit-
    ted.   (2)                                                              D
25. Income on Treasury       bills     was overstated.            (1)       D

26. All   income items were not reported.             (1)                   D

27. Cost of borrowed funds was overstated      because
    interest     was on the par value of Treasury
    bills    instead of the discounted value.     (2)                       D

28. Unrealistic interest rate used for calculating
    the cost of own bank funds used.   (1)                                  D

29. Miscellaneous     income items were incorrectly
    classified.      (2)                                                    D

30. Miscellaneous    interest        expense was inaccu-
    rately reported.       (3)                                              D

31. Expenses included certain  items not applicable
    to Government securities  activities.  (2)                              D

32. No schedule     supporting       expense allocations          was
    submitted.      (1)                                                     D
33. Interest-free   dealer       department capital         esti-
    mate was unrealistic         or not estimated.          (2)             D

34. Local income taxes were treated            inconsis-
    tently.   (6)                                                           F

35. Interest   expense was overallocated       as a result
    of including   costs incurred in financing        other
    than Government securities     activities.      (2)                     D

36. Data submitted     was not fully       on an accrual           ba-
    sis.  (3)                                                               F
    NCTE: Figures in parentheses   ( ] indicate                    the
          number of dealer errors.


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                                                     APPENDIX II




                  TABULATION OF DEFICIENCIES

                                                Number of
                                             deficiencies
                                           Type      Instances

D = caused primarily   by erroneous
    dealer procedures.                         32         51

F= caused primarily  by weaknesses in
   Federal Reserve Bank instructions,
   guidelines,  etc.                           -4         -15

                                               =36        =67




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