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Memorandum re attached plan e n t i t l e d "Credit for Small Industry" The plan was developed o r i g i n a l l y as a suggested mechanism for meeting the credit and c a p i t a l requirements for small industry, and i s submitted only as a general outline i n preliminary form, many details as to organization and operation being omitted. In view of the continued unsatisfactory condition of the c a p i t a l market, i t has been suggested that government aid for business should be extended to the larger corporations as w e l l as to the small ones. This could be accomplished by a government-sponsored i n d u s t r i a l credit corporation such as i s proposed i n the attached plan, with amendments as follows: 1. Removing the maximum l i m i t a t i o n of $1 m i l l i o n to any one borrower. 2. Permitting the corporation to invest i n existing securit i e s so as to assist the capital market, absorbing undigested issues or taking any other appropriate action. I t has been further suggested that under present conditions any plan for furnishing c a p i t a l a i d to business i n order to be of subs t a n t i a l effect and to serve as a recovery measure, must be ba^ed upon a rather l i b e r a l credit policy. I t would l i k e l y be necessary under present conditions that the credit corporation make a substantial port i o n of i t s advances or investments upon the security of junior securit i e s , including preferred stocks, and on terms more favorable than can be obtained presently i n the c a p i t a l market. In other words, i t i s reported that some large corporations would today undertake c a p i t a l improvements i f they could market their securities on favorable terms, which i s not possible i n the present state of the c a p i t a l market. I f these suggestions are to be followed, the p o r t f o l i o of the credit corporation would not permit the ready sale of debentures by the corporat i o n at a low enough coupon rate to permit the corporation to make the indicated loans at rates which would induce business to undertake capit a l expansion under present economic conditions. Therefore, to carry out such a program i t would be necessary to have the government guarantee the debentures of the credit corporation, also that the c a p i t a l of the corporation be substantially increased above the amount proposed i n the attached plan. February 21, 1938 Credit for Small Industry I. The Problem. Small industry 1 s need of enlarged credit f a c i l i t i e s arises from two causes* A. Depression: Creditors are aware of the deterioration of the r i s k s i n existing credits to small business and are pressing for payment or reduction. This tends to further r e s t r i c t the operations of small business and i f continued w i l l bring about a great deal of insolvency and bankruptcy. Thus there i s a need of short or medium term credits, partly for refunding and partly for maintaining or increasing present output. B. Capital Expansion: While at the moment there i s probably a limited demand by small industry for c a p i t a l expansion, there i s unquestionably some demand and with any general resumption i n business the demand w i l l be acute. Therefore, a mechanism should be i n operation at an early date to anticipate t h i s need. II. Present f a c i l i t i e s for capital inadequate: As against the period of the f 20 f s the following developments have impeded the flow of c a p i t a l to industry generally and p a r t i c u l a r l y to small industry. This i g not i n c r i t i c i s m of the l e g i s l a t i o n and regula- tions referred to i n their general purposes but simply to show f a c t u a l l y the effect of them on the flow of c a p i t a l to industry. A. Underwriting by banks of deposit: law. This has been prohibited by While the underwriting of security issues by investment bankers i s s t i l l permissible, a great deal of investment banking c a p i t a l was wiped out by the depression and i t i s generally admitted that there i s a shortage of c a p i t a l i n that f i e l d at present. Underwriting by banks was always an important ad- junct of the c a p i t a l market and while i t i s impossible to e s t i mate just what difference i t s absence i s making i n the present situation, i t i s reasonable to suppose that i t i s an important factor. B. The Securities Act of 1955s This Act and the regulations issued pursuant thereto have discouraged the issue of stocks and bonds generally and have prevented almost e n t i r e l y the f l o t a t i o n of securities by small industry. This i s not due to the registra- t i o n fee which i s very nominal, but to the fact that the registrat i o n process i s necessarily complicated and technical so that r e l a t i v e l y heavy expense i s incurred for lawyers, engineers, underwriters 1 expense, etc., which i s proportionately heavier for smaller issues. From a s t a t i s t i c a l survey by the SEC of the estimated costs involved i n the issuance of new securities (bonds, notes and debentures) from January 1, 1936, to June 50, 1937, the following percentages of cost as against gross cash r e a l i z a t i o n of the securities i l l u s t r a t e the heavier burden on the smaller issues, p a r t i c u l a r l y under one m i l l i o n d o l l a r s . Under #250- #500- $750- #1,000- #5,000- $10,000- #25,000 (In thousands) #250 499 749 999 4.999 9.999 24.999 or more 11 35 8 6 6 50 37 Number of issues . . 11 Commission and d i s 2.1 2.3 2.2 6.4 5.2 4.2 3.4 6.2 Other expenses . . . . 2.2 2.5 1.4 2.0 2.0 1.1 0.9 0.6 8.2 6.2 4.8 Total 8.6 7.7 3.4 3.1 2.7 - 5 The exemptions from registration as to ^private offerings* would afford some r e l i e f i f l i b e r a l i z e d . However, any change i n the registration requirements would be of no effect unless accompanied by appropriate changes i n the Comptrollers Regulat i o n on Investment Securities next referred t o . C. The Comptroller 1 s Regulation on Investment Securities: Even i f there were no registration requirement whatever, the Comptroll e r ^ Regulation would e f f e c t i v e l y prevent small industry from obtaining c a p i t a l from member banks through the issue of securities. The statute leaves wide discretion to the Comptroller to regulate the type of "investment securities® that may be purchased by member banks. The Regulation very properly endeavors to define ^investment securities 11 so that unsound or speculative issues are not e l i g i b l e . The d e f i n i t i o n , however, lays stress not only upon the inherent quality of the obligations but r e quires that they be "marketable*1. Marketability i s obviously closely related to the extent of d i s t r i b u t i o n and the Regulation proceeds on that ground by requiring that the issue be of a suff i c i e n t l y large t o t a l to make marketability possible and i n addit i o n that such marketability be protected or insured by a public d i s t r i b u t i o n unless i t i s an exempted security. In effect, t h i s means that small issues, hence l o c a l issues, cannot quality under the Comptroller's Regulation* Small business, therefore, i s now e f f e c t i v e l y blocked from the c a p i t a l market. - 4 But, one may ask, should banks be permitted to invest i n small issues? ability? Should they have securities of limited market- This comes down to the question of "liquidity 1 1 i n banks and involves the whole question of Federal Reserve credit policy and bank examination policy, discussed below. Suffice i t to say at t h i s point that small business i s today e f f e c t i v e l y barred from obtaining needed c a p i t a l from security issues, which furnish a substantial part of the c a p i t a l r e quirements of large industries. D. Capital loans and bank examination policy? In the l i g h t of the obstacles to the issue of securities by small industry and their purchase by banks, outlined above, the natural question i s , why do not the banks make d i r e c t capital loans to small industry, thus avoiding, for the bank, the Comptroller's Regulation and, for the borrower, the heavy expense and long delay involved i n registration and underwriting? The average banker would reply, "I don f t l i k e c a p i t a l loans i n the f i r s t place, and i n the second place, i f I made any, the bank examiner would c r i t i c i z e them severely." This i s perfectly true. By t r a d i t i o n bankers are f e a r f u l of c a p i t a l loans and i f there were any disposition on the part of banks to make such loans the bank examiners would soon discourage i t . At the same time i t i s considered highly proper f o r a bank to invest i n rated bonds which are simply another form of capital loan. But here the banker feels that - 5 he i s following sound practice because the bond i s "marketable11. Experience has shown, however, that marketability i s an i l l u s o r y quality and invariably disappears at a time when the bank most needs to dispose of i t s securities. The Fed- e r a l Reserve System, under the authority of the Banking Act of 1955, has recognized the inconsistency of looking at the form rather than the substance of a bank loan and has consequently made a l l sound assets of member banks e l i g i b l e for advances at the Federal reserve banks. Hence, i f any member bank or group of banks should make a sound capital loan to a l o c a l industry, this loan would be available for credit at the r e serve bank i n case of need. Nevertheless such a loan would un- questionably be severely c r i t i c i z e d by bank examiners of whatever authority, Federal or State. Examiners, l i k e most bankers, have the l i q u i d i t y complex and c l a s s i f y loans as "slow" i f the maturity i s beyond a few months. classification. There should be no "slow" A loan i s either good or i t i s a loss, i n varying degree; and maturity should not enter into the c l a s s i f i cation. A step i n t h i s direction was made by the Examiners Conference of 1954 called by the Treasury, but the "slow" c l a s s i f i c a t i o n s t i l l exists and should be eliminated by a l l the Fede r a l supervisory agencies. Undoubtedly the State supervisory authorities could be brought into agreement. Mr. Crowley, Chair- man of the FDIC, has already expressed the concurrence of his organization i n t h i s suggestion. Such a move would be i n l i n e - 6 with the present policy of the Reserve System i n recognizing sound credits regardless of form and maturity. But the a t t i - tude of examiners should be changed even farther so as to encourage banks to make sound c a p i t a l loans to l o c a l industries. Summary of the Problem: Small industry today has need of credit f a c i l i t i e s to provide: 1. A certain amount of short or medium-term credit for current operations and to arrest the present deflationary contraction of credit. 2. This i s urgent. Capital funds for expansion and refunding. This w i l l become urgent with any recovery of business a c t i v i t y . Meeting both these needs would contribute i n an important manner toward recovery, f i r s t by arresting the current deflat i o n and secondly by encouraging c a p i t a l expansion. The suggested program which follows does not deal with the question of underwriting by banks but would remove other barr i e r s , as w e l l as set up an entirely new mechanism. III. The Program. A. The objective. To provide ( l ) short or medium-term credit for which the depression has created an urgent need, and (2) capit a l funds to commercial and i n d u s t r i a l businesses of smaller size, such funds to be used for expansion, refunding, modernizat i o n or otherwise. - 7 B. Four complementary methods proposed? (1) L i b e r a l i z a t i o n of SEC regulations or amendment to the Securities Act of 1935 i f necessary, i n order to encourage the issue of l o c a l s e c u r i t i e s . (2) (See Appendix tt Atf) L i b e r a l i z a t i o n of rules regarding purchase of invest- ment s e c u r i t i e s by member banks through amendment to the regul a t i o n s of the Comptroller o f the Currency. (5) 1 1 (See Appendix Changing examining p o l i c y so as t o eliminate the Bn) n slowv c l a s s i f i c a t i o n and encourage sound c a p i t a l loans to l o c a l i n dustry, already discussed heretofore. (4) Establishment of a permanent i n d u s t r i a l loan f a c i l i t y by the Government. The w i n d u s t r i a l loan* operations of the Fed- e r a l reserve banks and the RFC under present authorizations and p o l i c i e s do not meet the problem either i n i t s current or i t s permanent aspects. (See Appendix "C11) There are several ways i n which the mechanism for furnishing the c r e d i t requirements of small business might be provided. The RFC could be empowered by necessary l e g i s l a t i v e amendments. Since, however, the mechan- ism should be permanent, there i s an apparent inconsistency i n having such operations performed by an emergency organization. S i m i l a r l y , l e g i s l a t i o n could be framed to authorize the Federal reserve banks to carry on the suggested a c t i v i t i e s but i t is f e l t that the reserve banks, being banks of issue, should not take i n t o t h e i r p o r t f o l i o s long-term c a p i t a l loans and preferred stocks. I t would appear, therefore, that the suggested a c t i v i t y could best - 8 be carried on by a newly formed corporation which would specialize i n the f i e l d and have no other a c t i v i t y . It is desirable, however, that i n the interest of a prompt beginning of the operations as well as i n the interest of economy, such a corporation be housed and staffed by some existing government agency. The Federal Reserve System has an almost ideal t e r r i t o r i a l d i s t r i b u t i o n of f a c i l i t i e s i n the twelve banks with t h e i r twenty-five branches a l l located so as to best serve the various trade areas of the country. At the present time the Reserve System i s extending very l i t t l e credit to i t s member banks. At the same time each reserve bank must be prepared to extend such credit and hence must maintain a well equipped d i s count and credit department so that there i s presently an overstaffed condition i n such departments. I t i s suggested, there- fore, that i n the interest of speed and economy, the proposed corporation be owned and operated by the Federal Reserve System, the twelve banks with their.branches furnishing the necessary f i e l d agencies and the Board of Governors with i t s s t a f f furnishing the necessary head o f f i c e direction and personnel. Therefore, with the addition of a few experts i n the investment banking f i e l d , the System, as agent of the corporation, could very promptly begin lending to industry and insuring i n d u s t r i a l loans made by insured banks. The more detailed discussion hereafter, i n which the Federal - 9 Reserve System i s connected up with the proposed corporation, i s suggestive only, and i f i t i s decided that the corporation should be owned and operated by some other agency of government, the purposes of the corporation could be carried out just as f u l l y although not with the same promptness as to i n i t i a l operations nor with the same economy. IV. Industrial Loan Corporation. A. Method of operations. I t i s proposed to create by law a cor- poration to supply c a p i t a l funds to small businesses, and to insure loans made by insured banks (FDIC System) to small businesses, the insurance mechanism to be similar to T i t l e I of the Federal Housing Act. board of three directors. This corporation would have a The Board of Governors from time to time would designate three of i t s own members as directors of the corporation and would also designate three alternate directors from among the remaining members of the Board of Governors or members of i t s s t a f f . The corporation would u t i l i z e , as o f f i c e r s and employees, such o f f i c e r s and employees of the Board of Governors as might be necessary. The corpora- t i o n would be authorized to u t i l i z e the Federal reserve banks as i t s agents, or, i f i t deemed i t desirable, to designate other agents or set up i t s own agents. Ho director of the corporation and no o f f i c e r or employee of the Board of Governors or a Federal reserve bank would receive any additional - 10 compensation for his services f o r the corporation. The Fed- e r a l reserve banks as agents would receive applications for i n d u s t r i a l loans and mice loans i n the name of the corporation. They would also handle the insurance of loans made by insured banks of their d i s t r i c t . The corporation would reimburse the Reserve Board and banks or other agencies for their expenses on such basis as might be determined by the Board of Governors. B. Capitalization and Debentures. I t i s proposed that the Treasury pay over to the Federal reserve banks $100,000,000 (being a part of the unpaid remainder authorized tinder section 15b of the Fede r a l Reserve Act). The Federal reserve banks would u t i l i z e the #100,000,000 to subscribe for stock i n the i n d u s t r i a l loan corporation. The Federal reserve banks would pay to the Treasury the amounts due the Treasury on account of sums received from i t under section 13b, within a period not exceeding years, and after the new corporation begins business the Federal reserve banks would make no new loans or commitments under 13b. Stock i n the corporation would have no voting r i g h t s . The corporation would have authority to issue debentures up to f i v e times i t s c a p i t a l and surplus; but i t would be required to pay a l l earnings into a reserve fund for losses u n t i l t h i s fund equaled f i v e per cent of outstanding loans. Thereafter (so long as the reserve did not f a l l below t h i s r a t i o ) earnings - 11 might be paid to surplus• The debentures would not be guaran- teed by the United States. I t i s further proposed that Congress appropriate #50,000,000 as an insurance fund to be administered by the corporation as set f o r t h below. C. Mature of loans to be made by corporation. The corporation would be authorized through the acquisition of notes, debentures, bonds or other similar obligations or of preferred stock to supply funds i n amounts not exceeding #1,000,000 to any one enterprize. The obligations enquired would mature i n not more than ten years, and at least fo£ty per cent thereof must be paid o f f through p a r t i a l payments before maturity. This would not prevent the renewal or extension of obligations at maturity. D. Insured loans. The #50,000,000 insurance fund would be a v a i l - able to the corporation i f and when needed to meet losses on insured loans made by any insured bank up to 20 per cent of the aggregate of a l l loans and advances made by such bank to any commercial and i n d u s t r i a l business. The maximum amount of any such loans to one borrower would be #50,000, but a loan exceeding # would be submitted to the corporation or i t s agent for approval before being made. Ho such loan could be made for the purpose of paying i n whole or i n part any existing indebtedness of the loaning bank. Any insured loan would have a maximum - 12 - maturity of ten years and provide for equal regular i n s t a l ment payments under which the entire loan would be r e t i r e d not l a t e r than the date of maturity. The t o t a l l i a b i l i t y for i n - surance which the corporation might have outstanding at any time, plus amounts paid i n settlement of insurance claims, could not exceed the amount of the insurance fund. This would provide i n - surance for a maximum of $250,000,000 of loans. E. Regulations and reports. A l l the operations of the corporation, including insurance of loans, would be subject to a broad authori t y i n the corporation t o make rules, regulations and requirements, with a right i n the Board of Governors to review and revise such rules, regulations and requirements from time to time. The Board of Governors would transmit to Congress with each of i t s Annual Reports an Annual Report of the corporation regarding the operations of the l a t t e r . February 19, 1938. APPENDIX A Registration of Private Issues under Securities Act of 1955 Law. - Section 5(a) of T i t l e I of the Securities Act of 1935 reads as follows: "Unless a r e g i s t r a t i o n statement i s i n effect as to a security, i t s h a l l be unlawful f o r any person, d i r e c t l y or indirectly*— n ( l ) to make use of any means or instruments of transportation or communication i n interstate commerce or of the mails to s e l l or o f f e r to bi$r such security through the use or medium of any prospectus or otherwisej or "(£) to carry or cause to be carried through the mails or i n interstate commerce, by any means or instruments of transportation, any such security f o r the purpose of sale or f o r delivery after sale." Exemptions. - A number of classes of securities are exempt from r e g i s t r a t i o n requirements under section 5 of T i t l e I of the Act. Subsection (11) of such section exempts the following: "Any security which i s a part of an issue sold only to persons resident within a single State or Territory, where the issuer of such security i s a person resident and doing business within or, i f a corporation, incorporated by and doing business within, such State or T e r r i t o r y . " Among other classes of securities which are exempt are Government securities, commercial paper, securities of r e l i g i o u s and charitable organizations, securities of building and loan associations and similar organizations, securities exchanged by the issuer with i t s existing security holders exclusively where no commission or other remuneration i s given, and others. The Commission i s author- ized by section 5(b) to exempt by regulation securities of an issue - 2 which does not exceed $100,000 and nnder t h i s authority i t has exempted securities sold entirely f o r cash, the aggregate offering price of which does not exceed $100,000, and other issues not exceeding $100,000. With the possible exception of the exemption of securities sold ent i r e l y i n the issuer 1 s State, the above exemptions are believed to be of l i t t l e significance i n connection with the present problem, but the exemption discussed below for transactions not involving a public offering i s believed to have important p o t e n t i a l i t i e s . Private Offerings. - Section 4(1) of T i t l e I of the Secur i t i e s Act provides that the prohibition upon the use of interstate commerce and the mails for the purchase or sale or transportation of unregistered securities i s not applicable to "transactions by an issuer not involving any public offering", and informally the Commission has taken the position that, generally speaking and subject to exception, securities which are offered to not more than twentyf i v e persons do not involve a public o f f e r i n g . However, t h i s ex- emption applies only with respect to transactions by an issuer and not to transactions by a dealer or underwriter. I t i s understood, however, that i n some circumstances an underwriter may be u t i l i z e d i n connection with unregistered issues not involving any public o f fering without v i o l a t i n g the law where he i s employed merely to attend to the details of the issue and he does not i n fact perform the usual functions of an underwriter, i . e . , purchase the securities with a view to public d i s t r i b u t i o n . - 369 - Proposal* - I t i s believed that there i s some uncertainty or misunderstanding as to the extent to which an underwriter may be u t i l i z e d i n connection with unregistered i s sties not involving a publ i c offering without v i o l a t i n g the statute and a more e x p l i c i t ruling or statement by the Securities and Exchange Commission, which could be publicized, as to the circumstances under which an underwriter might be u t i l i z e d would be very h e l p f u l i n encouraging issues where no public offering i s involved* I t would also be b e n e f i c i a l for the Commission to rule that an offering of securities exclusively to banks insured by the Federal Deposit Insurance Corporation of a limited number or i n a r e s t r i c t e d area would not be a public offering* of the Commission has stated that n The General Counsel the basis on which the offerees are selected i s of the greatest importance. Thus, an offering to a given number of persons chosen from the general public on the ground that they are possible purchasers may be a public offering even though an o f f e r i n g to a larger number of persons who are a l l the members of a particular class, membership i n which may be determined by the application of some pre-existing standard, would be a non-public o f f e r i n g . " The General Counsel has also stated that another factor to be considered i s the business of the purchaser, as for example, "whether the purchase of such a block of securities for investment i s consistent with i t s general operations Since insured banks as a class have f a c i l i t i e s and experience which - 4 enable them to evaluate securities and to protect themselves against fraud better than members of the public and since, as a rule, they purchase securities f o r investment rather than f o r resale, i t i s believed that a r u l i n g such as that proposed above would be consistent with the position heretofore taken by the Commission. Statutory Amendments* - Further l i b e r a l i z a t i o n of the r e g i s t r a t i o n requirements with respect to l o c a l , private, or small issues could be effected only through amendments to the law, and i t i s believed to be desirable that, as soon as practicable, amendments to the law be obtained as follows: (1) Exempting securities which are part of an issue sold only to persons resident within a State i n which the issuer has i t s p r i n c i p a l business instead of requiring, as the existing law does, that a corporate issuer not only do business within the State but be incorporated therein* (2) Increasing from #100,000 to #250,000 or #500,000 the maximum amount of an issue of securities which may be exempted from the Act by regulation of the Commission. February 19, 1938 APPENDIX B Purchase of Investment Securities by Member Banks Law. - Under section 5136 of the Revised Statutes, a member bank "may purchase for i t s own account investment securities under such limitations and r e s t r i c t i o n s as the Comptroller of the Currency may by regulation prescribe." The section further pro- vides that "the term investment securities 1 s h a l l mean marketable obligations evidencing indebtedness of any person, copartnership, association, or corporation i n the form of bonds, notes and/or debentures commonly known as investment securities under such further d e f i n i t i o n of the term 1 investment securities 1 as may by regulation be prescribed by the Comptroller of the Currency." Existing Regulations. - The regulations of the Comptroller of the Currency on t h i s subject include the following provisions: "Under ordinary circumstances the term 'marketable® means that the security i n question has such a market as to render sales at i n t r i n s i c values readily available. "In determining whether a given security i s marketable, i t must meet the following minimum requirements: "(a) That the issue be of a s u f f i c i e n t l y large t o t a l to make marketability possible; "(b) (1) That a public d i s t r i b u t i o n of the securities must have been provided for or made i n a manner to protect or insure the marketability of the issue, or, i n the alternative (2) other existing securities of the issuer have such a public d i s t r i b u t i o n as to protect or insure the marketability of the issue under consideration, and fchch issue must be registered under the provisions of the 'Securities Act of 19331 as amended, - 2 unless I t i s exempt from registration under Section 3 thereof. tt (c) That where the security i s issued under a trust agreement, the agreement must provide for a trustee independent of the obligor, and such trustee must be a bank or trust company." Since securities which have a public distribution must be registered under the Securities Act of 1955, i t i s obvious that as a p r a c t i c a l matter a l l investment securities purchased by a member bank must be registered unless expressly exempt from registration. Many securities which are floated i n small issues or which are issued only l o c a l l y are both sound and marketable, but nevertheless can not comply with the requirements of the Comptroller's regulations either because the issues are not s u f f i c i e n t l y large i n amount or because the securities do not have a public d i s t r i b u t i o n . I f a practicable means can be found by which member banks may purchase such securities, small businesses w i l l be greatly aided i n their endeavors to borrow c a p i t a l funds on a medium or long term basis• The regulations of the Comptroller also include the following provisions: n The purchase of 'investment securities 1 i n which the investment characteristics are d i s t i n c t l y or predominantly speculative, or 1investment securities 1 of a lower designated standard than those which are d i s t i n c t l y or predominantly speculative, i s prohibited. The purchase of securities which are i n default, either as to p r i n c i p a l or interest, i s also prohibited.® - 373 - A footnote provides: w The terms employed herein may be found i n recognized rating manuals, and where there i s doubt as to the e l i g i b i l i t y of a security for purchase, such e l i g i b i l i t y must be supported by not less than two rating manuals." Proposal - Small or Local Issues* - I t i s proposed, therefore, that the regulations of the Comptroller of the Currency regarding the purchase of investment securities by member banks be modified so as to substitute for the existing marketability provisions other less r e s t r i c t i v e provisions with respect to issues of a email or l o c a l character* Jj Securities which are part of an issue of less than and which are part of an issue which i s distributed l o c a l l y — t h a t i s , not beyond a radius o f , say, 100 miles of the princ i p a l o f f i c e of the issuer—could be exempted from the marketability provisions of the regulation. In l i e u of such provisions i t would be required that the bank be able to show that there i s or would be a reasonably ready market for the securities at i n t r i n s i c values i f they were offered for sale, but not necessarily that they might be Immediately disposed of at i n t r i n s i c values. The bank would be limited to 20 per cent of the amount of the issue or #50,000, whichever i s greater. The bank should be i n a position to demonstrate the marketability of any such securities that i t purchases by evidence of the f i n a n c i a l condition of the issuer, the standing of the issuer i n the community, evidence of demand f o r the securities when issued, the ease with which they were sold and other facts tending - 4 - to show probable a b i l i t y to dispose of them i f the bank wished to do so. Rating Manuals. - The present regulations prohibit the purchase of investment securities i n which the investment characteri s t i c s are d i s t i n c t l y or predominantly speculative and permit the use of rating manuals to establish the e l i g i b i l i t y of the securities f o r purchase. The use of rating manuals i s obviously not appro- priate for securities of a l o c a l character, and i t i s suggested that the reference to r a t i n g manuals as a method of determining whether a security i s an investment or a speculation be d.iminated altogether from the regulation. APFEHDIX C Although Federal Reserve banks have authority under section 13b of the Federal Reserve Act to make i n d u s t r i a l loans for working capital purposes, and although the Reconstruction Finance Corporation has authority to make loans to industry under certain conditions, these provisions do not meet the needs of the present situation and would not afford the same l i b e r a l basis for supplying funds to industry as that here under consideration. Loans by Federal Reserve Banks under Section 15b of the Federal Reserve Act. - Federal Reserve banks are authorized under this section to make loans to established i n d u s t r i a l or commercial businesses, either d i r e c t l y or i n cooperation with financing i n s t i tutions* However, such loans can be made only for the purpose of providing working c a p i t a l , must have a maturity of not exceeding f i v e years, and can be made only to established businesses. Many applications have been received by the Federal Reserve banks for loans under t h i s section which could not be granted because the proceeds of the loan, or a substantial portion thereof, were to be used for f i x e d or permanent c a p i t a l or for paying o f f existing indebtedness instead of for working capital. Applications have also had to be refused because the business applying f o r the loan could not demonstrate that i t was "established 11 , even though the management was highly regarded and i t s prospects for successful operations appeared good. - 2 The plan now under consideration would provide for loans for f i x e d capital as w e l l as working c a p i t a l and f o r other purposes, and would not be restricted to established businesses. Such loans could be made with maturities up to ten years, on an amortized basis requiring 40 per cent of principal to be paid before maturity. (Here i n s e r t such material as may be supplied by Mr. Smead1s o f f i c e . ) Loans by Reconstruction Finance Corporation. - Loans may be made by the Reconstruction Finance Corporation, either d i r e c t l y or i n cooperation with lending i n s t i t u t i o n s , to any i n d u s t r i a l or commercial business for the purpose of maintaining and increasing the employment of labor. Such loans, however, can be made only u n t i l June 50, 1959, must mature not l a t e r than January 51, 1945, and must be so secured as reasonably to assure repayment. In order to afford small commerce and industry an assurance of the continued and permanent a v a i l a b i l i t y of c a p i t a l funds, i t i s believed that the authority to make loans to business should not be of a temporary or emergency character, expiring next year, but should be placed upon a permanent basis; and for this purpose the planuunder consideration would set up a permanent corporation to supply funds to i n d u s t r i a l and commercial businesses. - 3 - Moreover, capital loans to business should not be limited to those which mpst mature within less than seven years, as under the Reconstruction Finance Corporation, because businesses frequently need to borrow for longer periods. The In- d u s t r i a l Loan Corporation proposed to be set up would have authority to make loans for ten years, and renewals or extensions might be made. The requirement that loans must be "so secured as reasonably to assure repayment" may have the e f f e c t of preventing the making of many loans ?/hich would otherwise be possible. This requirement i s believed to be unduly r e s t r i c t i v e i n certain meritorious cases where the f i n a n c i a l statement and character of management of the borrower, together with i t s prospects for successful operation, are such as to warrant the granting of the loan although i t i s unable to o f f e r the most desirable c o l l a t e r a l security. (Here i n s e r t such material as mpy be supplied by Mr. Smead1s o f f i c e . )