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For Release on Delivery
STATEMENT BY CHAIRMAN MARTIN OF THE
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
BEFORE THE SUBCOMMITTEE ON SECURITIES OF THE COMMITTEE
ON BANKING AND CURRENCY OF THE SENATE ON JUNE 27, 1955

Mr. Chairman and Members of the Committee:
The Board of Governors of the Federal Reserve System is in complete agreement with the purposes of S. 2054.
Under the Securities Exchange Act of 1934, corporations whose
securities are registered on a national securities exchange are subject
to specified requirements covering publication of financial reports and
related information, solicitation of proxies, and so-called "insiders'
profits" resulting from trading in the company's stock. With certain exceptions, S. 2054 would apply those requirements to large corporations
whether or not their securities are registered on an exchange.
These provisions would provide for the security holders of large
corporations whose securities are widely distributed but not registered on
an exchange, information and safeguards which the Securities Exchange Act
requires with respect to securities registered on an exchange. As these
provisions have been and would be administered by the Securities and Exchange Commission, the Commission is better able than the Federal Reserve
to express an informed opinion regarding them.
However, section 3 of the bill directly relates to the responsibilities of the Federal Reserve System. Under this section any security
of an issuer covered by the bill, unless excluded by the Board as "not



-2comprehended within its purposes", would be subject to the margin requirement provisions of the Securities Exchange Act in the same manner as if
the security were registered on a national securities exchange.
The bill contains certain exemptions. Besides the exemption of
banks, which are specialised institutions, the bill would exempt the
securities of all corporations which have less than $5 ' million in assets
and also the securities of all corporations which have less than 500
security holders.
Since securities covered by the bill would be subject to the
rules that now apply to securities registered on an exchange, let me
outline those rules and how they differ from the rules that apply to unregistered securities.
Under present law, when brokers lend for the purpose of purchasing or carrying securities, they can lend on registered securities the
amount specified in the Board's margin regulations — now 30 per cent

-

but they are forbidden to lend anything at all on unregistered securities.
In other words, in a brokerage margin account registered securities have
the loan value specified in the Board's regulations and unregistered
securities have no loan value whatever.

The rules that apply to loans

made by banks also depend on whether a security is registered or unregistered. Loans made by banks to purchase or carry registered securities are
subject to the standard margin requirements} loans made by banks to
purchase or carryunregisteredsecurities are exempt from the regulations*
Under S. 2054, securities covered by the bill would be entitled
to loan value in brokerage margin accounts just as registered securities
are, and loans by banks to purchase or carry securities so covered would
be subject to the usual margin requirements*



-3Stated differently, securities covered by section 3 would in one
respect be more favored than at present -- they would get the benefit
of having loan value in brokerage margin accounts; and in another respect
they would be less favored —

loans by banks to purchase or carry the

securities would become subject to the usual margin requirements.
Both S. 2054 and the present law regarding margin requirements
recognize that there are important differences between the securities of
small, closely held companies on the one hand and large, widely owned
companies on the other. The securities of small, closely held companies
usually do not enjoy a wide or ready market. They are more likely to be
purchased or financed on the basis of personal knowledge of the individual company, its conditions and prospects, and not on the basis
of ready marketability.

By contrast, the securities of large, widely

held companies are usually more seasoned, more widely known, more
readily marketable, and more likely to be traded on margin.
Section 3 says, in effect, that such securities should be treated
for the purposes of the margin requirements in the same way that the law
now treats securities that are registered on an exchange. Under the exemptions in the bill, a security would not be covered unless the issuer of
the security has at least $5 million in assets and also has at least 500
security holders.
The Board believes section 3 would help to carry out the general
purposes of the present provisions of law relating to margin ,requirements,
and that enactment of such a provision would be in the public interest.




6/27/55

July 14, 1955
MEMORANDUM FROM CHAIRMAN MARTIN OF THE BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM SUPPLEMENTING HIS
STATEMENT ON S. 2054

In connection with the exclusion of banks from S. 2054, questions have been raised as to the status of banks, the Federal regulation
and supervision to which they are subject, and the practices which they
now follow with respect to the matters covered by S. 2054. This memorandum is addressed to those questions.
Specialized Nature of Banks
Banks differ from most other corporations in several respects.
Most of these differences are related to the unique position of banks in
the national economy. They are the custodians of the bank deposits that
form the bulk of the nation's means of payment, its money supply.
Because of the strong public interest in the safety and mobility
of bank deposits, banks are subject to extensive Federal regulation and
supervision, especially under sweeping banking legislation passed by
Congress in the 1930's. The breadth of this regulation and supervision is
outlined later in this memorandum.
Federal regulation and supervision of banks is primarily concerned with the protection of depositors. However, since deposits constitute such an overwhelming proportion of the total funds available to
banks —

usually more than 90 per cent —

protection of the depositor

becomes closely intertwined with protection of the stockholder. Even
though protection of bank depositors and bank stockholders are not always
identical, they are so similar that measures to protect depositors also



-2protect stockholders. For example, the vigilance of the bank supervisory
authorities against harmful self-dealing by a bank's officers, directors
or large stockholders provides protection for both depositors and stockholders •
Similarly, limitations on the kinds of investments that banks
can make and on the kinds of activities in which they can engage protect
both depositor and stockholder. They tend to keep banks out of transactions that may result in heavy losses or spectacular profits. Officers,
directors and large stockholders —

so called "insiders" —

of banks are

thus less likely than those of other corporations to have "inside information" of the kind that would enable them to make heavy profits from shortterm trading in their corporation's stock. The non-speculative nature of
banking operations also causes bank stocks to be less volatile than most
others, thus generally reducing both opportunities and incentives for
profits from short-term trading in the stock*
Due to the large proportion of bank funds represented by deposits,
a measure of size which would be appropriate for other businesses would be
unsuitable for banks•

Thus, if the provision of S. 2054 which excludes

corporations with less than $5 million in assets were applied to banks,
the results would be widely different from when such a test is applied to
other corporations.
Regulation and Supervision of Banks
Federal regulation and supervision of banks is so extensive
that an adequate discussion of the subject would go far beyond the scope of
this memorandum, which merely touches upon certain aspects of the matter.
In addition to being subject to Federal regulation and supervision, banks




-3chartered under State law are also subject to State regulation and super-

vision, which is not covered in thismemorandum.Theexaminations of banks at
aspect of Federal regulation and supervision.

National banks are examined

by examiners commissioned by the Comptroller of the Currency, State member
banks of the Federal Reserve System are examined by examiners commissioned
by the twelve Federal Reserve Banks with the approval of the Board of
Governors of the Federal Reserve System, and insured State non-member
banks are examined by examiners commissioned by the Federal Deposit Insurance Corporation.

These examinations are not detailed audits. However, they are
concerned not merely with information as to the financial position of the
bank, but also with its soundness and its general operations and practices.
For example, examiners inspect the minutes of the meetings of the board of
directors* They inquire into the adequacy of insurance coverage against defalcation and other such losses. They consider the stockholdings of
officers, directors and principal stockholders. They are alert for any
evidence of self-dealing by the bank!s officers or directors which might conflict with the best interests of the bank*
These examinations delve into the affairs of the bank and develop
extensive information, much of it confidential, about the bank, its
directors, officers, employees, depositors and borrowers. Section 1906 of
the United States Criminal Code (U.S.C, title 18, sec. 1906) illustrates
the confidential character of this information,

It provides criminal

penalties for unauthorized disclosure by a bank examiner of information regarding a bank's borrowers or the collateral for its loans*



-4The supervisory authorities carefully review the reports of
these examinations , and the management of the bank is called upon to
correct any practices which appear to be illegal, unsafe or unsound*
Besides being examined by bank examiners, banks are subject
to other supervision and regulation. National banks and State member banks
of the Federal Reserve System must file a report of condition with the
Federal supervisory authorities at least three times each year, and these
reports must be published in a local newspaper. Insured State non-member
banks must file such a report at least twice a year and, although Federal
law does not require their publication, most State laws do.
National and State member banks must file with the Federal supervisory authorities semiannual reports of earnings, expenses, profits,
losses and dividends, and insured Statenon-memberbanks must file such
reports annually,
A bank cannot open a branch office without the approval of
the Comptroller of the Currency if a national bank, the Federal Reserve
Board if a State member bank of the Federal Reserve System, or the FDIC if
an insured Statenon-memberbank.
The deposit insurance of a bank can be terminated for violations
of law or for continued unsafe or unsound practices. Since it is not
practicable for a large bank to operate without deposit insurance, a bank's
management will not lightly incur such termination.
The Board of Governors of the Federal Reserve System may remove
an officer or director of a member bank of the Federal Reserve System for
continued violation of law or continued unsafe or unsound practices.



-5A member bank of the Federal Reserve System is forbidden to payto any officer, director or employee a higher rate of interest on deposits
than that paid to other depositors on similar deposits with the member bank.
A member bank may not make any loan to an executive officer of the
bank; the only exception is for a loan not exceeding $2,500 made with the
prior approval of a majority of the entire board of directors. If an
executive officer of a member bank borrows from any other bank he must make
a full report to the board of directors of his bank*

The bank examiner can,

of course, note these facts when he inspects the minutes of the meetings
of the board of directors.
A member bank is strictly limited with respect to loans which
it may make to institutions with which it is

"affiliated.

A bank cannot engage in the business of issuing, underwriting or
distributing securities other than obligations of the United States or
certain State or municipal obligations, and a member bank cannot be
"affiliated" with a company principally so engaged.
A member bank cannot buy any bonds, other than certain State
or municipal bonds, unless they meet certain investment standards. It
cannot purchase any stocks at all for its own account except iri a few
limited situations.
Requirements of S. 2054
S. 2054 would adopt specified requirements from the Securities
Exchange Act of 1934 and apply them to certain large, widely held corporations.

The requirements cover (1) publication of financial reports and

related information, (2) proxy solicitations, and (3) so-called "insiders1



-6profits" resulting from trading in the company's stock.

Securities of

corporations covered by S. 2054 would also be treated the same for the
purpose of the margin requirements as securities listed on an exchange.
The apparent purpose of S. 2054 and of the Securities Exchange
Act of 1934 on which it is based, is to provide protection for investors
chiefly through supplying them with information.

On the other hand, Federal

banking policy has been to provide protection for depositors and stockholders of banks chiefly through regulation and supervision.

Since almost

no banks have stocks listed on an exchange, most banks are not subject to
the requirements of the Securities Exchange Act. Accordingly, bank stockholders are not provided the same information that S. 2054 would require,
but instead they have the protection of Federal bank regulation and supervision. As indicated

before, Federal bank supervisory authorities not

only obtain even more information about banks than would be required under
S. 2054 but also exercise considerable supervision over them.
What has been said above applies, among other things, to the
solicitation of proxies from bank stockholders.

Since most banks are not

subject to proxy rules which the Securities and Exchange Commission issues
under section 14 of the Securities Exchange Act, banks generally do not
follow those requirements. For example, in soliciting proxies bank
managements usually do not state the salaries or other compensation received
by officers or directors, or the ownership of securities of the company by
officers, directors or principal stockholders. Except in the case of some
of the larger banks with more widely dispersed stockholders, the
solicitation often does not include a list of proposed directors. However,
it is understood that in solicitations of proxies for stock of larger

banks, stockholders


are customarily advised of the principal proposals for

-7which the stock will be voted if the proxies are granted. Of course, other
less important or routine matters may also come before the stockholders'
meeting.

It is also understood that managements of large banks customarily

supply information regarding operations, salaries and stockholdings when
specifically requested at meetings of stockholders. Less information may
be provided in the case of small banks with comparatively few stockholders —
just as in the case of other small corporations with few stockholders — but
it is understood that S. 2054 does not attempt to deal with such closelyheld situations.
Stockholders of banks, like those of other corporations, have
the right to inspect the books of the corporation.

This right, of course,

involves procedures different from those provided under the Securities
Exchange Act, but it affords some protection for bank stockholders in addition to the more comprehensive protection provided by Federal regulation
and supervision of banks•
It may also be noted that the law specifically requires that
each national bank keep at all times a "full and correct list of the names
and residences of all the shareholders ..., and the number of shares held
by each, in the office where its business is transacted.

Such list shall

be subject to the inspection of all the shareholders and creditors of the
[bank] .... during business hours of each day in which business may be
legally transacted." (R.S. 5210, 12 U.S.C, sec. 62)

This provision of

Federal law does not apply to State banks.
In attempting to distinguish between large, widely-held
corporations and small, closely-held ones, S. 2054 excludes from the operation of the bill all corporations with less than $5 million in assets.



-8As indicated before, due to the special nature of banks, tests of this kind
which would achieve reasonable results for most other corporations would
not be suitable for banks. Banks differ so markedly from most other
businesses that it does not seem feasible to use the same tests for both.
Summary
warm

Factors such as those outlined above presumably led to the
exclusion of banks from S. 2054. They may be briefly summarized.
The apparent purpose of S. 2054, and of the Securities Exchange
Act on which it is based, is to protect investors chiefly by supplying them
with information. On the other hand, Federal banking policy has been to
protect depositors and stockholders of banks chiefly by a comprehensive
system of Federal regulation and supervision.
To superimpose the requirements of S. 2054 upon the present system
of Federal bank regulation and supervision would raise difficult problems
of duplication and inconsistency.

If it should be thought desirable by

the Committee to provide additional protection for the stockholders of
banks, it would be preferable to consider the question separately as a
banking problem involving possible amendments to the specific laws that
relate to banks and the Federal bank supervisory authorities.