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STOCK EXCHANGE PRACTICES
HEARINGS
BEFORE THE
COMMITTEE ON BANKING AND CURRENCY
UNITED STATES SENATE
SEVENTY-THIRD CONGRESS
SECOND SESSION
ON
S.Res. 84
(72d CONGRESS)
A RESOLUTION TO INVESTIGATE PRACTICES OF STOCK
EXCHANGES WITH RESPECT TO THE BUYING AND
SELLING AND THE BORROWING AND LENDING
OF LISTED SECURITIES
AND
S.Res. 56 and S.Res. 97
(73d CONGRESS)
RESOLUTIONS TO INVESTIGATE THE MATTER OF BANKING
OPERATIONS AND PRACTICES, TRANSACTIONS RELATING TO
ANY SALE, EXCHANGE, PURCHASE, ACQUISITION, BORROWING, LENDING, FINANCING, ISSUING, DISTRIBUTING, OR
OTHER DISPOSITION OF, OR DEALING IN, SECURITIES OR
CREDIT BY ANY PERSON OR FIRM, PARTNERSHIP, COMPANY,
ASSOCIATION, CORPORATION, OR OTHER ENTITY, WITH A
VIEW TO RECOMMENDING NECESSARY LEGISLATION, UNDER
THE TAXING POWER OR OTHER FEDERAL POWERS
PART 16
National Securities Exchange Act (continued)
MARCH 23 TO APRIL 5, 1934
Printed for the use of the Committee on Banking and Currency
175641
UNITED STATES
GOVERNMENT PRINTING OFFICE
WASHINGTON 1934
COMMITTEE ON BANKING AND CURRENCY
DUNCAN U FLETCHER, Florida, Chairman
CARTER GLASS, Virginia
ROBERT F WAGNER, New York
ALBEN W BARKLEY, Kentucky
ROBERT J BULKLEY, Ohio
THOMAS P. GORE, Oklahoma
EDWARD P COSTIGAN Colorado
ROBERT R REYNOLDS, North Carolina
JAMES F BYRNES, South Carolina
JOHN H. BANKHEAD, Alabama
WILLIAM GIBBS McADOO, California
ALVA B. ADAMS, Colorado
PETER NORBECK, South Dakota
PHILLIPS LEE GOLDSBOROUGH, Mai ylancl
JOHN G. TOWNSEND, JR, Delawaie
FREDERIC C WALCOTT, Connecticut
ROBERT D CAREY, Wyoming
JAMES COUZENS, Michigan
FREDERICK STEIWER, Oregon
HAMILTON F KEAN, New Jersey
WILLIAM L HILL, Clerk
R H SPARKMAN, Aotmg Clerk
SUBCOMMITTEE ON STOCK EXCHANGE PRACTICES
DUNCAN U. FLETCHER, Florida, Chairman
CARTER GLASS, Virginia
ALBEN W. BARKLEY, Kentucky *
EDWARD P. COSTIGAN, Colorado
ALVA B. ADAMS, Colorado
4
8
PETER NORBECK, South Dakota 2
JOHN G TOWNSEND, JR , Delaware
JAMES COUZENS, Michigan
Alternate, Thomas P. Gore, Oklahoma.
Alternate, Phillips Lee Goldsborough, Maryland.
CONTENTS
Backus, Edward W, Minneapolis, Minn
7645
Black, Eugene R, Hon, Governor of the Federal Reserve Board, Washington, D 0
7415
Butcher, Howard, Jr, president of the Philadelphia Stock Exchange,
Philadelphia, Pa
7455
Ohinlund, Edwin F., representing Controllers Institute of America, New
York City, N.Y7491
Cotton, H. H., Los Angeles, Calif., representing the Investment Bank
of Los Angeles
7418
Gibbons, George B , president George B. Gibbons & Co., Inc., municipal
bond dealers, New York, N Y
.
•
7441
Healy, Robert E , ehiet counsel Fedeial Trade Commission, Washington,
DC
7587
Redmond, Roland L , attorney for the New York Stock Exchange
7539
Roosevelt, Archibald B , president of Roosevelt & Weifold, Inc, dealers
in municipal securities, New York, N Y, and George B. Gibbons, president George B Gibbons & Co, Inc., municipal bond dealers, New
York, N Y
,
7441
Smith, Tom K, Assistant to the Secretary of the Treasury, Washington,
DC
,
7470
Thompson, Eugene E , president of the Associated Stock Exchanges,
Washington, D C
7524
Unteimeyer, Samuel, attorney at law, New York City
7703,7731
Whitney, Richard, president of the New York Stock Exchange
7479, 7537
EXHIBITS
Telegrams to Senator William Gibbs McAdoo
7411,7412
Telegrams to Senator Phillips Lee Goldsborough
7413
Letter to Hon Duncan U Fletcher from Federal Reserve Board
7437
Memorandum regarding proposed revision of reserve requirements as to
member banks
7437
Telegram to Mr George B Gibbons from Morris S Tremaine, State
comptroller
7445
Letter to Senator Hamilton F Kean from Edward B Smith & Co, 15
Broad St, New York City
7467
Letter to Hon Duncan U Fletcher from Richard Whitney
7479
Report of the committee on bank reserves of the Federal Reserve System 7495
Letter to Hon Duncan U Fletcher from President Franklin D Roosevelt- 7577
Telegram to Senator Phillips Lee Goldsborough from Jacob France
7578
Telegram to Senator Phillips Lee Goldsborough from the committee of
put and call brokers and dealers in the city of New York
7579
Memorandum of proposed amendments to H R 8720
7579
Telegram to Hon Duncan U Fletcher
7586
Summary of report on Cities Service Securities Co
7627
Memorandum concerning the power of Congress, under the commerce
clause, to regulate security exchange
7634
Letter to Duncan U Fletcher from National Retail Dry Goods Association. 7642
Letter to Duncan U Fletcher from Backus-Brooks Co
7646
Statement of E W. Backus
7647
in
IV
CONTENTS
Document entitled "Supplementary List of Addresses Not Shown in
Original Reports "
Paper entitled " Cuitiss-Wnght Corporation, First Supplementary Report"
,
Document entitled "Wright Aeronautical Corporation Capital Stock,
First Supplementary Report"
Document entitled "Aviation Corporation of Delaware, First Supplementary Report"
Document entitled " Curtiss-Wnght Coiporation Class 'A', First Supplementaiy Report
Document entitled "Douglas Aircraft Co, Inc, First Supplementary
Report"
Petition on behalf of the specialists of the New York Stock Exchange
Petition on behalf of floor tradeis of the New York Stock Exchange
Copy of Whitney substitute stock exchange bill, draft no 6
Letter, Richard Whitney to Senator Phillips Lee Goldsborough
1
Retained in the committee's files
C)
(*)
(*)
0)
0)
(*)
7748
7750
7752
7758
STOCK EXCHANGE PEACTICES
FRIDAY, MARCH 23, 1934
UNITED STATES SENATE,
COMMITTEE ON BANKING AND CURRENCY,
WagJtyngton, D.C.
The committee met at 10:30 a.m., pursuant to call of the chairman
following adjournment on Friday, March 16,1934, in room 301 of the
Senate Office Building, Senator Duncan U. Fletcher presiding.
Present: Senators Fletcher (chairman), Bulkley, Gore, Costigan,
McAdoo, Adams, Goldsborough, Townsend, Carey, Couzens, Steiwer^
and Kean.
Present also: Senator King, of Utah.
Present also: Ferdinand Pecora, counsel to the committee; Julius
Silver and David Saperstein, associate counsel to the committee;
Frank J. Meehan, statistician to the committee; Roland L. Redmond,
counsel to the New York Stock Exchange.
The CHAIRMAN. The committee will come to order, please.
Senator MCADOO. Mr. Chairman, before you start the hearing may
I present some telegrams received from California in regard to the
bill now under consideration, and ask that they may be made a
part of the record and returned to me ?
The CHAIRMAN. The committee reporter will make them a part
of the record and return the original telegrams to you for your
purposes.
(The telegrams are as follows:)
Los ANGELES, March 22, 193$.
WILLIAM GIBBS MOADOO,
Senate Office Building, Washington, D G •
Amended Fletcher-Rayburn bill is improvement over the original Still think
it ambiguously worded and little thought given to margin provisions which ahe
inflexible and unworkable and places all stocks in same category regardless of
earnings, dividends record, and market history. Present bill continues to vest
potential power m Federal Trade Commission to control and dominate industry
and business which is fundamentally un-American. Sections relating to odd-lot
dealers, specialists, and segregating functions of broker and dealer poorly
worded, a,nd present wording would destroy functions of stock exchanges and
hinder marketability of odd lots of stock held by small investors, who comprise the majority of investors. Bill so technical only you in Washington can
comprehend Public continues to be misled in the belief that only excessive
speculation and brokers affected. You must know this is not the case; on the
contrary, think bill in present form would be extremely deflationary
FREDERICK A SPETK,
810 Roosevelt Building,
Los Angelas, Calif.
7411
7412
STOCK EXCHANGE PKACTICES
SAN FBANCISCO, CALIF, March 22, 1934
Hon.
WILLIAM GIBBS MOADOO,
Untied States Senate, Washington, D C
I am a stockbroker and taxpayer in San Francisco. I ask nothing for myself, but I have 102 loyal employees here to whom I am attached by ties of
friendship Many of them have been with me foi 15 years Ii the FletcherRayburn bill becomes a law in anything like its present form, no recourse is
open to me and to all other stockbrokers but to discharge 80 percent of these
excellent men and women. On their account I appeal to you to defeat this
measure or at least to secure its modification.
W. O. VAN ANTWERP.
Los ANGELES, CALIF, March 22, 1934
WILLIAM GIBBS MCADOO,
Senate Office Building, Washington, D G
Ask that you reconsider redrafted Fletcher-Rayburn bill and urge levision to
bill such as that introduced by Congressman Bulwmkle along lines suggested
by Dickinson repoit Also urge clarification ot language and that Fedeial
Beseive Board be given more discretionary powei in establishing marginal
requirements Believe amended bill may have unforseeable effects and consequences and this will certainly be true unless language simplified and clarified Urge vour reconsideration
HARRY C. ALLEN,
450 N Rosmone,
Los Angeles, Calif.
Los ANGELES, Match 22, 1934
WILLIAM GIBBS MCADOO,
Senate Office Building, Washington, D G
May I be permitted to earnestly say in past depressions the investment of
private capital in industries has always helped to pull us out The stock
•exchange bill appears to me and to others to whom I have talked to seriously
threaten accesses of industries to capital markets. Cutting such industries'
accesses could not increase the protection to either the investor or to national
recovery
C. L BUNDY,
2153 Larnesa Drwe,
Santa Monnoa, Calif
Los ANGELES, CALIF , March 22, 1934
WILLIAM GIBBS MCADOO,
Senate Office Building, Washington, D G.:
Hear tremendous amount of criticism of revised Fletcher-Rayburn bill.
First, excessive authority is granted Federal Trade Commission and fear i s
that commission will use its authority for regimentation of industry and for
purposes foreign to intent of bill. This could be cured by a section stating
rules and regulations of commission shall be reasonable and limited to provisions of bill as stated in section 2 Second, it imposes rigid regulation
instead of supervision They have provided margin provisions which are
arbitrary, unreasonable, inflexible, and unworkable instead of giving Federal
Reserve Board large authority Also alters greatly present machinery of
stock exchanges developed over many years and substituting something which
may or may not work Earnestly urge your reconsideration which is introduced
by Bulwmkle along ideas suggested by Dickinson's committee.
LESLIE LXTMLEY,
2563 Suluson Avenue,
Huntington Park, Calif
Senator GOLDSBOROTTGH. Mr. Chairman, I have a telegram that I
also should like to have made a part of the record.
The CHAIRMAN. The committee reporter will make it a part of the
record and return the original to you for your purposes.
(The telegram is as follows:)
STOCK EXCHANGE PRACTICES
7413
BALTIMORE, M D , March 21, 1934.
Hon PHILLIPS LEE GOLDSBOBOTJGH,
United States Senate:
This bank representing thousands of depositors and stockholders earnestly
requests your cooperation in opposing paragraph A, section 7, of the National
Securities Exchange Act of 1934 This unfair and un-American discrimination
against State banks is viewed with a deep concern by a laige portion of the
citizens of Maryland.
Respectfully,
MERCANTILE TRUST CO. OF BALTIMORE,
A. H S. POST, President.
The CHAIRMAN, I understand that Mr. Cotton, of California, is
here this morning and has only a word to say. Mr. Cotton, you may
come forward. ["A pause, without response.]
Senator MCADOO. IS Mr. H. H. Cotton here? [A pause, without
response.]
The CHAIRMAN. Very well; we will go on with our hearings. Is
Mr. Whitney here?
Mr. REDMOND. Mr. Chairman, Mr. Whitney will be here in a few
minutes. He was informed that he would be wanted later on in the
morning.
Senator COTJZENS. Mr. Chairman, why can't we go on now and hear
Governor Black?
Senator MOADOO. Oh, Mr. Chairman, Mr. Cotton has now returned
to the committee room. Will you hear him for just a moment?
The CHAIRMAN. Yes. Mr. Cotton, do you wish to make a statement to the committee in regard to municipal securities ?
Mr. COTTON. Yes, Mr. Chairman.
The CHAIRMAN. AH right. If it is to be very brief you may stand
right there. Please state your name, residence, and whom you
represent.
Mr. COTTON. My name is H. H. Cotton, of Los Angeles, Calif. I
represent the Investment Bank, of Los Angeles.
The CHAIRMAN. YOU may proceed with your statement.
STATEMENT OP H. H. COTTON, LOS ANGELES, CALEB1., REPRESENTING THE INVESTMENT BANK OP LOS ANGELES
Mr. COTTON. Mr. Chairman and gentlemen of the committee: I
should just like to say that the bill as now drawn does not seem
to protect securities oi municipal and political subdivisions as exempted securities, the objection offered, as I understand it, being
that some are now in default. I t seems to us that this would unduly
and without valid reason penalize the great majority of such
securities which are now not in default, and that even as to those
now in default they have a well-recognized market and collateral
value. We respectfully submit that they ought to be kept m the
bill as originally drawn as exempted securities.
Senator TOWNSEND. Have you any suggestions to make to the
committee as to how we might remedy that situation and also
improve the bill as drawn?
Mr. COTTON. I have only that one statement that I care to make
in regard to the bill.
The CHAIRMAN. But you wanted exempted State, city, and
municipal securities?
7414
STOCK EXCHANGE PRACTICES
Mr. COTTON. I should like to have State, city, municipal, and
political subdivisions exempted.
Mr. PECORA. Without regard as to whether any issues are in default or not?
Mr. COTTON. Yes; because if in default at this time they still have
a recognized market and collateral value, for we all feel that they
will be all right again, just as soon as the tax situation straightens
up a little.
Senator ADAMS. When do you anticipate that will occur?
Mr. COTTON. DO you mean the tax situation?
Senator ADAMS. Yes.
Mr. COTTON. Well, we hope it will straighten out very shortly.
No time limit is set by the proponents.
Senator MCADOO. And you do not think you will have to wait
for the millennium in that regard, do you ?
Mr. COTTON. NO.
Senator ADAMS. Well,
California seems to be getting about aU
of the Government money that we have.
Mr. COTTON. Well, we have left that for Senator McAdoo to look
after, as he has been rather the chief performer in it. That is, as
a money-getter he has been very nice to us.
Senator MCADOO. What about Senator Johnson?
Mr. COTTON. Oh, yes; he has done his part too.
Senator TOWNSEND. I think we will have to agree with you that
Senator McAdoo has been pretty satisfactory to his constituents in
the matter of getting money for them.
Senator MCADOO. I should like to have put in the record that Senator Johnson is entitled to much credit in that matter.
Senator ADAMS. YOU want to share the blame with him, do you?
Senator MCADOO. I referred to credit and not to blame.
Senator ADAMS. Well, that depends upon the point of view.
Mr. COTTON. I might suggest that California has more good things
to offer than most States.
Senator CAREY. I S the climate still good out there?
Mr. COTTON. The climate out there is a little better than it is in
Washington this morning, I can assure you.
Senator COUZENS. HOW about Florida? I am sure the chairman
could tell you something about that.
Mr. COTTON. Well, we are willing to share the good things with
the chairman.
The CHAIRMAN. All right, Mr. Cotton, we will consider your suggestion.
Mr. COTTON. And I wish to thank you gentlemen for hearing me.
(Thereupon Mr. Cotton left the committee table.)
The CHAIRMAN. Governor Black, we have asked you to come down
here this morning. The committee would like to have your views
regarding this measure, particularly S. 2693 and H.R. 8720, which
is a modification of S. 2693.
STOCK EXCHANGE PRACTICES
7415
STATEMENT OF HON. EUGENE E. BLACK, GOVERNOR OF THE
FEDERAL RESERVE BOARD, WASHINGTON, D.C.
Mr. BLACK. Mr. Chairman and gentlemen of the committee, I have
prepared a rather short statement, and, with your permission, will
be glad to read same.
The CHAIRMAN. The committee will be glad to have the benefit
of any views you are prepared to submit.
Mr. BLACK. The staff of the Federal Keserve Board conferred for
a week with representatives of the Treasury and with Mr. Pecora,
Mr. Corcoran, and Mr. Cohan, attorneys, in reference to the provision of the National Securities Exchange Act of 1934. Governor
Black participated in some of these conferences, was in close touch
with all of them, and kept the members of the Board fully advised.
During these conferences the attitude of the Board was requested,
and the following expression of this attitude was given:
The Board is in thorough accord with the following purposes of the bill:
1. To regulate national securities exchanges to the end that they may operate
under fair practices only.
2 That speculation be pioperly curbed and dishonest speculation be eliminated
3. That exchange credit be properly restrained and the undue use of credit
in speculation be prevented
4 That necessary penalties be enacted to guarantee the accomplishment of
these purposes
The Board is not primarily concerned with the features of the bill with regard to the policing or regulating of the exchange, but feels that these features
should be fair and in accord with established American business principles.
If it is desired the Board will be glad to undertake the responsibilities of the
bill regarding the fixation of marginal requirements upon loans based upon
exchange equities, whether the loans are made by brokers or banks, provided
power is vested m the Board to handle this subject in the public interest and
to the protection of the investor. This function would usefully supplement
the considerable powers vested in the Board under the Banking Act of 1933 to
prevent the undue use of credit for speculative purposes and would in the
judgment of the Board furnish effective protection against the economic evils
of speculation
During these conferences very many changes in the original bill
were recommended by the Federal Reserve staff. These recommendations were followed in substance and changes were made m the
bill, and the bill was greatly improved in order to properly effectuate its purpose.
The bill known as H.R. 8720, introduced in the House by Mr.
Rayburn, embraces these recommended changes. It is the feeling of
the Reserve Board that the revised bill H.R. 8720 is workable, is
right in principle, and will accomplish the purpose of regulating
national securities exchanges under fair practices and that undue
and excessive speculation will be properly curbed, and that exchange
credit will be properly restrained and the undue use of credit in
speculation be prevented. The Board is therefore prepared to approve the bill as revised.
The Board requests the privilege of making such further constructive suggestions as to the bill as may appear necessary or desirable
as the result of the further study of the bill, and this request applies
especially to questions affecting technical operations of the exchanges
covered by the bill.
7416
STOCK EXCHANGE PEACTICES
Now, Mr. Chairman, I will go into the matter at length if you desire me to do so, or I will answer any questions the members of the
committee may desire to ask me. I have stated the position of the
Federal Keserve Board.
The CHAIRMAN. Governor Black, there was one provision in the
original bill, section 7, paragraph (a) about which there has been
some controversy, or some objection raised. I believe there is a
modification in the amendment that has been offered. I wanted to
ask you about section 7, which provides that it shall be unlawful for
any member of a national securities exchange or person who transacts a business in securities through the medium of such member, directly or indirectly:
(a) To borrow on any security registered on a national securities exchange
from any person other than a member bank of the Federal Keseive System
Now, we have modified that provision. Do you think the modification meets the objection that has been made to it? It was pointed
out, for instance, that a number of industrial organizations, particularly the larger ones, had large sums out on call loans as much
as $20,000,000,000 in 1929, and that their loans were not made through
a bank at all, but made to brokers. So the requirement in the original bill that all such loans must be made through a member of the
Federal Reserve System met with some criticism and objection.
Now that we have modified that provision I think perhaps it would
meet the objection. Is that modification satisfactory to you?
Mr. BLACK. DO you mean that there has been a further modification than is shown in H.R. 8720?
The CHAIRMAN. NO. That is the modification I now refer to.
Mr. BLACK. The modification shown here is satisfactory to us.
The CHAIRMAN. That permits loans other than through a member
bank of the Federal Reserve System under certain circumstances
and conditions.
Mr. BLACK. That is correct, but it must be in accordance with
the rules and regulations of the Federal Reserve Board.
Senator GOLDSBOROUGH. Mr. Chairman, I should like to ask Governor B^ack a question or two.
The CHAIRMAN. Proceed, Senator Goldsborough.
Senator GOLDSBOROUGH. Governor Black, wouldn't section 6, paragraph (d)
Senator MCADOO (interposing). What page is that, Senator Goldsborough?
Senator GOLDSBOROUGH. Page 13. Wouldn't that section necessitate the Federal Reserve Board figuring out prices each day and
publishing them in order that the margins throughout the country
could be understood?
Mr. BLACK. Well, would you mind referring me to the page of
the bill, Senator?
Senator GOLDSBOROUGH. It is on page 13.
The CHAIRMAN DO you mean of the bill H.R. 8720?
Senator GOLDSBOROUGH. NO. I mean of the bill S. 2693. I t is
section 6, paragraph (d), which begins on page 13.
Mr. BLACK I don't see it.
Senator GOLDSBOROUGH. I t is section 6, paiagraph (d), I I .
Mr. BLACK. There doesn't seem to be a section 6, paragraph 2, I I .
STOCK EXCHANGE PRACTICES
7417
Senator ADAMS. I think what Senator Goldsborough refers to
begins on line 2 of page 15.
Senator GOLDSBOROUGH I t is subdivision (c).
Senator STEIWER. Which bill is it?
Senator GOLDSBOROUGH. Oh; I am now referring to ELK. 8720.
It is section C, paragraph (e), and then another paragraph (li).
Mr. BLACK. Yes; I see here on page 15 of H.R. 8720, section 6.
Senator GOLDSBOROUGH. And you will find paragraph (c) and then
a subparagraph (ii), found on page 15, being line 13 of the House
bill. Wouldn't these sections require the Federal Reserve Board to
figure out prices each day and publish them m order that margins
throughout the country could be followed properly ?
Mr. BLACK. The sentence that I have before me, on page 14, reads:
If such security has been traded in for a period of not less than 36 months—
Is that the one you are now referring to?
Senator GOLDSBOROUGH. And also the one on page 15, line 13*
which says:
If such security has been traded in foi a period of not less than 36 months—
and so forth
Mr. BLACK. Well, I think prices of securities are shown every day
on the exchanges. I see no reason why the Federal Reserve Board
every day would have to figure current market prices of securities.
Senator GOLDSBOROUGII. Then you do not think there is anything
in that provision requiring the Federal Reserve Board to publish
daily securities prices in order that the margins throughout the
country could be properly followed?
Mr. BLACK. I do not think so. I think these would be accepted as
current market prices.
Senator TOWNSEND. Governor Black, there has been a great deal
of discussion about the margin provisions of the bill. Do you consider the margin provisions, as now written in the bill, workable?
Mr. BLACK. Yes,/Senator Townsend; I think they are workable.
Senator TOWNSEND. YOU do not think the margin requnement is
excessive ?
Mr. BLACK. I think Congress has the right to express its opinion
by way of enactment of law as to what are proper marginal requirements, and as I understand the situation that is what this bill will
do; giving then to the Federal Reserve Board the power, under
certain exigent circumstances, to meet the situations as they may
arise.
Senator TOWNSEND. DO you feel that the provision as now written
would restrict credit?
Mr. BLACK. I think it would restrict speculation.
Senator TOWNSEND. But would not restrict credit?
Mr. BLACK. I do not see why the provisions of the bill should
restrict credit. I think they will restrict credit in speculation, and I
understand that that is the purpose of the bill.
Senator MCADOO. AS to this portion of the provision:
If such security has been traded in for a period less than 36 months, such
amount, but not more than 75 per centum of the cunent market pi ice, as the
Federal Reserve Board may by its rules and regulations prescribe as appropriate or necessary in the public interest or for the protection of investor
7418
STOCK EXCHANGE PBACTICES
Do you think as expressed there the Federal Reserve Board could
properly see to the administration of the matter ?
Senator GOLDSBOROUGH. I S that found on page 15 of the bill?
Senator MCADOO. NO. That is on page 14 of H.R. 8720, beginning
with line 6 and winding up with line 12.
Mr. BLACK. I think the Federal Reserve Board could fix rules
and regulations. I think the law would attend to proper observance
•of the rules and regulations, because the law fixes a very severe
penalty for violation.
Senator MCADOO. I mean, is it practicable, so far as current market prices are concerned, for the Federal Reserve Board to follow
these things and police tnem, see that the requirements are complied
with? I am now asking for information and not attempting to
express an opinion, as to how you will administer such a provision.
Mr. BLACK. I think the Federal Reserve Board can do that as
well as any other control agency. I see no reason why the Federal
Reserve Board could not keep itself informed of current market
prices in fixing the margin requirements.
Senator MCADOO. Would you have to do anything additional, in
particular?
Mr. BLACK. I think we would have to set up a separate department in the Federal Reserve Board to take care of it.
Senator MCADOO. YOU would have to police it?
Mr. BLACK. Yes; so far as margin requirements are concerned.
Senator MCADOO. DO you think it is practicable to do that? I
am merely looking at it from the administrative viewpoint, as to
whether or not it could be actually done without a very large organization and a very expensive one, being set up.
Mr. BLACK. I think it can be done. But it is going to entail some
work.
Senator MCADOO. It will require a very large organization, will
it not?
Mr. BLACK. Well, it is very difficult to answer that question. I t
would require a sufficient organization I will say. How large it
would have to be I do not know at this time.
Senator MCADOO. YOU understand, Governor Black, that this will
apply to the Nation
Mr. BLACK (interposing). Yes.
Senator MCADOO (continuing). Not to the New York Stock Exchange alone, but to all stock exchanges of the country; that they
must be policed.
Mr. BLACK. Well, I think the matter of policing is up to the Federal Trade Commission; not up to the Federal Reserve Board.
Senator MCADOO. Well, whatever the agency may be, it is going
to require a very large organization to police it, isn't it?
Mr. BLACK. I think so.
Senator MCADOO. There was running through my mind the matter
of the practicability of the scheme of trying to see that all transactions on the many exchanges of the Nation are properly policed, or
policed to the necessary extent to compel observance of this statute.
Mr. BLACK Well, I would hope that the exchanges would obey
the law in very large part.
Senator MCADOO Well, we hope for that in the case of all laws,
but whether or not we entertain such hopes, we have to set up police
STOCK EXCHANGE PRACTICES
7419
and courts and prosecuting attorneys and all the necessary machinery
for the administration of justice in order to enforce them.
Senator GORE. Oh, yes; that was true about prohibition.
Senator ADAMS. We have had laws against false pretenses on the
statute books for years, and, of course, they have to be taken care of*
Senator COTJZENS. The Interstate Commerce Commission has been
able to enforce the Interstate Commerce Act without undue trouble.
Senator MCADOO. I concede that, but I think the matter of transportation and rates are very much simpler than the multifarious
transactions that occur on all stock exchanges of the country.
Senator KEAN. Not only that occur on the stock exchanges of the
country, but the transactions of individuals.
Senator MCADOO. Yes.
The CHAIRMAN. Well, I take it as being hardly fair to assume that
the stock exchanges will have to be watched to see that they do not
violate the regulations laid down by the Federal Trade Commission^
and the Federal Reserve Board; or, at least, that they will cooperate in a proper spirit in this matter, and that it won't be necessary"
to watch every transaction taking place on the exchanges. I should!
think we may assume that the stock exchanges will be willing to
cooperate with the authorities in carrying out the law once it is
enacted.
Senator KEAN. But there are many people all over the United
States who will be involved in this thing if this provision is included.
The CHAIRMAN. Precisely.
Senator KEAN. And just the same you can assume, even with the
enormous forces of every State and every city, as well as those of
the United States, in the way of protective matters, and policemen,
the laws are violated every day.
The CHAIRMAN. Precisely. But we won't argue that matter now.
The question is, what do you wish to ask Governor Black?
Senator GOLDSROROTTGH. One other question: Governor Black, did
1 understand in the statement you submitted, that the Federal Reserve Board approves all provisions of this bill as now written 8
Mr. BLACK. Yes, sir; with the request that we may make further
suggestions, especially as to details of the technical operations of
exchanges as may appear necessary from a further study of these
technical operations.
Senator GOLDSBOROUGH. And that you are not now prepared to
submit to us.
Mr. BLACK. NO.
Senator ADAMS. But you are making a further
Mr. BLACK. We have oeen continually studying
study of the bill?
the bill since first
requested to do so a week ago.
Senator KEAN. Were you requested to study the entire bill or only
certain sections of it.
Mr. BLACK. I understood that we were requested to study HOB
entire bill, sir.
Senator KEAN. And you have studied the entire bill?
Mr. BLACK. I have studied every word of it, Senator Kean, 6 days
and 6 nights.
7420
STOCK EXCHANGE PRACTICES
Senator STEIWER. Governor Black, does tlie Federal Reserve
Board desire the function of fixing the regulations as to margin
requirements ?
Mr. BLACK. The Federal Reserve Board never requested that
power. I t was, perhaps in the second review of this bill, brought to
my attention and the Federal Reserve Board does feel that that
power should be given to at because it is credit control. The Federal
Reserve Board, together with its other credit control, should have
charge of this credit control, and no other department of the Government should have charge of credit control.
Senator STEIWER. And if this bill is enacted into law the Federal
Reserve Board would expect then to function in its capacity of
control of credit?
Mr. BLACK. Absolutely.
Senator STEIWER. Through the medium of margin requirements?
Mr. BLACK. A S one of the mediums of credit control; yes, sir.
There are a great many.
Senator STEIWER. Perhaps I misunderstood you a while ago. I
thought you said the margin requirements would restrict speculation,
but would not restrict credit. I now understand you to say that it is
the purpose of the Federal Reserve Board under certain circumstances and conditions to restrict credit through this medium if the
power is given to the Board.
Mr. BLACK. If I have said something that was misunderstood, I
regret it. Of course, in restricting speculation you have to do it
through restriction of credit under the provisions of this bill—I
mean, so far as the marginal requirements are concerned
Senator STEIWER. Well, to what extent would you feel justified m
restricting credit in order to restrict speculation2
Mr. BLACK. Wherever there is excessive speculation or undue ute
of credit in speculation.
Senator STEIWER. Has the Federal Reserve Board set up any
standard to which it would adhere in the determination of matters
of that kind?
Mr. BLACK. I t had not had the time to do that, and could not
properly attempt to do it until the occasion for doing it was approaching.
Senator STEIWER. I assumed that that would be your answer.
However, the net result is that if the Federal Reserve Board is
clothed with power to restrict speculation through the medium of
restriction of credit, the extent to which it would do it would be a
matter for further judgment.
Mr. BLACK. Precisely.
Senator STEIWER. And from time to time.
Mr. BLACK. Yes.
Senator STEIWER.
And Congress could have no way of knowing
now, while considering proposed legislation, the extent to which you
might see fit to restrict credit to business of this country.
Mr. BLACK. Well, I would prefer to use the expression: " Restrict
credit in prevention of undue or unwise or excessive speculation."
I would rather leave out, " of the business of the country " I do not
think that is comprehended in this bill. Further answering your
question, Senator Steiwer, of course the Congress, if it gives the
STOCK EXCHANGE PBACTICES
7421
Federal Eeserve Board the power to exercise its judgment in this
matter, could not be at this time advised as to what that judgment
may be at sometime in the future.
Senator STEIWTER. That is necessarily the fact, but I was wondering what your viewpoint was.
Senator TOWNSEND. YOU do not feel that you have sufficient authority, then, under the Glass-Steagall Bank Act, to do this thing
proposed here?
Mr. BLACK. Well, we have very great authority in restricting
speculation under the Glass-Steagall bill. We have the right, for
instance, to regulate reserves, to increase reserves; we have the right
to tell a bank that it cannot make any further security loans. We
have the right to fix the amount of security loans that a bank can
take. We have the right to take other steps for the prevention of
undue speculation in accordance with the wishes of the Secretary
of the Treasury. But I think this is another provision.
Senator TOWNSEND. Then this is giving additional power?
Mr. BLACK. Yes, sir.
Senator GORE. In that
connection let me ask you if you have
reached any conclusion on this point. In 1927 a good many people
felt that the rediscount rate was made too low; that it encouraged
an over-use of credit, accelerated a misuse of credit, and paved the
way for the crisis m 1929 and the depression which followed. Other
people felt that the Federal Reserve Board could have raised its
rediscount rate in 1928 and 1929 even more than it did, could have
then put on the brakes I rather doubt the latter, but think there is
a good deal of truth in the former charge.
Now, Governor Black, what is your conclusion about it, if you
have given it any critical thought?
Mr. BLACK. Senator Gore, you are now taking me back to 1927,
1928, and 1929,1 believe?
Senator GORE. Yes. When the rediscount rate was very low, in
September of 1927, some people alleged that in that action, to get
gold, it was not for our own purpose
Mr. BLACK (interposing). Of course, I was not on the Federal
Eeserve Board at that time, although I am not saying that by way
of excuse, and I think they were really doing it to try to spur business in Ainerica. And I think in 1928 and 1929 we did everything
on earth we could to stop, as far as we could, the drunken debauchery
in speculation. But I <Jo not believe any board on earth could
have stopped it at that time.
Senator GORE. I doubt it, too. But do you think it is possible
to devise any sort of mechanism that can stop the runaway passion
for gambling, like that was?
Mr. BLACK. I do not believe at that time it could have been
stopped. I think marginal requirements, with stocks going up every
day, would not have been effective. They might have been a deterrent. I think the discount rate, when men were making 20 or 30 or
40 percent a day on stocks in gambling would not have stopped it.
It might have been a deterrent. But I think we are now coming
into saner times, and
Senator GORE (interposing). Well, that is what we always think.
Mr. BLACK. Well, I hope so at least.
7422
STOCK EXCHANGE PRACTICES
Senator MCADOO. Temporarily, anyway.
Mr. BLACK. I hope so.
Senator GORE. But it takes time for such a gambling passion to
accumulate, and yet it does accumulate every time such a situation
arises.
Mr. BLACK. I think that is true. I want to say that I went
through the gambling in Florida, and that I was there before the
stock exchange situation started. So that perhaps I am rather an
expert on gambling.
Senator GORE. But you did not sell short down there.
Mr. BLACK. I sold it both ways, and lost at each end. [Laughter.]
Senator GORE. Then you qualify as an expert on it.
Mr. BLACK. Yes, sir.
Senator MCADOO. I should
like to ask two questions: First, in this
proposed legislation we establish by statute 40 percent as a marginal
requirement. Now, I should like to ask you if you think
Senator GORE (interposing). It is 60 percent here.
Senator MCADOO. Well, 60 percent, or whatever it is. I want to
ask you, Governor Black, if you think it wiser to establish an inflexible margin like that m a statute, or to leave it to an administrative board, like the Federal Reserve Board, to regulate that matter
from time to time to meet the conditions as they may develop ?
Mr. BLACK. Senator McAdoo, my own opinion about that in the
beginning was that there should be perfect flexibility in the matter
of margin requirements, and that it should be left to the regulatory
body. Now, since that time, I have thought about it a great deal. I
think the whole purport of this bill is to restrict speculation, to
prevent undue speculation, to guarantee fair practices in speculation,
and to get undue credit out of the excesses of speculation. And so far
as I am concerned as Governor of the Federal Reserve Board, I am
perfectly willing for Congress to give expression, and that is what
this is meant to be, to what they think the marginal requirements
should be. Now, then, there is a further provision in this bill, in
the same section, that the Federal Reserve Board under certain circumstances can change the margin requirements. Personally, I
would rather that were more flexible. But
Senator KEAN (interposing). In other words, do you mean to say
that you would prefer, because this margin business figures out into
absurd figures in some cases, to have it left entirely to the Federal
Reserve Board?
Mr. BLACK. I would be perfectly willing for the Federal Reserve
Board to take the responsibility for that.
Senator GORE. DO you think it could resist the pressure when
the flood tide comes? Don't you think the dam would break? This
is imperfect, of course, and we appreciate it, but I remember in
1929 when the race was running high, any suggestion by way of
raising the rediscount rate provoked a storm of protest, and I do
not think any human beings would have been able to withstand it,
or at least not any in politics.
Senator MCADOO. The rediscount rates attempted to control it,
but they did not have either the teeth or the capacity to control it
or to properly influence it. I think as Governor Black says a provision for increased reserve requirements would be very much more
STOCK EXCHANGE PBACTICES
7423
effective. But, Governor Black, I should like to get you back, if I
may, to the other question, as to whether or not I am correct in my
understanding that you prefer to have minimum marginal requirements established in this bill rather than to have a determination
of those marginal requirements established through regulation from
time to time by the Federal Reserve Board.
Mr. BLACK. Senator McAdoo, I think the wisest course would be
for Congress to express its opinion in the bill. And then widen
the provision as to flexibility, leaving variations from the expressed
opinion of Congress, to the judgment of the Federal Reserve Board.
Senator MCADOO. Well, that would cover the point. That gives
it some flexibility. Are the provisions of the bill such that you do
have that flexibility?
Mr. BLACK. The provisions of the bill do not give us that degree
of flexibility.
Senator MCADOO. YOU think it would be wise to insert it after the
expression of opinion of the Congress in the bill ?
Mr. BLACK. If the Congress is in accord with me, with my view
about that; yes.
Senator MCADOO. Well, now, one other question: You heard the
brief statement made by Mr. Cotton a moment ago about municipal
bonds, State bonds, and bonds of political subdivisions. What is
your idea about exempting them?
Mr. BLACK. My recollection about that is that they are not listed
as exempted securities, but that the power is vested in the Federal
Trade Commission to exempt them.
The CHAIRMAN. That is right.
Senator TOWNSEND. Should that power be vested in the Federal
Trade Commission or in the Federal Reserve Board ?
Mr. BLACK. In the Federal Trade Commission.
Senator KEAN. That will only leave them subject to every little
school district, every little town in the country, having to apply to a
bureau of the United States for permission ?
Mr. BLACK. SO far as I am concerned I would not object to making
municipal, county, and State bonds as exempt securities, if that is
what you are asking me.
Senator MCADOO. Yes; that is what you are being asked.
Senator GORE. It has been suggested that if the margin dropped
down to 59 percent a customer would be sold out arbitrarily. Is
that your understanding?
Mr. BLACK. That is as to new loans. As to old loans, they are
protected.
Senator GORE. That is, current accounts are exempted?
Mr. BLACK. Yes, sir.
Mr. PECORA. The revised
bill modifies that section of the original
bill.
Senator GORE. And that was in the original bill?
Mr. PECORA. Yes.
Senator GORE. That was too
Mr. PECORA. That has been
arbitrary, in my judgment.
considerably modified in the revised
version of the bill.
Senator GOLDSBOROUGH. TO what extent has it been modified?
Mr. PECORA. TO the extent that the revision allows for a sag of 20
percent in the market price before
175541—34—PT16
2
7424
STOCK EXCHANGE PRACTICES
Senator GORE (intelposing). Well, then, that covers that objection now?
Mr. PECORA. Yes.
The CHAIRMAN. Have you anything further, Governor Black &
Mr. BLACK. Mr. Chairman, these gentlemen seem to be especially
interested in this matter of the marginal requirements. I have
some intensive data on that which is very interesting to me, and if
the committee would like to have it
Senator GORE. Yes; let us have it.
The CHAIRMAN. YOU may go ahead and give it to us.
Mr. BLACK. The principal differences between the margin provisions of the revised bill and those of the first draft are as follows:
1. Loans are permitted up to 100 percent of the lowest value for
the preceding 3 years (except as stated in the next paragraph) instead of 80 percent of such value—but a maximum limitation of
75 percent of current market value is established in the revised bill.
In both bills loans may be in any case at least as much as 40 percent of the current market price.
2. The new bill provides that until July 1, 1936, the lowest price
since July 1, 1933, is taken in lieu of the lowest price for the preceding 3 years. The effect of this is to eliminate the extremely low
prices of 1932 and early 1933 as limiting factors upon loan values.
3. Provision is made in the new bill for maintenance of credits up
to certain points after accounts have become undermargined. For instance, an initial loan of 75 percent need not be closed out in an
adverse market as long as it does not exceed 85 percent of the current
market price, and an initial loan of 40 percent need not be closed out
as long as it does not exceed 60 percent of the current market price.
4. Under the new bill loans outstanding at the time of the enactment of the act are permitted to be continued, with certain restrictions as to substitutions and withdrawals, until January 1, 1939.
5. All loans on " exempted securities " and loans by banks on securities other than equity securities are specifically excepted from
the margin provisions of the new bill.
6. Under the new bill, as contrasted with the old bill, banks are
not subject to prescribed-margin requirements, except that when a
bank makes a loan on an equity security any excess over the amount
that a broker could loan is subject to such rules and regulations as
the Federal Reserve Board may prescribe to prevent the use of such
excess for the purchase or carrying of securities.
7. Under the original bill administration of margin requirements
was vested in the Federal Trade Commission, which could increase
but not lower margin requirements. Under the new bill, control
over margin requirements is placed under the Federal Reserve
Board, which may increase margin requirements and, in certain extraordinary circumstances, may also decrease such requirements.
8. The new bill directs the Federal Reserve Board in cooperation
with the Federal Trade Commission to study the feasibility of fixing maximum loan values on the basis of earnings, and on other
bases, and to submit its recommendations to Congress on or before
January 3, 1935.
NOTE : Regulation of short selling is vested in the Federal Trade
Commission in both bills. This appears to carry with it the control
of margin requirements on short sales.
7425
STOCK EXCHANGE PRACTICES
Summary of margin provisions, original and revised stock exchange bills
Bevised bill
Original bill
1 Maximum loans, when based on lowest prices
(a) Initial loan (percentage of low)
But not more than (percentage of market)
(b) Maintained loan (percentage oflow)
But not more than (percentage of market)
2 Maximum loans, when based on curient market prices
(a) Initial loan (percentage of market)—
(b) Maintained loan (percentage of market)
3 Period from which lowest price is to be selected
(a) Until July 1,1936
(b) After July 1,1936
4 Exemption for existing accounts
3 years.
3 years.
None
5 Power to exempt securities
Limited
100
75
100
85
40
Since July 1,1933
3 years
Exemption to Jan
31,1939
Discretionary
Now, Mr. Chairman, here is a little memorandum of the operation
of the margin provisions of the bill:
Application of the margin requirements of the stock-exchange
bill to a selected list of leading stocks traded in on the New York
Stock Exchange indicates that on the basis of current market prices
the maximum of 75 percent could be borrowed on a large number
of important securities; on many other securities between 60 and 70
percent could be borrowed; and the limit of 40 percent would apply
to few stocks.
On a number of the securities on which 75 percent could now be
borrowed, the loan could be further increased with a rise in price,
that is, the maximum loan now permitted does not equal 100 percent
of the lowest price reached since July 1, 1933.
In general, it appears that the margin provisions would operate
as follows:
1. Securities with relatively stable prices would carry the higheiloan percentages.
2. Securities that have been declining in price would carry the
higher-loan percentages.
3 Lower loan percentages would apply to securities that have
risen more than 33 percent from their lowest prices.
4 The lowest loan percentage—that is, 40 percent—would apply
to securities that have risen more than 150 percent from their lowest
prices.
Now, as compared with present margin prices as established by
the rules of the New York Stock Exchange, let me give you something on that:
The rules of the New York Stock Exchange prescribe margins of
at least 30 percent of the debit balance for accounts as large as
$5,000, and at least 50 percent of the debit balance for smaller accounts. Translating these requirements into the terms used by the
bill, they provide in effect for loan values up to 76.9 percent for the
larger accounts and 66.7 percent for the smaller accounts.
I t should be noted, however, that these are the requirements below
which the broker must not permit the customer to go. In practice
the broker would presumably be exacting higher margins; that is,
lower loan values. The 76.9 and the 66.7, therefore, are probably
more comparable with the 60-85 range within which margins must
7426
STOCK EXCHANGE PRACTICES
be maintained under the revised bill than with the range 40-75
prescribed for the initial extension of credit to customers.
However, it is not known exactly what margins are being maintained by customers in practice.
The CHAIRMAN. One criticism, I think, has been urged that the
Federal Eeserve Board might not be able to act promptly and
quickly in case of change of prices, and so forth; that their authority
to vary the margin might be covered in a general way, and that
they might Jay down general regulations, but could they act quickly
enough, for instance, during the day when prices are going up or
down. What have you to say about that?
Mr. BLACK. They could act only in compliance with this law, in
which you allow them to execute higher margins whenever they want
to, but lower margins only under very exigent circumstances. The
Federal Reserve Board, in order to have credit control, if this Congress wants them to have it, is perfectly willing to go ahead with this
bill. My personal opinion is that the margin requirements in order
to be scientific should be more flexible.
The CHAIKMAN. I think Mr. Potter testified before the committee,
referring to the powers of the Federal Reserve Board to prevent
any such occurrences as October of 1929, that if they had acted
quickly enough they could have checked that situation.
Mr. BLACK. Well, Mr. Chairman, a great many of these people
who criticize the Federal Reserve Board could be criticized themselves in the management of their own institutions. If they had
been a little less liberal themselves they wouldn't have had complaint
o± the Federal Reserve Board. Mr. Chairman, when anybody attacks the Federal Reserve Board, I try to come right back at them.
The CHAIRMAN. Well, I did not understand that Mr. Potter was
attacking the Federal Reserve Board but was merely expressing his
opinion of that situation.
Mr. BLACK. I have a very great respect for Mr. Potter, and a
warm personal feeling for him, and I was not referring to his institution, but that is my opinion of a great many institutions.
Senator MCADOO. One further question: The purpose of this bill
is to restrain speculation, and it proceeds upon the theory that all
speculation is bad and ought to be suppressed. Now, if you are
going to be thoroughly effective in that, I should like to know if you
would think it wise to require that all transactions on exchanges be
on a cash basis, that a purchaser must buy his stock and pay for it,
and if he has to have any additional money that he will go to a bank
and borrow it, that he will there get the credit he needs if he can.
Would that, in your opinion,be a wise thing? That is, to go the
whole hog at once and be done with it? I am not expressing any
opinion myself, but am asking you for an expression of opinion on
the matter.
Mr. BLACK. I think it would be too drastic a step to take at once.
But my best recollection is that that is the process in England.
Senator BTJLKLEY. Will you answer that question without regard
to the time element; that is, as to how long you might give to put it
into effect; would it be a good system ultimately, regardless of the
embarrassment of the time it might take to put it into effect?
Senator MCADOO. Senator Bulkley, I was just going to ask Governor Black that very question.
STOCK EXCHANGE PRACTICES
7427
Mr. BLACK. Senator Bulkley, there are two very strong views
about that. One of them is that it would be a good thing to do.
Senator BTJLKLET. What is you view of it ?
Mr. BLACK. I think ultimately it might be a good thing to do.
Senator MCADOO. HOW much time do you think wou.d be necessary for a reasonable transition period?
Mr. BLACK. I think it would be such a drastic step to take with
the markets of America that it should not be done within any less
period than you have here about your long-time loans, and I think
it should not be done without a very exhaustive study, to see what
effect it will have. I should like to answer your question directly,
but it is a very hard question to answer.
Senator BULKLEY. What would be the nature of the exhaustive
study you suggest?
Mr. BLACK. I think I should like to know exactly how it operates
in England, what are the factors relative to it in England, what are
the practices in England, if I am correctly advised that that is the
practice in England, and I think I am correct about it
Senator KEAN. That is the practice in London.
Mr. BLACK. I think so.
Senator KEAN. This country is a good deal bigger than England.
Mr. BLACK. I said I wish I could answer your general question
directly on that, but I cannot do it.
Senator GORE. In this connection I want to ask a question. Sen
ator McAdoo asked you and you stated a while ago that the purpose
of this bill was to stop speculation. In your mind don't you make
a substantial and real distinction between " speculation" and
'•gambling"?
Mr. BLACK. I sort of prefer gambling. You are there and know
what you are doing.
Senator KEAN. Y OU prefer puts and calls ?
Mr. BLACK. I prefer poker, Senator.
Senator GORE. I might agree with you there, but, to make it literal,
do you think that all speculation ought to be prohibited?
Mr. BLACK. NO, sir. I do not. I think it is absolutely necessary
in America to have stock exchanges in order to have a free market
for equity securities in America.
Senator GORE. And legitimate speculation, if you want to call
gamb^ng illegitimate speculation and the other category legitimate
speculation, that might represent the point I have in mind, and the
point to which I want to get your reaction. I think if you stop all
legitimate speculation, that is, people who, after investigating all
the facts, reach the conclusion that the stock will ^o up and there
will be improvement in business and an increase m its earnings and
it is bought for a rise—I do not think that is any crime. It ought
not to be in law and m morals. It is not in morals.
Mr. BLACK. I do not either, Senator, and I would like to be distictly understood as favoring the maintenance of national securities
exchanges in order that there may be a perfectly free market in
America for securities.
Senator GORE. A market place where people who want to buy
securities can buy, and where people who want to sell can sell.
What I have in mind by gambling is this: We had it here in 1929.
People—janitors and judges, as well as waitresses and heiresses—
7428
STOCK EXCHANGE PRACTICES
bought stock today because they thought they could sell it for more
tomorrow, without any regard to the physical properties in the business, the management, the earnings, prospects, or anything else.
That is what I characterize as gambling. That is what we want to
stop.
Senator COTJZENS. That is what the governor says he is driving at.
Senator GORE. Yes; I want to get that on the record, because just
to say stop speculation in this country is not quite accurate.
The CHAIRMAN. NO one has contended that we should not check
that kind of thing.
Senator ADAMS. Senator McAdoo said that the purpose of the bill
was to stop " all speculation."
Senator COTJZENS. Well, he assumed a premise that I think is not
in the bill. •
Senator MCADOO. N O ; I said on the presumption, as I recall it,
that that was the intention. I did not say that it was. I agree with
Senator Gore and with Governor Black that we ought to stop the
evils of speculation.
Senator ADAMS. I think what we are trying to do is to stop using
loaded dice.
Senator MCADOO. I think we ought to preserve the markets as a
place for legitimate buying and selling. The point is to get rid of
wild speculation on these exchanges, because they do render a useful
service and create a liquid market.
Mr. BLACK. Unquestionably.
Senator MCADOO. A market which is there for special business
transaction. I do not like to be misunderstood or misconstrued m
questions that I ask you, because I merely want to bring out the
argument without having it indicated at all that the questions I
asked represent any contentions or views of my own
The CHAIRMAN. Governor, I would like to ask you this question:
Some telegrams and letters have come to me expressing apprehension
that the business of the country would be greatly and adversely disturbed by this kind of legislation. Do you see anything m this bill
that would cause that sort of reasonable apprehension? Do you
think business will be harmfully affected if we pass this bill?
Mr. BLACK. I haven't any apprehension about that. I think we
have gone through a great many radical changes in the past year
trying to better conditions in America; I have heard the same
prophecy and I have not seen the result.
Senator CAREY. Governor Black, I would like to ask you if you
think it is better to have the margin fixed in the law or'to leave it
to the discretion of the Federal Eeserve to fix it ?
Senator COUZENS. The Governor answered that question before
you came in, Senator.
Senator CAREY. I was not here.
Mr. BLACK. I will be glad to answer it again. I would be perfectly
willing for the margins to be named as they are m the bill for the
purpose of indicating the expression of the views of Congress relative to them. I would be willing even to operate under the bill with
the power given to the Federal Reserve Board relative to margins.
I think that as a matter of scientific operation of credit there should
be more flexibility vested in the Federal Eeserve Board relative to
margin requirements.
STOCK EXCHANGE PEACTICES
7429
Senator KEAN. And Governor Black has already said that he
thought the Federal Reserve could regulate these margins, as they
were charged with regulating credit.
Senator GOLDSBOROUGH. Governor Black, referring to margin requirements, which you outlined so definitely a moment ago, is not
the understanding current among the bankers and brokers and customers throughout the country that they have always figured their
margins on loans on the debit basis?
Mr. BLACK. I think that is correct.
Senator GOLDSBOROUGH. If that is correct, sir, do I understand that
60 percent of the current market price would be 150 percent of the
debit?
Mr. BLACK. The way they figure it; yes.
Senator GOLDSBOROUGH. And 40 percent would be 66% percent?
Mr. BLACK. Figured on a debit balance, yes, on their present practice. There is not any question about these margin requirements
requiring more cash paid on stock, Senator. That is the purpose
of it.
Senator GOLDSBOROUGH. I think that is very evident by the requirements.
Mr. BLACK. That is the purpose.
Senator COUZENS. TS not the provision of this bill more liberal
than the present rules and regulations of the stock exchange ?
Mr. BLACK. Senator, I cannot answer that question.
Senator COUZENS. I thought you in part answered it when you
gave us those figures awhile ago.
Mr. BLACK. Well, I would not say they are more liberal. You
mean as to marginal requirements ?
Senator COUZENS. Yes.
Mr. BLACK. I would not §ay they are more liberal.
Senator COUZENS. I S there any great difference between the rules
and regulations of the stock exchange on margins and as provided
in the bill?
Mr. BLACK Only as I read from that memorandum.
Senator COUZENS. That is what I thought. As I interpreted the
memorandum that you read, the bill is somewhat more liberal than
the present rules and regulations of the stock exchange.
Mr. BLACK. I do not think that is correct
Senator MCADOO. I understood him to say that this revised bill
was more liberal than the previous bill but not more liberal than the
stock exchange.
Senator COUZENS. Yes; but I think there is a margin of 30 percent.
Mr. BLACK. They are not more liberal than the stock exchange
Senator MCADOO. They are less liberal, as a matter of fact
Senator KEAN. Governor Black, we had before us Mr Potter, of
the Guaranty Co., and Mr. Johnston, of the Chemical Bank. Mr.
Johnston said he agreed with Mr. Potter He had read the statement made by Mr. Potter, so he agreed with that statement. In that
statement Mr. Potter said that if these rules for margins were put
into effect at once, why, it would mean a deciease or a liquidation of
loans in his bank to a very large amount, and also the Chemical Bank.
Mr. BLACK. If I understand the provisions of the bill, that protection is granted for 5 years on existing loans
7430
STOCK EXCHANGE PRACTICES
Senator KEAN If they carry a loan, but nobody is going to carrv
a loan—at least I never have—for 5 years
Mr BLACK. Then they have 5 years in which to work it out.
Senator KEAN. NO ; because your customers buy and sell and you
have got to make substitutions, and as soon as you make substitutions
you come under the new rule.
Mr. PECORA. Senator Kean, Mr. Potter's observations were based
upon the provisions of the original bill.
Senator KEAN. Surely.
Mr. PECORA. The revised bill contains the provision that Governor
Black has alluded to, which allows virtually a 5-year period for the
liquidation of existing margin accounts unless they are brought up
to the standards fixed by this bill.
Senator KEAN. Unless you make substitutions.
Mr. PECORA Substitutions have to be made, of course, in accordance with the bill.
Senator KEAN And that changes your whole loan
Mr. PECORA. NO ; it does not change the whole loan, m my opinion.
It prevents a utilization of existing margin accounts for the purpose
of evading the provisions of this bill. It maintains margin accounts
now existing in their present status It preserves their status, but
will not permit of the utilization of those accounts as a means of
evasion of the bill. The fear expressed by Mr. Potter and by other
opponents of the original bill, as I interpret their opposition here,
was that under the original bill a forced liquidation would be compelled by the time the bill went into effect, which was October 1
next. Now, that period has been extended to January 1939.
Senator KEAN. Mr. Chairman, most of these brokers' loans are
made day-to-day loans. They are callable any time from 11 in the
morning till 1 in the afternoon; and I assert, and I think I am correct, that there is no broker that has a loan that has run for 5 years
or 3 years or 2 years All loans are paid off long^ long before that,
unless it is a special loan made on special terms with the institution.
Therefore, all brokers' loans would come within a year under this
clause.
Senator COTJZENS. Yes; but you referred awhile ago to the bankers' objections, and that has been overcome.
Senator KEAN. N O ; I do not think it has, because these loans
would not run that time. They are brokers' loans.
Mr. PECORA. Senator Kean, may I call your attention to the provisions of the revised bill appearing on page 18 of the House draft,
subsection (f):
The provisions of this section shall not apply on or before January SI, 1939
to any loan, renewal or extension thereof, made on any security or securities
prior to the enactment of this act, or on any exempted securities and/or
securities registered in a national securities exchange substituted therefor
So that that provision is certainly broad enough to take care of
the situation that you have in mind, sir.
Senator KEAN. Mr. Chairman, I cannot agree with the counsel
for the committee that that broadens the question that I have in
mind, because a client comes m today and buys a hundred shares
of stock and we borrow the money for him, and within 2 weeks or
3 weeks he comes m and sells that stock and buys another share of
stock or something or other. Those loans do not run for the periods
STOCK EXCHANGE PRACTICES
7431
that I am telling you are in the bill, and they cannot possibly run.
We have got to make substitutions for new customers. We have got
to make substitutions under the loans. And therefore the loan
becomes a new loan or it is called.
The banks do not carry these loans. The banks^ vary every day.
One day they are debited a million dollars at the clearing house.
The next day they are credited with a million dollars at the clearing
house They send that money down to the exchange to be loaned
for their account. That money is loaned for their account, and they
call 1 day for the loans or a part of their loans. The next day
they loan so much money. So that the loans are swinging back and
forth between different institutions all around the street.
Mr. PECORA. If it were your purpose to preserve existing margin
accounts in the fashion that you indicate, you would be announcing
right now to the world that any margin accounts established prior
to the enactment of this act on any margin basis lower than the
provisions called for by this act with respect to new margin accounts
could be utilized for all time to come.
Senator KEAN. NO.
Mr. PECCRA. AS the credit basis for the operation of that account;
and you would take all existing margin accounts and constitute them
wide-open doors to evade the provisions of this act.
Senator KEAN. NO. What I am saying is
Mr. PECORA (interposing). You might just as well not enact the
act, because anybody could establish a margin account between now
and the date oi the act going into effect, unless this bill were properly drawn to prevent such an evasion, and thoroughly escape the
consequences of this act so far as margin provisions are concerned.
Senator KEAN. Not at all, Mr. Chairman. That is not what I am
driving at at all. Counsel is trying to put words in my mouth which
I did not say, which I do not mean. What I say is that these loans
will all be paid off and changed within a year, so that this 5-year
plan does not mean anything.
The CHAIRMAN. We get the point, Senator.
Senator GOLDSBOROUGH. May I ask Governor Black just one more
question? Governor, may I direct your attention to section 6 (a),
on page 13? Does this section still leave unprovided for all unregistered securities?
Mr. BLACK. May I read it, Senator ?
Senator GOLDSBOROTTGH. Certainly.
Mr. BLACK (after perusing section). It appears to do so.
Senator GOLDSBOROUGH. It does. That is all.
Senator TOWNSEND. Governor Black, does the Federal Reserve
bank, or banks, often find it necessary in order to stabilize Government obligations to buy and sell Government securities?
Mr. BLACK. Senator, you mean do we buy and sell Governments
for the purpose of making a market?
Senator TOWNSEND. In order to stabilize the market.
Mr. BLACK. I do not think we do that, sir.
Senator MCADOO. The Treasury does that, doesn't it, Governor?
Mr. BLACK. Well, if it is done, the Treasury does it. Let me put
it that way. Senator.
Senator GORE. I t would not be a proper function of the Federal
Reserve bank?
7432
STOCK EXCHANGE PEACTICES
Mr. BLACK. NO, sir; the Federal Keserve bank.
Senator TOWNSEND. If it is done by the Treasury Department
would not subsection 8 of section 8 (a), page 23, prohibit that—
To engage in any series of transactions for the purchase and sale of any
security registered on a national securities exchange or any security not so
registered, which has the purpose of pegging, fixing, or stabilizing the price
of such security—
And so forth?
Mr. BLACK. I think governments are exempt from the operation of
it.
Mr. PECORA. There is a general clause here, Senator Townsend,
which exempts Government securities from the provision of this
act.
/
Senator TOWNSEND. Then the pegging of a Government security
would stand in a separate category from pegging other securities;
is that the idea ?
Mr. PECORA. Government securities are exempt from the provisions of this act.
Senator MCADOO. The Government may do what the individual
cannot do.
Mr. PECORA. What the Government does is done for the public
good. What individuals do is presumed to be done for their individual good.
Senator TOWNSEND. That may be true and it may not be true.
Senator ADAMS. Mr. Pecora, were you saying that it exempted
the Government or it exempted dealers in Government securities?
Mr. PECORA. It exempts Government securities from the provisions of this act.
Senator ADAMS. There is no provision prohibiting a banker or
a broker from buying and selling Government securities for the purpose of stabilizing or affecting the market ?
Mr. PECORA. I think that is correct, sir.
The CHAIRMAN. There is no evidence that that practice prevails.
Senator MCADOO. Governor, I would like to ask just one more
question, a,nd I would like to revert to the administrative feature
that we discussed a bit ago, the difficulty of administering these
margin requirements and all.
Would it in your opinion simplify that machinery and add to
the effectiveness of the policing if on each stock exchange in the
country there were a Government representative, in other words, a
Government agent or a Government director or Government governor, who had no responsibility for the operation of the exchange but
who was there to represent the public interest to see that the
exchanges complied with the law ?
Mr. BLACK. Senator, I personally would dislike to see that done
very much.
Senator MCADOO. We do that with the banks, because we have a
Federal Reserve agent and a chairman of the board, and he has three
Government directors on this board.
Mr. BLACK. Senator, I believe the exchange is going to comply
with your rules.
Senator MCADOO. I think they will.
Mr. BLACK. I would hate to think of the necessity of a man having
to see it done.
STOCK EXCHANGE PRACTICES
7433
Senator MCADOO. Well, we thought the Federal Eeserve directors
would comply with the rules too, but in order to make sure of it we
appointed
three Government directors on each one of these boards.
Mr. B r ACK. Well, I have just answered your que&tion as best I can.
Personally, I would not like that at all.
Senator GORE. The Federal Reserve Board is a quasi-Government
institution.
Senator TOWJSTSEND. This language says in section 8 ( a ) ;
To engage m any series of transactions for the purchase and sale of any
security
Mr. BLACK. " Registered on a national exchange "—well, that is
correct. But there is another provisions in this bill that this act does
not apply at all to exempted securities, and governments are exempted
securities. If I am wrong about that I would like to be corrected.
Senator KEAN. Governor Black, as I said before, Mr, Percy Johnston and Mr. Potter were down here. They testified that if this bill—
and that was the old bill but it was practically this bill—if this bill
went into effect it would mean a large liquidation of the loans: m
their banks, and they figured that out. Now, wouldn't you think
that was probably so if they had figured it out ?
Mr. BLAOK. If those gentlemen have figured it out and state it, I
would put a great deal of reliance on the statement of those two
men. I think they are both perfectly straight and perfectly honorable and perfectly capable. But that may be one of the things that
is desired in connection with this bill, Senator—I don't know.
Senator KEAN. What study did the Department make of this
bill? I am talking now from the stock-exchange standpoint. What
study did they make about the practices, and so forth, of the stock
exchange?
Mr. BLACK. YOU mean the Federal Eeserve Board?
Senator KEAN. Yes.
Mr. BLACK. And the Treasury Department?
Senator KEAN. Yes.
Mr. BLACK. And the representatives of the committee?
Senator KEAN. Yes.
Mr. BLACK. Well, we consulted with some experts. We are not
experts on this question, Senator. And if you will note in my
statement, I have put a provision in that I would like to make sucn
suggestions relative to the technical parts of the operation of this
bill as may seem necessary.
Senator KEAN. And in regard to these call loans, why, you think
that this provision of 5 years would really not be effective from the
causes that I have named ?
Mr. BLACK. I think probably it would affect them very considerably, relative to brokers' loans in banks.
Senator KEAN\ In other words, all loans would be changed in the
course of a few weeks?
Mr. BLACK. I think that is correct, Senator.
The CHAIRMAN-. Any other questions of Governor Black? If
not
Mr. BLACK. Mr. Chairman, may I bring up one other matter that
the Board has asked me to submit to the committee?
The CHAIRMAN. Very good, sir.
7434
STOCK EXCHANGE PBACTICES
Mr. BLACK. We have made recommendations a number of times
that reserve requirements of member banks be changed, and be based
upon velocity of turn-over rather than to be fixed. It has been
studied very exhaustively. During the consideration of the Glass
bill we sent up a proposed bill to that end.
By basing reserves upon velocity of turn-over we would automatically correct a great many of these abuses. I would like very
much to leave a report of our committee on that with your committee and have your committee give study to that> either in connection with this bill or independent of this bill.
Senator MCADOO. What is that, the velocity of what?
Mr. BLACK. The velocity of turn-over of a bank, instead of having
fixed reserve requirements.
Senator GORE. NOW, Governor, on that point, don't you think it
would be a good idea to allow the Federal Reserve Board to have
the power to enforce either requirement? I have understood that
the velocity of circulation might be prejudicial to the small banks
of the country, whereas it would be applicable to the big banks in
the big cities.
Mr. BLACK. I think it would be prejudicial to the big banks, if you
want to use the word " prejudicial."
Senator GORE. Yes.
Mr. BLACK. I think it would be more restrictive of the big bank<
and a great deal less restrictive of the small banks.
Senator GORE. The point has been made that the velocity of circulation taken as a basis of the bank would not be equally applicable,
but if the board had the power to apply one standard in one particular set of banks and another in another, it would meet the varying circumstances of the the two categories. Don't you think that
would be better than tying our hands and limiting it to either one
and excluding it from the other.
Mr. BLACK. Senator, I think this is a scientific way to do it f 01
all banks.
Senator ADAMS. Governor Black, what do you mean there by
"velocity of turn-over"?
Mr. BLACK. Well, suppose, like times are now, banks are domjr
very little, very little business going on, very little speculation going
on. You will find a small turn-over for most banks. The drawing
on accounts by customers is very small.
Senator AIMMS. YOU mean the total amount of business in relation
to the total resources of the banks?
Mr. BLACK. TO the total deposits of the banks.
Senator ADAMS. Total deposits
Mr. BLACK. In times of excessive speculation that turn-over ib
very rapid; and, gaged by the turn-over, if the reserve requirements
automatically followed the turn-over as it went up or went down,
you would have a very good check on the use of credit in speculation.
Senator ADAMS. Then you would increase the reserve requirements as the turn-over increased in velocity?
Mr. BLACK. That is correct, sir. I would like very much to be
allowed to leave that memorandum with the committee and ask
that they give study to it, because the Board is very strongly committed to the view that it aids very largely in the solution of the
problem we have before us.
bTOCK EXCHANGE PRACTICES
7435
Senator GORE. DO you have copies of it, Governor ?
Mr. BLACK. Senator Gore, I will be glad to send you copies.
Senator KEAN. Will you send one to me, too ?
Mr. BLACK. I will, Senator. I am not suggesting that so much in
connection with this bill, because I would hate very much to be put
in the position of thinking that I have thrown some other factor in
this bill, but I would like very much for the committee and counsel
for the committee to study this problem, because it can be done just
as well'independent of this bill as in connection with the bill.
The CHAIRMAN. I doubt if it is relevant to this particular matter,
but the committee as a whole will receive it and it may be in the
record so as to preserve it.
Senator ADAMS. I t would have the effect of operating as a deterrent to excessive speculation ?
Mr. BLACK. Automatically.
I am asking you now, please, not to be misunderstood; to consider
that this is suggested in connection not with this bill necessarily but
simply that the committee will study it, because we believe that it is
an automatic check on this kind of speculation.
(The matter submitted by Mr. Black, at this point will be found
m the record at the end of Governor Black's testimony.)
Senator TOWNSEND. What treatment is given to savings banks
under this bill; the same as the Federal Reserve banks ?
Mr. BLACK. The same as any other bank.
Senator TOWNSEND. The same as any other bank?
Mr. BLACK. In reference to brokers' loans or loans on equities.
The CHAIRMAN. Governor, our plan is to close the hearings entirely
on this bill and the proposed amendment to the bill tomorrow. You
suggest in your statement that you may have something further to
submit as a result of further study. Could you let us have that
early next week?
Mr. BLACK. Yes; I will.
The CHAIRMAN. I S there anything else ?
Senator MCADOO. Just one question I would like to ask the Governor. It is not altogether germane to this bill but relating to the
question of reserves and the liquidity of banks, which is always a
troublesome problem. I again wish to say that I am not expressing
an opinion in this question; I am merely asking for information
Would you think, Governor, that there was any virtue in the idea
that all reserves for banks be dispensed with, and in lieu thereof that
they should be required to keep liquid by making loans to the extent
of their deposits only on eligible paper, the definition of which might
be expanded or enlarged, and they be permitted to invest their capital
and surplus in other forms of securities?
Mr. BLACK I think they should keep their reserves, Senator.
Senator MCADOO. I mean if they were required to make their loans
only on a liquid basis.
Mr. BLACK. I think they should keep their reserves.
Senator MCADOO. Suppose they keep their reserves as they are required and are permitted to make loans to the extent of their deposits
on eligible paper only, the definition of which might be enlarged?
Mr. BLACK. I do not think you could restrict a bank's operations
that way, Senator. You and 1 are not in business. Of course, this
7436
STOCK EXCHANGE PRACTICES
is, as far as I am concerned, rather a far-flown thought, but I might
be perfectly good for a thousand dollars.
Senator MCADOO. Well, you have the capital and surplus at the
bank to be employed in such loans
Mr. BLACK. But I do not think they would take care of what I
would term personal loans.
Senator MCADOO There are not any of those any more, are there (
Mr. BLACK. Senator, you are discouraging me in my thoughts.
Senator ADAMS. In the small outside banks the personal loans are
a very substantial percent, and the smaller percent is eligible paper *
Mr. BLACK. That is true. You could not do that, because you
cannot obtain eligible paper.
Senator MCADOO. YOU would have to enlarge the definition, of
course.
Senator KEAN. I am going to ask Governor Black a disagreeable
question.
Mr. BLACK. I have had so many since I got to Washington it
does not make any difference.
Senator KEAN. The law says thrit you shall discount, rediscount
or discount, eligible paper and buy eligible paper. I t specifies that
it shall be commercial paper given for a transaction. Now, then,,
how much paper of that kind is there ?
Mr. BLACK. Very little, sir.
Senator KEAN. In other words, you are discounting paper every
day which is not in strict compliance with the law?
Mr. BLACK. Senator, I am not going to confess here about it.
[Laughter.]
Senator KEAN. I told you it was a disagreeable question. I t was
brought out by another Senator.
Senator MCADOO. I recognize the necessity in any such idea as
this of enlarging the definition of " eligible paper."
The CHAIRMAN. This does not apply to this bill. Let us discuss
that later. Let us go on with this hearing. Any other questions?
That is all very interesting, but we have other witnesses here to
hear on this subject. If there are no other questions, Governor,
we are very much obliged to you.
FEDERAL RESERVE BOARD,
Washington, March 24, 1984
Hon DUNCAN U FLETCHER,
Chmrmm Senate Committee on Banking and Currency,
United States Senate, Washington, D.C.
DEAR SENATOR FLETCHER4 At the hearing before the Banking and Currency
Committee of the Senate yesterday on the so-called "stock-exchange bill",
Governor Black of the Federal Reserve Board referred to a report on Member
Bank Reserves submitted by the Committee on Bank Reserves of the Federal
Reserve System and approved by the Federal Reserve Board He also read
to the Committee a memorandum containing a brief review of the proposal to
change reserve requirements as recommended by the Committee on Bank
Reserves
With the thought that each member of the Banking and Currency Committee
would desire copies of the material above referred to, Governor Black has
requested me to send you a copy of the committee report and a copy of the
statement which he read before your committee While there is included in the
report of the Committee on Bank Reserves a proposed amendment to Section 19
of the Federal Reserve Act which would give effect to the committee's recommendations, it has been necessary to revise the amendment by reason of changes
made m the law since the committee report was submitted, and, therefore, a
STOCK EXCHANGE PEACTICES
7437
revised diaft of amendment to Section 19 of the Federal Reserve Act in accordance with the committee's recommendations is also inclosed
Very tiuly yours,
CHESTEB MOKRTIX, Secretary
MEMORANDUM REGARDING PROPOSED REVISION OF RESERVE REQUIREMENTS AS TO
MEMBER BANKS
As an amendment to the bill regulating security exchanges, the Federal
Reserve Board wishes to leiterate its recommendation made two years ago for
basing member bank reserve requirements not solely on the volume of deposits
but also on the rapidity of their turnover, m other words, on the extent to
which the deposits are utilized
Member bank reserve balances are high-power money On the basis of
one billion dollars ot excess reserves, member banks can extend credit amounting to between ten and fifteen billion dollars without having to resort to
borrowing at the Federal Reserve banks The volume of excess reserves at the
piesent time is one and one-half billion dollars, and these excess reserves furthermore may increase greatly when a period of credit expansion sets in.
Under existing law national banks can issue an additional seven hundred million dollars of bank notes, which when deposited with the Federal Reserve
banks add to the leserves of member banks There is also still a billion or a
billion and one-half of currency that has not leturned from hoarding but is
likely to be utilized and thus flow back into the banks when an expansion sets
in. In these circumstances if an expansion of credit should get under way,
the member banks will have a laige volume of leserves without recourse to the
Federal Reserve banks These banks therefore would be out of touch with
the market and thus not in a position to exeit a restraining influence through
discount policy
The Board's proposal carries out to its logical conclusion the existing distinction between time deposits, which require a 3 percent reserve, and demand
deposits, which require a 7, 10, or 13 percent reserve, depending upon the
location of the bank The proposal would result in an automatic increase of
reserve requirements when boom conditions arise and an automatic decrease
of reserve requirements in times of depression The proposal furthermore has
the advantage of making the increase in reserves applicable not to all banks
in all localities alike, but rather to those banks in those communities only
where excessive speculative activity is manifesting itself If this proposal
were adopted, its operation, together with the authority existing under the
Thomas Amendment to raise reserve requirements with the consent of the
President when an emergency arises fiom excessive credit expansion, would
make it possible tor the Federal Reserve Board to combat the recunence of
speculative excesses The proposal, therefore, piesents a logical complement
to the bill for the legulation of security exchanges
The proposal would counteract two abuses that have developed under existing
law and have created serious obstacles to credit control One is the evasion
of reserve requirements by classifying as time deposits many deposits that to
all intents and purposes are demand deposits, a practice that has developed
since the classification of deposits in one or the other category has determined
the volume of reserves that a bank must carry. And the other, the reduction
of actual reserves carried through diminishing the volume of till money which
under existing law does not count as reserve The pioposal would permit banks
within certain limitations to count their vault cash as reserves and would
therefore close the door to the practice of greatly reducing actual reserves by
diminishing cash holdings to a nominal amount
In times of great speculative activity, such as 1928 and 1929, the banks under
a law like the one pioposed would have had to carry three or four hundred
millions of additional reserves and would, therefore, have had to increase their
borrowings at the Reserve banks by that amount This would have greatly
increased the power of the System to exercise a restraining influence at an
early date On the other hand in times of depression when deposits aie
inactive member bank reserve requirements would dimmish and there would
be a decrease in the volume of idle funds that the banks would be lequiied to
carry as reserves In effect, ,the plan would supplement open-market operations
by the Reserve banks, by withdrawing funds trom the market under boom
conditions and furnishing additional funds at times ot depression
7438
STOCK EXCHANGE PRACTICES
The plan would also woik for a more equitable distribution of reserves as
between city banks and country banks City banks, owing to their proximity
to the Reserve baDks, have been able to reduce their vault cash to a very small
proportion of their deposits, while at country banks a much more considerable
proportion has been necessary As a consequence the actual distabution of
effective reserves differs from that contemplated by the law and is much moie
favorable to banks in financial centers. The Board's proposal would do away
with this disparity
Most important ot all, however, the proposed plan would result in an increase
of reserve requirements not only at the time when such an increase will be in
the interests of sound banking conditions but also at the spot where speculative
excesses get under way, and at the banks where enhanced activity of deposits
will be caused by a rising tide of speculation Big nation-wide booms develop
at financial centers, and this proposal by imposing restraints on speculation in
these centers without increasing the burden of idle reserves for banks in thobe
communities to which the boom has not penetrated, will not only be more
equitable but will serve the purpose of applying restraining influences automatically at the right time, in the right places, and to the right institutions
With the heavy responsibilities imposed upon the Federal Reserve System
in connection with the possibilities of speculative expansion, the adoption of
this plan would place into their hands an instrument that would be of great
assistance in seivmg the interests of trade and industry by restraining the
use of credit for speculative purposes.
Concretely under the proposal, member banks would be required to carry
5 percent reseives against their net deposits plus 50 percent of the amount of
the bank's average daily debits to deposit accounts In order to avoid too
heavy bmdens in extreme cases, the proposal provides that in no case shall
agggregate reserves required of a bank exceed 15 percent of its gross deposits
In computing their leserves, the member banks would be permitted to count
as reserves a certain proportion of their vault cash At banks in cities near
the Federal Reserve banks or branches, the banks would be required to cairy
four-fifths of their total reserves as deposits with the Federal Reserve banks,
while at other banks they would only be required to carry two-fifths of their
reserves as balances with the Reserve banks.
As an exhibit in connection with this statement I should like to submit the
report of a committee of the Federal Reserve System on bank reserves presented to the Federal Reserve Board in 1931 Your attention is particularly
called to the chart on page 10 of this report which shows that demand
deposits and consequently reserve balances of member banks showed practically no increase during the period of the greatest credit expansion in 1928
and 1929, while bank debits during that period increased at a very rapid rate
Another chart on page 19 of the report shows how under the proposed plan
reserve requirements would have risen rapidly during the expansion and
would have declined much more rapidly than actual reserves after the depression set in.
A BILL TO amend Section 19 of the Federal Reserve Act as amended
Be it enacted by the Senate and House of Representatives of the United
States of America in Congress assembled, That Section 19 of the Federal
Reserve Act, as amended, is further amended and reenacted to read as follows:
" RESERVES OF MEMBER BANKS
" SEO 19. (a) Each member bank shall establish and maintain reserves
equal to five per centum (5%) of the amount of its net deposits, plus fifty
per centum (50%) of the amount of its average daily debits to deposit accounts: Provided, That any member bank, at its option, for any period not
less than 90 days, may omit any specific deposit account or accounts from
> such> computation of its reserve requirements if such account or accounts
are reported separately to the Federal reserve bank and if a reserve of 50%
is maintained against such account or accounts* Ptouided, however, That, in
no event, shall the aggregate reserves required to be maintained by any member bank exceed fifteen per centum (15%) of its gross deposits.
"(b) Each member bank located in the vicinity of a Federal reserve bank
or branch thereof shall maintain not less than four-fifths of its total required
STOCK EXCHANGE PEACTICES
7439
reserves in the form of a reserve balance on deposit with the Federal reserve
bank, and cveiy other member bank shall maintain not less than two-fifths
of its total lequned reserves in the form of a reserve balance on deposit with
the Federal reserve bank The remainder of the total required reserves of
each member bank, over and above the amount required to be maintained in
the foim of a leserve balance on deposit with the Federal reserve bank, may,
at the option of such member bank, consist of a reserve balance on deposit with
the Federal leserve bank, or of cash owned by such member bank either in its
actual possession or in transit between such member bank and the Federal
reserve bank Provided, That when, in its judgment the public interest so
lequnes, the Federal Reserve Board may limit to an amount less than that
peimitted heieunder the amount of cash which any member bank or banks
may count as reserve Provided, however, That, in pi escribing such limitations,
the Federal Reserve Board shall be guided by the general principle that member banks should be permitted to count as reserve, within the limitations of
this section, as much cash as they reasonably need in view of the character of
their business and their degree of accessibility to the currency facilities of the
Federal reserve banks
"(c) The term * gross deposits', within the meaning of this section, shall
include all deposit liabilities of any member bank whether or not immediately
available for withdrawal by the depositor, all liabilities for certified checks,
cashiers', treasurers', and other officers' checks, cash, letters of credit, travelers'
checks, and all other similar liabilities, as further defined and specified by the
Federal Reserve Board: Provided, however, That, in computing the amount of
* gross deposits', (1) amounts shown on the books of any member bank as
liabilities of such bank payable to a branch of such bank located in a foreign
country or in a dependency 01 possession of the United States, and (2) liabilities payable only at such a branch, shall be treated as though said liabilities were due to or payable at a nonmember bank
"(d) The term 'net deposits', as used in this section, shall mean the
amount of the gross deposits of any member bank, as above defined and as
further defined by the Federal Reserve Board, minus the sum of (1) all
balances due to such member bank from other member banks and their
branches in the United States and (2) checks and other cash items in process
of collection which are payable immediately upon presentation in the United
States, within the meaning of these terms as further defined by the Federal
Reserve Board
"(e) The term * average daily debits to deposits accounts,' as used in this
section, shall mean the average daily amount of checks, drafts, and other items
debited or charged by any member bank to any and all accounts included m
gross deposits as above defined and as further defined by the Federal Reserve
Board, except charges resulting from the payment of certified checks and
cashiers', treasurers', and other officers' checks
"(f) The term '-cash' within the meaning of this section, shall include all
kinds of currency and coin issued or coined under authority of the laws of the
United States
"(g) The term ' reserve balances', as used in this section, shall mean a member bank's actual net balance on the books of the Federal reserve bank representing funds available for reserve purposes under regulations prescribed by
the Federal Reserve Board
"(h) The term * vicinity of a Federal reserve bank or branch thereof,' as
used in this section, shall mean the city in which a Federal reserve bank or
branch thereof is located, until such term is otherwise defined by the Federal
Reserve Board: Provided, That with respect to each Federal reserve bank and
each branch thereof, the Federal Reserve Board, from time to time, in its
discretion, may either (1) define a specific geographic area as comprising the
vicinity of such Federal reserve bank or branch thereof, within the meaning
of this section, or (2) compile a list of member banks which shall be deemed
to be located in the vicinity of such Federal reserve bank or branch thereof,
within the meaning of this section, and add banks to, or remove banks from,
such list, from time to time: Provided, however, That, in defining such areas
and compiling such lists, the Federal Reserve Board shall be guided by the
general principle indicated in subsection (b) hereof.
"(i) With respect to each member bank, the term ' Federal reserve bank', as
used in this section, shall mean the Federal reserve bank of the district in
which such member bank is located
175541—34—PT16
3
7440
STOCK EXCHANGE PRACTICES
"(j) The Federal Reserve Board is authorized and empowered to prescribe
regulations defining further the various terms used in this Act, fixing periods
over which reserve requirements and actual reserves may be averaged, determining the methods by which reserve requirements and actual reserves shall
be computed, and prescribing penalties for deficiencies in reserves Such regulations and all other regulations of the Federal Reserve Board shall have the
force and effect of law and the courts shall take judicial notice of them.
"(k) Subject to such regulations and penalties as may be prescribed by the
Federal Reserve Board, any member bank may draw against or otherwise
utilize its reserves for the purpose of meeting existing liabilities: Provided,
however, That, whenever the reserves of any member bank have been continuously deficient for fourteen consecutive calendar days, the Federal Reserve
Ag§nt or Assistant Federal Reserve Agent of the district in which such member bank is located shall send to each director of such bank, by registered mail,
a letter advising him of such deficiency and calling attention to the provisions
of this subsection, and each director of such bank who after receipt of such
a letter, assents to or acquiesces in the making of additional loans or investments by such bank before the leserves ot such bank shall have been restored
to the amount required by this section, shall be held liable in his personal or
individual capacity for any and all losses sustained by such bank on any such
loans or investments
"(1) All penalties for deficiencies in reserves incuried under regulations
prescribed by the Federal Reserve Board pursuant to the provisions of this
Act shall be paid to the Federal reserve bank by the member bank against
which
they are assessed.
%
'(m) No member bank shall keep on deposit with any State bank or trust
company which is not a member bank a sum in excess of ten per centum of its
own paid-up capital and surplus No member bank shall act as the medium
or agent of a nonmember bank in applying for or receiving discounts from a
Federal reserve bank under the provisions of this Act, except by permission of
the Federal Reserve Board
"(n) National banks or banks organized under local laws, located in Alaska
or in a dependency or insular possession or any part of the United States
outside the continental United States, may remain nonmember banks, and shall
in that event maintain reserves and comply with all the conditions now provided
by law regulating them or said banks may, with the consent of the Federal
Reserve Board, become member batiks of any one of the Federal reserve districts, and shall in that event take stock, maintain reserves, and be subject to
all the other provisions of this Act
"(o) Notwithstanding the foregoing provisions of this section, the Federal
Reserve Board, upon the affirmative vote of not less than five of its members
and with the approval of the President, may declare that an emergency exists
by reason of credit expansion, and may by regulation during such emergency
increase or decrease fiom time to time, in its discretion, the reserve balances
required to be maintained
"(p) No member bank shall act as the medium or agent of any nonbankmg
corporation, partnership, association, business trust, or individual in making
loans on the security of stocks, bonds, and other investment securities to
brokers or dealers in stocks, bonds, and other investment securities. Every
violation of this piovision by any member bank shall be punishable by a fine of
not more than $10Q per day during the continuance of such violation, and
such fine may be collected, by suit or otherwise, by the Federal reserve bank
of the district in which such member bank is located
"(q) No member bank shall, directly or indirectly by any device whatsoever,
pay any interest on any deposit which is payable on demand: Provided, That
nothing herein contained shall be construed as prohibiting the payment of
interest in accordance with the terms of any certificate of deposit or other
contract heretofore entered into in good faith which is in force on the date
of the enactment of this paragraph, but no such certificate of deposit or other
contract shall be renewed or extended unless it shall be modified to conform
to this paragraph, and every member bank shall take such action as may be
necessary to conform to this paragraph as soon as possible consistently with
its contractual obligations* Provided, however, That thisi paragraph shall not
apply to any deposit of such bank which is payable only at an office thereof
located in a foreign country, and shall not apply to any deposit made by a
mutual savings bank, nor to any deposit of public funds made by or on behalf
STOCK EXCHANGE PBACTICES
7441
of any State, county, school district, or other subdivision or municipality, with
respect to which payment of interest is required under State law.
"The Federal Reserve Board shall fiom time to time limit by regulation
the rate of interest which may be paid by member banks on time deposits,
and may pi escribe diffeient rates for such payment on time and savings
deposits having different maturities or subject to different conditions respecting withdrawal or repayment or subject to different conditions by reason of
different locations No member bank shall pay any time deposit before its
maturity, or waive any requirement of notice before payment of any savings
deposit except as to all savings deposits having the same requirement For
the purposes of this subsection, the Federal Reserve Board is authorized to
define the terms * time deposits' and * savings deposits'
"(r) All acts or parts of acts in conflict with this section are hereby repealed
only m so far as they are in conflict with the provisions of this section "
There aie hereby repealed the provisions of Section 7 of the First Liberty
Bond Act, approved April 24, 1917, Section 8 of the Second Liberty Bond
Act, approved September 24, 1917, and Section 8 of the Third Liberty Bond
Act, approved April 4, 1918 (U S Code, Title 31, Section 771) which read as
follows:
" That the provisions of section fifty-one hundred and ninety-one of the
Revised Statutes, as amended by the Federal Reserve Act, and the amendments thereof, with reference to the reserves required to be kept by national
banking associations and other member banks of the Federal Reserve System, shall not apply to deposits of public moneys by the United States in.
designated depositaries "
This section shall become effective on the first day of the seventh calendar
month following the enactment of this Act
Senator ADAMS. Senator Fletcher, may I ask a question? You
made a statement a while ago about closing the hearings. Has that
been the definite action of the committee ?
The CHAIRMAN. Yes.
Senator TOWNSEND. There has nothing been taken definite before
the committee ?
The QHAIRMAN I t was taken up yesterday before the committee
and that was the understanding.
Senator TOWNSEND. I was not here.
Senator ADAMS. I was not here.
Senator TOWNSEND. Personally, I feel we ought not to foreclose
somebody who wants to be heard myself.
The CHAIRMAN. Mr. Roosevelt and Mr. Gibbons are here, I believe. They wish to be heard this morning on the subject of municipals. Are they present? Mr. Roosevelt, we will hear from you
now, and Mr. Gibbons.
STATEMENTS 0!F ABCHIBALD B. BOOSEVELT, PBESIDENT OF
ROOSEVELT & WEIFOLD, INC., DEALEBS IN MUNICIPAL SECURITIES, NEW YORK, N.Y., AND GEORGE B. GIBBONS, PBESIDENT
GEOBGE B. GIBBONS & CO., INCr, MUNICIPAL BOND DEALEES,
NEW YORK, N.Y.—Besumed
The CHAIRMAN. Mr. Roosevelt, have you seen the proposed amendment to the bill ?
Mr. ROOSEVELT. I have seen the new bill, but I have not seen any
proposed amendment. That is H.R. 8720.
The CHAIRMAN. Yes; they were introduced before this committee.
Mr. ROOSEVELT There is no change since then?
Mr. Chairman and gentlemen of the committee, since I was last
here I have made a little effort to find out some other aspects as to
7442
STOCK EXCHANGE PRACTICES
how the bill affects not only us but other people. Obviously, I being
merely a municipal bond dealer, I only know well the immediate
effect ]t has on me and on my colleague, Mr. Gibbons here. But I
took the opportunity in the last week to discuss the bill and talk
over the bill with a couple of my friends who are in municipal and
State government positions. They had no conception in two cases
that the present bill had anything to do with anything except regulating the stock exchange, and did not realize that municipals were
contemplated in any way.
I think it was Chief Justice Marshall who said that the "power
to tax is the power to destroy." Well, I think jon can go further
than that and say that the power to restrict credit is also the power to
destroy. And I feel very strongly that to turn over to seven appointees of the Federal government the power to regulate to a certain extent at least—and it looks as though quite a lot—the credit of
sovereign States and their subdivisions, is not intended by the legislators and has not been contemplated, but under the present bill this
would be the case.
Now, as I am not an expert in that end of the thing, I would
strongly suggest that before making any decision on the municipal
or State credit as it is affected by this bill the committee get before
them as witnesses State and city officials to discuss how the bill
affects their credit and affects the credit of the political localities.
Mr. Gibbons has touched some aspects of this and has a statement more or less prepared on this subject, and some comments on
it, and he and I both want you to know we are not experts on the
problems of the municipalities themselves, but are simply putting up
something for you ^eirtlemen to consider from that point of view,
as well as certain things which we do know about in our own business, and I will ask Mr. Gibbons to go on with the testimony here.
The CHAIRMAN. Proceed, Mr. Gibbons.
Mr. PECORA. May I ask a question of Mr. Roosevelt? I presume
you are familiar with the observations that Mr. Gibbons is going
to make. Might I ask if those observations would be necessary m the
event that this bill were intended so as to put all State and municipal
bonds in the exempt class of securities?
Mr. ROOSEVELT. NO. If they were exempted from the bill entirely
I do not see—again, I am not a lawyer, Mr. Pecora, and you might
be able to dig up things that did show it in the bill. Section 16
might. I am not sure about that.
Mr. PECORA. The provision that not only Government securities
but securities issued by a State or any political subdivision of a
State be exempted, as Government securities now are, would probably meet all the criticisms you are about to give expression to?
Mr. ROOSEVELT. I think so, sir.
Senator GORE. Would not to include municipalities go too far?
Wouldn't it include some that ought to be excluded?
The CHAIRMAN. That is a question for the committee, but what
is your view about that?
Mr. ROOSEVELT. What was that? I did not get that, Senator
Gore.
Senator GORE. The inclusion of municipalities just in general
towns, wouldn't that include some that ought to be excluded, in
STOCK EXCHANGE PRACTICES
7443
view of the fact that there are some 17,300 cities and towns that
are delinquent?
Mr. ROOSEVELT. I don't think so. We have that taken up very
carefully in this statement that we prepared.
Senator MCADOO. Even the delinquent bonds have some value,
and you would only deal with their market rate?
Mr. ROOSEVELT. That is quite right. And, Senator, we have a
point on that in here if yon would let us come to it.
Senator GORE. There is a bill that has already passed the House
and is now on the Senate calendar permitting cities at least to go
under the bankruptcy laws. Do you think now that municipalities
ought to be listed and dealt in by innocent persons when perhaps
bankruptcy is pending or actually started?
Senator GOLDSBOROTJGH. Let him give his statement. He says he
is going to cover that.
Mr. ROOSEVELT. We will cover that. If you will talk, Mr. Gibbons,
now, on this.
Mr. GIBBONS. Senator Fletcher and gentlemen of this committee,
in going over this bill as amended and nnding that State and municipal bonds are not specifically exempted, we have tried to summarize the reasons why in our opinion we think they should be
exempted.
This bill apparently is designed to correct speculative abuses, particularly speculative abuses as they are believed to exist in trading
on the stock exchanges; but it is also applicable to abuses in connection with securities issued by States and their subdivisions and
agencies. They issue a class oi securities regarding which the abuses
which this bill is aimed to eliminate do not occur.
There is practically no speculation or market operations in municipal bonds. They are usually sold at public advertised sales,
either to bond dealers or banks or local individuals. I t is very
difficult to speculate m them if you should wish to do so. Once a
new issue is sold it is not again available for the purpose of speculation.
The purchasers of municipal bonds are quite different from those
that buy stocks in many cases, and where they are the same purchasers they buy municipal bonds for a different purpose, and they
are largely held by public institutions, insurance companies, savings banks and trust companies, and by corporations for their surplus account, against the time that they may need to sell them, and
they are held by individuals for investment purposes. The ultimate
purchaser of a municipal bond, excluding the dealer that buys them,
very seldom buys them on margin, except possibly for a short period
when he first purchases them, until he gets other funds m to complete payment.
It is almost impossible to effect wash sales of municipal bonds,
and there would not be any object gained if you did effect a wash
sale.
It is also practically impossible to sell municipal bonds short,
except in the case of Government bonds, because there are not enough
of them of any one particular interest rate and date of maturity and
purpose. In other words, once you had sold a bond it would be very
difficult to buy it back, so you could not sell it short.
7444
STOCK EXCHANGE PEACTICES
So far as buying bonds and speculating in them with their customer's money, it practically does not exist in municipal bonds. The
dealers use their own money. They have no customers' money on
deposit. Those depositors are not made with a municipal bond
dealer. If he is a member of an exchange he may have, but not
otherwise. The only money most municipal bond dealers would ever
have on deposit from a customer would be an advance payment for
bonds.
Any bill which injures the marketability of municipal bonds or
damages their availability as collateral likewise hurts the ability of
the public to borrow for public purposes, such as unemployment relief, health, education, water, sewer, schools. This bill vests in the
Federal Trade Commission, a board of 7 men appointed by the
President for 7 years, the power to either exempt or to refuse to
exempt the bonds of every State or municipal subdivision or agency
withm each State from the provisions of this act. The refusal to
exempt a municipal bond of any State, city, or subdivision, would
have a disastrous effect on its value and on the prices received for
any new bonds offered for sale by the municipalities themselves and
would have a disastrous effect on the sale and the prices of the bonds
already outstanding.
I have permission to read a telegram to you from a man who is the
custodian of a fund of about $180,000,000 of municipal bonds—that
is, the Comptroller of the State of New York—and it is as follows
[reading] :
ALBANY, N Y., March 22, 1934.
GEORGE B
GIBBONS,
New Willat d Hotel, Washington, DC.
You are authorized to use this telegram before any governmental committee
and file it as a matter of record I firmly believe that the listing of municipal
bonds on any stock exchange would be injurious to the credit of our
municipalities
Senator GORE (interposing). Read that again, please.
Mr. GIBBONS. Certainly. [Keading:]
You are authorized to use this telegram before any governmental cWmittee
and file it as a matter of record I firmly believe that the listening of municipal
bonds on any stock exchange would be injurious to the credit of our
municipalities, and serious harm would come from such listing for the reason
that manipulation of prices on an exchange for this type of security is far
more likely than if they were traded in over the counter Printed prices for
small issues of securities, such as some of them are, could be used as a basis
of soliciting orders above a natural market
In other words, by selling the bond at one selling price and quoting
it on the exchange, you might get a similar price for a bond not as
good.
Depressing prices could also be done through public quotations At the
present time theie are 15 issues of New York City bonds listed on the New York
Stock Exchange but trades m these issues—
By that he means transactions—
are very seldom recorded The State of New York has more than a hundred
and eighty million dollars of its investment funds in over (500 municipalities
of this State The State annually invests upwards of $15,000,000 in municipal
securities of this State and I believe as the State's chief fiscal oflicer that it
would not be helpful to the great majority of these municipalities-—
STOCK EXCHANGE PEACTICES
7445
And there are some nearly 9,000 in the State of New York subdivisions—
to have their securities listed on any exchange at the present time A banker
doing service for these municipalities is ready and willing to support the
market for the securities that he has sold to his customers I can see no gam
from listing these securities and this is demonstrated by the active trading
in New York City bonds in over-the-counter market as compared to the exchange where they are listed Several banks took their securities off the New
York Stock Exchange because of the possibility of manipulation and the consequent effect on credit of banks I believe this same rule might be a serious
menace to the holders of municipal securities if listed on the exchange Therefore I strongly recommend as far as the State of New York is concerned that
they neither be listed nor come under the supervision of the Federal Trade
Commission It is the business of New York State to manage its own municipalities and their finances
Respectfully submitted.
MORRIS S TEEMAINE,
State Comptroller
Senator GORE. One thing I want to ask. He says that 15,000,000
of bonds of cities of New York are listed on the New York Stock
Exchange, and he says he does not think any ought to be; is that
the point ?
Mr. GIBBONS. That is the point. No good object is achieved by
having them listed, and there are particularly no sales there. But
if they all had to be listed, of course, the sales would be there.
The CHAIRMAN. What is the reason now that they did that?
Mr. GIBBONS. I really don't know, Senator, why they did it.
There are bonds listed in Baltimore and in San Francisco and Cleveland. They are listed on all exchanges, certain issues are. Just
why, I don't know.
Senator GORE. I S the real reason stated there why bank stocks are
taken off the exchange ?
Mr. GIBBONS. That I could not guarantee, sir. I don't know.
I t is our belief that the bonds of States—reading again from my
own memorandum—and the political subdivisions and agencies
thereof should be eliminated from the National Securities Act of
1934. This bill is aimed to correct speculative abuses which do not
exist in the sales and distribution 01 municipal bonds. State and
municipal securities have no rightful place in the bill and no useful
purpose is served by including them in the bill. The inclusion of
State and municipal bonds in the bill does not confer any benefit on
the holders of municipal bonds nor on the municipalities issuing
them. On the contrary, it imposes a very distinct hardship on both
the municipalities and the purchasers of their bonds and will seriously affect their value as an investment. The exemption of a
municipal bond would not add to its present value, and refusing
exemption would seriously impair its value.
If being exempted from this bill is helpful to United States Government bonds, certainly States and municipalities need that help
also. If not being exempted would be harmful to Government bonds,
certamlv States and municipalities should not suffer that harm.
They all belong to the same family, and the parent Government,
having the strongest credit of all of them, needs the advantage of
exemption from the bill less than any single one of the 200,000 or
more municipal subdivisions in the country.
7446
STOCK EXCHANGE PRACTICES
If I may go over the bill by paragraphs, this is a very short matter, section 3, subdivision (a) (7), seems to us to be slightly ambiguous, and the only reason we care about that is that it might affect the
ability of banks to lend the money on municipals.
And it should be made perfectly clear that the term " dealer "
and the term " broker " does not include a bank. We have an amendment for that which probably clarifies it somewhat. I t now reads:
The term "broker" or "dealer" shaU not include a bank or any person—
And so on.
We would change it this way:
The term " broker " or " dealer " shaU not include a bank—comma—nor shall
it include any person insofar as he buys or sells a security or securities for
his own account and not as a part of a regular business.
In other words, many banks act as dealers for themselves and
banks for you, because they lend you money on your municipal
bonds, and if they acted as dealers they might come under a provision of the dealer part of the act and not be able to lend you the
money, and it should be clarified.
Section (a) (13): State bonds and the bonds of their political
subdivisions and agencies are not exempted by the provisions of
this act, and they are under the power of the Federal Trade Commission. That gives them, if they so care to use it, a very dangerous
power over the financial anairs of all the States, cities, counties, and
political subdivisions and agencies in them, and it might be exercised
to their great disadvantage.
The credit of a State, or a municipality or agency within it, and its
ability to finance its many needs for roads, schools, preservation of
health, and so on, would be seriously crippled by the refusal of the
Federal Trade Commission to exempt its bonds or by the imposing
of unreasonable conditions for granting such exemption, and cause
irreparable damage and loss to both the State or municipality and
to the holders of their outstanding bonds by the withdrawal of exemption in cases where it had once been granted.
The fact that such power exists would greatly depress bond prices,
for it would be a constant threat, and one can never tell when a
municipal bond now exempted might be withdrawn from exemption,
so everybody would buy a bond in the constant fear that that might
happen, and the price would accordingly be lower. I t would have
a continual depressing effect on bond prices.
Now, municipal securities are held to the extent of billions by
insurance companies, fraternal orders, savings banks, Postal Savings
funds, pension funds, banks, and other corporations, as well as by
individuals, as well as your own governmental agencies, who would
loan the money, and by corporations and individuals; so that anything that affects their value is vital.
Senator GOLDSBOROTJGH. Trust estates.
Mr. GIBBONS. Yes; including trust estates, of course.
Now, in section 7, subdivision ( a ) : This subsection affects a dealer
or broker in municipal securities in cases where he is a member of
an exchange. In New York City and throughout the country many
dealers in municipal bonds are also members of exchanges and do
a combined stock and municipal bond business. In such cases he
STOCK EXCHANGE PRACTICES
7447
must make loans on all listed securities only through a member of
the Federal Reserve System or in accordance with regulations of the
Federal Reserve Board. I t applies to municipal securities that are
listed on an exchange, and they would either all have to be listed
or exempted, and many municipal securities are now listed on the
various exchanges throughout the country, usually their local exchange. I t would be necessary to ascertain, when borrowing upon
a municipal bond, whether that particular municipal bond was listed
on some exchange, and it would be next to impossible to do tikis.
Some exchanges might list thousands of them, and it would cause
a great delay and embarrassment and practically retard the prompt
sale and purchase of municipal bonds, which is a desirable thing
if the market is to be kept free dud open.
The subsection (b) of section 7 prevents a dealer from assuming
liabilities exceeding 10 times of his net capital unless such securities are exempted. In other words, it would prevent a dealer even
bidding at any one time for bonds in the aggregate of more than
10 times his capital, after deducting such bonds as he is already
carrying. As only a small percentage of the bids made by dealers
are successful in buying the bonds bid for, this would limit the
amount of bonds bid for at a time, and would therefore greatly
reduce the amount of competition that now exists in the public sale
of State and municipal securities Many a man will take a chance
in bidding for a large lot of bonds more than 10 times his capital.
In this way it would be illegal for him to do so.
Senator GORE. Figuring he would get some and not all?
Mr GIBBONS. Correct, Senator. If he did get them, he could sell
them before he would have to carry them or sell part of them. And,
of course, a municipality does not care how much capital the dealer
has, provided he has enough money and can finance his purchase
when the bonds are delivered.*
Senator GOLDSBOROTTGH. He generally has to put up a certified
check when he bids.
Mr. GIBBONS. Exactly; and how much money he has back of that
they do not care, because if he does not comply with the terms of
the bid he forfeits his check.
Senator GORE. Yes; because he is collecting interest, not paying it.
Mr. GIBBONS. And furthermore, if a dealer can buy a million of
bonds and borrow $950,000, why shouldn't he? It is a good thing
for the municipality, and it helps to keep the price maintained.
They do not care how much capital he has, providing he pays for
bonds he has bought.
Some dealers join together to bid for an issue of bonds which is
too large an amount for any one of them to bid for alone. These
accounts are often made on the basis of being undivided as to liability. For instance, if 10 dealers join together to buy 10 millions of
bonds and they are successful in making the purchase, each dealer
would have an interest of a million dollars. I i one of those dealers
should fail, the liability of the other nine dealers would each be
increased by his share of that failed dealers liability. If a dealer
bought two millions of bonds with one other dealer on an undivided
liability account and one dealer failed, the remaining dealer would
7448
STOCK EXCHANGE PRACTICES
be liable for the entire $2,000,000, whereas he only anticipated being
liable for a million.
In other words, it would be very difficult for a dealer in municipal
bonds, if he were limited as to the amount of bonds he could buy in
proportion to his capital, to go ahead on one of these accounts and
bid for a large block of bonds.
Senator GORE. He would not get the bonds, anyway, unless he
paid for them ?
Mr. GIBBONS. NO. And if he did get them, he might be liable for
more than he bought.
As an ordinary business chance he is willing to run that risk,
but he is not willing to run the risk of going to jail and paying a
$25,000 fine, and the answer is he would not bid on the bonds, and
the municipality would not get the competition. Competition
means a lot there. There were only two bids for 30 millions Pennsylvania State bonds. Forty-five houses joined on one bid and were
successful, and many houses were in the other bid, and they were
unsuccessful. Any one dealer on the successful bid might have
been liable for that entire amount.
Senator GORE. YOU mean the combination got the bonds that was
successful, or the other?
Mr. GIBBONS. There were two combinations, and one combination, Senator, got them, and they assumed the liability. If they
had not had a great many smaller houses in that account, the bonds
would have been sold to a few large banks, and they would not have
paid the high price that they did pay, that is, a premium for a
bond bearing interest at 3% percent, because they would not have
had the assistance of the small dealers in selling the bonds for
them.
Senator GOLDSBOROTJGH. In other words, the limitation of capital
put a burden on them and restricted their purchasing power?
Mr. GIBBONS. Absolutely; and it would have eliminated competition at the sale.
Senator GORE. What loss or damage does this provision safeguard the investor against?
Mr. GIBBONS. TO have municipals in it?
Senator GORE. Yes.
Mr. GIBBONS. Senator, I cannot see that it does one atom of good
to a holder of municipal bonds, or to a municipality or State, not one
atom, and it is possible that it may do irreparable harm.
The CHAIRMAN. If municipal bonds are exempted from the bill
that cures all those sections you mentioned ?
Mr. GIBBONS. Then this would not apply. These are some of our
reasons why, in our opinion, municipal bonds and State bonds, bonds
of their agencies, should be exempted absolutely and irrevocably.
The CHAIRMAN. Does that include district bonds and other subdivisions ?
Mr. GIBBONS. I t should, because many States have many districts.
For instance, the most important subdivision in New York State is
that of the district, outside of the big cities, that is, the school
districts.
The CHAIRMAN. DO you think they ought to be exempted?
STOCK EXCHANGE PBACTICES
7449
Mr. GIBBONS. The school districts? They are undoubtedly the
safest bonds we have in our State and in many other States.
Senator GORE. DO you know, Mr. Gibbons, how many Government units or subdivisions there are in the United States that have
authority to issue bonds ?
Mr. GIBBONS. Something between 175,000 and 200,000, Senator.
New York State
Senator GORE. There are 6,353 in Oklahoma alone.
Mr. GIBBONS. HOW many?
Senator GORE. SIX thousand is all.
The CHAIRMAN. New York State has how many, you say %
Mr. GIBBONS. About 8,000; between eight and ten thousand.
Senator GOLDSBOROTJGH. It is stated in that telegram, I think.
Mr. GIBBONS. NO. He said that he had 180 million dollars of bonds
of 600 different municipal subdivisions in New York, but there are
nearly a thousand towns in New York State, some 57 cities, 60 counties and over 500 villages. Every town is subdivided into a school
district, an average of about 8 to a town. The school districts are
formed in their boundaries for the convenience of getting pupils to
their schools. Their credit is of the utmost importance to them.
Whether they sell a 6-percent bond or a 4%-percent bond is a vital
matter to them; and for their credit. The cheaper they borrow their
money the lower their taxes are.
The CHAIRMAN. Are any of those districts in default?
Mr GIBBONS. In New York State?
The CHAIRMAN. Yes.
Mr. GIBBONS. Not a one, to the best of my belief.
Senator GORE. I S there any way the public could
be safeguarded
by amending this bill or otherwise, against the sale or against the
purchase of these municipal bonds that are not delinquent now or
where delinquency is imminent?
Mr. GIBBONS. Senator, it is very difficult to tell when you buy a
bond what the future will bring for that bond. The present administration sells a bond which under their proposed bill would entitle it
to exemption, and that would justify a dealer in paying a high
price for that bond. A subsequent administration might bring about
a different situation, a worse one.
Senator GOLDSBOROTJGH. Isn't it a fact that the delinquency on
many of these bonds has occurred through the noncollection of taxes
and that when the taxes are collected those bonds will come back?
Mr. GIBBONS. That is correct in many places, and in some places
of course they sold too many bonds based on exceedingly high appraisal of property. But that is not general by any manner of
means. As a matter of fact, in this country it is estimated as
closely as may be that 1 percent of all, numerically, of the municipalities, are in default.
Senator GOLDSBOROTTGH. That covers the entire country?
Mr. GIBBONS Yes. That would mean m Senator Gore's State,
with 6,000 subdivisions, that 60 of them would be m default. In
New York State there are practically none. I know of none in
actual default. Many of them have oeen late. I t is very difficult
to tell what a default is. What would a default be ? A week's delay
m paying interest or a week's delay in paying principal, or 6 months'
7450
STOCK EXCHANGE PBAOTIOES
delay? They might have a default of a month on one note and pay
it and be restored, and in another month have another default on
another note and pay that in 6 weeks. I t is very difficult to decide
what is a default and what is not. In New York State there are
none in default that I know of.
Senator GORE. Isn't it a fact that about $35 of taxes or carrying
charges per $1,000 worth of property is the danger line or rather the
dead line?
Mr. GIBBONS. In actual value that is fairly high. Senator; not
necessarily of assessed value.
Senator GORE. In my State I think it is $278, and the town just
moves off the townsite and the obligations both.
Mr. GIBBONS. Well, if you did not exempt a defaulted bond how
would that help either the municipality or the bondholder?
Senator GORE. I S there any way that you could vest this administrative agency with the power to forewarn prospective purchasers
that the bond of a certain town is a bad investment? Is there any
red light at all? One of the objects of this bill is to protect the
fool against his follies. I do not know whether they can do it or
not, but I do not see any difference between the man that loses his
money by buying municipal bonds that are no good, I do not see
that he is any better off than if he put it in a railroad bond or a
chewing-gum factory bond or something of that sort. He lost his
money. Is there any form of protection or warning that can be
afforded ?
The CHAIRMAN. Having reference to the investors particularly?
Senator GORE. Yes; from his point of view.
Mr. GIBBONS. I t is very difficult for this reason, that the great
money that has been lost in municipal bonds has not been lost by the
ignorant man going in and buying a bond which was bad at the time
he bought it and buying that bond at par or thereabouts. The
money has been lost by the investor—when I speak of investor I
include insurance companies—with every means to investigate, and
savings banks with every means to investigate. The money has been
lost by their buying a bond which, after their investigation, they
decided was a good bond for them to buy, and they j)aid the price
for a good bond. And later things went bad in that city or State—
take Arkansas for instance; millions df bonds were sold to insurance
companies and savings banks at par, when they thought the bonds
were worth that or they would not have bought them. Since then
they have declined in value.
Senator GOLDSBOROTJGH. Those insurance corporations had statistical departments, didn't they?
Mr. GIBBONS. Certainly; and spent thousands of dollars keeping
them up and keeping themselves posted to the last degree.
Now, how could you save the purchasers of those bonds from losing
money if, after investigating, they decided the bond was good to
buy and 5 years afterward it declined in value ?
Senator "GORE. NOW, that brings me to the point: Suppose that
happened, they would decline, and yet Tom, Dick, and Harry knows
nothing about all these facts. He goes ahead and somebody wants
to sell him a bond, and he buys it. Is there any sort of warning that
this agency can give of what you describe as having happened?
STOCK EXCHANGE PBACTICES
7451
Notwithstanding the foresight in this case of this insurance company, it actually has happened, and the people who know it has; it
can be verified by the fact that it has happened.
Mr. GIBBONS. Senator, it is very difficult, as near as I can see, to
guard against losses, and I will tell you an example. I bought New
York City bonds last year when I thought they were a good purchase, and they went down 30 points, and I am a dealer in bonds, and
I am every day there on the job, and I lost $60,000 on the New York
City bonds. If there is any way that you could pass a law to prevent
my doing that, it would be invaluable not only to me but to everybody. I have thought for years of some way whereby I could avoid
losing money on municipal bonds, but I have never struck a way yet.
Senator GORE. And between those you have lost. There is no way
m which you could provide a warning or no basis on which you could
base any sort of law or regulation?
Mr. GIBBONS. I have never found one yet. Senator.
Senator GORE. I guess that is the fool with his folly. That is not
personal at all.
Mr. GIBBONS. Section 10, subdivision ( a ) : This provision seems to
apply to the segregation of broker and dealer functions only to members of an exchange. However, many municipal-bond dealers are
members. This is true throughout the country. There is not
enough business, certainly in municipal bonds, either as a dealer or a
broker, in most cases, for a man to subsist on. The customer does
not care whether you own the bond or buy it for him. Municipalbond dealers act in both capacities, and to prevent them acting as a
broker or as a dealer would eliminate competition in the buying of
municipal bonds.
And I will illustrate that: If, in bidding for the 30,000,000 Pennsylvania State bonds which were sold recently, the unsuccessful house
or the unsuccessful bidding syndicate was prevented from acting as
brokers, then the syndicate which bought the bonds would know m
advance that if they bought them they would have no outside help in
marketing those bonds.
Now, what actually happens is this: On 30,000,000 of State of
Pennsylvania bonds—and the same applies to other places in lesser
amounts—when they were offered for sale and various groups of
dealers and banks join hands, the group I am in bids and the group
you are in bids. The group that puts in the highest bid gets the
bonds, and each group knows in advance—and there may be 10
groups—that if their group gets the bonds then the other groups
who have been cultivating their customers in advance and getting
orders for those bonds will have to come to them and buy them.
Well, they are willing to bid higher, accordingly, because they would
not have to sell them all themselves. If they make 1 percent profit
on the bonds and allow a quarter of 1 percent to brokers, they know
that a lot of those bonds are going to be taken right off their hands
by their competitors.
Senator GORE. They would have a sort of a ready-made market?
Mr. GIBBONS. Correct. In other words, all the dealers, maybe 60
or 90, will join hands to bid. All have a certain amount of orders.
Now, they go ahead, the dealers. If they do buy the bonds as
dealers, they sell the bonds a^ dealers. But the unsuccessful groups
7452
STOCK EXCHANGE PRACTICES
would have to go and sell the bonds as brokers To prevent them
from doing that would mean that the competition of those bonds
would not be so great, and that would be a very costly thing to
the State of Pennsylvania in selling those bonds, or any others.
Senator GORE. YOU know, this distinction between dealers and
brokers is hocus-pocus—now you see it and now you don't. It looks
to me like running Hyde and Jekyll or changing colors when you
get good and ready.
Mr. GIBBONS. That would not apply to a municipal bond, but if
it did apply it would be to the disadvantage of the municipality and
.also to the bond dealer, as well as the State subdivisions.
Senator GORE. State that again. I didn't get the first part of it.
Mr. GIBBONS. If there is segregation of broker and dealer and it
were made to apply to bonds, to the municipal bond dealer, it would
not only be costly to them, because, unless they had bought the
Pennsylvania bonds they could not sell them to their customers and
make a commission. But knowning in advance that they could not
*do that, they would not bid for the bonds as high a price as they did.
Senator GORE. It is your idea that municipal bonds ought to be
deleted from this bill altogether?
Mr. GIBBONS. State and municipal bonds and their political subdivisions and agencies should be absolutely out of this bill.
Senator GORE. Just forget them?
Mr .^GIBBONS. Absolutely out of it from start to finish.
The CHAIRMAN. They should be included m the exemption ?
Mr. GIBBONS. Half the municipalities in this country, even the
cities who have their own conference of mayors, are not aware yet
that they are in this bill. When Comptroller Tremame, of New
York State, heard about it he was not exactly amazed, because he
had heard about it before, but he was pretty well wrought up. He
could not imagine such a thing and he sat right down and sent me
this telegram, which I read to you and have placed on file.
In times of stress, when bonds are low in prices, the man who has
heretofore been a dealer is afraid to buy bonds and risk his money
in it. He does not risk his customer's money; he risks his own. So
he goes out to people who have bonds and buys them and sells them
to his customers for a brokerage, and that is the way he subsists, the
way he pays his living. Take that business away from him and you
might just as well take the hand off a cobbler.
Senator GORE. That fellow you described there, isn't he the man
that might work off a lot of these worthless bonds on innocent
purchasers?
Mr. GIBBONS. Senator, if a man in the municipal-bond business
decides to do a brokerage business instead of being a dealer, and he
decides to work off worthless bonds on the public, he absolutely
would do it anyway, and the mere fact that you prevent him from
acting at a dealer would not make one atom of difference.
Senator GORE. They sold liquor even when it was against the law.
Mr. GIBBONS. Yes; and drank it, too. But the investment bankers
Code requires, that when you sell bonds to your customer you
advise him whether you act as a dealer or broker.
Senator GORE. That is the rule now?
Mr. GIBBONS. That is the rule under the Code, and that is something to inform a man. If you, for instance, were buying some
STOCK EXCHANGE PRACTICES
7453
Tulsa bonds would you care whether you got them from me as a
dealer or, John Smith as a broker?
Senator GORE. I would not know how to react in either case. It
would not make any difference.
Mr. GIBBONS. Not a particle.
Senator GORE. I would not know
Mr. GIBBONS (interposing). What he meant. There are many
others too, Senator.
Mr. ROOSEVELT. Neither will the dealer and the broker.
Mr. GIBBONS. Section 14 does not specify what constitutes making
a market. If the publication of quotations constitutes making a
market, this section would seriously restrict the purchase and sale
of municipal securities and also make it impossible to value them
for appraisal, which is a very important function.
For instance, bonds of the city of Buffalo, or a city of a small population, for instance, may not have sold for 6 months. The man that
owned them may not be able to sell them. But the city of Rochester
may have sold at 80, and they are practically worth the same. So
you would be using your judgment as to what the market is in advising these people that the Buffalo bond they had that day was in your
opinion worth 80. The only way you can tell is that the bond of
such-and-such a place is worth 80 and others are about the same.
You see, you have got to make quotations.
Mr. PECORA. Mr. Gibbons, are you overlooking that provision of
section 14 which in effect states that a broker or dealer in the overcounter market may make or create a market in accordance with
rules and regulations which the Federal Trade Commission may
prescribe?
Mr. GIBBONS. I have not overlooked it.
Mr. PECORA. A S you have just discussed the section, one would be
led to the inference that the section absolutely prohibits unqualifiedly
the making of a market.
Mr. GIBBONS. Well, if it required me to go to the Federal Trade
Commission to ask them whether I could tell you that Rochester
bonds were 85 cents on the dollar, it would delay me.
Mr. PECORA. This does not provide any such thing.
Mr. GIBBONS. I did not read from the bill. I just took it from you.
Mr. PECORA. A S you read the bill
Mr. GIBBONS. I have read the bill, but have not
Mr. PECORA. YOU are discussing section 14, and apparently are
ignoring the provisions that say that it shall be unlawful for any
broker, dealer, and so forth, to use the mails or any means or instrumentality in interstate commerce for the purpose of making or creating or enabling another to make or create a market in any security
listed on a national securities exchange? and so forth.
Mr. GIBBONS. Mr. Pecora, I asked this question on that. I did not
state it as a criticism. I said this section does not specify what
constitutes making a market.
Mr. PECORA. The Commission is going to define the circumstances
under which it may be made.
Mr. GIBBONS. All right; but the section does not specify it.
Mr. PECORA. That is why it is left to the Commission. If the
section did specify it, the Commission would not have to define it.
7454
STOCK EXCHANGE PRACTICES
Mr. GIBBONS. My remark was a question.
Senator GOI*DSBOROTJGH. YOU mean in lines 6 to 11, where they prescribe their regulations of all transactions ?
Mr. PECORA. Yes, sir.
Mr. GIBBONS. It was a
question—if publication of quotations consist in making the market, this section would seriously restrict the
purchase and sale of municipal securities. I am simply stating my
reaction to that section I t would also make it impossible to value
them for appraisal, a most important function.
Now, the next section and the last one here, is section 16. Municipal bond dealers as such have no objection whatever to having their
books examined and their operations otherwise investigated by the
properly constituted authorities. This section, however, could easily
result in a great hardship on the dealer. I t could place an unsupportable burden on any dealer, and repeated investigations could be
made ruinous to him. The provision for the charging of the expense
of the investigation against the person examined should be eliminated
from this section, in our opinion. You might have an examiner in
their once a week or once a month, and it would be a great burden.
Senator GORE. Would it help it to provide that the expanse would
not be charged against the concern other than once in a given period
of time?
Mr. GIBBONS. If you fixed a maximum expense and made it nominal, it would be grand.
Mr. PECORA. Fixed a maximum expense and made it nominal ?
Mr. GIBBONS. If you fixed the limit—that the charge should not
exceed a certain amount in any one year—that would simply be
another tax; and I don't care how I pay my taxes, one way or the
other; it would be the same.
Senator GORE. YOU would know it in advance?
Mr. GIBBONS. I am limited in the liabilities which I can incur in
the buying of bonds, but I am unlimited in the liabilities the Government may force upon me in examining my books and business.
The CHAIRMAN. HOW would it do to have a provision to charge
$25 in there for each examination?
Mr. GIBBONS. If you charged a dealer not exceeding $25 in any
1 year I would not say anything about it.
The CHAIRMAN. $25 for each examination—how would that be ?
Mr. GIBBONS. Not more than one payment in a year, regardless of
the number of examinations. Suppose they came in every week
at $25?
Mr. PECORA. DO you really feel that way, Mr. Gibbons?
Mr. GIBBONS. N O ; $25 an examination is fine. I t is all right.
Mr. PECORA. DO you really feel that examiners would come into a
bond dealer's office and make an examination once a week?
Mr. GIBBONS. I had an income-tax man come in there and live for 2
months once. If I had been paying him by the day at a high rate
I would have felt very badly. I felt that way anyway, bad enough.
Mr. PECORA. But in discussing this bill do you feel that it would
be necessary to make an examination once a week ?
Mr. GIBBONS. He might come in there and stay 2 months.
Mr. PECORA. YOU still do an extensive business?
Mr. GIBBONS. Yes; and I might do it for a great many years, and
he might go back over all of it.
STOCK EXCHANGE PEACTICES
7455
Mr. PECORA. With bank examiners they examine 50 banks in 2
months' time.
Mr. GIBBONS. They tell me they just about live m the banks year
in and year out.
Senator GORE. But you say you did enjoy the company of that
income-tax examiner ?
Mr. GIBBONS. I liked his company, Senator, but he stayed too long
and it was too costly.
The CHAIRMAN. DO you have any other questions of this gentleman? If not, we are very much obliged to you, Mr. Gibbons, and
you are excused.
Mr. GIBBONS. Thank you, gentlemen.
Senator GOLDSBOROGH. I move we adjourn.
The CHAIRMAN. After the recess we will hear Mr. Smith and Mr.
Whitney. We will take a recess now until 2:30.
(Accordingly, at 1:05 p.m., a recess was taken until 2:30 p.m.)
AFTERNOON SESSION
The committee resumed at 2:30 pm., on the expiration of the
recess.
The CHAIRMAN. The committee will come to order, please. Mr.
Butcher is here from Philadelphia, representing the Philadelphia
Stock Exchange, and says he desires a tew minutes before the committee. I think we had better take him right now.
Mr. BUTCHER. Thank you very much, Mr. Chairman.
The CHAIRMAN. Have a seat right here at the table. Please give
your name, place of residence, and whom you represent.
Mr. BUTCHER. My name is Howard Butcher, Jr. I am president
of the Philadelphia Stock Exchange, Philadelphia, Pa.
STATEMENT OF HOWARD BUTCHER, JR., PRESIDENT «F THE
PHILADELPHIA STOCK EXCHANGE, PHILADELPHIA, PA.
The CHAIRMAN. NOW, Mr. Butcher, have you seen the revised bill,
H.R. 8720?
Mr. BUTCHER. Yes, sir; I have read that bill very carefully.
The CHAIRMAN. Well, you appeared before tne committee once
before
Mr. BUTCHER (interposing). Yes, Mr. Chairman.
The CHAIRMAN (continuing). And if you want to make a statement now in regard to the revision of the
bill, you may do so.
Mr. BUTCHER. I will be very glad to/ do so.
The CHAIRMAN. YOU may proceed.
Mr. BUTCHER. When I was here the last time you were good enough
to tell me, Mr. Pecora, that we would not have to close up shop. I
want to say, after reading this bill very carefully, it is my considered
opinion that the Philadelphia Stock Exchange would not be able to
operate under it. There are at least 8 or 9 provisions in it, if not
more, that would oblige us to close before the bill became operative.
The CHAIRMAN. Will you state what provisions of the revised bill
would bring that about? Let us have something specific, not simply
some general allegation of apprehension.
175541—34—PT16
i
7456
STOCK EXCHANGE PRACTICES
Mr. BUTCHER. The provision for margin requirements in my opinion is quite unworkable. Those requirements are too large in some
cases too high, and too low m others. They vary in such a way that
it would be almost impossible as a practical question to operate under
the margin provisions of the bill.
The CHAIRMAN. That is section 6, is it?
Mr. BUTCHER. I t is section 6, paragraph (a).
The CHAIRMAN. All right. Proceed with your statement.
Mr. BUTCHER. The limitations under section 6, paragraph (d) do
not give sufficient elasticity in regard to questions of credit.
The CHAIRMAN. Did you say section 6, paragraph (d) ?
Mr. BUTCHER. Yes, sir. A broker at times would have to make a
material loan, and it might be on Government bonds, or it might be
on the highest grade of State or city bonds, or it might be on some
other security, and the broker might have to make a very considerable
loan, perhaps only for a few days. But under this paragraph he
would be placed in a position where he would be willfully committing a breach of the regulations, and would be obliged to suffer the
penalty of 10 years in jail or a $25,000 fine, or both.
It is my considered opinion that it is entirely unfair to take a
group of men who have had an honorable existence, as in our case
since 1790, and arbitrarily inflict a 10-year jail penalty or a $25,000
fine, or both, for what has heretofore always been a perfectly routine
matter of business, a matter of business that is not adverse to the
public interest, that is not adverse to individual morals, that is not
contrary to the laws of our land as they have existed for very many
years. I think it would be a very great injustice, indeed.
The CHAIRMAN. What next do you object to in the revised bill ?
Mr. BUTCHER. A S to the question of specialists, the segregation
and the limitation of the activities of brokers, specialists, and dealers, under section 10, paragraph (a), I think I am probably in
accord with what the drawers of the bill would like to do as proposed or as is indicated by this section, but I am entirely opposed
to the means whereby they are attempting to do it. The specialistbroker-dealer matter may not be, in our community at least, segregated as it is proposed m this bill and permit us to live. We must
have, sometimes in 1 day, all three functions. And that would
apply, I should think, to many other cities. And it can be done
and has been done with perfect honesty to customers. A bond
broker must also be a bond dealer, the transactions it may be only
5 minutes apart. And in my opinion it is a very wrong way to set
a hard and fast law, as is now written in this bill, to require one
given regulation for everybody under all circumstances at all times.
If this were left to a study by the Commission to whom you are
going to refer the matter—the Federal Trade Commission or whatever other commission it might be—it would be much better to have
them study it and consider it more carefully than has been done
here. As now written, these things would compel my firm to liquidate, and I might add that my firm and our predecessors have been
engaged in business for approximately 60 years, and so far we have
had an honorable existence, and we certainly do not propose at this
late date to do anything that is not in the interest of and helpful to
our clients, as we have always done in the past.
STOCK EXCHANGE PRACTICES
7457
The CHAIRMAN. YOU arc speaking now as a broker and not as a
member of the Philadelphia Stock Exchange, I take it?
Mr. BUTCHER. I am simply one of about 206 members of the Philadelphia Stock Exchange.
The CHAIRMAN. What is the name of your firm ?
Mr. BUTCHER. It is Butcher & Sherrard.
The CHAIRMAN. All right. You may continue your statement.
Mr. BUTCHER. A S to odd lots, that also is a material part of the
business of our exchange and similar exchanges, but they could not
be traded in under this regulation. We simply could not function
m the way provided here. That is a highly technical matter, and
I do not want to take up too much of your time, as you have given
me a second hearing today; but that is very definitely my opinion
of the matter. You see, in the case of our exchange—and I guess in
the case of many other exchanges—the odd-lot business is done by
specialists, and a specialist may be a bond broker one minute, a bond
dealer another minute—or not the next minute, but the two transactions might be 5 minutes apart—and the specialist and the oddlot man—well, a person might have all four functions m the course
of a day's work, and still they would all be perfectly ethical all the
way through.
I sometimes wonder whether you, Mr. Chairman, and the other
Senators interested in this bill, have thought for a moment what
it would mean to the real-estate people of your own State, Florida,
and other places, if the last liquid source of securities were to be
frozen. If this bill is enacted in anything like its present form
the market for securities would be down and out unless done through
bootleggers. In other words, securities would have to be bootlegged,
just like liquor was handled recently.
Mr. PECORA. Why do you say that?
Mr BUTCHER. For the reason that I told you informally the last
time I had the pleasure of talking to you. I mean to make an understatement rather than an overstatement when I say that in case at
least 8 or 10 paragraphs of this bill are enacted into law I would
not be willing to stay in business. And there are hundreds of other
brokers who have just as high standards as I have, and possibly even
higher, who would not stay in business. Then, the business would
have to be done, no doubt, by men who would not mind taking the
chance under the bill.
Mr. PECORA. Why couldn't you stay in business and conduct it m
the manner that this bill would permit you to do it?
Mr. BUTCHER. Because I would be handcuffed and hog-tied.
Mr. PECORA. The bill allows specialists and dealers to be members
of stock exchanges. It would allow odd-lot dealers to be members
of exchanges.
Mr. BUTCHER. But it would not allow an odd-lot dealer to be a
bond broker, a bond dealer, a specialist, and an odd-lot man all at
the same time. And that is what our men are.
Mr. PECORA. If you assume the functions in one capacity; that is,
in one where it is inconsistent with another, it puts you where you
are frequently called upon to make a choice between serving your
own interest and serving the interest of your customer. Don't you
think that is bad in principle ?
7458
STOCK EXCHANGE PRACTICES
Mr. BUTCHEK. No; I do not think it is bad m principle because it
cannot be helped. A decision has to be made a great many times,
and that is the thing we do, and I think 99 percent of the brokers do.
We may own bonds, and we sell them and take a profit on them if
the customer desires them. Otherwise the customer would take something else.
Mr. PECORA. The evidence which has been introduced before this
committee will show that when dealers have in their inventories such
securities they may and some have passed them on to unsuspecmg
clients who face a loss on them. It is only natural to assume that
where an individual is called upon to serve two interests, the one his
own and the other his customer's, there is a strong temptation that
the advice he will give to his customer will be that advice which will
best serve the dealer's own interest.
Mr. BUTCHER. I am entirely in accord with you on that phase of
it, but
Senator KEAN (interposing). Isn't it your practice, and in fact
practically the rule of the exchange that if you own a security you
must tell the customer you own it, and that you are selling it to him
without any commission?
Mr. BUTCHER. Absolutely.
Mr. PECORA. IS it a rule of the exchange ?
Mr. BUTCHER. Yes. You cannot be a broker and an agent at the
same time. You cannot charge a commission on something you buy
or sell.
Mr. PECORA. That is true, but at the same time if you are selling
a security as a dealer and you inform a customer that you are selling
him your own merchandise, that customer might be induced to buy
that merchandise from you on your advice.
Mr. BUTCHER. Naturally; but in that case
Mr. PECORA (continuing). Which advice might be tinctured by
your desire to serve your own interest and not your customers
interest.
Mr. BUTCHER. But that is a recognized human element which
you cannot erase and which you cannot prevent in all cases.
Mr. PECORA. But that is a temptation that ought to be removed,
for a broker-dealer to cater to his own interest in a given situation
as against the interest of his customer.
Mr. BUTCHER. Mr. Pecora, you must remember
Mr. PECORA (continuing). This bill is designed to promote the
greatest good for the greatest number, and the greatest number in
my humble opinion is the public.
Mr. BUTCHER. I will have to take very polite but every definite
issue with you on that. The bill is not so drawn as to bring about
that result. The bill would do the greatest harm to the greatest
number.
Mr. PECORA. I cannot see that. You are stating general conclusions. You haven't given us anyfacts or examples to illustrate the
soundness of your conclusions. Why not do that?
Mr. BUTCHER. Well, in order to give illustrations I must be a
little bit personal, which I am sorry to have to be, but I have been a
broker or bond dealer for over 30 years, and during that time I have
had a part in a great many million dollars' worth of transactions, involving a great many hundred thousand individual transactions, and
STOCK EXCHANGE PBACTICES
7459
I have yet to be called to task for any one of them. And I believe
there are a great many other brokers in the same situation.
Mr. PECORA. Well, if all brokers conducted their business in the
way you say you conduct yours there probably would not be any
agitation for the enactment of such a law as we now propose. Legislation, you know, follows exposure of evils as a rule, it does not
anticipate them.
Mr. BUTCHER. YOU are looking at this thing, and very naturally,
from the standpoint of the prosecutor.
Mr. PECORA. NO, sir; I am not. I gave up being a prosecutor
several years ago and do not want to return to that role. Twelve
years of it is enough in any man's lifetime.
Mr. BUTCHER. Well, I do not wish to send you back there.
Mr. PECORA. And I haven't any prosecutor's complex. Neither
have I a banker's complex, nor a broker-dealer's complex.
Mr. BUTCHER. Well, I don't think I have any complex, or if I do
it is only such complex as would come after 30 years' trying to engage in square dealing with my clients. And also let me say this,
that I have longer experience in the matter of disciplinary proceedings as to brokers than jrou have, because I have been upon the board
of governors of the Philadelphia Stock Exchange for many years,
and when I speak of myself as a personal matter I am only the
average broker, or mine is only the average experience, and I believe
that the very great majority of the members of exchanges have the
highest standard of ethics there is. But here in this bill we are to
be treated as a bunch of criminals, and in saying that I do not mean
to be emotional on the subject.
Mr. PECORA. I think the purpose of the bill might be said to be,
to make all broker-dealers function in the way you say you have
functioned for the last 30 years. But we have too many pagCL of
testimony taken before this committee to accept that view, for much
of the testimony shows that they have not all functioned like that,
and that the public has paid the price.
Mr. BUTCHER. I do not believe it is possible by means of legislation to prevent any and all dishonesty.
Mr. PECORA. Oh, no. You cannot prevent any and all dishonesty.
You can only hope to provide a deterrent influence through fear of
punishment for infractions hi law. The laws against burglary have
not prevented burglary from being committed, not entirely so. And
that may be said with regard to any and all of our penal statutes.
But I venture to say there would be no difference of opinion if I were
to assert the fact that having such laws, defining such acts to be
crimes punishable as such, has prevented the commission of more
such crimes than otherwise would have been committed.
Mr. BUTCHER. That I think is almost axiomatic and almost unanswerable. But don't you yourself feel, Mr. Pecora, that it would
be almost impossible for a man with a clean record, or for a stock
exchange with a clean record like that to function under this bill.
Mr. PECORA. NO. I do not agree with you on that.
Mr. BUTCHER. Well I am sorry. At the same time I am clearly
convinced that that would be the case.
The CHAIRMAN. We are hoping to cause them to function more
efficiently and more satisfactorily than heretofore.
7460
STOCK EXCHANGE PEACTICES
Mr. PECORA. DO you think the effect of reducing the number of
persons engaged in this business might not be unwholesome? You
will recall that during 1928 and 1929 brokerage houses established
branch offices on a scale never before attained, and that was a bad
thing because it aided and abetted and encouraged speculation that
led to the crazy situation of 1929.
Mr. BUTCHER. Mr. Pecora, don't you believe any brokers?
Mr. PECORA. Why, of course I do.
Mr. BUTCHER. I was getting the feeling that
Mr. PECORA (interposing). Of course, I believe brokers.
Mr. BUTCHER. I was getting the feeling from what you have told
me that
Mr. PECORA (interposing). I do not challenge the good character
and the integrity of every individual when I advocate the enactment
of a law that would make kidnaping a crime merely because a very
small percentage might be addicted to that crime. Because I advocate the enactment of a law against kidnaping is no reason why
every individual should feel that if the law is enacted they are
potentially regarded by lawmakers as criminals. Such a law is
designed to reach those individuals who are anti-social.
Mr. BUTCHER. Well, there have been a number of men to testify
here, and I have heard some of them myself, who have said perhaps
about the same things that I have, and still this bill comes back
in supposedly revised form, but with almost no change whatever
Mr. PECORA. Why, Mr. Butcher, other persons who are not bankers or brokers, have come before this committee, only this morning
I might say, and after having made a careful and intensive study
of the bill, have called the committee's attention to the very marked
changes which have been made in this revised draft as compared
wath the original draft. And I might cite none other than Governor
Black of the Federal Reserve Board, who expressed his views m
that respect this morning.
Mr. BUTCHER. I do not believe Governor Black has ever had to
make a living out of the brokerage business.
Mr. PECORA. And it may be that is why he has not the broker
complex and is able to view this bill with an impartial mind.
Mr. BUTCHER. And that may be why he does not see some other
things m it that are injurious.
Senator KEAN. Perhaps Governor Black does not understand the
brokerage business.
Mr. BUTCHER. That is quite likely.
The CHAIRMAN. AS I understand, the rules of the exchange require certain things of brokers, and you approve of such rules, and
yet you do not want them put in the shape of a law.
Mr. BUTCHER NO, sir; I haven't said that. I haven't that thought.
The CHAIRMAN. Well, that seems to me to be the effect of what
you are saying.
Mr. BUTCHER Oh, I beg to differ with you there.
The CHAIRMAN. All right. You may proceed with your statement.
Mr. BUTCHER. Under the rules of stock exchanges, as I know
them, a man may not be on the same transaction as broker and
dealer. But on the same day, or even within a very few minutes,
STOCK EXCHANGE PRACTICES
7461
he may be dealer, broker, odd-lot man, and specialist on our exchange. Now, this bill very definitely prohibits that and subjects
him, for something he has been doing, if he has lived as long as I
have, every day for 30 years to the penalty of a 10-year sentence or
a $25,000 fine, or both. There is no justice in that.
Mr, PECORA. This bill is simply designed in that respect to put
such a person in a position where he will not have dangling before
him the temptation to serve his own interest as against the interest
of his customer.
Mr. BUTCHER. Mr. Pecora, I can say to you that there will be
nothing dangling before me if you pass this bill in this form, if you
pass this bill in this form, except to go out and grow cotton or wheat.
The CHAIRMAN. Well, that is a mere conclusion. Let us go on
with any specific objections you may have to offer to the revised bill.
Mr. BUTCHER There is one other statement I should like to make
if I may.
The CHAIRMAN. Very well You may proceed.
Mr. BUTCHER. Under this proposed regulation, under this bill,
I think I may say in justice to the exchanges, that as well as regulating them, governormg them, managing them, it takes from the
board of governors practically all of their responsibilities. At the
present time from the time a man comes in until he is expelled
or otherwise leaves the exchange he is subject at all times to the
rules and regulations of the Federal Trade Commission or whatever
other commission you may decide to refer this matter. In my opinion that is a grave mistake. Things must be decided promptly, and
in a very great majority of cases, I should say in over 99 percent
of the cases, they are decided honestly and fairly. Our standards
today are probably above, from the ethical standpoint, the ordinary
laws of Pennsylvania or of the United States. A client who is
dealing with a member of an exchange can bring his complaint
before the secretary's office and get almost immediate satisfaction—
or, not satisfaction, perhaps, but almost immediate justice. And
this is a very serious matter.
Senator ADAMS. YOU mean an immediate decision, don't you?
Mr. BUTCHER. Yes, sir; a decision almost immediately, instead
of having it dragged over perhaps 2 or 3 years.
The CHAIRMAN. What section do you refer to ?
Mr. BUTCHER. I am not familiar with the bill by sections. But
I think that is in section 18 of the bill.
The CHAIRMAN. All right.
Senator ADAMS It is on page 43 of the bill.
Mr. BUTCHER. That would result almost immediately in the bootlegging of securities. When your stock exchanges close people
must find a market somewhere, and they will find a market somewhere, and it will likely be through people who are not controlled by
any rules or regulations, except their individual wishes, and that
would result in my opinion in a very much worse situation than
has ever been, a condition very much worse than Mr. Pecora suspects
us of.
The CHAIRMAN. All right. Is that all?
Senator TOWNSEND. Mr. Butcher, I was not present when you first
began your statement. How long have you been in the stockbrokerage business?
7462
STOCK EXCHANGE PBACTICES
Mr. BUTCHER. AS distinguished from that of bond broker?
Senator TOWNSEND. Either one.
Mr. BUTCHER. I started in the bond business in 1901, and T became
a member of the Philadelphia Stock Exchange I think in December
of 1909.
Senator TOWNSEND. DO you think this bill would put brokers out
of business, that is, if it should be enacted in its present form? Is
that your contention before this committee ?
Mr. BUTCHER. My very definite conclusion, after a careful study of
the revised bill, is that the Philadelphia Stock Exchange could not
continue.
Senator WALCOTT. That is, that the exchange could not continue?
Mr. BUTCHER. Yes, sir. It could not continue, and it would
compel my firm to liquidate. The Philadelphia Stock Exchange
was started in 1790. It has a most honorable record and has rendered a great service to the community. I think while some of you
gentlemen have the idea that you will prevent crime or wrongdoing
you are taking the very serious responsibility upon yourselves of
closing stock exchanges and of compelling brokers to liquidate,
involving the throwing out of employment of many thousands
of people and the doing away of salaries which would mean
$300,000,000.
Mr. PECORA. Then I take it your argument is based on the belief
that all stock exchanges and all brokers are going to be put out of
business in event of the enactment of this bill.
Mr. BUTCHER. I should not like to speak for all exchanges,
although I am authorized to speak for the Philadelphia Stock Exchange. And I say that quite definitely for the Philadelphia Stock
Exchange.
Mr. PECORA. But the Philadelphia Stock Exchange hasn't a pay
roll of $300,000,000 a year.
Mr. BUTCHER. NO, sir.
Mr. PECORA. YOU were
referring, when you mentioned such a pay
roll, to all exchanges?
Mr. BUTCHER. Yes, sir.
Mr. PECORA. And you think
they are going to be put out of business in the event of the enactment of this bill ?
Mr. BUTCHER. That is my opinion.
Mr. PECORA. Didn't the bankers make a similar direful prediction
a score of years ago when the Congress was considering the enactment of the Federal Keserve Act?
Mr. BUTCHER. NO, sir.
Mr. PECORA. That is my recollection of the situation.
Mr. BUTCHER. I do not think that was a parallel case.
Mr. PECORA. It was parallel in that direful predictions
were made,
predictions that were not realized after the event.
Senator WALCOTT. Mr. Butcher, I came in just as you were concluding with section 10 of the bill. On page 27, line 21, I find certain language. Suppose we were to strike out the sentence:
It shall be unlawful for an odd-lot dealer to act as a broker
That provision, as I understand it, is one of the serious difficulties
of this bill. If we should strike out that language, you would then
STOCK EXCHANGE PBACTICES
7463
be subject to regulations as imposed by the Federal Trade Commission, which are recited on pages 28 and 29. What about that?
Mr. BUTCHER. That would be a big help, unquestionably, if that
language were stricken out. Yes; it would be a great help.
Senator WALCOTT. YOU are in favor of doing that?
Mr. BUTCHER. Yes, sir. I do not believe you gentlemen realize on
how small a margin brokers have been doing business for the last 4
years. We have been just on the ragged edge of doing business in
the red. And many of us have been in the red all the time.
Mr. PECORA. Well, that is true of all businesses.
Mr. BUTCHER. NO, sir; not of all businesses.
The CHAIRMAN. I think the committee has pretty well concluded
to strike out that language.
Mr. BUTCHER. Well, that would be a help. Then if you would
go on and give specialists relief. May I say one more thing, Mr.
Chairman ?
The CHAIRMAN. Yes.
Mr. BUTCHER. I am
a member of what we call an out-of-town
commission firm in Philadelphia. A lot of our orders are executed
on the New York Stock Exchange. They go to specialists. Ordinarily, if anybody were to make complaint about what a specialist
does on the New York Stock Exchange, it would come from me or
my partners or associates. But I want to be perfectly outspoken
in my commendation of the members there, of what the specialists on
the New York Stock Exchange have done and are doing today for
the general public. Where one man might have slipped—and you
know Mark Twain has said " there is a yellow dog in every pack
of hounds ", and perhaps there is; and there may have been times
when one or two specialists have slipped, but by and large over the
years these specialists on the New York Stock Exchange have stood
there and taken punishment; yes, a punishment that you gentlemen
would have found very difficult to withstand day after day and
have rendered a service to the public that I feel is quite outstanding. And I am one of those who would be quick to criticize, or from
whom criticism would be expected to come if criticism were due, but
they have given service time and time again. Some of them have
made money and some have not. For more than 99 percent of the
time they have given us, and I mean by " us " the public, the people
from the smaller towns and communities who send business through
us to the New York Stock Exchange or the New York Curb Exchange; I say to you that these specialists have given good work.
We have had exonerated before this committee practically all but
one or two men, and while they were being criticized we have heard
practically nothing of the 250 or 253 other men who have rendered
outstanding service, whose outstanding labors and clean-cut work is
more or less overlooked.
Senator ADAMS. DO you have specialists on the Philadelphia
Stock Exchange ?
Mr. BUTCHER. Yes, sir; but they function a little differently
from the way a specialist functions on the New York Stock Exchange or the New York Curb Exchange. The specialist there
handles odd lots also. He does not handle hundreds—but I do not
7464
STOCK EXCHANGE PEACTICES
want to take up your time going into these details of technical
matters unless you wish me to do so.
Senator KEAN. Have you figures for all these margins that would
be required under this bill?
Mr. BUTCHER. Yes, sir. I stated the last time I appeared before
your committee that I thought the margin requirements wen
fantastic.
Senator KEAN. Well, are they still fantastic under the revised
bill, or are they better under this bill ?
Mr. BUTCHER. This is more reasonable. The Federal Reserve
Board under certain circumstances may have something to say, but
very little. If they were all left to the Federal Reserve bank, I
would be satisfied. These margin requirements are too great in some
cases and not as great as my firm would require in other cases. I t
should be elastic. If you want the business to be continued to be
conducted, it must be elastic. That, Senator Kean, is a thing that
would compel my firm to close. We could not do business under it
as it is written in the revised bill. And if you were to look into the
matter of the margin requirements, you would find them very satisfactory as now required under the rules and regulations of the
exchanges.
Senator ADAMS. What percentage of the business going through
your firm is now a margin business ?
Mr. BUTCHER. That varies very much according to the activity
of the market and the year. If we were to speak of 1933, while I
have made no particular study of it, I should think that very much
more than three fourths of our business has been for cash, and that
only about one fourth of the business has been on margins. The
amount of money we were lending to our clients in 1932 was about 7
percent of that loaned in 1929. And the fact that we could liquidate
down to that point shows that we carried proper margins.
Senator GORE. Have you taken much by way of losses?
(Before the witness could answer, the next question was propounded, as follows:)
Senator TOWNSEND. Mr. Butcher, I have a letter from a very large
corporation saying if this bill were enacted into law they would have
to withdraw from the exchanges; that is, withdraw their stock. He
does not give the reasons. Could you assign any reason why that
would have to be done ?
Mr. BUTCHER. I think that would be because the presidents of
companies would want to stay out of jail. These provisions from
a corporation standpoint, I think, are almost prohibitive. I mean
that a corporation man
Mr. PECORA (interposing). Can you specify in what respect they
are prohibitive? Tell us what provisions particularly you think
would lead to a withdrawal of securities of aJ big corporation from
the New York Stock Exchange.
Mr. BUTCHER. The obligations imposed on them in reference to
registering their securities. If there should be some little bit of a
slip occurring somewhere, and perhaps a perfectly honest mistake*
they face a penalty of 10 years m jail and a fine of $25,000. No corporation man is going to take that chance, if he values the welfare
of his family and his own reputation.
STOCK EXCHANGE PEACTICES
7465
Mr. PECORA. Don't you realize that one little slip would not be a
criminal act; that it would have to be a willful violation; and that
it is just exactly what this bill states?
Mr. BUTCHER. Mr. Pecora, I took that point up with you the last
time I was here, and we came to the same conclusion. This bill is so
drawn that any act is a willful act. For instance, if the corporation
continues to exist it continues to exist willfully.
Mr. PECORA. I beg pardon. Look at the penalty section of the bill
and see for yourself.
The CHAIRMAN. If the officer of a corporation tells the truth and
sets forth the facts, do you mean he is a criminal ?
Mr. BUTCHER. Under this bill he could very readily be declared a
criminal.
Mr. PECORA. Section 25 of the bill is the one providing the penalties, and it starts off with the sentence:
Any person who willfully violates any provision of this act—
Mr. BUTCHER. Well if a person signs a report, and that report
Mr. PECORA (interposing). It says:
or any person who willfully and knowingly—
is responsible for any statement in any application which is false or
misleading. But it has got to be willfully false, and a mere slip
would not be a willful violation.
Mr. BUTCHER. I am sorry but I cannot agree with you. And the
language of your bill does not protect one from an innocent mistake.
Mr. PECORA. Then you are closing your eyes to the language of the
bill which says:
Any person who willfully violates any provision of this act.
Mr. BUTCHER. Yes; I say that word " willful", and I understand
what willful means, I think—and I might say that I have by my wife
been accused of being willful, but
Mr. PECORA (interposing). With all due respect to Mrs. Butcher,
I might say that she probably hasn't a judicial mind.
Mr. BUTCHER. Well, judicial to the extent of being the last word
in that matter. [Laughter.]
Senator ADAMS. Perhaps your wife may be carrying the burden
there.
Mr. BUTCHER. Well, she is always right. I know that. And, Mr.
Pecora, the " willful " part here is all right, perhaps—and now please
don't think I am trying to be personal in saying this, but this is
simply what I call a "technicality", and I just don't like technicalities.
Mr. PECORA. Oh, no. I t is not a technicality at all. It is a very
substantial provision, and is intended to mean just what it says.
There is a great difference between a willful violation of a penal
statute and an innocent violation of it. Yes; there is all the difference in the world between the two.
Mr. BUTCHER. Well, Mr. Pecora, I am not an engineer and I am
not an expert accountant, although I have spent some time on accountancy matters. But suppose somebody who goes over some
property makes an engineering report and makes a mistake in his
figures of, sajr, 100,000 pounds in relation to the weight of a certain
piece of machinery, a perfectly honest mistake on his part. Then he
7466
STOCK EXCHANGE PBACTICES
sends in his engineering report, and it goes on down the line, and
the president and treasurer of the corporation sign it. If the president signs that report that is a willful act.
Senator ADAMS. Oh, no.
Mr. PECORA. DO you mean if he signs it with knowledge of its
falsity?
Mr. BUTCHER. Oh, no.
Mr. PECORA. DO you think
that would be a willful violation of
the act?
Mr. BUTCHER. I do not see how it would be considered in any
other way.
Mr. PECORA. I t depends on whether he willfully does the thing.
Senator ADAMS. Mr. Butcher, your construction of " a willful act"
would seem to refer to the fact that he had the will to do it but
without any intention to do a wrong.
Mr. BUTCHER. I t is my idea that this bill is written with that idea
in view.
Senaior ADAMS. And in this section there is another limiting
statement:
Which statement is, in the light of the circumstances under which it wa&
made, false or misleading in any matter sufficiently important to influence the
judgment of an average investor
In other words, the trifling errors you speak of would not come
within that provision.
Mr. BUTCHER. Have you ever seen the average investor ?
Senator ADAMS. Well, I think I have been one.
Mr. BUTCHER. Well, I think you are above the average.
Senator ADAMS. I appreciate the compliment and wish it were true.
Senator KEAN. In regard to these margins, I have a letter from
Edward B. Smith & Co.—and they are large brokers m your city,
aren't they?
Mr. BUTCHER. Yes, sir; and in good standing.
Senator KEAN. They say that under the figuring in this bill if one
wore to buy 100 shares of General Motors at $36 per share, and
borrowed on it, they would then have to put up 3 3 ^ percent. Under
the present custom of the exchange you would put up $1,200 as a
margin, but under this bill they would have to put up $900 more.
Is that the way you figure it?
Mr. BUTCHER. I haven't figured it.
Senator KEAN. This would mean a 150 percent margin. Is that
the way you figure it ? Or you can take the letter and read it. After
you have read the letter, I should like to propound that question
to you.
(While Mr. Butcher was reading the letter, the following occurred:)
The CHAIRMAN. What do you want Mr. Butcher to do, Senator
Kean—confirm the statement made by Edward B. Smith & Co. ?
Senator KEAN. Yes. And I want to put the letter in the record.
Senator BULKLEY. There would be no purpose in the witness confirming it unless the letter is put m the record.
The CHAIRMAN. Let the letter go in and it will speak for itself.
Mr. BUTCHER (after reading the letter). Do you want me to say
anything, or do you just want me to present the letter ?
STOCK EXCHANGE JL'KACTIOES
7467
Senator KEAN. I will ask you about the.letter.
Mr. BUTCHER. I have read the letter hastily and believe it to be
correct.
The CHAIRMAN. The letter may go in the record.
Mr. BUTCHER. The 150-percent margin referred to is on the debit
balance, not on the market price of the stock.
Senator KEAN. Let the record be completed by inserting the letter.
(The letter is as follows:)
EI>WAKD B S M I T H & Co ,
15 Broad Street, New York, March 22, 19H
Senator HAMILTON F KEAN,
Senate Office Bwildmg, Washington, D C
DEAR SENATOB In leference to our conversation over the telephone this morning and in connection with the hearings which I understand are to be reopened
upon the " National Securities Exchange Act of 1934 ", I wish to point out a
question which we discussed in reference to section 6 of the bill, which I
believe is causing some confusion not only m Congress but in the minds of
exchange members Section 6 of the bill allows the member of an exchange
to loan 40 percent of the market price of a security which is qualified as collateral within the meaning of the act It is the universal practice among
brokers to speak of the margin requirement in terms of the percentage of
the debt balance, oi in other words, the amount which the borrower owes
when he purchases the security that he intends to use as collateral for his
loan with the broker For example, take the case of a customer who wishes
to buy 100 shares of General Motors at the present price of $36 per share—
the total purchase price of this stock would be $3,600 The broker would,
under the present requirement with the customer, i.e, that the equity be 33%
percent of the debit, require upon such purchase that the customer deposit
one third of $3,600, or $1,200 This would mean that the customer has an
equity in the account of $1,200 and owes to the broker $2,400. This would
leave the account just adequately margined.
Upon the margin as required in the bill that the broker may loan 40 percent
of the market price it would be necessary that the customer deposit 60 percent
of $3,600, or $2,160, which would be the customer's equity in the account, and
the account as previously adequately margined would need additional margin
to the extent of the difference between $2,160 and $1,200, or $960, which the
customer must deposit or render it necessary to sell a part of his stock in
order to comply with the law.
This uncertainty in speaking of margin in one instance in the terms of the
loan the act allows upon the stock, and in the other instance in terms of the
amount that the customer owes the broker, is a question that is causing a
great deal of confusion. Under the bill as it is now drawn when a broker
may only loan 40 percent of the market value of the stock, the customer has
an actual margin, according to our method of computation, of 150 percent,
since the customer's equity of 60 percent is 150 percent of the debit balance
of 40 percent which remains unpaid.
I believe it would be extremely helpful if some expression of opinion could
be obtained from the Treasury Department or the Federal Reserve Board and
possibly written into the bill which would clarify the question.
Please allow me to thank you for the opportunity of bringing this matter
to your attention.
With kindest personal regards.
Yours sincerely,
(Signed)
JOHN W. CUTTER
The CHAIRMAN. I S that all, Mr. Butcher?
Mr. BUTCHER. Yes, Mr. Cnairman; and I wish to thank you very
much.
The CHAIRMAN. Are there any further questions by members of
the committee?
Senator GORE. Mr. Butcher, you were discussing a minute ago the
functions of specialists. I was talking to an old friend the other
7468
STOCK EXCHANGE PRACTICES
night who is a mere layman and yet he has given a good deal of
thought to the pending bill. He used this illustration of what might
result if too much limitation were placed upon specialists, dealers,
and brokers. He said American Telephone & Telegraph might close
some afternoon at 115, we will say, and the ordinary citizen buying
it occasionally might take it for granted that it would open around
that figure the next day, and yet under this bill he thought it might
drop something like 15 or 20 points. Could that happen; and if so,
why? And did you say the other day, Mr. Pecora, that that section
had been amended?
Senator KEAN. Mr. Pecora did not hear your question, Senator
Gore.
Mr. PECORA. What was that, Senator Gore?
Senator GORE. YOU said the other day that the point I mentioned
had been amended, but never mind. Mr. Butcher, will you answer
the question?
Mr. BUTCHER. YOU are asking me a question which will take a
moment or two to answer.
Senator GORE. My friend seemed to think that a specialist in that
sort of case would make a market to protect the purchaser against
such a drop as I have suggested, which he referred to as just a sinking spell. How about that?
Mr. BUTCHER. A specialist under the New York Stock Exchange
regulations has the right to buy for his own account after the stock
has first been offered to the group around him. In other words,
after he has announced the offering he may take it himself if
nobody else wants it. Or that is the way I understand it. But he
always is at a disadvantage as compared with the group around him
to the extent of one eighth or to the extent of no offering or no bid.
He can only take a stock when it is not wanted by anybody else.
That tends to bring the spread in the stock closer together. If American Tel. & Tel. closed at 119 and the next morning there is no bid, or
a bid of only 114, and the stock is offered at the market, he could
technically take it at 114%. But very likely under those circumstances he would take it a point away from the close of the night
before, knowing that sooner or later somebody would come forward
and there would be more activity. The specialist, instead of being
one who abuses the public, is the man who helps the public. I do
not believe it would be possible for the New York Stock Exchange to
handle 2,000,000 shares a day without specialists, and if the New
York Stock Exchange cannot handle the business and handle it right
as it has done in the past, there is very serious injury being done to
the general public.
Senator GORE. That is, the specialist is a sort of stopgap.
Mr. BUTCHER. Yes; and sometimes they win and sometimes they
lose. But the specialist is there, and makes the market very often
when nobody is prepared to do it. He hopes, of course, to win, but
he takes his chances.
Senator GORE. A S the market is operating now he would be in
that situation a protecting influence against a tendency to drop 10
or 15 points if nobody was there to buy the stock.
Mr. BUTCHER. I do not quite understand your question.
STOCK EXCHANGE PRACTICES
7469
Senator GORE. AS the market is operated now the specialist would
be there and would be in a position to get the stock on the way down
and thus prevent its dropping 10 or 15 points.
Mr. BUTCHER. Yes, sir. He also prevents too great a rise. He
acts as a sort of shock absorber either way. And he is functioning
now better than ever before in the history of American business.
Senator GORE. DO you think this pending bill lays too severe limits upon his functions?
Mr. BUTCHER. Undoubtedly so, in my opinion. I might say that
I am one of those who is ordinarily supposed to be hostile to specialists, for specialists are constantly executing my orders.
The CHAIRMAN. Are there any other questions ?
Senator KEAN. Yes, one more: Mr. Butcher, if you wanted to buy
100 shares of stock for yourself under this bill, and you telegraphed
to your broker in New York to buy such stock, and you were prevented from giving an order to anybody on the New York Stock
Exchange under this bill, how could you do it?
Mr. BUTCHER. Well, there wouldn't be any market except through
some bootleg source, and I would have to keep the money and could
not buy the stock. That is what I spoke about, that it would freeze
up tight like real estate, and it will be a tremendous blow to Florida
i± you pass this bill. And, Mr. Chairman, I enjoyed being down
there in January.
Now, Mr. Pecora, you told me the last time I was here that I
would not have to close up shop. I am going to hold you to that.
Mr. PECOJRA. I hope you are not looking to interest me as a
partner.
Mr. BUTCHER. Partners are not so willing to take the risks these
days.
The CHAIRMAN. All right, if that is all. Mr. Butcher, you spoke
about Florida, and I have a telegram from a man saying that perhaps under the bill the State of Florida next winter will very much
resemble the State of Nevada. I do not know what he means. Do
you?
Mr. BUTCHER. I can tell you later, after your hearing.
Mr. PECORA. Perhaps he means that the wives of brokers will
seek divorces. [Laughter.]
The CHAIRMAN. I think Nevada is doing very well.
Mr. BUTCHER. Well, I think I know what he has reference to,
but I would rather tell you after the hearing closes today.
(Mr. Butcher left the committee table.)
The CHAIRMAN. Mr. Smith was supposed to come before us first
this afternoon, but Mr. Butcher wanted to go back home in Philadelphia, and promised that he would not take very long, and in order
to give an opportunity for more members of the committee to be in
attendance we delayed hearing Mr. Smith. Now, Mr. Smith, if you
will take a seat at the committee table opposite the microphone, and
will state your name, residence, and occupation.
Mr. SMITH. My name is Tom K. Smith. I am president of the
Boatman's National Bank, St. Louis, Mo., temporarily acting as Assistant to the Secretary of the Treasury.
7470
STOCK EXCHANGE PRACTICES
STATEMENT OF TOM K SMITH, ASSISTANT TO THE SECEETARY
OF THE TBEASTTBY, WASHINGTON, D.C.
The CHAIRMAN. Mr. Smith, have you considered some portions,
anyhow, of this bill, H.K. 8720? If so, we would like to hear your
views about the bill.
Mr. SMITH. Mr. Chairman, if you please, I should like to make a
prepared statement first.
The CHAIRMAN. Very well; you may proceed.
Mr. SMITH. The Nation has experienced undoubtedly the most
severe depression in its history. There seems to be no doubt that
excessive speculation and harmful practices that developed in the
securities market—particularly on the stock exchanges—were among
the major causes of economic disaster.
We have started on our way to recovery. It is of supreme importance that a repetition of old mistakes should not wreck our efforts to bring about a broad and lasting economic improvement. The
time is appropriate for legislation to remedy stock-exchange abuses
and to place stock-market activities under reasonable and adequate
regulation in the public interest. Those who wish to invest their
savings, and industries having legitimate need for capital funds,
must alike be protected from the evils of wild and unchecked
speculation.
The general purposes of the National Securities Exchange Act of
1934 is to attain these ends. And, incidentally, I am referring to the
House bill as revised. But, I take it that is understood.
Mr. PBCORA. YOU mean H.R. 8720.
Mr. SMITH. Yes.
The CHAIRMAN. YOU may continue your statement.
Mr. SMITH. The general purposes of the National
Securities Exchange Act of 1934 is to attain these ends. Its major objectives are:
First. To establish Federal supervision over securities exchanges.
Second. To prevent manipulation of security prices and to protect
the public against unfair practices.
Third. To prevent excessive fluctuations in security prices due to
speculative influences.
Fourth. To discourage the use of credit in the financing of excessive speculation in securities.
With these general objectives the Treasury is in full accord.
The Treasury has been consulted on certain parts of the bill which
are of direct concern to it. Within the limited time available, these
have been studied to determine whether they would have an unduly
adverse effect on the marketing of Government securities or on the
national financial structure. Changes which were regarded as necessary within the framework of a general regulatory measure were
suggested to the counsel for the committees or the Senate and House
and were, in all material respects, incorporated in the bill.
The Treasury has not considered those provisions of the bill which
relate to the strictly technical matters of stock-exchange practice and
regulation. Failure to comment on those provisions does not mean
that the Treasury is opposed to them, but only that they have not
been the objects of our study. The Treasury is, therefore, not in a
position to express an opinion on them.
STOCK EXCHANGE PBACTICES
7471
Mr. Chairman, I am submitting that statement with the approval
of the Secretary of the Treasury. I will be glad to answer any
questions the members of the committee may desire to ask.
The CHAIRMAN. Are there any questions ?
Senator ADAMS. Personally, I should like to have Mr. Smith's
views about the bill.
The CHAIRMAN. He has given them to us.
Senator GORE. HOW well is this bill designed to attain the desires
ascribed to it?
Senator ADAMS. He has not given us very much about the bill
so far.
Mr. SMITH. That is all that I can give you.
Senator KEAN. What portions of the bill did you study ?
Mr. SMITH. We studied the portions that had to do directly with
Government financing.
Senator KEAN. Which ones were those?
Mr. SMITH. I would have to go through the bill in order to be
able to tell you. They are parts of sections all the way through the
bill. It would be better, perhaps, for you to ask me about particular
sections of the bill, and then I can tell you.
Senator KEAN. Did you study the section in regard to margins?
Mr. SMITH. NO, sir.
Senator KEAN. Don't
you think that that section might seriously
affect the banks ?
Mr. SMITH. I cannot answer that question because the subject of
margins was not submitted to us for study.
Senator KEAN. Suppose that the president of the Chemical National Bank and the president of the Guaranty Trust Co. were down
here and they said in regard to the other bill, and this bill is practically the same, that it would make for tremendous liquidation in a
number of their loans. Wouldn't that affect banking if that were
true?
Mr. SMITH. I am instructed by the Secretary of the Treasury only
to comment on those sections that we studied at the request of the
committee.
Senator WALCOTT. What sections of the bill did you study?
Mr. SMITH. We studied section 10.
Senator WALCOTT. There is no reference in your statement to what
portions of the bill you studied.
Mr. SMITH. I t is impossible to do that.
Senator WALCOTT. We would like to know for our information.
Mr. SMITH. Well, we studied section 10 of the bill, which has to
do with brokers-dealers.
Senator GOLDSBOROTJGH. YOU answered Senator Kean that you had
not studied section 6 with reference to margin requirements, I
believe.
Senator ADAMS. He goes beyond that, Senator Goldsborough, and
says he is instructed not to comment on other sections of the bill.
Senator GOLDSBOROITGH. Then I do not care to ask him any
questions.
Senator WALCOTT. What sections of the bill can you speak to us
about ?
Mr. SMITH. Only the sections submitted for our study.
175541—34—PT16
5
7472
STOCK EXCHANGE PRACTICES
Senator ADAMS. And you are under instructions not to give a
personal opinion about things? I had supposed you were more or
less an expert and student of this bill.
Mr. SMITH. We studied section 6 inasmuch as we considered the
question of regulation by the Federal Keserve System of the flexibility of the control of bank loans.
Senator GOLDSBOROTJGH. Does the Treasury Department approve
of that section?
Mr. SMITH. Not in its entirety.
Senator TOWNSEND. HOW would they want it modified in order
to comply with the desires of the Treasury Department?
Mr SMITH. We are not asking for any modification.
Senator TOWNSEND. YOU understand, I take it, that we are engaged here in an effort to get this bill in shape and are very anxious
to have the ideas and recommendations of the Treasury Department.
Mr. SMITH. We were asked to study certain sections of the bill,
Senator Townsend, and that is what we have done.
Senator GORE. Well, your statement does not contribute very
much, and you will probably agree with us that it is not very helpful
in solving the problem before us.
Senator BULEXEY. Mr. Smith, are you instructed not to tell which
sections of the bill you have studied?
Mr. SMITH. NO, sir.
Senator WALCOTT. Well, what sections have you read ?
Mr. SMITH. All of them.
Senator WALCOTT. What sections are you now speaking of?
Mr. SMITH. If you care to ask me questions about sections
of the
bill, I will tell you whether we were asked to study them or not;
and if we did study them, we will give you our views.
Senator ADAMS. DO you have permission to give expression as to
whether or not this bill, if put in operation as it stands, would affect
seriously the operations of stock exchanges as a legitimate market
for securities?
Mr. SMITH. I will let my prepared statement answer that question.
Senator ADAMS. My reason for asking you that question is this:
That the stock market as it stands is one of the places where Government securities are sold. You realize that?
Mr. SMITH. Yes,
Senator ADAMS.
sir.
And therefore, if the bill had a tendency to destroy that as an open market, it would have a very decided effect
upon your department. I thought you would be interested in that
general effect of the bill.
Mr. SMITH. I t was not a question of what we were interested in
but what we were asked to report on.
Mr. PECORA. Mr. Smith, may I ask you a question right there?
Mr. SMITH. Certainly.
Mr. PECORA. In your prepared statement you say the Treasury has
been consulted on certain parts of the bill which are of direct concern to it. Now, what were those parts of the bill?
Mr. SMITH. YOU will recall that at the first conference we were
asked to give our views as to the effect on Government financing and
bank credits as well as other subjects of direct concern to the Treasury
and were not consulted about the regulatory provisions of the bill.
Senator GORE. Who asked you about those?
S^OCK EXCHANGE PEAOTIOES
7473
Mr. SMITH. The Secretary of the Treasury, or those were the instructions I received from the Secretary. The chairman of your
committee and Mr. Pecora understood that.
Senator KEAN. Did Mr. Pecora ask you that ?
Mr. PECORA. I gave no instructions. I was not presumptuous
enough to try to give instructions to the Treasury Department.
Mr. SMITH. Well, you understood the nature of the request^ Mr.
PecOra.
Mr. PECORA. And I also understood that
Senator TOWNSEND (interposing). Who gave you the instructions?
Mr. SMITH. The Secretary.
Senator TOWNSEND. Who wrote this bill?
Mr. SMITH. I cannot answer that question.
Senator WALCOTT. Weren't you allowed to answer that question?
Mr. SMITH (laughing, without making answer).
Senator WALCOTT. Mr. Smith, I am perfectly serious in asking
you that question. I am studying this bill, and we are simply wasting your time and our own if you cannot answer questions.
Mr. SMITH. Well, Senator Walcott, did you hear the question he
asked me ?
Senator WALCOTT. Yes. But I do not understand why you cannot
answer these questions.
Mr. SMITH. He asked me who wrote this bill.
Senator WALCOTT. I t was done down in the Department, wasn't it?
Mr. SMITH. This bill?
Senator WALCOTT. Yes. Or you say you do not know who wrote it.
Mr. SMITH. The first time I heard of this bill I was asked to get
in touch with the chairman of your committee, and I did so, and he
asked Mr. Pecora to meet us. Previous to that time we had gotten
in touch with the chairman of the House committee, who asked us
to meet his counsel, Messrs. Corcoran and Cohan.
Senator ADAMS. Were you as cautious in advising Mr. Pecora as
you have been in advising this committee ?
Mr. SMITH (simply laughing, without making answer).
Senator WALCOTT. Did you get in touch with Mr. Corcoran and
Mr. Cohan?
Mr. SMITH. Yes; but I do not know who wrote this bill.
Senator GORE. Did you talk with them at all ?
Mr. SMITH. If they had any questions to ask about the bill.
Senator WALCOTT. Well, our questions are entirely related to the
bill, but you do not answer any of them.
Mr. SMITH. I do not know who wrote the bill. I t was not written
in the Treasury Department.
Senator GORE. I think Mr. Smith better go back and tell them to
stop tattling.
Mr. SMITH. Did you have the impression that the bill was written
m the Treasury?
Senator WALCOTT. I was told it was partly written there.
Mr. SMITH. We made suggestions regarding the revised copy.
Senator WALCOTT. What suggestions did you make ?
Mr. SMITH. We made suggestions as to the separation of brokerdealer, and as to the question of bank loans, and as to the question of
Government financing.
7474
STOCK EXCHANGE PRACTICES
Senator KEAN. Well, Mr. Smith, wouldn't it be to the advantage
of the Treasury and to the advantage of the United States and to the
advantage of everybody if this thing were put under the Federal
Keserve Board or the Treasury Department instead of being placed
under some other department not interested in credits?
Mr. SMITH. AS the bill was submitted to us it showed a division
of the work between the Federal Trade Commission and the Federal
Reserve Board, and insofar as that touched the subject of our study,
it was perfectly satisfactory. We were not asked to decide between
the two except to say whether it was satisf actory.
Senator GORE. I f you were on this committee, would you recommend any changes in the bill ?
Mr. SMITH. AS a representative of the Treasury, Senator Gore, I
cannot answer that question.
Senator TOWNSEND. Mr. Smith, are you familiar with or do you
know whether the same questions were put to the Federal Reserve
Board that were put to the Treasury on this bill?
Mr. SMITH. NO, sir; I could not answer that.
Senator TOWNSEND. Did the Federal Reserve Board and the Treasury sit in on the bill ?
Mr. SMITH. Yes, Senator. Some of our studies were made at joint
meetings with the staff of the Federal Reserve Board.
Senator WAIICOTT. When you met Mr. Corcoran and Mr. Cohan,
what did you have to say to them? You said they directed you to do
something.
Mr. SMITH. We were directed to make a study of these certain provisions with them and to give them our suggestions, which we did.
Mr. PECORA. And those suggestions have been substantially incorporated in the revised bill?
Mr. SMITH. Yes, sir. I will be glad to answer as to any particular
section. We did not keep a record of them.
Senator WAiiCOTT. We cannot read your mind, Mr. Smith. We
asked you a plain question, to state what was said about this biE
in these conferences and those in which you had any influence, and
you refused to tell us.
Mr. SMITH. I did not refuse to do that. I beg your pardon,
Senator. I will go through the bill section by section if you wish.
Senator GORE. He asked your present opinion about it.
Senator WALCOTT. He said he was not allowed to answer that.
Senator BTJI/KLET. NO, he said he was allowed to answer that.
Mr. SMITH. NO, I will answer that. I will take the bill up section
by section but I suggest for the sake of brevity that you inquire about
any particular section that you are interested in.
Senator WALCOTT. We are interested in them all.
The CHAIRMAN. Did you have your general counsel and other
assistants to assist in this?
Mr. SMITH. Yes, sir; we had our staff.
Senator TOWNSEND. Did Mr. Cohen and Mr. Corcoran represent~
the Treasury, or whom do they represent?
Mr. SMITH. NO, sir. In this case we were to meet them as representatives of the House committee and Mr. Pecora as a representative of the Senate committee.
Senator TOWNSEND. And Mr. Corcoran then represented the
House?
STOCK EXCHANGE PRACTICES
Mr.
SMITH. Yes,
7475
sir.
Mr. PECORA. Mr. Smith, I understood after our first conference,
which was held as I recall it a week ago Tuesday, that the gentlemen assigned by the Treasury Department to the consideration of
this bill, as well as the gentlemen assigned by the Federal Reserve
Board to a similar duty, desired to make a further independent
study and analysis of the entire bill for their own information, and
for that reason further conferences were deferred from Tuesday
of last week until Friday of last week. I, frankly, was under
the impression that the intervening time was spent by the gentlemen
representing the Treasury Department, as well as those representing
the Federal Reserve Board, to such an independent study and analysis of the entire bill. Apparently I was in error so far as the Treasury Department was concerned.
Mr. SMITH. The entire bill ?
Mr. PECORA. Yes, sir.
Mr SMITH. NO, sir.
Of course, you were not at the final conference, Mr. Pecora. Our position was very clearly stated at that conference where you asked Messrs. Cohen and Corcoran to represent
you
Mr. PECORA. The final conference was held last Sunday?
Mr. SMITH. Yes; Sunday evening, at which we stated
Mr. PECORA (interposing). I did not know the conference had
been fixed for that time or I would have made arrangements to be
present.
Senator GORE. Were there any Senators or Congressmen in that
conference ?
Mr. SMITH. Congressman Rayburn was there.
Senator GORE. Any others?
Mr. SMITH. Congressman Rayburn, Mr. Corcoran, Mr. Cohen, and
Mr. Landis.
Senator WALCOTT. D O you think Mr. Cohen had anything to do
with the drafting of the bill?
Mr. SMITH. I have heard him mention that he did.
Senator WALCOTT. And Mr. Corcoran?
Mr. SMITH. Yes.
Senator WALCOTT.
All right; as to section 10, is that a section on
which you were allowed to speak?
Mr. SMITH. Yes, sir; a section we studied as far as its effects on
Senator KEAN (interposing). Then this bill is not the Treasury
bill?
Mr. SMITH. NO, sir; it is not a Treasury bill.
Senator KEAN. Nor is it a Federal Reserve Board bill?
Mr. SMITH. I could not answer that.
Mr. PECORA. But whatever recommendations for revision were
made by the Treasury Department representatives had been incorporated in this revised bill, isn't that so ?
Mr. SMITH. We studied certain sections of the bill, made recommendations concerning those sections, and you adopted them.
Mr. PECORA. Yes,
sir.
Mr. SMITH. Concerning those sections.
Senator KEAN. Did they adopt your words, or were they words of
their own?
7476
STOCK EXCHANGE PRACTICES
Mr. SMITH. We did not attempt to put words in their mouths. In
some of these cases it is principles.
Senator TOWNSEND. Were all of your recommendations incorporated m the bill, Mr. Smith, from the Treasury?
The CHAIRMAN. I will state that S. 2693 was referred to the
Treasury and other departments for report.
Senator TOWNSEND. Were the Treasury recommendations all
incorporated m the bill ?
Mr. SMITH. In all material respects.
Senator WALCOTT. DO you approve m section 10 of this provision
to this end, that it shall be unlawful for an odd-lot dealer to act as a
broker ?
Mr. SMITH. That is the part of the technique of the New York
Stock Exchange about which we were not supposed to make any
investigation or study, and I do not know whether it is sound or not.
Provisions there as to the separation of the broker and dealer do meet
with our approval.
Senator WALCOTT. Then on the next page you take that back by
saying that it may be allowed, provided it meets with the approval
of the Federal Trade Commission. One contradicts the other.
Mr. SMITH. The principle of that section as far as we are concerned is that it permits the broker-dealer to continue to act as long
as he discloses his position in regard to a security and does not extend credit on his own underwntmgs for a period of 6 months after
they are offered. We felt that the dealer-broker was necessary in the
Government interest and that he should be allowed to continue in
business for that purpose.
Senator WALCOTT. And would you approve of the exemption under
exemptions of leaving out municipal bonds, State bonds, and others ?
Mr. SMITH. The clause regarding exemptions gives the Federal
Trade Commission full power to extend those exemptions.
Senator WALCOTT. If you were a broker dealing in municipal
bonds almost exclusively outside of some of the large cities would
you be satisfied with taxing that risk?
Mr. SMITH. We felt, as far as it affected our study, that the provision was satisfactory.
Senator KEAN. And all your study was in United States bonds?
Mr. SMITH. We were studying it from the Government's standpoint. I t affects other Government bonds.
Senator WALCOTT. YOU evidently do not consider it important,
then, to keep brokerage houses throughout the country, to have a
ready market for these securities, like municipals, for instance?
Mr. SMITH. Well, a broker-dealer will feel that need.
Senator WALCOTT. But not if he is denied the privilege of
selling
Mr. SMITH (interposing). We did not see that the broker-dealer
was not protected in no. 10. It was our impression that he was
protected.
Senator ADAMS. YOU were not concerned with the securities and
obligations of States ?
Mr. SMITH. We felt that the provision giving the option to the
Federal Trade Commission was sufficient protection.
STOCK EXCHANGE PRACTICES
7477
Senator ADAMS. That is, you thought it was sufficient to give the
Federal Government the right to determine whether State securities
should be marketed or not ?
Mr. SMITH. Well, you are giving the Federal Trade Commission
certain powers here over government that the option to exercise
Senator ADAMS (interposing). I am asking you, Why did you
make the distinction in bonds between a Federal bond and a State
bond?
Mr. SMITH. Because of a perfectly obvious reason; you must distinguish between securities of the United States Government in
these days and those of States. You cannot draw any general conclusions.
Senator ADAMS. I am unable to see lhat it is so obvious, if you
theoretically were representing the people generally, not merely the
department. That is, the bill was being drawn for the benefit of
the people as a whole, not merely for the benefit of one particular
class of securities.
Mr. SMITH. YOU could not exempt State bonds in their entirety
at the present time, Senator.
Senator ADAMS. Why not?
Mr. SMITH. Because they do not all fall in the same class.
Senator ADAMS. Why not?
Mr. SMITH. Because they are not all the same. Some States of
our Union are in default at the present time.
Senator ADAMS. Therefore you would exclude all of them?
Mr. SMITH. YOU would have to exclude them from an action of
this sort.
Senator WALCOTT. But you exclude them all.
Mr. SMITH. Well, you give authority to the Federal Trade Commission. I am not arguing for the provision.
Senator WALCOTT. In other words, you want to put in the hands
of the Federal Government an agencj
Mr. SMITH (interposing). No; I beg your pardon^ Senator. The
bill as submitted to us puts that power there and gives an option.
We were not asked to state whether that was satisfactory but it is
satisfactory to us.
Senator WALCOTT. YOU, as an American citizen, are willing to have
a special board of the Federal Government have absolute authority
as to the credit of a State or a municipality. You must be. You
must take that position, if you take the position you do.
Mr. SMITH. I am sorry, I cannot agree with you.
Senator KEAN. I think the position that he took was a position
that he was an officer of the Treasury and was not acting in any
other capacity, and therefore, as long as the United States bonds
were excluded, why, that was the extent that he went.
Senator ADAMS. I suppose if he had represented district 20 from
your county, all he would want would be the bonds of district 20.
Senator KEAN. Absolutely.
Senator ADAMS. But that would not help this committee.
Senator TOWNSEND. What have you to say as to whether the
authority should be lodged in the Federal Trade Commission instead
of the Treasury or the Federal Eeserve Board ?
7478
STOCK EXCHANGE PBACTICES
Mr. SMITH. We were asked whether the arrangement as submitted was satisfactory, and we said, " Yes; it is." We were not
asked any preference at all; just, is the section as submitted satisfactory?
The CHAIRMAN. Mr. Smith, may I ask you, outside of your official position, without regard to speaking for the Treasury or anybody else, but as a banker and as a citizen, do you see any objection to including in the exemption State and municipal bonds?
Mr. SMITH. Mr. Chairman, if you please, I prefer not to express
a personal opinion, but as we considered that subject in our studies
and felt that there should be some distinction between the State
issues as such.
Senator GORE. Mr. Chairman, I move we excuse Mr. Smith from
further testifying and strike his statement from the record.
Senator TOWNSEND. I want to ask one question: Mr. Smith, you
state that you were asked to approve this set-up. Who were you
asked by?
Mr. SMITH. Asked to approve what?
Senator TOWNSEND. TO approve the set-up as given to you. Who
submitted it to you?
Mr. SMITH. The bill was submitted to us by Messrs. Corcoran^
Cohen, and Pecora.
Senator GOLDSBOROUGH. Finally, so that I may get it, I understand
the Treasury is not in a position to express any opinion as to the
matters of stock-exchange practices?
Mr. SMITH. That is correct. I t was not submitted for our study*
Mr. PECORA. Mr. Smith, in order to clear up any possible misunderstanding, from an answer that you made to a question that I
believe was put to you by Senator Kean about whether or not the
Treasury Department approved the provisions of section 6, section 6
is the section that deals with margins, and you said, as I recall it,
that it might be construed as a statement that the Treasury Department did not approve section 6. Did you mean to say that you had
no opinion to express bout section 6 one way or the other because
that section was not referred to you by the Secretary for study?
Mr. SMITH. Part of it was submitted to us for study and approved*
and the other part was not submitted, and therefore we have no
opinion concerning the other part of it. There is no disagreement
between us about that at all.
The CHAIRMAN. Very well; we are much obliged to you, Mr.
Smith. Now, Mr. Whitney.
Senator ADAMS. Mr. Chairman, I rather think that there is some
disclosure in this little memorandum of some things which I do not
think the Treasury really wanted to let us know, because they have
discovered one or two things in reference to uniair practice in the
stock exchange, and I do not believe they mean to express any
opinion even as to the purpose of the bill.
The CHAIRMAN. Well, they did express it.
Now, Mr. Whitney, will you take the stand ?
STOCK EXCHANGE PEACTICES
7479
STATEMENT OF RICHARD WHITNEY, PRESIDENT NEW YORK
STOCK EXCHANGE, NEW YORK CITYr-Resumed
The CHAIRMAN. Mr. Whitney, you wrote me a letter, which I
might put in the record, asking to be heard on this matter; and you
stated, I think—
I shall be glad to appear before your committee at any time you may designate and state the reasons for my conclusions I am also prepared to suggest
to the committee the changes which would be necessary to make the bill workable without in any way limiting the power to control credit and regulate
stock-exchange practices
That is very interesting, and we will be glad to hear from you, Mr.
Whitney.
(The letter is as follows:)
NEW YOKK STOCK EXCHANGE,
Eleven Wall Street, March 21, 1984
Hon DUNCAN U FLETCHEK,
Chairman Committee on Banking and Currency,
Senate Office Building, Washington, D C.
MY DEAR SENATOR FLETCHEK I am mfoimed that the new Rayburn bill, now
pending in the House committee, will be considered by your committee. Recalling your statement that when amendments to the original Fletcher-Rayburn
bill were prepared persons interested would be given a hearing, I respectfully
request that time be allowed to me to state to the committee the objections of
the New York Stock Exchange to the new measure.
I believe that the new bill will prove unworkable m essential features and
will seriously affect security markets and security prices It differs from
the
original bill in its treatment of many important points, but its effects4 will
be almost as destructive as those of the original bill
As this bill is of vital concern not only to stock exchanges but also to all
business and industry, it deserves the most serious consideration
I shall be glad to appear before your committee at any time you may designate and state the reasons for my conclusions. I am also prepared to
suggest to the committee the changes which would be necessary to make the
bill workable without in any way limiting the power to control credit and
regulate stock-exchange practices.
Faithfully yours,
RICHARD WHITNEY, President.
Mr. WHITNEY. Mr. Chairman, I haven't a very long statement to
make. I do think if it could be made consecutively without adjournment, it would be better for all of us. Would you prefer
having me appear tomorrow, or may we have about an hour?
The CHAIRMAN. I think we had better go on now, Mr. Whitney.
Senator ADAMS. HOW long a statement have you ?
Mr. WHITNEY. Depending upon the questions, Senator Adams.
The CHAIRMAN. I think you better make your statement without
interruptions.
Mr. WHITNEY. I am very glad to be interrupted as much as
you wish.
The CHAIRMAN. We can ask questions afterwards.
Senator WALCOTT. I suggest, Mr. Chairman, he be allowed to read
straight through and then have the questions asked afterwards.
The CHAIRMAN. Yes; that is the proper thing to do, to save time.
Mr. WHITNEY. I understand that the bill introduced in the House
of ^Representatives by Mr. Eayburn and numbered H.K. 8720 is
being considered by this committee as if it were an amendment to
the Fletcher-Kayburn Bill. The New York Stock Exchangef is op
7480
STOCK EXCHANGE PBACTICES
posed to the new Rayburn bill because it contains in substance the
same objectionable features as the Fletcher-Rayburn bill. The
Rayburn bill, which for the purpose of this discussion I will consider
as a bill pending before this committee, contains modifications of
some of the provisions of the original bill. Our basic objections to
the old bill apply, however, with equal force to the Rayburn bill.
There is not time to discuss all of its provisions and I shall, therefore, confine my remarks to the most vital sections. I shall deal
only with sections 6 $nd 8, which refer to margin requirements and
the restrictions on members' borrowings; section 10, which deals
with segregation of the functions of broker and dealer; sections 11
and 12, which deal with the requirements for the registration of
securities and the reports which will be required of corporations
whose securities are registered on an exchange; and section 18, which
deals with the powers of the Commission over exchanges. There
are many other sections of the bill which, m my opinion, should be
amended.
Before discussing any provisions of the bill I want to make my
position absolutely clear. I think this bill is unworkable and will
have destructive effects not only upon stock exchanges but also upon
the value of securities and the business of the country. I do not believe that sound legislation can be based on the framework of this
bill. However, I understand that the committee would like to have
constructive suggestions for the improvements of the Rayburn proposal. I shall, therefore, suggest specific amendments to the sections
of the bill which contain the most harmful and unworkable provisions. In making these suggestions I do not# wish to be understood
as qualifying in any way my fundamental objections of the bill.
The amendments which I shall propose did not emanate solely
from the New York Stock Exchange. They were discussed with
representatives of the New York Curb Exchange, the Boston Stock
Exchange, the Chicago Stock Exchange, and also with the president
of the Association of Stock Exchanges, which is composed of 18
stock exchanges located in all parts of this country. The representatives of these exchanges have indicated to me their entire approval of the suggestions which I am about to make.
Section 6, with regard to margin requirements: Section 6 of the
bill purports to vest control of margin requirements in the Federal
Reserve Board. However, it restricts the power given to the Federal
Reserve Board by prescribing rigid minimum margin requirements,
which are based upon percentages of current market value or of the
lowest price which a security has reached within 3 years preceding
the date of the loan, provided, however, that until July 1, 1936, the
lowest price at which a security has sold since July 1, 1933, may be
taken in lieu of the lowest price in the 3-year period preceding the
loan. Different minimum margin requirements are established for
the initiation of a loan and its maintenance.
Furthermore, there is a provision to the effect that loans existing
on the date of the enactment of the bill will not be subject to the
minimum margin provisions until January 31, 1939. This last provision was admittedly intended to prevent a forced liquidation of
existing loans, which would necessarily follow if the margin requirements of the bill became immediately operative. Let me call to your
STOCK EXCHANGE PRACTICES
7481
attention that declining markets resulting from the enactment of this
bill would bring in their tram the very liquidation you seek to
forestall by this provision.
I have already said that I consider the margin requirements of the
original Fletcher-Eayburn bill excessive. While the margin requirements of the pending bill are more liberal at this moment due to prevailing market prices, they would in the event of a rise in security
values reach the same excessive level as was fixed in the FletcherRayburn bill. In brief, the margin requirements of this bill and the
Fletcher-Rayburn bill are both defective, in that they base credit
solely upon a percentage of market value or upon the lowest market
price reached within arbitrary periods of time.
Earnings, likewise, cannot be used as the sole criterion of value for
securities. The loan value of a security must be determined by a consideration not only of earnings and market value but of the size and
activity of the particular issue, its distribution among investors, the
extent to which it is held in loans or margin accounts, the volatility
of the security and the general condition of the market and of the
industry in which the security represents an interest. These are the
factors which reasonable men must consider in determining the
amount of credit which can be advanced upon security collateral,
and they cannot be reduced to a formula.
The control of credit necessarily involves the use of judgment,
and excessive speculation in securities can only be prevented if the
persons controlling credit are thoroughly familiar with credit conditions and have full power to raise or lower margin requirements as
circumstances may require. In our opinion, therefore, the Federal
Reserve Board, which is already vested with power to control the
credit resources of the country and which now has the responsibility
for such credit control, should be given full power to fix such margin
requirements as it may deem necessary in view of economic
conditions.
To accomplish this result, I suggest that section 6 of the bill be
amended to read as follows:
SEC 6 It shall be unlawful for any member of a national securities exchange or for any broker or dealer transacting a business in securities through
any such member, directly or indirectly, to extend or maintain credit to oi for
any peison in contravention of such rules as may be adopted from time to time
by the Federal Reserve Board for the purpose of preventing the excessive
use of credit for speculation
Another section which directly refers to credit conditions is subsection (a) of section 7, which deals with brokers, borrowing from
nonbanking institutions. We believe that the Federal Reserve Board
should likewise be given full power over this subject, and we, therefore, suggest that section 7 be amended so as to read:
SEC 7 It shall be unlawful foi any member of a national securities exchange
or for any broker or dealer who tiansacts a business in securities through the
medium of any such member, directly or indirectly, to secure the repayment
of anv money boriowed by the pledge or hypothecation of any securities in
contravention of such rules and regulations as may be adopted from time to
time by the Federal Reserve Board for the purpose of preventing the excessive
use of credit for speculation
We suggest that the substance of the other subsections of section
7 be transferred to section 18 of the bill, which I will discuss
later on.
7482
STOCK EXCHANGE PRACTICES
Section 10 dealing with the functions of broker and dealer: Section 10 of the bill deals with the segregation and limitation of the
functions of broker, specialist, and dealer. It has been changed so
as to permit memuers to combine, under certain safeguards, the
functions of dealer and broker, provided they do not act as dealers
on the floor of the exchange.
The section still prohibits the function of broker and dealer being
combined by a member when on the floor of the exchange. This
limitation will effectively put out of business all bond brokers, because they customarily act as dealers and also will put out of business all specialists. It will make it impossible for the odd-lot business to be carried on except on the New York Stock Exchange,
which, alone of all the exchanges m the country, has some members
who engage exclusively in the odd-lot business.
I cannot believe it is wise to make such a revolutionary change in
the accustomed method of doing business until it is shown that any
possible abuses cannot be eliminated in some less drastic manner. I
suggest, therefore, that this section be amended so as to allow the
•Commission to adopt such rules and regulations as it may deem
necessary in regard to members of an exchange combining the function of dealer and broker when actually engaged in business on the
floor of the exchange. This suggestion will give the Commission
full power to change and correct its rules as conditions may require.
Such a power is essential to experimental regulations in so technical
a field and is not possible under fixed rules of law.
I suggest, therefore, that section 10 be amended so as to read:
SEC 10 (a) It shall be unlawful for a member of a national securities
exchange, while on the trading premises of such exchange, to act as a dealer
and broker in contravention of such rules and regulations as the Commission
may prescribe as necessary or appropriate in the public interest or for the
protection of investors
(b) Subject to such rules and regulations as the Commission may prescribe
as necessary or appropnate in the public interest or for the protection of investors, to insure compliance with the provisions of this subsection, the rules of
a national securities exchange may provide for the registration of members
with the privilege of acting as dealers, and any member so registered shall
have the privilege of acting as a dealer and as a broker within the limitations
of this subsection It shall be unlawful for a member with the privilege of
acting as a dealer who also acts as a bioker to effect any transaction in a
security by use of any facility of a national securities exchange or otherwise,
(1) if in connection with any such transaction he directly »r indirectly extends
or maintains or arranges for the extension or maintenance of credit for a
customer on any security (other than an exempted security) which was a part
of a new issue offered to the public by him as a dealer or distributor within 6
months prior to such transaction, or (2) unless, if the transaction is with a
customer, he discloses to such customer in writing any interest he may have
in connection with the security which is the subject matter of the transaction
and offers the customer of a reasonable time, not exceeding 10 days, to refuse
the transaction after the disclosure if the disclosure is not made at the time
of the taking of the order and confirmed in writing substantially simultaneously
therewith
Sections 11 and 12, registration requirements for securities, corporate reports: Sections 11 and 12 deal with the registration requirements for listed securities and the reports to be made by listed corporations. These provisions are among the most vital in the bill.
1 have already expressed our opposition to them. In view of the
technical nature of these provisions and particularly of those dealing
with accounting, I have secured from Mr. J. M. B. Hoxsey, execu-
STOCK EXCHANGE PEACTICES
7483
tive assistant to the committee stock list of the New York Stock
Exchange, a memorandum discussing these provisions and suggesting the changes which in the light of his experience he believes necessary, Mr. Hoxsey has been engaged in active business for many
years and has had a very wide experience in analyzing corporate
accounts and corporate affairs. Since he came to the exchange about
10 years ago it has been his sole duty to analyze corporate accounting
from the point of view of developing for the benefit of stockholders
and investors the most informative type of corporate reports. As
Mr. Hoxey's memorandum is quite lengthy, I shall not read it, but I
have had copies of it prepared which I shall submit to you.
(Copies of the memorandum were distributed to members of the
committee.)
In line with my attempt to make concrete suggestions, I am having
these sections of the bill redrafted in order to carry out the recommendations made by Mr. Hoxey and I shall submit copies of these
proposed amendments as soon as they are prepared.
The CHAIRMAN. May I ask, Mr. Whitney, if you will indicate
when those will be presented 1
Mr. WHITNEY. The memorandum is here in printed form, and
the others will be in your hands in printed form by Monday morning.
Mr. PECORA. May I take advantage of this interruption to ask you
a question, Mr. Whitney ? The last time I heard of Mr. Hoxsey was
about 3 weeks ago, when Mr. Altschul, one of your board of governors, was before this committee. He then said Mr. Hoxsey was
in South America. Has he returned?
Mr. WHITNEY. He has returned, yes. I think he got back about
a week and a half ago.
Powers of Commission over exchanges; referring to section 18:
I have already suggested that certain provisions of section 7
should be transferred to section 18 which deals with the disciplinary
powers of the Commission over exchanges. In order to carry out
this suggestion and also to make clear that the Commission shall
have power to require exchanges to adopt rules and regulations to
prevent excessive speculation or unfair practices in security transactions, I suggest that subdivision (5) of section 18 be amended so as
to read:
SEC 18 The Commission is authorized—
Then, gentlemen, leaving m the present subsections 1, 2, 3, and
4, we come to subsection 5
If after appiopnate request in writing to a national securities exchange that
such exchange should effect on its own behalf specified changes in its lules and
practices, and after appropnate notice and opportunity for hearing, the Commission determines that such exchange has not made the changes so requested,
to require such exchange to adopt and enforce such rules and regulations as are
necessary for the protection of investors or for the insuring of fair dealing m
secunties traded m upon such exchange Without limiting the general power
contained m this subsection, the Commission shall have power to require any
national securities exchange to adopt lules and regulations with respect to—
(a) Market letters, advertising, or other publicity by its members and the
solicitation of business by its members or their employees
(&) Pools, syndicates, and joint accounts formed for the purpose of stabilizing
or otherwise influencing the market price of any security registered on a national securities exchange and also with respect to options, puts, calls, straddles
or other similar privileges
7484
STOCK EXCHANGE PBACTICES
(c) The amount and nature of the capital employed in Ms business by a
member of such national securities exchange carrying margin accounts and the
ratio which must be maintained of such capital to the liabilities of such member.
(d) The short sale of any security upon such national securities exchange
(e) The acceptance and execution of stop-loss orders by members of such
national securities exchanges
(f) The hypothecation of securities carried for the account of any customer
by a member of such national securities exchange or the lending of such securities without the written consent of such customer or the use of such securities
for delivery on any contract in which such member is, directly or indirectly,
interested.
(g) The fixing of a fair settlement price in lespect of any contracts in any
security registered on such national securities exchange which has been coinered or of which any person or persons have acquired such a control that
such security cannot be obtained for delivery on existing contracts except at
prices or on terms arbitrarily dictated by such person or persons
(h) The books and records to be maintained by members of such national
securities exchange and the right of such exchange to require, periodically ©*
otherwise, reports in regard to the transactions and affairs of the members of
such national securities exchange and the duty of such members to permit the
officers or representatives of such national securities exchange and of the
Commission to examine such books and records
In some respects these suggestions go further than anything contained in the bill. If they are adopted, a large part of section 7
and the whole of sections 9 and 16 should be eliminated.
These provisions give the Commission ample power to require
exchanges to adopt rules for the prevention of excessive speculation
and unfair practices in security transactions. To correct these
abuses it is not necessary to give the Commission power to prescribe
the method of electing officers and committees, the hours of trading,
the time and method of making settlements, payments, and deliveries by members and customers, and so forth. To exercise such powers is not to supervise or regulate exchanges, but is actually to operate them.
Other provisions: There are many other provisions of the bill
which should be amended or qualified. This is true of section 8.
which describes manipulative transactions in very broad terms; ot
section 13, which makes the solicitation of proxies a crime; of section 15, which prohibits officers, directors, and principal stockholders
of listed corporations from buying and selling equity securities of
such corporations within any 6 months' period; of section 252 which
imposes excessive criminal penalties; and of section 30, which imposes registration fees on national securities exchanges.
I mention these sections only in passing because of the limitation
of time. They are of very grave importance, but are less so than
those which I have chosen to discuss in more detail. I trust some
means may be found to convert them and other sections which I
have not mentioned into fair and temperate legislation.
My conclusion: Finally, I wish to state as emphatically as I can
that it is my belief, based upon my experience, that the adoption
of the bill in its present form would seriously disrupt our organized
security markets and American business. It is impossible to forecast all of the consequences of such an event, but at least it is certain
that it would cause great loss to individual security owners and
would delay for an indefinite period the present recovery program.
In addition, it would also tend to drive the security business of the
country away from the organized stock exchanges and into the un
STOCK EXCHANGE PRACTICES
7485
organized over-the-counter markets which exist in every financial
center. Proper and orderly regulation of security practices is possible when transactions take place on stock exchanges, but it is almost
impossible to regulate unorganized over-the-counter markets.
The New York Stock Exchange has been charged with opposing
fhe bills pending before this committee for the sole purpose 01 avoiding any form of Federal regulation. There is na foundation or
truth whatever for these charges. The exchange authorized me
when I appeared before this committee last month to make a definite
proposal looking toward the adoption by Congress of a sound regulatory law.
These untrue charges arise out of a fundamental difference of
opinion between the proponents of the bill and the authorities of the
stock exchanges as to the proper scope of Federal control. The
theory of the proponents of the bill is to provide a measure of Federal control far beyond the limits of what is necessary to correct possible abuses. They insist that certain rigid and unworkable statutory provisions be substituted for the discretion of the administrative
agencies which they have selected to control the security business
of the country. Our proposal is to give the Federal Reserve Board
unrestricted power to control credit for the prevention of excessive
speculation and to give to an administrative Federal authority ample
power to make, amend, and modify rules for the regulation of exchange practices after having achieved thorough knowledge of the
subject as a result of careful study. It is our view that the scope of
Federal control should be limited to the minimum necessary to prevent unfair practices in security transactions, leaving to the exchanges the responsibility for actual operation.
We are in entire agreement with the proponents of the bill in the
belief that the law should be provided with " teeth " and should
impose criminal penalties upon all unfair practices on exchanges.
The New York Stock Exchange and the other leading exchanges
of the country have suggested amendments to the Rayburn bill,
not because they consider it a sound measure but solely for the purpose of correcting the entirely unworkable and destructive provisions
of the bill. The purpose of the exchanges in making these suggestions is to preserve for the benefit of the American people the safeguards which exist today by reason of the public character of transactions on organized stock exchanges.
We are in the process of recovery. If normal conditions are to be
restored business must revive. The securities dealt in on American
stock exchanges represent a large part of the liquid capital of the
Nation. The market value on March 1, 1934, of the securities listed
on the New York Stock Exchange alone exceeded $73,000,000,000, or
substantially one quarter of the estimated total wealth of the entire
Nation. This is no time for hasty or ill-considered legislation which
might freeze such a large part of the liquid resources of the country.
The New York Stock Exchange and, I am sure, every other exchange in the country stand ready to furnish your committee with
ail the technical and expert advice at their command and to assist
in drafting amendments to the pending bill or in drafting a new bill,
which will give whatever administrative authority may be chosen,
full power to prevent excessive speculation and to regulate unfair
7486
STOCK EXCHANGE PEACTICES
practices in security transactions. They are, however, united in
opposing legislation which may destroy the security markets of the
Nation.
The CHAIRMAN. Are there any questions of Mr. Whitney?
Senator WALCOTT. I would like to ask you, Mr. Whitney, whether
you think, in addition to what you state there, that there would be
very severe withdrawals on the part of large corporations from the
stock exchange if we pass such a bill? I have received word from
three of the largest in the country that they would immediately
withdraw. What is your impression of that?
Mr. WHITNEY. Senator Walcott, I am confident that there would
be tremendous, if not universal, withdrawal if the bill is passed in
the present form.
Senator WALCOTT. In that event it would throw those securities
open to street barter, would it not ?
Mr. WHITNEY. TO the so-called " bootleg " markets; yes, sir.
Mr. PECORA. If the bill were to be revised in accordance with the
suggestions embodied in this statement, do you think those withdrawals of listed securities would also follow f
Mr. WHITNEY. NO, sir. I think it would very greatly diminish
any such withdrawals along the lines of the amendments suggested
by Mr. Hoxey and ourselves.
Senator ADAMS. Mr. Whitney, I gathered from one of the earlier
parts of your statement that you are of the opinion that the enactment of the bill would result in a decline in values of securities, both
listed and unlisted.
Mr. WHITNEY. I believe so, sir.
Senator ADAMS. We had an instance before the committee some
time back of a very large institution that withdraw its securities
from the stock market rather because the effect of their being listed
was to reduce their value, due to the fact that they felt that they
were better able to retain their values without that free interchange
of opinion which takes place on the stock exchange.
Mr. WHITNEY. If we are speaking about the same security, then
we were in a very different position as far as world-wide conditions
were concerned. We were in a rising market and, insofar as the
exchange has knowledge, Senator Adams, at that time the reason
was that the very wide fluctuations in that particular bank stock
that took place on the exchange and were printed on the ticker and
got such, universal or world-wide notoriety were injurious to the
stockholders of the bank.
Senator ADAMS. I gather from the use of the last words that you
and I agree.
Mr. PECORA. YOU might recall, Mr. Whitney—if you and I are
thinking of the same bank stock—that following the withdrawal of
that stock from the exchange and its trading in the over-the-counter
market the fluctuations became much wider than they had been
while the security was listed.
Mr. WHITNEY. I would not be a competent witness. Some of the
bank-stock dealers could tell you that. I do not know that.
Mr. PECORA. That is my recollection, based upon evidence presented to this committee by me about a year ago.
Senator ADAMS. The point I had in mind was whether or not
there was any direct connection between the listing and the other*
STOCK EXCHANGE PEACTICES
7487
Of course, if your market were closed, the available opportunities
to sell would be withdrawn and the available opportunities to buy
would be withdrawn, and you might have a result, it seems to me,
either way. The fact that you break down the lines of commerce
and exchange might have the effect of raising as well as lowering,
That is, your stock exchange acts, in a measure, as an equalizing
place where the different currents of opinion meet until they reach
a point of agreement.
Mr. WHITNEY. Yes, sir; but you asked my opinion of the effect
of the entire bill if passed as it is, and in my opinion—and that is all
I am here to give, sir, together with such advice as the stockexchange authorities can give thereon—this would be of an extremely
disastrous and deflationary nature. I do not want it understood in
any regard, Senator Adams, that I am casting any aspersions on
the bank-stock dealers as such, of which there is an association in
New York of the highest standing. Bank stocks happen to have,
particularly New York bank stocks, a pretty well organized over-thecounter market. They are rather the exception. If you put the
flood of listed securities in the over-the-counter market-^—
The CHAIRMAN. We had some testimony from Detroit bankers to
the effect that they did not think it wise to list the bank stocks on
the exchange.
Mr. WHITNEY. I understand that view is fairly widely held. I
think they come in a different category than the ordinary listed
security.
Senator WALCOTT. Speaking of equity stocks generally, would you
not say that withdrawal from the large exchange, from the national
exchange, to either a curb or to street bargaining or bootlegging,
which might be the result of a drastic bill, if it were too drastic,
would tend to increase the spread because it reduces the purchases
and sales ?
Mr. WHITNEY. Unquestionably. That is one of our prime arguments against section 10, preventing specialists from trading for
their own account. It would increase the spread.
Senator WALCOTT. That, in turn, increases your gambler's chance
of making turns.
Mr. WHITNEY. Exactly.
Mr. PECORA. Mr. Chairman. Mr. Whitney in his statement makes
certain specific suggestions tor modifications of the present bill.
It is somewhat interesting to note that on page 12 he says that some
of those suggestions go further than anything contained in the bill.
It is some comfort to know that we have been conservative in some
respects anyway.
He also has indicated that other amendments which he would like
to propose to the present bill would be presented here in written form
on Monday. I think it might be profitable to defer any further
consideration of these things with Mr. Whitney until we have before
us all those amendments in the definite form in which he wants to
propose them. Then, beginning with Monday morning, we could
begin to go over all your suggestions, those presently made and those
to be presented on Monday. In that way we would not have to take
two bites at the cherry.
Senator ADAMS. Will your statement be available ?
175541—34—PT 16
6
7488
STOCK EXCHANGE PRACTICES
Mr. WHITNEY. The statement that I have just made, sir?
Senator ADAMS. Yes.
Mr. WHITNEY. It will be available, I think, tomorrow. This
statement, Senator Adams, is very nearly identical, with some
changes, with what I said to the itouse yesterday morning. That
is printed. This will be printed, also. The amendments, at least,
are identical.
Senator WALCOTT. Of course, they apply to the same bill.
Mr. WHITNEY. Mr. Pecora, to those further amendment to which
I referred, they are contained m the printed form that I just gave
you, compiled by Mr. Hoxey. The reasons are given in that printed
form, and in order to clarify it and make it more simple, we are
drafting a paper that will show merely the amendments.
The CHAIRMAN. I t will show these amendments that are mentioned
in this memorandum?
Mr. WHITNEY. Exactly; it is really supplemental to that. But,
of course, if it is your wish for me to appear here Monday, I shall
be delighted to.
The CHAIRMAN. I do not want to ask an impertinent question, Mr.
Whitney, and I suppose it is unnecessary. If these amendments
which you propose were incorporated in this bill would there be
any further objections to the bill?
Mr. WHITNEY. There would be objections to the bill, as to some
of the other sections which I have not specifically touched on today.
I think we would be prepared, sir, to answer those specifically, section by section, sometime next week if that is your desire.
Mr. PECORA. Why would it not be proper, then, to have Mr.
Whitney submit his specific objections to such other provisions, so
that they may be considered during the present stage of the hearings, while the committee is engaged in considering objections to
the bill in its present form? I think it ultimately would prove a
timesaver and a labor saver.
Mr. WHITNEY. We shall be very glad to submit, together with
these amendments we have already presented, amendments to each
and every section of the present pending bill by Monday morning,
we hope. This is quite a task, gentlemen, as Mr. Pecora knows
himself. We have spent most of our nights recently on this thing.
Senator WALCOTT. Let me understand. Mr. Whitney, you listed
at the close of your remarks certain sections that you thought ought
to be changed somewhat. I have a note of them here.
Mr. WHITNEY. Yes,
sir.
Senator WAiiCOTT. Let us see if we understand—sections 8, 13, 15,
25, and 30.
Mr. WHITNEY. That is right, Senator Walcott, and there are some
others too.
Senator WALCOTT. YOU mean that by Monday you think you could
have something for us to consider on all those points ?
Mr. WHITNEY. On all sections of the bill where we suggest changes
or amendments, having already given you those applying to sections 6, 7, 8, 9, 10,11,12,13
Senator WALCOTT. Not 13.
Mr. WHITNEY. NO ; sections 18; and 16 to be eliminated.
STOCK EXCHANGE PRACTICES
7489
The CHAIRMAN. YOU suggested the elimination of only two, as I
recall, sections 9 and 16.
Mr. WHITNEY. Nine and 16; and 7 largely eliminated, and what
was left put into section 18.
Senator WALCOTT. Mr. Chairman, I move that we request Mr.
Whitney to prepare these data for us and submit them to us at the
earliest possible date, not later than Tuesday, and that he be here
himself to present the case.
(The motion was duly seconded and agreed to.)
The CHAIRMAN. I think that is all agreed to, Mr. Whitney.
Mr. WHITNEY. Thank you, sir. We shall be here.
Senator GORE. Have you an extra copy of your statement?
Mr. WHITNEY. Yes, sir.
Senator WALCOTT. Mr. Whitney,
for the sake of your authority
when you come here next week, can you not consult with some representatives, for instance, of the Philadelphia, Washington, and Chicago exchanges, and so forth?
Mr. WHITNEY. I was just going to suggest that
Senator WALOOTT. SO that we may have a concrete illustration
of the principal exchanges here.
Mr. WHITNEY. What I have just read to you, and the amendments
contained therein, has the approval of the representatives of the
Chicago and Boston exchanges, and of the president of the Association of Stock Exchanges, as well as the representatives of the
New York curb. We would not think of presenting anything here
that was our idea alone. We will certainly get the criticism and
advice of those others to whom we have already referred. That
is your desire?
Senator WALCOTT. Yes. I think that is the better way to do it.
It will save a lot of time.
Mr. WHITNEY. We have not any thought of doing it any other
way.
Senator WALCOTT. Would you take in, for instance, a mining exchange? Probably not.
Mr. WHITNEY. 1 do not know of any representatives of the
Senator WALCOTT. The only one that occurs to me is the one that
has been referred to in the various meetings, the Miners' Exchange
of San Francisco. I think Senator McAdoo has referred to it two
or three times. I do not know that it is important at all.
Mr. WHITNEY. There is a representative here from Los Angeles
with whom we would certainly desire to consult.
Senator WALCOTT. That would represent California, and you
would, of course, take care of the question of open market and overthe-counter transactions.
Senator ADAMS. Mr. Whitney, has the prospect of the passage of
the bill had any effect on the value of memberships on your exchange?
Mr. WHITNEY. They have sold down $80,000 between sales; yes,
sir. The last sale was $190,000, and this week one sold at $110,000
and another sold at $105,000. I think it is correct to say that on
the curb exchange a similar reduction took place, or proportionately
so.
Mr. PECORA. That would be due to the fact that they believed
undue speculation was going to be curbed?
7490
STOCK EXCHANGE PEACTICES
Mr. WHITNEY. I think it was occasioned by a great many facts.
The CHAIRMAN. And Canadian seats went up.
Mr. WHITNEY. Canadian seats went up—perhaps London, too, but
I am not informed. So long as you ask that question, Senator Waicott, this fact might interest you. We were quoted today a cablegram
received by a member here in New York from his correspondent m
Londong [reading]:
Considerable amount of straight American orders to buy American stocks
coming to London English brokers willing to carry American stocks on 10peicent margin only, one commission to pay for a month's run.
I am not trying to bring up the bugaboo of business running out of
the country. This is gratuitous. I did not seek it.
Senator WALCOTT. That is regardless of settlement days, too. They
have a fortnightly settlement over there.
The CHAIRMAN. We are very mush obliged to you, Mr. Whitney.
We will see you, then, either Monday or Tuesday.
Mr. WHITNEY. We will try to be ready Monday. Will it be proper
for us to advise Mr. Sparkman, or Mr. Pecora?
The CHAIRMAN. Advise Mr. Sparkman.
Mr. PECORA. I am going back to New York tonight. If you are
not going to be ready until Tuesday, I will not come back until Monday. If you are going to be ready Monday, I will come back Sunday.
Mr. WHITNEY. Thank you, gentlemen. I am sorry to have taken
so much of your time.
The CHAIRMAN. There are just two witnesses here, who will be very
brief, and it will save our meeting tomorrow if we can hear them
now.
Senator ADAMS. Let us hear them.
The CHAIRMAN. I S Mr. Thompson here? Mr. Thompson, you
made a statement before the committee with reference to the original
bill. Now, with reference to this> proposed amendment to the bill,
have you some views to express ?
Mr. THOMPSON. I have, Mr. Chairman. If you are going to have
a session tomorrow I should like the opportunity to present it I
have not quite finished my memorandum.
The CHAIRMAN. We would rather go on now and finish if we can.
Mr. THOMPSON. I am not quite ready.
Senator TOWNSEND. Inasmuch as we have to hold a hearing on
Monday, if we do not have any out-of-town witnesses, why not let
him go on Monday ?
The CHAIRMAN. There are no hearings Monday. Can we not go
on tomorrow?
Senator ADAMS. We do not want to have a special meeting for
those two witnesses.
The CHAIRMAN. Can you not go on now, Mr. Thompson?
Mr. THOMPSON. I have not my data complete. I do not have my
memorandum with me.
The CHAIRMAN. YOU can supply that later for the record.
Mr. THOMPSON. I do not have it with me. It is being written
now.
The CHAIRMAN. I S Mr. Chinlund here?
STOCK EXCHANGE PBACTICES
7491
STATEMENT OF EDWIN F. CHINLTJND, REPRESENTING CONTROLLERS INSTITUTE OF AMEEICA, NEW YORK CITY
The CHAIRMAN. Mr. Chinlund, do you have any views to express
arding this proposed amendment?
fr. CHINLUND. Representing the Controllers Institute of AmerSenator GORE. That comprises what membership?
Mr. CHINLUND. That represents an institute which is made up of
the controllers of corporations of the country. It has about 300
members, which represent the controllers of many of the companies
listed on the exchange.
The CHAIRMAN. Proceed, Mr. Chinlund.
Mr. CHINLUND. I submitted a statement to the committee about
2 weeks ago, and in the revised H.R. 8720 I notice that some modification has been made of sections of which I recommended modifications at that time.
I want to state that under sections 11 and 12 I made the statement
that the necessary work to be completed prior to the effective date
of registration oi securities under this bill would not allow ample
time for the completion of the work necessary to accomplish that
purpose, or to complete the audits provided by certified public accountants under the bill. The revised bill has given authority for
a 6 months' extension which, in my opinion, is not adequate if the
amount of audit required remains the same.
I made the further suggestion that the purposes of the bill might
be better accomplished by giving the Federal Trade Commission,
or whatever regulatory body has control, the right of approval of
the rules of the exchange for listing, instead of taking on its own
shoulders an implied approval of listings by failure to take action
during the 30 days provided in the bill.
Senator GORE. State that again.
Mr. CHINLUND. Under the provisions of the bill as originally
written, and as still retained in the present bill, the Federal Trade
Commission has 30 days after the filing of a registration statement
during which period it can question the listing. If they take no
action, the exchange has the authority to complete the listing. I t
seems to me that is an implied approval, even though the Commission may not have had time to study the voluminous data which
would have to be filed for that registration. It seems to me that that
is a dangerous responsibility for the Government to vest in the
Federal Trade Commission, in that investors undoubtedly in many
cases will put more weight on the implied approval of the Federal
Trade Commission for listing than rightfully belongs there.
Senator GORE. Would you extend the time, or what is your
recommendation ?
Mr. CHINLUND. My recommendation is that instead of burdening
the Federal Trade Commission with the terrific amount of detailed
work to approve listings or disapprove listings during the period
that they have time to disapprove them, that they modify the bill to
give the Federal Trade Commission authority over the rules and
regulations of the listing committees of the exchanges, which will
accomplish all the purposes of protection of the investor without
creating the implied approval by the Federal Trade Commission,
7492
STOCK EXCHANGE PEACTICES
particularly since the period of time they will have to study the data
filed is probably not adequate without building up a terrific force.
Senator GORE. And let it go at that, without any final approval?
Mr. CHINLTJND. Without any final approval or disapproval of
issues. There is no final approval provided for in the bill, but there
is an implied approval in the fact that if they do not disapprove in
30 days the exchange can go ahead.
I have various other comments to make, but since intending to
make them I have read in the papers of the statement made by Mr.
Hoxey. I have not read it in detail, but his recommendation, as
I read it in the papers last night, was that the Federal Trade Commission have the authority to approve the rules and regulations of
the listing committee, with which the Controllers Institute, as representing the corporate officers who would be responsible for the
accumulation of a great part of the information, I am sure are in
full agreement.
That is the extent of my statement.
The CHAIRMAN. If that is all, we are very much obliged to you.
Are there any questions of this witness. [No response.]
We have notified some people who have inquired that we would
hold hearings today and tomorrow and that we would conclude
them tomorrow. There are one or two whom we have not heard,
and we do not know whether they are coining or not, but they may
come. Therefore, I think we had better adjourn until tomorrow at
10:30 and give them an opportunity to be heard at that time.
(Whereupon, at 4:40 p.m. Friday, Mar. 23, 1934, an adjournment
was taken until tomorrow, Saturday, Mar. 24, 1934, at 10 30 am.)
As an amendment to the bill regulating security exchanges, the Federal
Reserve Board wishes to reiterate its recommendation made 2 years ago for
basing member bank reserve requirements not solely on the volume of deposits
but also on the rapidity of their turnover, m other words, on the extent to
which the deposits are utilized
Member bank reserve balances aie high-power money On the basis of
$1,000,000,000 of excess reserves, member banks can extend credit amounting
to between 10 and 15 billion dollars without having to resort to borrowing at
the Federal Reserve banks. The volume of excess reserves at the present time
is one and one half billion dollars, and these excess reserves fuithermore may
increase greatly when a period of credit expansion sets in Under existing
law national banks can issue an additional $700,000,000 of bank notes, which*
when deposited with the Federal Reserve banks add to the reserves of member
banks There is also still a billion or a billion and one half of currency that
has not returned from hoarding but is likely to be utilized and thus flow back
into the banks when an expansion sets in In these circumstances, if an expansion of credit should get under way, the member banks will have a large
volume of reserves without recourse to the Fedeial Reserve banks These banks
therefore would be out of touch with the market and thus not in a position to
exert a restraining influence through discount policy
The Board's proposal carries out to its logical conclusion the existing distinction between time deposits, which require a 3-percent reserve, and demand
deposrts, which require a 7-, 10-, or 13-percent reserve, depending upon the
location of the bank The proposal would result in an automatic increase of
reserve requirements when boom conditions arise and an automatic decrease
of reserve requirements m times of depie^on The proposal furthermore has
the advantage ot making the increase in reserves applicable not to all banks m
all localities alike, but lather to those banks in those communities only where
excessive speculative activity is manifesting itself If this proposal weie
adopted, its operation, together with the authority existing under the Thomas
amendment to raise reserve requirements with the consent of the President
when an emergency arises from excessive credit expansion, would make it
possible tor the Federal Reserve Board to combat the recurrence ot speculative
STOCK EXCHANGE PRACTICES
7493
excesses. The proposal, therefore, presents a logical complement to the bill
for the regulation of security exchanges
The pioposal would counteract two abuses that have developed under existing
law and have created serious obstacles to ciedit control One is the evasion
of reserve requirements by classifying as time deposits many deposits that to
all intents and purposes are demand deposits, a practice that has developed
since the classification of deposits in one or the other category has determined
the volume of reserves that a bank must cany And the other, the reduction
of actual reserves carried through diminishing the volume of till money which
under existing law does not count as reserve The proposal would permit
banks within certain limitations to count their vault cash as reserves and
would therefoie close the door to the practice of greatly i educing actual
reserves by diminishing cash holdings to a nominal amount
In times of great speculative activity, such as 1928 and 1929, the banks under
a law like the one proposed would have had to cany thiee or four hundied
millions of additional reseives and would, therefore, have had to increase their
borrowings at the Reserve banks by that amount This would have greatly
mcieased the power ot the System to exercise a restraining influence at an
early date On the othei hand in times of depression when deposits are
inactive member bank reserve lequirements would dimmish and there would
be a decrease in the volume of idle funds that the banks would be required to
carry as reseives In effect, the plan would supplement open-maiket operations
by the Reserve banks, by withdrawing funds from the market under boom conditions and furnishing additional funds at times of depression
The plan would also work for a moie equitable distribution of reserves as
between city banks and country banks City banks, owing to their proximity
to the Reserve banks, have been able to reduce their vault cash to a very
small pioportion of their deposits, while at country banks a much more considerable proportion has been necessary As a consequence the actual distribution of effective reserves differs from that contemplated by the law and is
much more favorable to banks in financial centers The Board's proposal
would do away with this disparity
Most important of all, however, the proposed plan would result in an increase
of reserve requnements not only at the time when such an increase will be m
the interests of sound banking conditions but also at the spot where speculative
excesses get under way, and at the banks where enhanced activity of deposits
will be caused by a using tide of speculation. Big Nation-wide booms develop
at financial centers, and this proposal by imposing restraints on speculation in
these centers without increasing the burden of idle reserves for banks in those
communities to which the boom has not penetrated, will not only be more
equitable but will serve the purpose of applying restraining influences automatically at the right time, in the right places, and to the right institutions.
With the heavy responsibilities imposed upon the Federal Reserve System in
connection with the possibilities of speculative expansion, the adoption of this
plan would place into then hands an instrument that would be of great assistance in serving the interests of trade and industry by restraining the use of
credit for speculative purposes
Concretely under the proposal, member banks would be required to cany 5
percent reserves against their net deposits plus 50 percent of the amount of
the bank's average daily debits to deposit accounts In Older to avoid too
heavy burdens in extieme cases, the proposal provides that in no case shall
aggregate reserves required of a bank exceed 15 percent of its gross deposits.
In computing their reserves, the member banks would be permitted to count
as reserves a certain proportion of their vault cash At banks in cities near
the Federal Reserve banks or branches, the banks would be required to carry
four fifths of their total reserves as deposits with the Federal Reserve banks,
while at other banks they would only be required to carry two fifths of their
reserves as balances with the Reserve banks
As an exhibit in connection with tins statement I should like to submit the
report of a committee of the Fedeial Reserve System on bank reserves presented to the Federal Reserve Board in 1931 Your attention is particularly
called to the chart on page 10 of this report which shows that demand deposits
and consequently reserve balances of member banks showed practically no
increase during the period of the greatest credit expansion in 1928 and 1929,
while bank debits during that penod increased at a veiy rapid rate Another
chart on page 19 of the report shows how under the proposed plan reserve
requirements would have risen rapidly during the expansion and would have
declined much more rapidly than actual reserves after the depression set in.
MEMBER BANK RESERVES
REPORT OF THE COMMITTEE ON BANK RESERVES OF THE
FEDERAL RESERVE SYSTEM
With the permission of the Federal Reserve Board, and pending consideration
thereof by the Board and the Federal reserve banks, the accompanying report
of the Committee on Bank Reserves of the Federal Reserve System is being
published for the information of the member banks of the system and others
interested in the subject
MEMBERS OF THE COMMITTEE
E L SMEAD, Chief Division of Bank Operations, Fedeial Reserve Board,
Chairman
IRA CLERK, Deputy Governor, Federal Reserve Bank of San Francisco.
M J. FLEMING, Deputy Governor, Federal Reserve Bank of Cleveland.
E A. GOLDENWEISER, Director, Division of Reseaich and Statistics, Federal
Reserve Board
L R ROUNDS, Deputy Governor, Federal Reserve Bank of New York
W. W. RIEFLER, Division of Research and Statistics, Federal Reserve Board,
Executive Secretary.
TERMS OP REFERENCE
The subject of bank reserves is one of the utmost importance, requuing the
most careful scientific study by experts devoting their entire time to the matter
with a view of drafting a report to the Federal Reserve Board, proposing such
amendments to the law or regulations as in their judgment may be necessary to
remove any present inequalities or defects and to establish bank reserves
throughout the country on a more logical or effective basis than now appears
to be possible under present laws, State and Federal (Resolution adopted at
the conference of governors of the Federal reseive banks, December 12, 1929 )
REPORT OF THE COMMITTEE ON BANK RESERVE® OF THE FEDERAL RESERVE SYSTEM
SUMMARY OF COMMITTEE RECOMMENDATIONS
In accordance with its terms of reference, the committee has examined the
operation of present legal requirements governing the reserves held by member banks and submits herewith definite recommendations for their improvement. These requirements are established by the Federal reserve act and apply
to all banks, both State and National, which and members of the Federal reserve
system. Changes in the law recommended by the committee are submitted
at the end of this report in the form of a proposed* amendment to section 19
of the Federal reserve act In the event this amendment is adopted, Regulation D of the Federal Reserve Board will have to be modified to meet the
changes proposed in the law Modifications recommended by the committee
are discussed in the body of the report
Defects of present reserve requirements—In the opinion of the committee,
our present system of legal requirements for member bank reserves has never
functioned effectively since its inception in 1914. It has not operated to relate
the expansion of member bank credit to the needs of trade and industry, nor
has it adequately reflected changes in the volume and activity of member
bank credit Furthermore, the committee also finds that present requirements
for reserves are inequitable and unfair as between individual member banks
and groups of member banks and do not adequately take into account genuine
differences in the character of banking m which a member bank may be engaged.
7495
7496
STOCK EXCHANGE PRACTICES
The committee takes the position that it is no longer the primary function of
legal reserve requirements to assure or preserve the liquidity of the individual
member bank The maintenance of liquidity is necessarily the responsibility of
bank management and is achieved by the individual bank when an adequate
proportion of its portfolio consists of assets that can be readily converted into
cash Since the establishment of the Federal reserve system, the liquidity
of an individual bank is more adequately safeguarded by the presence of the
Federal reserve banks, which were organized for the purpose, among others,
of increasing the liquidity of member banks by providing for the rediscount
of their eligible paper, than by the possession of legal reserves The two mam
functions of legal requirements for member bank reserves' under our present
banking structure are, first, to operate in the direction of sound credit conditions by exerting an influence on changes in the volume of bank ciedit, and,
secondly, to provide the Federal reserve banks with sufficient resources to
enable them to pursue an effective banking and credit policy Since the volume
of member bank credit needed to meet the legitimate needs of trade and industry
depends on the rate at which credit is being used as well as on its aggregate
amount, it is essential for the exercise of a sound control that legal lequirements differentiate in operation between highly active deposits and deposits of a
less active character Requirements for reserves should also be equitable in
their incidence, simple in administration, and, so far as possible, not susceptible
of abuse
Similar principles underlie the present reserve law, which in requiring
lower reserves against time deposits than against demand deposits, and lower
reserves against the demand deposits of country banks than against the demand deposits of reserve and central reserve city banks may have been
expected to impose higher reserves on more active deposits than on less active
deposits Notwithstanding the fact, however, that existing requirements would
appear to be so arranged as to make reserve requirements vary with the volume
and activity of deposits, experience shows that since 1914 and especially since
1922 the proportion of primary reserves held by member banks has steadily
declined in relation to the volume of member bank deposits and to their activity.
This outcome has been the result of detects m the definition of reserves, m
the method of determining liabilities against which reserves must be carried,
and in the classification of banks and of deposits for reserve purposes. The
exclusion of vault cash from required reseives of member banks in 1917 has
been followed by a reduction in the vault cash holdings of some city banks to
a minimum; the rule that amounts due from banks may be deducted only trom
amounts due to banks has tended to decrease reserves in times of business
activity and to increase reserves in times of depression, and the establishment
of a low reserve against time deposits in 1914 has facilitated the growth of
bank credit without a corresponding growth in reserves Even if these particular defects in the present system of reserves had not existed, however, the
rapid increase in the turnover of demand deposits which has occurred in recent
years would still have tended to prevent reserve requirements from increasing
in proportion to the growth in the effective use of credit by the customers
of member banks
Proposals of the committee—Before deciding to recommend fundamental
changes looking toward the establishment of a new basis for calculating
required reserves, the committee made every effort to frame provisions designed 1o correct the existing situation through modifications in the classification of cities for reserve purposes and in the classification of deposits
subject to reserve, including a more stringent definition of time deposits As
these proposals were studied, however, it became more and more evident that
they would not be effective and that an entirely new approach to the reserve
problem was necessary
The committee proposes, consequently, to abolish completely the classification
of deposits into time and demand deposits, and the classification of member
banks according to their location, into central reserve city banks, reserve
city banks, and country banks. Instead, the committee recommends that all
member banks and all deposits be treated alike for reserve purposes, and that
the formula used in calculating reserve requirements take into account directly,
instead of indirectly as in the existing law, the activity as well as the volume
of the deposits held by each individual member bank, without regard to the
location of the bank or the terms of withdrawal on which the deposits are
7497
STOCK EXCHANGE PRACTICES
technically held To accomplish this, the committee proposes that each member bank be required to hold a reserve equivalent to (a) 5 per cent of its total
net deposits, plus (&) 50 per cent of the average daily withdrawals actually
made trom all of its deposit accounts These withdrawals, which are shown
by debit entries on the books of members banks, are the only real test of the
activity of a deposit account and furnish the only basis by which that activity
can be equitably and effectively reflected in requirements for reserves Under
this proposal, therefore, each deposit will carry a total reserve based on its
activity as well as on its amount A totally inactive deposit will cany a total
reserve of only 5 per cent, while a deposit balance which is checked out on
the average once a week will carry a total reserve equivalent to 12 per cent
of its amount For the average member bank the total reserve "under the
proposed formula will be equivalent to about 8 per cent of its deposits To
prevent this formula from imposing too great a burden m extreme cases, the
recommendations of the committee also provide that in no case shall the aggregate reserve required of a bank exceed 15 per cent of its groos deposits
The committee proposes to include in legal reserves, m addition to the funds
which member banks have on deposit with their Federal reserve bank, their
vault cash, with certain limitations, as both classes of funds contribute to
the strength of the reserve banks and have a direct effect on the reserve system's control of changes in member bank credit It proposes also to place
-country member banks on a parity with city banks with respect to deductions
from deposit accounts by permitting banks in calculating net deposits subject
to reserve to deduct balances due from member banks and items in process of
collection from total deposits instead of from balances due to banks alone,
as is the practice at present
Volume of reserves,—The committee feels that the existing volume of reserves is sufficient at the present time to provide the reserve banks with the
funds they require to perform their functions. Its proposals, consequently,
do not contemplate a change in the total amount of reserves They are
intended rather to change the nature of fluctuations m the volume of reserves
and to iron out inequitable features m their distribution among the member
banks
A comparison of the reserve requirements proposed by the committee with
present and past requirements is presented in the following table
SUMMARY OF PAST, PRESENT, AND PROPOSED RESERVE REQUIREMENTS FOR MEMBER
BANKS
Classification of banks
Reserve required against—
Reserve held in the form of—•
NATIONAL BANKS PRIOR TO THE ENACTMENT OF THE FEDERAL RESERVE ACT
Total net deposits
Central reserve city banks
Reserve city banks
Country banks
Percent
25
25
15
In vault
All
One half
Two-fifths
In vault or on deposit with designated correspondent barks
None
One-half
Three-fifths
B. MEMBER BANKS UNDER ORIGINAL FEDERAL RESERVE ACT1
On deposit with
Net
Tune Federal
demand deposits
Reserve
deposits
bank
Central reserve city banks.
Reserve city banks
Country banks
3
Percent Percent
5
Seven-eight18
eenths
Six-fifteenths
15
12
Five-twelfths
In vault
Six-eight- Five-eighteenths
eenths
Five-fifteenths F o u r - fifteenths
Four-twelfths. Three-twelfths
This distribution of reserves wa<? to become effective m No\ ember, 1917
In vault or on
deposit with
Federal reserve
bank
7498
STOCK EXCHANGE PRACTICES
SUMMARY or PAST, PRESENT, AND PROPOSED RESERVE REQUIREMENTS FOR MEMBER
BANKS—Continued
Eeserve reQUired against—
Classification of banks
Reserve held in the form of—
C. MEMBER BANKS AT PRESENT
Net
Tune
demand deposits
deposits
Central reserve city banks,
Eeserve city banks
Country banks
On deposit with Federal reserve bank
Percent Percent
3
13
All
3
10
All
3
AU
7
D. PROPOSED BY THE COMMITTEE ON BANK RESERVES
Total
net deposits,
both
demand
and
tune
Member banks m vicinity of Federal reserve banks or branches
All other member banks
Daily
average debits to
deposit
ac
counts
vault or on deposit
On deposit with Federal Inwith
Fedeial reserve
reserve bank
bank
Percent Percent
5
50
Four-fifths..
Two-fifths. .
One fifth
Three-fifths
The calculation of net deposits subject to reserve has varied from time to
time. At present net demand deposits include total demand deposits of individuals, corporations, etc, plus the excess, if any, of demand deposits due other
banks over items in process of collection and funds held on deposit with other
banks. Under the proposed plan, net deposits subject to reserve would include
total deposits, both demand and time, less items in process of collection and
deposits with other member banks in the United States.
United States Government deposits, which have been exempted from reserve
requirements since 1917, would require reserve under the proposed formula the
same as all other deposits.
Vault cash eligible for reserve excluded national bank notes, Federal reseive
notes, and Federal reserve bank notes prior to 1917 Since 1917 no vault cash
has been eligible as reserve Under the proposed plan all kinds of currency and
cash issued or coined under authority of the laws of the United States which are
held in the vaults of member banks would be eligible to count as reserve.
FAILURE OF EXISTING RESERVE REQUIREMENTS
In the opinion of the committee, the principal purposes served by legal
requirements for member bank reserves are, first, to help to regulate the volume
of credit at member banks in accordance with the legitimate credit needs of
trade and industry, and, secondly, to insure that the Federal reserve banks at
all times have resources adequate to their rsponsibilities The committee does
not believe that it is the purpose of legal requirements for reserves to insure
the liquidity of individual member banks, nor that it is possible for legal
reserve requirements to accomplish this purpose.
Liquidity—For many years, the maintenance of liquid assets available to
meet withdrawals was regarded as the principal function of commercial bank
reserves Nevertleless, prior to 1914, when cential leserve city national banks
in this country were lequired to hold vault cash reserves as laige as 25 per
cent of both time and demand deposits they were loiced to suspend payments
at times of banking strain. The inauguration of the Federal reserve system
with its provisions for the mobilization of banking reseives and for the rediscount of member bank papei was a recognition of the fact that a commercial
bank does not guarantee its liquidity by maintaining its legal reserves. To
the extent that the member banks since 1914 have remained liquid through
STOCK EXCHANGE PEACTICES
7499
periods of unprecedented banking strain, they have been able to do so not
because of the legal reserves that they have cairied, but largely because they
have been able by borrowing at the reserve banks to convert their eligible assets
into cash.
The effect of this borrowing, furthermore, has not been confined to paper
which is eligible for rediscount at the reserve banks The mere fact that the
reserve banks stand ready to lend on eligible paper has helped to maintain
a ready market for all types of sound bank assets Under present conditions,
therefore, in which member bank reserve balances cover only 7 per cent of
their deposit liabilities, it is clear that the liquidity of the average individual
member bank can be more adequately guaranteed by the possession of a substantial portfolio of eligible paper or of other assets readily convertible into
cash in the market than by any practicable increase in its requirements for
legal reserves
As our banking system is now organized, legal requirements for member bank
leserves contribute to the security of bank depositors by providing the reserve
banks with funds available for assisting banks in emergencies and by adding
strength to the whole banking system through the exercise of eiedit control
rather than through determining the volume of reserves held by individual
member banks In order to be able to utilize the strength of the reseive banks
in emergencies, however, it is essential that the individual member bank maintain an adequate portfolio of sound assets readily convertible into cash, and,
particularly, of assets eligible for rediscount at the reserve banks
Control of credit—The most important function served by member bank
reserve requirements is the control of credit This function has a bearing on
the liquidity of bank credit, for, in the nature of things, bank credit is most
liquid when credit conditions aie sound, and unsound credit conditions do not
usually develop unless the banking community in general has expanded its
credit beyond the needs of trade and industry The overexpansion of credit
may take a particular form, such as excessive loans on farm lands, on urban
real estate, or on securities, or it may be more general applying to a wide
range of bankable assets Whatever its form, it has the effect of temporarily
inflating the general purchasing power of the community and also of raising
for a time the market value of bank assets beyond their intrinsic worth It
is the function of reserve requirements to restrain such overexpansian by
making it necessary for banks to provide for additional reserves before they
expand their credit. To perform this function adequately, however, it is
essential that reserve requirements reflect both the volume and the activity of
credit outstanding, for unsound credit conditions can develop either out of an
excessive volume of bank credit in relation to the needs of trade and industry
or out of an excessive use of a given amount of credit Credit could be
•expanded indefinitely, for example, without any inflationary effect whatever,
provided the bank deposits thus created were never drawn upon to effect an
exchange of goods or services Conversely, it is possible for an unsound credit
situation to develop without an increase in the volume of deposits, but merely
out of an increase in their activity Unsually, unsound credit conditions are
accompanied by an increase both m the volume and in the activity of deposits
In 1928 and 1929, however, during the most extravagant phases of the stock
market boom, excessive credit demands were reflected in an increase in borrowings from nonbanking lenders, and an unprecedented increase in the activity of bank deposits, without an increase in their total volume Reserve
requirements, consequently, failed completely during those crucial years to act
as a brake on the unsound use of credit.
Progressive dwunutton of member bank reserves under present requirements—Between 1914 and 1931, the period covered by our present system of
reserve requirements, total net deposits of member banks increased from
$7,500,000,000 to $32,000,000,000, or more than 300 percent in less than two
decades. Some of this increase reflects the accession of State banks to
membership in the Federal reserve system, but the greater part reflects the
expansion of member bank credit While war financing and the huge inflow
of gold which followed the war constituted the immediate driving force
back of much of this expansion, it was facilitated by a progressive reduction
in effective member bank requirements for reserves Thus, member banks
actually hold at the present time about $2,900,000,000 of reserves against
$32,000,000,000 of net deposits This includes both the legal reserves which
they hold with the Federal reserve banks and cash which they hold in their
vaults. If the vault cash reserve requirements of national banks prior to
1914 had been retained in the Federal reserve act up to the present time,
7500
STOCK EXCHANGE PEACTICES
member banks would now be required to hold about $4,400,000,000 in reserves
instead of $2,900,000,000 This means that in the aggregate total reserve
requirements ot member banks are now about 35 percent less in proportion
to their deposits than they were before the Federal reserve act was passed
It is clear, consequently, that the large expansion ot member bank credit since
1914 has been facilitated by a progressive diminution in leseive requirements
as well as by large imports of gold Without this diminution member banks
would have needed in order to expand their credit to its present volume additional Federal reserve bank credit to the extent of $1,500,000,000 By applying to the reserve banks for this additional credit, the member banks would
have correspondingly increased the effectiveness of reserve bank credit policy
Of the total decrease ot $1,500,000,000 in present requirements as compared
with pie-war requirements, about one-halt reflects the ettect of the amendment
which lemoved vault cash from required reserves in 1917, while the lemainder
reflects m pait the lowering of reserve requirements by the original Federal
leserve act, and in pait, the rapidly decieasing propoition of member bank
deposits which have been classified as demand deposits since the inauguration
of a lower reserve on time deposits in 1914 This decrease has occurred, moieover, during a time when the average turnover of all deposits has mcj eased
indicating that differentials in reserves as between time and demand deposits
and as between demand deposits at city and country banks have not effectively
registered changes in the activity of deposits or in the use of member bank
credit by the community. Such figures as are available for earlier years indicate that the average turnover of bank deposits in this country increased
steadily from 1914 up to 1929 Between 1925 and 1929, alone, estimates made
for the committee indicate that the rate of turnover of the average dollar
deposited in member banks increased from 24 times a year to 33 times a year,
notwithstanding the fact that 64 cents of this dollar was classified as a demand
deposit in 1925 as against 59 cents in 1929.
Failure of existing requirements to reflect credit developments.—In the accompanying chart there is portrayed the extent to which existing legal requirements for reserves have failed to leflect credit developments at member banks
in recent years The upper line reflects movements in the total dollar volume
of transactions which pass thiough the deposit accounts of customers of member banks. The middle line shows niembei bank time and net demand deposits
combined and reflects movements m the total volume of member bank deposit
liabilities The bottom line shows the reserve balances which member banks
have maintained with the Federal reserve banks During the period covered
by the chart all the legal reserves have been held in this form The lines are
plotted as index numbers with January, 1924, equal to 100
This chart brings out the failure of member bank reserve balances under our
present reserve requirements to reflect fundamental changes in the demand
for credit In the first year shown on the chart, 1924, the total volume of
debits or check payments made through member-bank accounts was low, reflecting a relatively inactive business situation Member-bank requirements for
leserves, however, increased in 1924 more rapidly than in any other year shown
on the chart because the inactive local demand for funds throughout the countiy caused banks to redeposit funds with their correspondent banks in the
larger cities, which were required to hold reserves of 10 or 13 per cent against
these funds As a consequence, an inactive demand for funds from trade and
industry in 1924 was reflected in a sharp increase both in member-bank deposits and in member-bank requirements for reserves During 1925 and 1926,
on the contrary, when business became more active, these redeposited funds
were withdrawn fiom correspondent banks and loaned directly in the market,
with the result that aggregate requirements for factor in the credit situation
in 1928 and 1929 when an extraordinary demand for funds from the stock
market was met without an increase in reserve requirements of member banks
In fact, the agglegate legal requirements of member banks for reserves were
about $75 000,000 lower in September, 1929, at the very peak of reserves remained for two years at about the level of December, 1924, failing completely to reflect an increase in the market demand for funds
The failure of reserve requirements to reflect fundamental changes in the
demand for funds and to operate in such a manner as to bring these changes
under control became a major factor in the credit situation in 1928 and 1929
when an extraordinary demand for funds from the stock market was met without an increase in reserve requirements of member banks. In fact, the aggregate legal requirements of member banks for reserves were about $75,000,000
lower in September, 1929, at the very peak of the stock-market boom than in
7501
STOCK EXCHANGE PBACTICES
December, 1927, despite a situation in intervening months in which the demand
for stock exchange loans was sufficient to lequire biokers to increase their
borrowing by over $4,000,000,000 at rates which in some months averaged
nearly 10 per cent. This situation arose because corporations and other
nonbankmg lenders, seeking to profit by high rates, drew upon their balances
with member banks and loaned funds in huge volume directly to brokers,
permitting an extraordinary demand for credit to be met without any increase in the deposits against which member banks were required to maintain reserves The activity of these deposits increased rapidly, however, as
is shown by the cnart Had reserve requirements reflected the activity of
deposits, this sharp increase in turnover of deposit accounts, which helped
materially to finance speculative developments in 1928 and 1929, would have
caused an equally sharp increase in member bank requirements for reserves,
and this increase in turn would have acted as a powerful restraint against
unsound credit developments.
PER CENT
LEGAL RESERVES, NET DEPOSITS AND ACTIVITY OF
DEPOSIT ACCOUNTS AT MEMBER BANKS
PER CENT
200
ZOO
180
100
80
60
1924
1925
1926
1927
1928
1929
1930
Vault oash—Mtev reviewing member bank operations during recent years
the committee is convinced that the removal of vault cash from required reserves in 1917 has had undesirable consequences that were not forseen at the
time Prior to 1917, member banks in central reserve cities were required
to hold aggregate reserves equal to 18 per cent of their demand deposits, the
corresponding percentages for leserve city and country member banks being
15 and 12 per cent lespectively At the same time, the requirement against
time deposits was 5 per cent at all classes of member banks Part of these
reserves were held as balances with the reserve banks and part as caslh in the
vaults of the member banks Federal-reserve notes and national-bank notes
held by member banks, however, could not be counted as legal reserves Under
the 1917 arnerdment, reserve requirements against demand deposits were reduced by 5 per cent and against time deposits by 2 per cent at all classes
7502
STOCK EXCHANGE PRACTICES
of banks, and at the same time member banks were required to hold all of
their legal reserves on deposit with the Federal reserve banks.
The mam purpose of the 1917 vaujt-eash amendment was to concentrate the
gold holdings of the country in the Federal reserve banks. Up to that time,
member banks had been required to hold their vault-cash reserves in gold
or lawful money, with the result that the monetary gold resources of the
country were only partially mobilized in the Federal reserve banks* a1 large
proportion being absorbed in the form of circulating notes held by the member banks and the public The 1917 amendment corrected this situation by
removing the inducement for member banks to hold their vault cash in the form
of gold rather than Federal-reserve notes and so permitted the mobilization of
gold in the Federal reserve banks
In addition to concentrating the gold resources of the country m the Federal
reserve banks, however, the 1917 vault-cash amendment incidentally opened the
door for a gradual diminution in the actual reserves of the member banks In
the last 14 years, the amendment has permitted a reduction in aggregate
reserves, amounting at the present time to over $700,000,000 Had this amendment not been passed, consequently, member banks today would be required,
other things being equal, to hold aggregate reserves more than $700,000,000
larger than their present legal reserves plus their holdings of vault cash.
These additional reserve requirements would have exercised a wholesome restraint during the boom period which culminated in 1929 and the policy pursued
by the Federal reserve system would have been much more effective had the
member banks at that time been forced to borrow this additional $700,000,000
from the Federal reserve banks
Between June 1917, before the new requirements went into effect, and June,
1930, net demand plus time deposits of member banks increased from $12,000,000,000 to $32,000,000,000, but holdings of vault cash at the same tune decreased from about $800,000,000 to less than $500,000,000 By making progressive economies in their use of vault cash at a time of rapid increase in their
deposit liabilities, member banks were able to reduce their cash holdings to less
than 3 per cent of their net demand plus tnne deposrts by 1919, to less than 2
per cent by 1924, and to less than 1% per cent by 1930 The chart shows that
this reduction has been especially marked at large city banks In New York
City member bank holdings of vault cash in June, 1930, were equal to threefourths of 1 per cent of their net demand plus time deposits and to less than
1 per cent of their net demand deposits alone
Part of this decline reflects a reduction in the operating lequirements of
banks for vault cash The American public has widespread banking facilities
and is thoroughly educated in the use of checks Their demand for pocket
currency, consequently, is relatively small since its use is limited largely to
transactions in which currency is the only convenient method of payment In
recent years there has also taken place a rapid increase in the use of checks
for wage payments which has materially reduced the demand for cash for
industrial pay rolls While this substitution of checks for cuirency may reflect
a socially desirable development, it does not constitute a logical or valid reason
for a reduction in the reserve requirements of member banks since the effect
upon business activity and upon the position ot the individual member bank
is the same whether a depositor's account is drawn upon to make payments
by check or by currency
By no means all of the economies in the use of cash which member banks
have been able to effect since 1917, however, reflect the substitution of checks
for currency in making payments On the contrary, a special study of the
daily vault cash holdings of member banks has shown definitely that location
in the vicinity of a Federal reserve bank or branch is the largest single factor
accounting for the reduction in member bank holdings of cash This investigation showed that member banks situated close enough to Federal reserve
banks or their branches to be able to deposit surplus currency at the reserve
banks or to obtain additional currency supplies from the reserve banks within
a few minutes, maintained vault cash holdings equal on the average to only
138 per cent of their net demand deposits This group of member banks holds
about 60 per cent of the total deposits of all member banks
During the same period, the remaining member banks held vault cash equivalent to 4 64 per cent of their net demand deposits, or more than three times the
proportion that was held by member banks close to the reserve banks The
investigation also showed that member banks located within short distances
of cities where Federal reserve banks or branches are located held as high
a proportion of vault cash, on the average, as country member banks, which
7503
STOCK EXCHANGE PEACXIOES
because of their inaccessible location ordinarily can not receive additional
supplies of currency until one or two days after it has been ordered. The
amount of vault cash reserves which member banks find it necessary to hold
at the present time, therefore, depends mainly on whether or not they are
located in the immediate vicinity of the reserve banks. If they are close
enough, they, can deposit with the reserve banks for credit to their reserve
balance a large proportion of the vault cash which their business would otherwise
require them to hold.
PER CENT
PERCENT,
1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930
The 1917 amendment eliminating vault cash from legal reserves, consequently,
has had two unfortunate effects. First, it has materially reduced the total
reseive requirements of member banks and thus further facilitated expansion of
bank credit at a time when huge gold imports arising out of war and postwar
disturbances were already placing difficulties m the way of the effective
administration of the country's credit resources Second, these reductions in
aggregate reserve requirements have not been equally available to all membei
banks but have particularly favored those banks which are located in close
geographical pioximity to the Fedeial reserve banks As these membei banks
175541—34—PT 16
7
7504
STOCK EXCHANGE PBACTICES
are classified as reserve or central reserve city banks, the amendment has had
the practical effect of reducing or eliminating differentials in reserve requirements between different types of banks which are justified by the character of
their business.
Up to 1917, time deposits required the same reserve of 5 per cent at all
types of banks, while net demand deposits required a reserve of 12 per cent
at country banks as compared with 15 per cent at reserve city banks and 18
per cent at central reserve city banks. These differentials were maintained
after the 1917 amendment in the form of a 3 per cent reserve against time
deposits at all classes of banks and a required reserve excluding vault cash
against net demand deposits of 7 per cent, 10 per cent, and 13 per cent at the
different classes of banks. However, when the amount of vault cash which
member banks find they must actually hold under normal conditions is taken
into account, and a 3 per cent reserve against their time deposits is allowed,
it appears that central reserve city member banks now hold 14 per cent
in reserve against their net demand deposits in contrast to 12 per cent at both
reserve city and country member banks. In other words, in its practical effect,
the 1917 amendment in addition to reducing reserves against time deposits
from 5 to 3 per cent at all member banks reduced reserves against net demand
deposits from 38 to 14 per cent at central reserve city banks, and from 15
to 12 pr cent at reserve city banks, while country banks received no reduction
whatever in their requirement against demand deposits The present classification of cities for reserve purposes, therefore, does not function equitably.
The purpose of the 1917 amendment to mobilize reserves could have been
accomplished without this diminution in total reserve requirements of member
banks by retaining the reserve ratios of the original Federal reserve act and
at the same time permitting member banks to count Federal reserve notes
as part of their legal vault reserve. Federal reserve notes are a liability
of the Federal reserve banks, just as the present legal reserve balances of
member banks are a liability of the Federal reserve banks Of the two types of
liabilities, furthermore, those evidenced by Federal reserve notes which are
a first lien on all assets of the Federal reserve banks and in addition are an
obligation of the United States Government are the more strongly secured.
In recommending, consequently, that the legal reserves of member banks
include all kinds of currency and coin as well as balances on deposit with the
Federal reserve banks, the committee provides a plan which retains the advantages of a mobilized reserve and also avoids the possibility that member bank
reserves will be further diminished through economies m the use of vault
cash.
Time deposits.—The committee is also convinced on the basis of the system's
experience that there is no practicable way of defining time deposits and
demand deposits without opening the doors to evasions of the intent of the
law The general principle underlying the existing classification, namely, that
more active deposits should carry higher reserves, the committee believes to
be sound. Experience has shown, however, that the methods by which this
principle is now applied have permitted evasions, which can not in practice
be remedied so Ion* as lower requirements for reserves on time deposits
furnish a constant incentive to member banks to classify as time deposits
accounts which are essentially of an active character.
Deposits classified as time deposits have grown rapidly at member banks
since 1914. In that year, when national banks were required to maintain
the same reserve against all of their deposits, they held only about $1,200,000,000 in time deposits. Following the lowering of reserve requirements
against these deposits, time deposits increased steadily and amounted to about
$8,700,000,000 at national banks alone in 1930 During the same period, time
deposits of nonnational commercial banks, including both State member and
nonmember banks, increased from about $2,800,000,000 to $10,200,000,000 and
savings deposits of mutual and stock savings banks from $4,800 000,000 to
$10,500,000,000. The increase in time or savings deposits for national banks
during the period was over 600 per cent, for nonnational commercial banks
over 250 per cent, and for savings banks 120 per cent Considering all of
our commercial banks together, both State and National, time and savings
deposits have increased from less than one-fourth of total deposits in 1914
to nearly 40 per cent in 1980. In 1914, furthermore, these commercial banks
held about 45 per cent of the total time deposits of the country; while by
1930 that proportion had grown to about 65 per cent Of the total increase
in time deposits in the interval more than 70 per cent was concentrated at
commercial banks. By 1930 more than one-third of all member bank deposits
STOCK EXCHANGE PEACTICES
7505
consisted of time deposits and nearly one-half of the time deposits of the
country were held by member banks.
While there have been other factors in the growth of time deposits, it is
clear that the introduction of a lower reserve on such deposits has encouraged
the growth of savings deposits at commercial banks, in part at the expense of
the growth of deposits at specialized savings institutions, with the result
that some of our so-called commercial member banks now operate largely with
funds that are classified as time or savings deposits. From the point of
view of bank reserves, however, the problem to determine is not the extent
to which member banks have competed more effectively with other banks for
the savings-deposit business of the country, but the extent to which member
banks, because of the low reserve against time deposits, have been induced
to classify as time deposits, deposits that are essentially demand in character.
It has been repeatedly asserted in recent years that this reclassification of
deposits, rather than effective competition on the part of member banks for
savings deposits, has been responsible for a substantial part of the growth
in time deposits at member banks.
While it is the opinion of the committee that the gi eater portion of time
deposits held by member banks, particularly country member banks, represent
funds which are genuine savings deposits, the committee is convinced that
a significant part of these deposits, especially in metropolitan centers, are
not m the nature of savings, but have a considerable velocity of turnover,
and should be classified as demand deposits and carry correspondingly larger
reserves. The volume of such deposits is sufficient to constitute a major
departure from the principles underlying present reserve requirements
A special investigation conducted m May, 1931, revealed the fact that out
of $13,000,000,000 of time deposits held by member banks at that time,
$3,000,000,000 consisted of individual accounts with balances m excess of $25,000.
Even though these accounts may consist of inactive deposits with a low
turnover, they are not the typical small savings accounts for the accommodation of which the low reseive against time deposits was primarily instituted
Of the $3,000,000,000 held m these large individual accounts, 27 per cent were
held in accounts evidenced by savings pass books, 24 per cent in accounts
evidenced by certificates of deposit, and 49 per cent in other types of time
accounts, chiefly open-book accounts payable in moie than 30 days or subject
to an agieement by the depositor at the time of deposit to give 30 days' notice
before withdrawal.
A further violation of the intent of the law has grown up in certain localities where, to meet the competition of State savings banks, some member banks
have devised a special savings account on which checks may be drawn without the presence of the depositor at the bank These accounts are evidenced
by savings pass books in which the bank reserves the right to require 30
days' notice before making payment on a withdrawal When the account is
opened, a duplicate savings pass book is issued, the original being held by the
depositor and brought up to date from time to time, while the duplicate
is left with the bank, which enters therein the amount of each withdrawal
at the time checks on these accounts are presented for payment So far as
the committee can ascertain, this practice of permitting withdrawals from
savings accounts by check without presentation of the pass book has not, as
yet, spread widely. An investigation of the turnover of these socalled savings
accounts indicates that they are less active on the whole than demand accounts
in the same banks, but much more active than other time accounts They are,
furthermore, no less active than accounts classified as demand deposits in
many sections of the country.
In the opinion of the committee even the existence of a low rate of turnover in time-deposit accounts would not necessarily mean that the present system of reserves is functioning in accordance with the intent of the law. It
is not necessary to classify deposits incorrectly in order to reduce reserve
requirements under existing conditions With only a 3 per cent reserve
required against time deposits, there is an inducement for member banks to
persuade or permit commercial customers to classify a large part of their
working accounts as time deposits and then to permit a very rapid turnover
on that small part of these accounts that remain in the demand-deposit classification In such cases, the customers' aggregate deposits constitute the working balance, but all of the checks are cleared through the demand accounts,
with the consequence that relative inactivity in time accounts is balanced by
7508
STOCK EXCHANGE PEACTICES
a corresponding increase in the activity of the demand balances While it is
impossible to ascertain the extent to which this practice has influenced the
growth of time deposits at member banks in recent yeais, it is known that
the turnover of demand accounts has increased rapidly. There has also been
a giowth in the volume and number of time-deposit accounts maintained
by corporations While both of these developments have reflected, in part
at least, other factors than the effect of the 3 per cent reserve on time
deposits, this reseive requirement has facilitated the movement and has undoubtedly been a factor in the decrease of the ratio between total bank
reserves and the outstanding volume of bank credit
These conditions the committee is convinced can not be effectively remedied
so long as lower reserve requirements on time deposits offer an inducement for
evasion Some improvement might be effected by limiting the total amount
of time deposits which a bank could hold for the account of any one depositor
to a fixed amount, but the net effect of the limitation would probably be small
It would not prevent depositors from splitting up larger time accounts among
several member banks, and might also encourage further abuses by inducing
large depositors to open accounts in the names of employees and others, the pass
books or certificates of deposit evidencing such accounts being assigned to the
real owner of the funds after the deposits are made Such devices would
go far to nullify as well the effects of another suggested restriction which the
committee has had under consideration, namely, that the number or amount
of withdrawals permitted from a single time deposit account be limited during
a stated period Limitation on the number of checks drawn might reduce
the apparent activity of a single account, but would be completely ineffective
to the extent that it induced depositors to split their existing time-deposit
accounts into several accounts and thereby multiply the number of checks
which could be legally drawn each month Ft has also been suggested that
the definition of time deposits carried in the Federal reserve act be made
more stringent so as to require the presence of the depositor at the bank each
time a withdrawal is permitted 01 to prohibit in all cases withdiawals from
these accounts except after 30 days' notice Entirely apart from the annoyance
and inconvenience
which such restrictions would entail to many time depositors,
they con16. be effectively nullified if banks adopted more generally the practice
of making loans on savings pass books to depositors wishing to make an immediate withdrawal Such loans, which can be made to the depositor either in
pei son or through an agent, are secured by the time-deposit account, and
en tail no loss to the depositor unless the rate of interest charged on the loan
is in excess of that paid by the bank on the deposit None of these suggestions,
furthermore, offers a remedy for the situation which arises when a depositor
splits his balance into a small and extremely active demand-deposit account
and into a time-deposit account which is theoretically inactive but which in
practice constitutes the balance that justifies the bank in carrying the companion demand deposit
Activity of demand deposits—Studies by the committee of the effectiveness,
from the reserve point of view, of the present grouping of member banks into
central reserve city banks, reserve city banks, and country banks have convinced it that this classification does not, in actual operation, result m an
equitable and economically sound distribution of reserves. While it is true
that, on the average, the activity of deposits is much higher in New York City
than elsewhere in the country, and also that the activity of deposits at reserve
city banks is higher on the average than at country banks, there remains within
these general averages a great diversity in deposit activity both between cities
and between banks in the same city In numerous small cities, where reserve
requirements are those of country banks, deposit activity is materially higher
than in many reserve bank cities, while in some country towns the activity of
demand deposits is apparently as low or lower than the activity of time
deposits at many city banks Within cities, moreover, the same divergence
occurs between the activity of deposits at neighboring banks There are individual member banks in New York City carrying 13 per cent reserves against
deposits that are less active than those of many country banks carrying a 7
per cent reserve It is not possible, in fact, to arrive at any classification of
banks based on size of cities or their location which will reflect with accuracy
the average activity of demand deposits at individual member banks. Since
it is the committee's conviction that the reserve of an individual bank should
fluctuate with changes in the volume of transactions financed by its deposits
STOCK EXCHANGE PEACTICES
7507
and that in the country as a whole aggregate reserves should change with the
volume of business done, it is necessary in order to accomplish this purpose
to discard completely the present system of basing reserve requirements on the
location of banks and to adopt instead a reserve formula which will take
direct account of the activity of each individual bank's deposits
COMMITTEE BFCOMMENDATIOFS
The committee recommends, therefore, that the reserves required to be carried by each individual member bank be determined, first, on the basis of the
total volume of deposits held by the bank irrespectrve of whether they are
held by city or country banks or whether they are classified as time deposits
or demand deposits, and, secondly, on the basis of the actual activity of these
deposits, that is, the actual dollar volume of charges which are made to these
accounts More specifically, the committee proposes that each bank be required
to hold a reserve equivalent to 5 per cent of its net deposits plus 50 per cent of
the average daily debits or charges made to these deposit accounts on the books
of the bank As already indicated the reserves thus determined are to include
both cash in vault and collected balances with the Federal reserve bank.
For a bank with stationary deposits, this is equivalent to a total reserve of
5 per cent, for a bank with deposits which turn over once a month, it JS
equivalent to a reserve slightly under 7 per cent of total net deposits, while
for a bank with an aveiage turnover of once a week, the total reseive is about
12 per cent of total net deposits
This formula will eliminate all of the classifications of deposits at present
used to determine required reserves It makes no distinction between a deposit
classified as a time deposit and a deposit classified as a demand deposit and
so avoids all of the complications which have accompanied the attempts of
the Federal Reserve Board to define time deposits The formula, furthermore,
eliminates the distinction between demand deposits held by banks classified
as central reseive city banks, reserve city banks, and country banks, and so
avoids the problem of determining which cities should properly be classified
as central reserve or reserve cities for reserve purposes The formula automatically distinguishes between these cities, nevertheless since the average
member bank in a central reserve city, where the turnover of deposits is. higher,
will be required to carry larger reserves than the average bank in a reseive
city or the aveiage country member bank which has a low rate of turnover.
The pioposed formula also distributes the total volume of reserves more effectively and moie equitably among member banks, because in the central
reserve cities high reserves will be carried only by such banks as* have active
deposits, while banks in these cities having less active deposits, that is, banks
whose business resembles more closely that of a country bank, will be required
to carry reserves equivalent to those of a country bank At the same time, the
active country bank engaged in business different from its1 neighbors1 and more
nearly resembling that of a city bank will be required to cany reserves equivalent to those carried by a city bank
This formula, therefore, by basing reserve requirements directly on the
volume and activity of the deposits of the individual member bank, places each
member bank on an effective parity with respect to the type of banking business in which it is engaged, and achieves in practice those distinctions which
theoretically should but actually do not result fiom the present classification
of cities and deposits'for reserve purposes.
Deductions irom deposit accounts—The committee recommends that net
deposits subiect to a 5 per cent reserve be determined by subtracting from
gross deposits the sum of all balances due from member banks in the United
States and their domestic branches and all checks in process of collection and
other cash items payable upon presentation in the United1 States This recommendation differs from present practice with respect both to the deposits from
which deductions are permitted and the items which member banks are permitted to deduct
At the present time, the law states that deductions may only be made from
"balances due to other banks," that is, deposits held by one member bank
to the credit of another bank These balances include, according to the present Regulations of the Federal Reserve Board, all amounts due to banks,
bankers and trust companies, and certified, cashiers' and treasuieis' checks
outstanding.
7508
STOCK EXCHANGE PEACTICES
This provision has given rise to widespread protest, especially from country
banks which are not in a position to take advantage of deductible items
because they hold little or no amounts due to banks from which to subtract
them. The city banks, on the other hand, holding, because of their correspondent relationships, large balances due to other banks, have been able to
decrease their deposits subject to reserve by the full amount of their deductible items At the present time this factor is equivalent to about 1 per
cent on the average in the required reserves against net demand deposits of
country banks; that is, the aggregate reserves held by country member banks
against net demand deposits are in effect equal to 8 percent, rather than 7
per cent, if an adjustment is made for their inability to utilize items now deducted from deposits by banks in large cities
In making its recommendation the committee also noted the fact that the
present provision governing deductions permits many city member banks to
carry banker's balances without thereby increasing their requirements for reserves, since a bank with deductible items normally m excess of its balances
due to banks can accept bankers' deposits up to the point where this excess no
longer exists without increasing the reserves which it must hold In recommending that deductions be made from gross deposits, consequently, the committee provides for a more equitable treatment of country member banks and also
provides a formula by which any bank which increases its balances due to other
banks will thereby increase its reserve requirements
The committee also recommends a new definition of items which may be
deducted from gross deposits. At present, these items are defined in the law
as balances due " fiom other banks." This phrase has been construed by the
Federal Reserve Board to include items with Federal reserve banks in process of collection, amounts due from banks and trust companies in the United
States, balances payable in dollars due from foreign branches of other American banks, and exchanges for clearing house and other checks on local
banks In effect, consequently, deductible items now include all funds deposited with other banks in this country, dollar balances deposited with
branches of other American banks abroad, and the bulk of checks and other
items in process of collection
The committee recommends that this definition of deductible items be changed
to include only "balances due from other member banks and their branches
in the United States " and " all checks in process of collection and other cash
items payable upon presentation in the United States" The principle which
the committee has followed in making these recommendations is that, in so far
as it is administratively practicable, the aggregate body of reserves maintained
by member banks should reflect changes in the volume and use of member
bank credit by the public, since it is the public's use of credit which has a
direct relationship to the volume of the country's business Aggregate reserves
should not, as a matter of principle, be affected by purely interbank transactions which do not directly reflect the public use of credit, but, instead, changes
in transactions between banks which are on a large scale in our banking system
because of the large number of unit banks.
A system of reserve requirements would not be sound under which aggregate
reserves might decrease during the next decade solely as a result of some
change in our bank relationships which would materially reduce the volume
or proportion of interbank deposits now held by member banks The proposal
advanced by the committee avoids this contingency since the aggregate net
deposits of member banks subject to reserve will not be affected by changes
in the volume of balances kept by one member bank with anothei Under
this recommendation, also, the individual member bank which is responsible for
the maintenance of reserves against a member bank deposit will be that bank
which lends it to the public, I e, an interior member bank will only hold
reserves against those deposits on its books which it lends or invests directly
with the public If it passes the deposit on to another member bank in the form
of an interbank deposit, it will hold no reserve against it since it will be
sable to deduct this amount from its gross deposits The bank which will
receive this interbank deposit and loan the funds involved back to the public,
however, will be the one that will be responsible for the reserve which must
be maintained against it
Reserves on United States Government deposits,—The recommendations of the
committee make no exceptions with respect to deposits of the United States
Government, but treat these deposits for reserve purposes the same as any
STOCK EXCHANGE PRACTICES
7509
other deposits The committee recommends the repeal of the 1917 amendments which relieved these deposits from reserves as an inducement to member banks to participate to the fullest extent in war financing. The fact that
deposits are secured by the pledge of government or other securities does not
constitute a valid reason for their exemption from reserve requirements. A
bank as a matter of necessity must have assets to cover and secure all of its
deposit liabilities, but this fact does not relieve a bank from its responsibility to
maintain adequate reserves. The security of a deposit has nothing to do with
the reserve that should be carried against it. The banks have the use of
their United States Government deposits the same as of any other deposits
and it is equitable, therefore, that these deposits should contribute to the
reserve fund in the same relative proportion.
Operation of proposed formula m recent pears —This resume" of the principles
and evidence upon which the committee has proceeded in formulating its recommendations indicates that under the system of reserves proposed requirements
for reserves will be more equitably apportioned among the member banks.
It is even more important, however, that the proposed formula exert a constructive influence toward the preservation of sound credit conditions
Unsound credit developments arise usually during periods of prosperity when
the public is optimistic and both bankers and borrowers are likely to overestimate the value of collateral which is offered to banks as a basis for loans.
Such conditions are reflected usually both by an increased demand for bank
credit and by increased activity in the deposit balances of those individuals or
corporations which deal in the commodities, securities, or services that are
acquiring a speculative value. Thus, the speculative value of faim lands, which
accompanied the prosperity of agriculture during the war, was reflected both in
a sharp increase m the activity of deposit accounts at agricultural banks and
in a heavy demand for credit secured by farm mortgages at inflated values.
So, also, the prosperity which prevailed in this country during recent years was
accompanied by a widespread boom in urban real estate, by speculation in Florida real estate, and finally by an inflation in common-stock prices, each of which
was reflected in unsound demands for bank credit at inflated speculative values
and m a larger thn average increase in the activity of deposits at those banks
whose customers were becoming heavily involved in these speculative situations.
In the boom which ended in 1920, the increase in deposit activity was widespread, but the greatest relative increase occurred at the center of farm land
and commodity speculation in the Middle West In the boom, which ended in
1929, on the other hand, the greatest increases in deposit activity occurred in
New York City and other large eastern cities, where speculation in common
stocks was most active
No formula for detei mining member bank reserves can prevent these speculative situations from recurring, but the proposed formula will operate to check
their growth and help to bring them under control It will increase requirements
for reserves sharply at those individual member banks whose customers are
at the center of an incipient speculative movement, and so set in motion forces
of a restraining nature at the focal point of disturbance. These forces will
probably take different forms Bankers whose requirements for reserves
increase sharply as a result of these activities will find their leading power
reduced somewhat and so will be less inclined to finance speculative developments. Customers with highly active accounts will probably be expected to
maintain larger deposit balances, or else the member banks will institute service charges based on the activity of accounts The forces set in motion by the
proposed formula, consequently, will make it more difficult for an unsound
development to obtain credit, will increase the amount of credit needed to
finance the development, or will increase its cost of operation The restraining
effect of these forces, moreover, will be concentrated almost wholly on speculative credit developments, since the reserves required under the proposed formula will not be such as to effect adversely banks holding the working balances of soundly financed commercial enterprises Very few ordinary business
accounts turn over more rapidly than once a week, in which case the effective
required reserve under the proposed formula will equal no more than 12 percent This is no larger than the average amount now held in cash and at the
reserve banks on all net demand deposit balances at reserve city and country
member banks.
In the banking situation as a whole, the effect of the proposed formula on
the demand for loans at the reserve banks will be to strengthen Federal reserve
policy and thus to exert an influence toward sounder credit conditions This is
7510
STOCK EXCHANGE PBACTICES
illustrated m the chart which compares aggregate member bank holdings of
reserves and vault cash under present requirements during the past seven
years with an estimate of the aggregate reserves which the formula proposed
by the committee would have produced It will be noted that, while under the
present formula aggregate reserves did not increase between December, 1924,
and the summer of 1927, under the proposed formula they would have increased
by nearly $300,000,000 during the same period The greatest contrast between
the effect of the two formulas on general credit conditions, however, would
have appeared during the years 1928, 1929, and 1930 The failure of present
requirements for reserves to exert any influence of restraint in the presence of
abnormal credit demands in 1928 and 1929 has been discussed earlier m this
report There it was pointed out that aggregate reserves did not reflect the
increased use of credit in 1928 and 1929, or exercise a restraint over its
growth, because no increase in reserve requirements accompanied the large increase in brokers' loans which, owing to high call-money rates, were supplied
PRESENT MEMBER BANK RESERVES PLUS VAULT CASH
COMPARED WITH REQUIREMENTS UNDER PROPOSED FORMULA
MILLIONS OF DOUARS
MILLIONS OF DOLLARS
4000
4000
MEMBER BANK RESERVE REQUIREMENTS -
Proposed
3000
3000
Present
(In dating Vault Cash)
2000
2000
,1000
1O0O
192**
1925
1926
1927
1928
1929
1930
by interior banks, corporations, and others out of funds previously held on deposit with the larger city banks Our present system of reserve requirements
thus facilitated an expansion of credit at a time when the situation called for
fttiong restraint It was also pointed out that m 1930, after the break in the
stock-market boom, these same factors acted to increase reserve requirements
At that time rates on security loans fell below rates on deposits in consequence
of a diminished demand for credit in the market, and both corporations and
interior banks converted funds previously loaned to brokers into deposits at
city banks against which reserves were required
The chart shows that requirements based directly on the activity of member
bank accounts, as well as on their volume, in accordance with the proposed
formula, would have acted in the direction of sounder credit conditions during
these years In 1928 and 1929, an increase m aggregate reserves under this
formula would have acted to check sharply an excessive use of credit for
stock-market trading, while in 1930 a corresponding decrease in requirements
lor reserves would have acted to ease credit conditions In all three years,
consequently, changes in required reserves would have supplemented the openmarket policy of the Federal reserve system, since, in 1928 and 1929, restraint
STOCK EXCHANGE PRACTICES
7511
would have been exerted on the market by increased member bank requirements for reserves, as well as by sales of securities by the Federal reserve
banks, and in 1930, the easing effect of purchases of securities by the reserve
banks would have been supported by a decrease in member bank requirements
for reserves.
Practicability of proposed requirements —The committee believes that the proposed system of reserve lequnements is not only sound m principle, equitable
as between the membei banks, and constructive in its influence on credit conditions, but that it is also simple to administer and not susceptible of abuses
such as those which have giown up aiound the existing provisions granting a
low reserve foi time deposits The committee has canvassed the administrative
difficulties which may arise undei the proposed system and also the possibility
that once introduced it will not opeiate in the manner expected
Inauguration of any new system of reserves such as that proposed will require the careful preparation of repoit forms and of instructions governing
their use for the guidance of member banks Once placed in operation, however,
there should be fewer opportunities Jtor administrative 'difficulties to arise undei
the proposed system of reserves than under present requirements In the first
place, there are avoided all of the problems attending the classification ot
member banks foi reserve purposes into central reserve city, reserve city, and
country banks, and also the classrhcation by member banks of their deposits
into time deposits and demand deposits
Under the committee's proposals, the reserves required of a member bank
will depend, first, on its net deposits which are to be deter mined by subtractrng
from rts gross deposrts its balances with other member banks and its items in
process of collection, and, secondly, on its total debits to deposit accounts
None of the items used m detei mining these amounts is difficult for the member
banks to obtain from their books or for the bank examiner to check Determination of daily requnements for reserves, consequently, should be greatly simplified
as compared with present requirements
The committee proposes, moreover, to simplify the problem of maintaining
reserves by establishing a system oi averaging, by which member banks will
know definitely in advance their requirements for reserves and thus be in a
position to provide th^ leserves called for under the requirements
Since the activity of a bank's deposits on any given day or in any given
week is not a reliable indicator of the real actruty of rts accounts or ot the
reserves which should be held against them, the committee recommends that
in the event the proposed formula is adopted the Federal Reserve Board issue
a regulation providing that that part of a bank's reserve which is based on
the activity of its deposits shall repiesent 50 percent of its average daily debits
to deposit accounts during the eight weeks precedrng rts current reserve computation perrod In other words, the reserve agarnst deposit activity would
not be based on current opcratrons, but on the activity which a member bank
might properly expect on the basis of its past eight weeks' experience While
there will be individual cases when this experience is not borne out, investigation has indicated that a period of eight weeks is sufficiently long on the
average to give a satisfactory record of the activity to be expected from a
deposit account without at the same time lemovmg requrrements for reserves
too far from current bankrng developments On the basrs of thrs eight week's
daily average, each member bank would know at the beginning of each
reserve computation period the exact amount of reserves agarnst actrvrty
which it would be required to hold during that period The committee recommends that the 5 per cent reserve required on net deposits be computed
against net deposits held at the close of the preceding day as at present The
actual volume of reserves held would net have to equal these requrrements
each day, however, since member banks would have complied with the law
if their reserves during a given reserve computation period were substantially
maintained and were equal on the average to their average reserve requirements Changes recommended by the committee in the length of reserve
computation periods are discussed later in this report
The proposed requirements, consequently, should be more simple to admrnrster than present requirements They should also prove less susceptible ot
abuse The committee is aware that banks, when their requirements for
reserves wrll depend drrectly on therr actrvity, will make an effort to hold
down the turnover of their accounts, and the commrttee expects some resultant
decrease in total debits to deposit accounts There is likely to be some
decrease in the turnover of correspondent bank accounts, for example, and
7512
STOCK EXCHANGE PEACTICES
a corresponding increase in the use of the check collection facilities of the
reserve banks since correspondent banks will find extremely active balances
of other banks less attractive to hold than at the present time There may
also be some increase in the use that brokers make of the clearing facilities
of the organized security exchanges which will be reflected in a corresponding
decrease in the volume of transactions cleared through member bank accounts.
Both of these developments will probably reduce somewhat the volume of
debits to deposit accounts on which the calculations of the committee are
based. On the other hand, the effect of this reduction in total required reseives
will probably be offset somewhat by an increase in reserves held against
member bank deposits since under the proposed formula member banks will
probably require customers having highly active accounts to increase their
deposit balances Any net change in aggregate reserves resulting from these
operations should not, therefore, be sufficient in volume to affect seriously the
functioning of the proposed system once it is effectively placed in operation
Distribution of reserves under proposed system—To check its calculations
of the distribution of reserves under the proposed reserve formula, the committee requested all member banks to repoit for each day of May, 1931, the
items on their books which are necessary to calculate their legal requirements
for reserves under the plan recommended by the committee The following
computations based on these reports include figures for 80 per cent of the
member banks holding 96 per cent of total member bank reserves
For these banks as a whole, the proposed formula would have produced
during May, 1931, reserves in vault and in the reserve banks equivalent to
99 7 per cent of their actual required reserves plus vault cash under present
requirements, i e, for the member banks as a whole, the total body of reserves
would be the same under either formula This is in keeping with the intent
of the committee, as previously stated, of selecting a formula which would
produce at the time of transition the same aggregate body of reserves as is
now held under the present law
Of the total reserves produced under the proposed law, 56 per cent would
represent the 5 per cent reserve which would be required to be held against
total net deposits, and 44 per cent the reserve required against activity of
deposit accounts at the rate of 50 per cent of average daily debits. For member banks as a whole, total reserves including vault cash would be 7 8 per cent
of their gross deposits, and 8.9 per cent of their net deposits. The average
turnover of net deposits in May was at a rate of a little over twice a month.
Of the 6,308 member banks included in the tabulation, the aggregate reserves
held by 5,303, or 84.1 per cent of the total, would be reduced under the proposed formula, while those of 349 banks, or 5.5 per cent of the total, would
be essentially unchanged, and those of 656 banks, or 10.4 per cent of the total,
would be increased Most of the banks whose reserves would be reduced are
small country banks which now find it necessary to carry a relatively large
volume of vault cash, but this group also includes a number of banks in central
reserve and reseive cities which are now required to hold high reserves against
demand deposits, the turnover of which is relatively low. Of this group of
5,303 member banks, 808 on the basis of May, 1931, figures would receive a
reduction of 10 per cent or less in required reserves under the new formula,
1,247 a reduction of between 11 and 20 per cent, 1,637 a reduction of between
21 and 30 per cent, 1,168 a reduction of between 31 and 40 per cent, and 443
a reduction of more than 40 per cent. More than 90 per cent of the member
banks in the San Francisco, St. Louis, Atlanta, Kansas City, and Dallas Federal reserve districts would have some reduction in their reserves under the
proposed formula. In the Minneapolis, Chicago, and Cleveland districts, reductions would occur at from 80 to 90 per cent of the member banks, and in the
Boston, Philadelphia, and Richmond districts at from 73 to 80 per cent. In
the New York district only 65 per cent of the member banks would be in a
position to reduce their aggregate holdings of reserves. These reductions reflect
largely the fact that under present requirements, member banks located at a
distance from the reserve banks must hold more vault cash than more conveniently situated banks.
Most of the increased reserves under the new formula would be carried by
the large active member banks situated in cities where Federal reserve banks
or branches are located These are the banks where the proportion of aggregate reserves to total credit outstanding has decreased most rapidly in recent
years, because their location has permitted them to reduce their holdings of
vault cash to a minimum. In addition, this group includes in many instances
STOCK EXCHANGE PEACTICES
7513
banks with a large proportion of deposits now classified as time deposits, and,
also, the larger money market banks of the country which hold the exceptionally active demand balances of other banks and of brokers and dealers in
securities. Of the 656 member banks in this group as a whole, the increase
in total required reserves would be less than 10 per cent in the case of 366
banks, between 11 and 20 per cent in the case of 182 banks, between 21 and 30
per cent in the case of 64 banks, and more than 30 per cent in the case of only
44 banks About 23 per cent of the member banks in the New York district
would have some increase in reserves as compared with less than 2 per cent
in the Dallas district.
This test of the formula shows that the reserve plan recommended by the
committee would produce the total volume of reserves expected and would
distribute these reserves more equitably among the member banks, by restoring
differentials in reserves held to the proportion justified by the activity of
deposits, and by removing advantages now obtained solely from geographical
location which enables a member bank to maintain messenger contact with the
cash facilities of its Federal reserve bank.
Limitation of toted reserve to 15 per cent of gross deposits—The
committee
has also tested the effect of its proposed limitation of the maximum reserve
which a member bank may be required to carry under its formula to 15 per
cent of its gross deposits. The purpose of this limitation is to prevent the new
requirements from becoming prohibitive in isolated cases where banks have
specialized in accounts that turn, over at a much higher rate than ordinary
business deposits These accounts consist mostly of brokers' balances and
balances at stock-yard banks. During May, 1931, only two member banks would
ha\e been affected by this maximum limitation. In the summer and fall of
1929, when stock-market speculation was reflected in an extremely high rate
of deposit activity m New York City, it is estimated that the limitation would
have been effective in the case of not more than 15 member banks. The number of member banks with sufficient deposit activity to be affected by the maximum limitation, consequently, is small
This maximum limit is based upon gross deposits lather than net deposits
because banks holding highly active accounts necessarily hold also a large
volume of uncollected checks The net deposit in an abnormally active account
is small, since it is computed by subtracting all ot the checks on other banks
deposited by a customer from his gross deposit A maximum limitation based
upon net deposits, therefore, would not produce anything like adequate reserves
and would defeat the whole purpose of the committee's! proposal which is
directed toward making active deposit accounts carry the largest reserves
Limitations on amounts of vault cash included m reserves.—In order to
assure that each member bank will at all times maintain an adequate deposit
balance with its Federal reserve bank, the committee proposes to limit the
amount of vault cash which a member bank may include in its legal reserve.
It recommends that member banks located in the vicinity of a Federal reserve
bank or branch be required to hold four-fifths of their total legal reserve in
the form of a deposit balance with their Federal reserve bank These are the
member banks which do not need to hold a large volume of vault cash since
they can obtain quickly additional currency from their Federal reserve banks.
In the case of member banks not so situated, the committee recommends that
reserves held as deposit balances with the reserve banks comprise at least
two-fifths of total legal requirements for reserves
A test of the effect of these limitations in May, 1931, indicated that they
would have permitted about 70 per cent of the member banks to count as legal
reserves all of the vault cash which they held at that time About 30 per cent
of the member banks, however, held more currency last May than they would
have been permitted to count as legal reserves under the formula lecommended.
The total amount of this excess vault cash was in the neighborhood of
$40,000,000 for all the member banks affected, and did not constitute an appreciable burden for the great majority of these banks
Kinds of vault cash eligible for reserves—The committee recommends that
banks be permitted to count as reserves all kinds of cash now in circulation.
It also recommends that in computing reserves cash in transit between a
member bank and its Federal reserve bank be counted as the equivalent of cash
in vault.
Debits subject to reserve—The committee recommends that debits subject to
reserve shall include all debits to all accounts included in gross deposits, except
charges resulting from the payment of certified, cashiers' or other officers'
7514
STOCK EXCHANGE PRACTICES
checks The exception of debits resulting from the payment of ceitified checks
is due to the fact that a debit entry is made at the time of ceitification The
second debit made when these checks are finally paid should not, therefore,
also be included in the reserve computation since to do so would involve duplication. Debits resulting from the payment of cashiers' and other officers'
checks are also excepted, because they represent either transactions similar to
certified check transactions or else payments made by member banks on their
own account Such payments do not represent the use of member bank credit
by the public and should not be subject to reserve
Admmastroution and enforcement of reserve requirement—At the request of
the committee the counsel of the Federal Reserve Board has prepared a draft
of an amendment to section 19 of the Federal reserve act embodying the recommendations of the committee for the new system of member bank reserve
requirements discussed above This draft, which appears at the end of this
report, repeats certain provisions in the present law which are not concerned
directly with member bank reserves but are included m the proposed amendment in order to facilitate the legislative drafting of the bill These provisions,
which are carried m paragraph (m) of the proposed amendment, have not
been considered by the committee and make no changes in the wording of the
present act.
It is the purpose of the committee to make the determination and enforcement of the reserve requirements recommended in the draft as simple as
possible The committee recommends, consequently, that Regulation D of the
Federal Reserve Board be changed to permit member banks located in the
vicinity of a Federal reserve bank or branch to compute their reserves over a
period of one week, and other member banks over a period of four weeks.
Within these reserve computation periods the committee recommends that
member banks be permitted to average their daily holdings of reserves against
their daily reseive requirements, provided they aie not continuously deficient
for three or more consecutive business days if they are located in the vicinity
of a Federal reserve bank or branch, or for six or more consecutive business
days if they are not so located. Member banks with consecutive deficiencies for
three or six days respectively would lose the privilege of averaging their
reserves during the entire reserve computation period in which they were continuously deficient, and pay a penalty to their Federal reserve banks for all
actual deficiencies occurring during such period The committee also recommends that the board amend its regulation to permit a Federal reserve bank,
with the consent of the Federal Reserve Board, to require any member bank in
its district to maintain reserves each day in accordance with requirements for
that day The purpose of this recommendation is to provide a method for
dealing with individual member banks which flagrantly abuse the privilege of
averaging their reserves against their requirements
At the present time, a member bank is prohibited from declaring dividends
or making new loans while its reserves are deficient and is required pay a
penalty to its Federal reserve bank on all average deficiencies in its reserves
within a reserve computation period If it declares dividends 01 makes new
loans on any day or at any time when its reserves are deficient, it violates the
law and its directors are presumably liable for all losses accruing to the
bank theiefrom This provision, the committee thinks, is too drastic in its
present form, since it is almost impossible for a member bank to tell whether
its reserves are deficient or not at any given time during the day when a new
loan application is under consideration The committee would modify this
provision, consequently, to read that " if any member bank shall fail for 80
consecutive calendar days to maintain the reserves required by this section,
it shall not declare or pay any divident, or make any new loan or investment
until its leseivos aie restored to the amount required" This means that
only a definite failure to maintain reserves over a period will make directors
personally liable for losses arising from violation of the law, and not technical
deficiencies in reserves that may arise fiom a variety of| circumstances at any
time during the ordinary course of bank operations The committee also
recommends that the Federal Reserve Board provide in its regulation for the
notification of the directors of a delinquent member bank in advance of the
expiration of the 30-day period specified in the proposed law, such notification
to state that their bank is incurring continued deficiencies and that unless
steps are taken to correct the situation the directors will become subject to the
penalties pi escribed in the Federal reserve act for violation of the law
STOCK EXCHANGE PRACTICES
7515
The committee would also modify the provision governing penalties to be
paid by member banks for leserve deficiencies At the present time penalties
for deficiencies m a member bank's reserve are assessed by its Federal reserve
bank at a rate of 2 per cent per annum above its current rediscount rate.
In some Federal reserve districts, a progressively higher penalty rate is
assessed for reserve deficiencies prevailing over long periods The committee
recommends that the provision relating to progressive penalties be eliminated
from the Federal Reserve Board's regulation, since in most cases progiessive
rates are incurred by member banks not as the result of negligence or indifference but as the consequence of conditions, that make compliance with
requirements difficult if not impossible The committee also feels that when
discount rates are below 4 per cent the present penalty rate is too low to
prevent member banks from becoming negligent with respect to their reserves.
It, therefore, recommends that the penalty rate be 2 per cent above the discount rate on 90-day commercial paper but that in no case shall such penalty
rate be less than 6 pei cent
Effective six months after enactment—In event the proposed amendment
to section 19 of the Federal reserve act is adopted, the committee recommends
that a 6-month period be allowed before changes in reserve requirements
become effective.
E L SMBAD, Chairman,
IRA CLERK
M J. FLEMING
E A GOLDENWEISER,
L R ROUNDS
W. W
RIEFUEE,
Executive Secretary.
PROPOSED AMENDMENT TO SECTION 19 OF FEDERAL RESERVE ACT
A BILL To amend section 19 of the Federal reserve act, and for other purposes
Be it enacted by the Senate and House of Representatives of the United
States of America in Congress assembled, That section 19 of the Federal reserve
act (United States Code, title 12, sections 461 to 466, inclusive, and section
374) as amended be further amended and reenacted to read as follows:
" BANK RESERVES
*' SEC 19 (a) Each member bank shall establish and maintain reserves
equal to 5 per centum of the amount of its net deposits, plus 50 per centum
of the amount of its average daily debits to deposit accounts; but, in no
event, shall the aggregate reserves required to be maintained by any member
bank exceed 15 per centum of its gross deposits
"(b) Each member bank located in the vicinity of a Federal reserve bank
or branch thereof shall maintain not less than four-fifths of its total required
reserves in the form of a reserve balance on deposit with the Federal reserve
bank, and every other member bank shall maintain not less than two-fifths
of its total required reserves in the form of a reserve balance on deposit
with the Federal reserve bank The remainder of the total required reserves
of each member bank, over and above the amount required to be maintained
in the form of a reserve balance on deposit with the Federal reserve bank,
may, at the option of such member bank, consist of a reserve balance on
deposit with the Federal reserve bank, or of cash owned by such member
bank either m its actual possession or in transit between such member bank
and the Federal reserve bank
"(c) The term 'gross deposits', within the meaning of this section, shall
include all deposit liabilities of any member bank whether or not immediately
available for withdrawal by the depositor, all liabilities for certified cheeks,
cashiers', treasurers', and other officers' checks, cash letters of credit, travelers'
checks, and all other similar liabilities, as further defined and specihed by the
Federal Reserve Board; Provided, however, That the term 'gross deposits'
shall not include any liability of a foreign branch
"(d) The term ' net deposits', as used in this section, shall mean the amount
of the gross deposits of any member bank, as above defined and as further
defined by the Federal Reserve Board, minus the sum of (1) all balances due
to such member bank from other member banks in the United States and theiy
7516
STOCK EXCHANGE PRACTICES
domestic branches, and (2) checks and other cash items in process of collection
which are payable immediately upon presentation in the United States, within
the meaning of these terms as further defined by the Federal Reserve Board.
"(e) The term * average daily debits to deposit accounts', as used in this
section shall means the average daily amount of checks, drafts, and other items
debited or charged by any member bank to any and all accounts included in
gross deposits as above defined and as further defined by the Federal Reserve
Board, except charges resulting from the payment of certified checks and
cashiers', treasurers', and other officers' checks.
"(f) The term 'cash', within the meaning of this section, shall include all
kinds of currency and com issued or coined under authority of the laws of the
United States.
"(g) The term ' reserve balance,' as used in this section shall mean a member
bank's actual net balance on the books of the Federal reserve bank representing
funds available for reserve purposes under regulations prescribed by the
Federal Reserve Board.
"(h) The term * vicinity of a Federal leserve bank or branch thereof, as
used in this section, shall mean the city m which a Federal reserve bank or
branch thereof is located, unless otherwise defined by the Federal Reserve
Board.
"(i) With respect to each member bank, the term ' Federal reserve bank,' as
used in this section, shall mean the Federal reserve bank of the district in which
such member bank is located
"(3) The Federal Reserve Board is authorized and empowered to prescribe
regulations defining further the various terms used in this act, fixing periods
over which reserve requirements and actual reserves may be averaged, determining the methods by which reserve requirements and actual reserves shall
be computed, and prescribing penalties for deficiencies in reserves Such regulations and all other regulations of the Federal Reserve Board shall have the
foice and effect of law and the courts shall take judicial notice of them
"(k) Subject to such regulations and penalties as may be prescribed by the
Federal Reserve Board, any member bank may draw against or otherwise utilize its reserves for the purpose of meeting existing liabilities: Provided, however, That if any member bank shall fail for thirty consecutive calendar days to
maintain the reserves required by this section, it shall not declare or pay any
dividend or make any new loan or investment until its reserves are restored
to the amount required by this section.
"(1) All penalties for deficiencies in reserves incurred under regulations prescribed by the Federal Reserve Board pursuant to the provisions of this act
shall be paid to the Federal reserve bank by the member bank against which
they are assessed.
"(m) No member bank shall keep on deposit with any State bank or trust
company which is not a member bank a sum in excess of 10 per, centum of its
own paid-up capital and surplus. No member bank shall act as the medium
or pgent of a nonmember bank in applying for or receiving discounts from a
Federal reserve bank under the provisions of this act except by permission of
the Federal Reserve Board.
"(n) National banks, or banks organized under local laws, located in Alaska
or in a dependency or insular possession or any part of the United States
outside of the continental United States may remain nonmember banks, and
shall in that event maintain the reserves and comply with all the other conditions provided by law regulating them prior to the enactment of the Federal
reserve act; or said banks may, with the consent of the Federal Reserve Board,
become member banks of any one of the Federal reserve districts, and shall in
that event take stock, maintain reserves, and be subject to all the other
provisions of this act.
"(o) The provisions of section 7 of the first Liberty bond act, approved April
24,1917, section 8 of the second Liberty bond act, approved September 24, 1917,
and section 8 of the third Liberty bond act, approved April 4, 1918 (United
States Code, title 31, section 771), which exempt deposits of public moneys by
the United States in designated depositaries from the reserve requirements of
this act and all other acts or parts of acts in conflict with this act are herrby
repealed only in so far as they are in conflict with the provisions of this act."
SFO 2. This act shall become effective six months after its approval by the
President of the United States.
STOCK EXCHANGE PEACTICES
7517
MEMORANDUM REGARDING "NATIONAL SECTJBITIES ACT OF 1934" (HE 8720)
AS AMENDED, WITH PARTICULAR RELATION TO AOT AS IT AFFECTS LISTED CORPORATIONS DIRECTLY OB THE RELATIONS BETWEEN STOCK EXCHANGES AND
LISTED CORPORATIONS
This comment is confined specifically to Sections 11, 12, 13, one clause in
Section 18, with references to Section 3 (13)
Insofar as any of the provisions of the foregoing sections involve a form of
regulation of corporations, it would appear, upon the whole, wiser, to the
extent that such legislation may be needed, to provide a well considered separate
act, dealing directly with the corporations through the medium, perhaps, of a
national incorporation act
It would seem that certain phases of the government's dealing with this
matter indirectly may not be satisfactory. The following comments are therefore subject to the foregoing general views
Section 11 (a) This section makes it unlawful for any person to effect any
transaction in any security on a national securities exchange unless a registration is effective as to such security, as provided, and unless such security
has been issued This section must be considered in connection with Section
3 (13), which defines the term "security" in a broad sense, but contains certain exceptions and permits others to be made by the Commission It must also
be considered in connection with Section 11 (e) which provides that the Commission may permit securities listed on any exchange, at the time of registration of such exchange, to be registered provisionally for a period ending
not later than April 1, 1935, without complying with the preceding paragraphs
of Section 11
There are numerous securities now listed upon stock exchanges as to which
no one has any present interest in making an application for listing or a registration statement In some cases, these listings represent minority interests
which the majority owners would be glad to see removed by default from
the exchanges, thus depriving minority holders of a market and perhaps compelling them to accept terms not regarded by them as favorable There are
also coiporations in leceivership which are out of the control of their officers
and directors, foreign securities or American Shares representing foreign
securities, and perhaps others To require that tiadmg upon exchanges should
cease in regard to securities for which no registration statement would be made
would inflict grave injury upon security holders, and would restrict the basis of
credit.
Ak> to securities the present sponsors of which desire that they shall continue
to be listed upon stock exchanges, the provision that the act becomes, in this
respect, effective on April 1, 1935, imposes what appears to be a great burden
ot useless work and expense upon the corporations, the Commission, and the
stock exchanges It is to be assumed that the stock exchanges have acted in
good faith in admitting securities to listing, and this legislation should be
concerned more with the future than with the past
The requirement for audits, unless suspended by the Commission, would
increase gravely the difficulties and expense, and the burden of scrutinizing and
considering seriously the registration statements to be filed would interfere with
the efficient progiess of work on the exchanges as regards new listing applications
The Bill contains provisions permitting the Commission to classify exchanges,
and if it is felt that this section can not be modified in the manner to be immediately suggested as to all exchanges, it is suggested that Section 11 (a) be at
least amended in &uch manner as to exempt securities listed on a Class I exchange, prior to a date thirty days later than the passage of the Act, from the
necessity of filing an additional registration statement, but requiring, of course,
application and registration statements for all additional securities issued by
such corporation and not covered by then existing approved listing applications.
If it be argued that the filing of a registration statement (or listing application) requires the corporation to assume certain undertakings and obligations,
the listed corporations might be readily required to make such undertakings and
assume such obligations as may be regarded as essential, without the filing of
additional registration statements The provision as it stands is not practical.
If, however, it cannot be changed as above suggested, then it is suggested that
the language of Section 11 (a) permit the Commission, in its discretion, to
exempt from registration, for all time, particular types of securities now listed,
such as those outlined in the earlier portion of the comment upon this paragraph.
7518
STOCK EXCHANGE PRACTICES
This paragraph also forbids trading in securities upon an exchange unless
the security has been issued Presumably this is to prevent "when issued"
listings It is believed that exchanges are careful not to grant such "when
issued" listings unless it is in the public interest, but at tunes the "when
issued " market serves to aid in the business of providing capital for industry,
and it would appear desirable to omit this reference and not to forbid the
existence of such a market.
Section 11 (b) (I) • This provision requires that the issuer undertake to
comply with rules and regulations made or to be made under the act, and not
to lend iunds except upon exempted securities at the money post of any exchange
or to specified individuals, except in accordance with such rules and regulations
as the Federal Reserve Board may pi escribe
This constitutes an undertaking so serious that there is reason to fear it may
interfere with the listing of securities upon registered exchanges and drive
them into unorganized markets
It would seem well to make the undertaking apply only to compliance with
rules already made, for the reason that authority will remain m the hands of
the Commission and/or the exchange to strike from the list securities of any
corporation refusing to agree to any reasonable rules and regulations .thereafter
to be made
It is quite possible that there may be periods when the Federal Reserve
Board may not think it necessary to promulgate specific rules and regulations
as to the lending of funds, and it would seem well to amend the last part of
this paragraph so as to constitute an agreement on the part of the issuer to
observe such rules, if any, as the Federal Reserve Board may, from time to
time, prescribe in regard to the subject matter of the paragraph.
Section 11 (b) (II) : This requires from issuers such information as to the
issuer and affiliates as the Commission may, by rules and regulations, require
This provision would appear to require the Commission to issue, on its own
motion, rules and regulations regarding the act of listing. It is suggested that,
for a considerable period of time, at least, any Commission charged with the
administration of this act will find it difficult to acquire sufficient detailed
information to enable it to issue wise rules and regulations in this respect.
Moreover^ the action of an exchange in admitting a security to listing is an
affirmative action The action of the Commission in this respect, in not forbidding or deferring such listing, is a negative action. The exchange has the
direct contact with the issuers, and it would appear to be in the interest of
that flexibility which is essential m the business of dealing in securities to
allow the exchanges to make the rules and requrements for listing, with provision for approval by the Commission if such rules or requirements are to have
the force of law, and with the provision that the Commission may direct the
making of rules and regulations, if any particular exchange appears to be lax
its duty in this respect.
This comment will apply to all future sections where rules and regulations
affecting registration statements are to be made by the Commission
This difficulty could be removed by making the first sentence of Section 11
(b) (II) read"Such information as to the issuer and affiliates as the exchange, with the
approval or at the direction of the Commission may, by rules and regulations,
require as necessary or appropriate in the public interest or for the protection
of investors in respect of * * * ".
Further in this connection, it is noted that Section 11 (a) and Section 11 (a)
(I) both refer to rules and regulations under the act, without stating by whom
such rules and regulations are to be made It might be well to amend the two
paragraphs just referred to to include similar language, and thus carry out the
idea advanced throughout this comment The present language of these two
sections, however, is sufficiently flexible if it appears better not to amend
them
Section 11 (b) (II) (4): The requirement for making public the names of
the principal security holders does not seem to be necessary in the public interest, and it is suggested that it be omitted
The requirement to state the remuneration of directors and officers is believed to be adverse to the interest of security holders A large part of the
business of this country is in the hands of corporations, and inducements are
needed to insure to corporations, now and in the future, a proper type of
corporate officer. The average stockholder is of small means, and will tend to
bring pressure upon directors to reduce salaries, entirely reasonable in them
STOCK EXCHANGE PBACTICES
7519
selves, but much larger than the income of the individual stockholder There
is reason to believe that, m spite of conspicuous instances to the contrary, thecorporate officials of this country are, on the whole, under-paid in relation to
the responsibilities assumed by them, and anything tending to prevent ambitious and able men from going into corporate employ is to be deplored
In addition, disclosure of this information would frequently be of competitive disadvantage.
Many of the ablest corporate officials have relatively small financial interests
in the company which they serve No good reason is known for requiring that
the interests of officers and directors in the securities of companies should be
stated. I t is suggested that this paragraph be rewritten to require a statement
of the names of directors, officers and underwriters, the remuneration of the
underwriter in connection with the particular issuance for which listing is
desired, together with any continuing remuneration to the underwriter, and a
statement of any contracts, other than contracts of employment, between directors and/or officers on the one hand, and the issueis and its affiliates on the
other.
Section 11 (b) (II) (5) • For the same leason as is given above, it is suggested that this paragraph in regard to stating the remuneration to others
than directors and officeis exceeding $20,000 per annum be omitted altogether
Section 11 (b) (II) (6) This requires a statement of particulars regarding
bonus and profit-sharing arrangements Insofar as it may require disclosure
of names of individuals benefitting by bonus and profit-sharing arrangements
or payments to particular individuals described by title or otherwise, it is
believed to be subject to the same objections outlined to (4) and (5) above
In addition, it is frequently advisable to select particular individuals for
special remuneration of this nature, and the disclosure of the fact to others
not thought by the officials to merit such treatment would cause serious
jealousies and disturbances
It is suggested that this provision be modified by the substitution of an agreement to submit, in the future, all such plans in general teims to stockholders
for ratification before they may become effective, and that, both as to past
and future arrangements of this nature, all annual reports published should
restate such general terms and the total amount of bonus payments or profits
shared thereunder
Section 11 (b) (II) (7) . This provides for disclosure of the particulars of
management and service contracts The meaning of this paragraph is very
obscure, and what constitutes management and service contracts should be
better defined in order that the issuers may be able to fulfill the requirements
Section 11 (b) (II) (9) : I t is suggested that this paragraph be stricken
on account of its difficulty of administration The determination of what
constitutes a material contract and as to what is a material patent is to difficult that the only safe means of compliance may be the publication of particulars regarding all contracts not made in the ordinary course of business and
a description of all patents, which, in the case of many companies, would
burden the record with an enormous mass of worthless material
Section 11 (b) (II) (10) This requires submission of balance sheets for
preceding years, certified by independent public accountants or otherwise as
the Commission may prescribe
The number of years is not stated It is suggested that the provision should
be made more definite by making it apply to the last three fiscal years of the
corporation, if it has been that long in existence, and to permit specifically
that certified statements, when required, shall not be required for a longer
period than the last fiscal year, unless the reports for such longer period
have been previously certified by independent public accountants
I t is particularly suggested that the words " fiscal year " be inserted in all
references to annual reports, with the idea in mind of having corporations, as
far as practicable, adopt a natural fiscal year, in order that the work of
auditing may be spread more evenly throughout the year, instead of being
concentrated, as it now is, largely, in a few months in the early part of the
year
Section 11 (b) (II) (11) The number of rears' profit and loss statements
to be filed is not stated. I t is recommended that amendments similar to those
suggested for Section 11 (b) (II) (10) be made in this respect
Section 11 (b) (II) (12) * This requires, in regard to any matters similar
to the preceding sections, such information as the Commission deems necessary to insure the proper protection of investors and fair dealing in the
175541—34—PT10
g
7520
STOCK EXCHANGE PEAOTIOES
security It is recommended, in view of the immediately preceding text, and
m view of the comment above on Section 11 (II), that this be changed to read:
"Any similar financial statements, information regarding which the exchange,
with the approval or at the direction of the Commission, may deem necessary
to insure the proper protection of investors and fair dealing in the security "
Section 11 (b) (III): The same suggestion is made as heretofore, as to the
substitution of rules made by the exchange, with the approval or at the
direction of the Commission, in place of rules made directly by the Commission.
Section 11 (c): This provides that if, in the judgment of the Commission,
reports required under Section 11 (b) are inapplicable to specified classes of
issuers, the Commission shall require, in lieu thereof, such reports, if any,
as it may deem applicable to such class of issuers. It is recommended that this
read*
" The exchange, with the approval or at the direction of the Commission, may
determine that any report or reports required under sub-section (b) are inapplicable to any specified classes of issuers, and, in such event, may require,
in lieu thereof, the submission of such reports, if any, as it may deem applicable to such class of issuers The exchange may receive and act upon listing
applications using its own best judgment in this respect, subject to the right
of the Commission to require an amended statement from the issuer, should the
Commission not concur in the action taken."
This provision is in the interests of the time element, and to carry out the
idea of the Commission working through the exchanges with the applicants.
Section 11 (d) This provides that, upon certification by the exchange authorities to the Commission that the security has been approved by the exchange
for listing and registration, the registration shall become effective thirty days
after the filing of such certification with the Commission, with appropriate
provision for cases in which the Commission does not approve. A certain
amount of time is required for the submission, correction, consideration and
approval of any listing application by a well-organized exchange, ordinarily, in
times of normal volume of business, from ten days to two weeks When thirty
days is added to this, the delay becomes so serious that it will materially affect
many transactions, and interfere with the business of underwriting new issues
for financing capital requirements, and for dealing with the maturities of existing corporations to a serious extent It is suggested, therefore, that the thirty
day limit be taken off entirely, and that securities be regarded as fully registered from the date of approval of the listing application by a registered stock
exchange, subject to the right, elsewhere reserved to the Commission, to suspend
trading in securities, this right to be exercised if the Commission finds such
securities not suitable for registration
It is further suggested that the exchanges be permitted to list securities
growing out of existing securities, such as certificates of deposit and other like
instruments, in advance of registration, upon request by letter, accompanied
by an assurance that a listing application, in form required by the exchange,
will be forthcoming within a reasonable time This action, of course, would
also be subject to the Commission's right to suspend.
Section 11 (e) • This provides that the Commission may, by such rules and
regulations as it deems necessary or appropriate, permit securities listed on any
exchange at the time of the registration of such exchange as a national securities exchange becomes effective, to be registered provisionally for a period
ending not later than April 1, 1935, without complying with the piovisions
of this Section.
Reference is made to the comment upon this feature in connection with
Section 11 (a) on pages (2) and (3) of this Memorandum It is urged that
this Section, in the general public interest, should be amended in accordance
with the recommendations just above referred to
Section 12 ( a ) : This is subject to the preceding remarks, that the filing of
the required information should be in accordance with rules and regulations
to be prescribed by the exchange, with the approval or at the direction of
the Commission, etc
Section 12 (a) (2) : To carry out the idea of this Memorandum, the annual,
quarterly, and other reports to be filed should be such as the exchange with
the approval or at the direction of the Commission, may prescribe This
Section is much more flexible than the similar Section in the preceding draft
of the Bill There is no occasion for changing it excepting as stated, but it is
STOCK EXCHANGE PEACTICES
7521
to be hoped that the eventual requirements will not include quarterly balance
sheets, which, excepting with investment trusts and like corporations, are
illusory, and that the requirements for making quarterly earnings reports will
be sufficiently flexible to avoid lequmng such reports from corporations in
cases where such reports would be misleading, impracticable, or unduly expensive to the stockholders of the corporation
Section 12 (b) * This section should really be left out in its entirety If this
cannot be done, it should be set forth that the items or details to be shown in
the balance sheet and earnings statement need not be uniform, and that the
exchange may adapt its requirements in this respect to the circumstances of
individual corporations, subject to the right of the Commission to require
the corporation, in future financial statements, to give such additional information, it any, as the Commission may think essential Under no circumstances
should the Commission be empowered to prescribe the methods to be followed
in the preparation of accounts, in the appraisal or valuation of assets and
liabilities, in the determination of depreciation and depletion, in the differentiation of recurring and nonrecurring income, and in the differentiation of investment and operating income Any attempt to regulate these matters by fixed
written rules is doomed by the nature o£ the subject to failuie, and the
existence of such rules would tend to crystallize and prevent all future progress
in the accounting art
Accounting is, and always must be so much a matter of judgment, that
the best that can be done is to try by common consent to narrow in certain
instances the limits within which that judgment may be properly exercised
In lieu of the provisions which, as above stated, it is essential to stuke, it
might be provided that the methods to be followed in the preparation of
accounts, in the appraisal or valuation of assets and liabilities, in the determination of depreciation and depletion, in the differentiation of recurring
and non-recurring income, and in the differentiation of investment and operating
income, shall be in accordance with sound standards of the day as practiced
by professioal men of standing This will give ample authority to take measures to remove from the list of all registered exchanges, the securities of
corporations whose accounts manifestly aie not kept in accordance with such
standards
In addition to this, there might well be an additional paragraph in Section
18, requiring each listed corporation to cause a statement of the methods of
accounting and reporting employed by it to be formulated in sufficient detail to
serve as a guide to its accounting department; to have such statement adopted
by its Board, so as to be binding upon its accounting officers, and to file such
statements with the Commission, making a copy thereof available to any stockholder upon request, and upon payment, if desired, of a reasonable fee.
Another paragraph might require the listed corporation to give assurances
that the methods so formulated will be followed consistently from year to
year, and that, if any change is made in the principles, or any material change
in the manner of application, the stockholders, the exchange and the Commission shall be advised when the first accounts are presented in which effect is
given to such change
There are grave reasons why the filing of the information suggested above,
directly with the exchange, would or might be inadvisable, but the filing
of such statements within a reasonable period of time, say one year, with the
Commission, would have certain marked advantages
Section la (b) : This Section provides that proxies may not be given, or
authorization in respect of any security registered on a national securities
exchange and carried for the account of a customer, without a specific written
authorization from such customer Some exchanges have this rule already
in existence.
There is reason to doubt its wisdom as applied to non-dividend-paying securities. Such securities often pass from hand to hand for years, without change
of name. They may pass through a number of hands after leaving t^e custody
of the firm in whose name originally registered, and it is impossible for the
firm in question to give the name of the true owner. This makes it difficult
and at times absolutely impossible to secure a quorum for necessary action by
stockholders, and at times constructive plans of corporations for their lehabilitation have been defeated by the existence of this difficulty. The ru'e is a good
one as applied to dividend-paying stocks, and as to the non-dividend-paying
stocks, it should be remembered that the actual owner of a security may at any
7522
STOCK EXCHANGE PKACTICES
time get it and vote it, in spite of any proxy that may have been given in the
name of the registrant.
Section 18 (5) This Section empoweis the Commission to alter or add to
the rules, regulations, and practices of a national securities exchange, including, among other things, rules in regard to the limitation or piohibition
of the registration or trading in any security within a specified period after
the issuance of primary distribution thereof Attention is called to the comment upon Section 11 (a) in regard to the advisability of not unduly restricting the " when issued " market for securities.
Apart from this, however, the possibility of this limitation or prohibition
should not extend to additional issues of the same class of securities as have
already been listed by a given corporation
The possibility of such limitation or prohibition is doubtless contemplated
only as to original security issues Practicallv all additional issues must be
authorized for listing subject to official notice of issuance, otherwise the business of making additional issues of a listed security would have to cease
It is suggested, therefore, that this paiticular clause be changed to read
"The limitation or prohibition of the registration or trading in the first,
or initial, issue of any class of securities made the subject of an application
or registration statement, within a specified penod after the issuance or
primary distribution thereof * * x "
With this alteration, the Section as a whole is flexible enough to enable
the Commission to allow "when issued" trading in securities if it thinks
it advisable
Section 22 This Section empowers the Commission, Comptroller of the
Currency, the Federal Reserve Board, and Interstate Commerce Commission
to make such rules and legulations as may be necessary for the execution
of the functions granted to them under this act There should be added at
the end of the Section language approximately as follows
"Any registered national securities exchange of a class to be determined
by the Commission may, with the approval of the Commission, or at its
direction, make such rules, regulations, and requirements affecting the listing
and retention upon the list of securities, not inconsistent with the provisions
of this act, and such rules, regulations and requirements, so approved or
directed by the Commission, shall have the same force and effect as though.
initially made by the Commission Nothing, however, shall prevent the exchange from prescribing other rules, regulations and requirements deemed
by it to be necessary m this connection, without formal approval of the
Commission Such unapproved rules, regulations, and requirements, however,
shall not have the force of law, and may be set aside upon due hearing, in
the discretion of the Commission."
The first part of the foregoing addition to Section 22 is for the purpose
of carrying out the consistent idea of this Memorandum, that it is better
that the Commission should work through the exchanges with listed
corporations.
The second part is based upon the fact that nearly all requirements of
exchanges have been evolutionary in their nature, and it is necessary to
preserve a certain degree of flexibility in regard to them, for which, however,
the Commission should not be made responsible, nor should such unapproved
requirements have the force of law.
J
M B HOXSEY,
Executive Assistant to Committee on
Stock List, New York Stock Exchange
MAECH 21,
1934
STOCK EXCHANGE PEACTICES
SATURDAY, MARCH 24, 1934
UNITED STATES SENATE,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.C.
The committee met at 10:30 a.m. pursuant to adjournment on yesterday, in room 301 of the Senate Office Building, Senator Duncan
TJ. Fletcher presiding.
Present: Senators Fletcher (chairman), Barkley, Gore, Byrnes,
McAdoo, Adams, Goldsborough, Townsend, Walcott, Carey, Couzens,
Steiwer, and Kean.
Present also: Eoland L. Eedmond, counsel to the New York Stock
Exchange; William A. Lockwood, counsel to the New York Curb
Exchange; and Eugene E. Thompson, president of the Associated
Stock Exchanges.
The CHAIRMAN. The committee will come to order, please. Some
people telegraphed me the other day about our hearings and I notified them we were going to close after yesterday and today. I do
not know whether they are here today or not. If they are present
and ready to be heard we will hear them. Now, any of those who
wish to make statements will come forward to the committee table
and give their names now.
Mr. THOMPSON. Mr. Chairman, I am president of the Associated
-Stock Exchanges, and
The CHAIRMAN (interposing). I know that you are here, Mr.
Thompson. Is anybody else present who wishes to be heard? [after
a pause:] There was a Mr. Ladd, I think from Pittsburgh, who
wired asking permission to be heard, and I answered telling him
I would give him a hearing.
Senator GOLDSBOROUGH. There was a Mr. Laird, representing a
hig firm
The CHAIRMAN (intelposing). No; this was a Mr. Ladd.
Senator GOLDSBOROUGH Well, that is another man.
The CHAIRMAN. I S there anybody else present this morning who
wishes to be heard on the bill ?
Mr. PAUL. Mr. Chairman, my name is W. G. Paul, of Los Angeles,
representing the Los Angeles Stock Exchange. I should like the
opportunity to appear before your committee but am not sufficiently
prepared to make a statement this morning. We are now working
on the suggested amendments which we intend to submit, and 1
think it would be futile for me to sit down now and take your time.
The CHAIRMAN. DO you now have your amendments in shape to
submit to the committee?
7523
7524
STOCK EXCHANGE PRACTICES
Mr. PAUL. NO, sir; we are working in connection with Mr*
Whitney, and as he stated on yesterday, he will submit his amendments later. I could now merely sit down and chat with you gentlemen, but I think that would be an unnecessary waste of your time.
The CHAIRMAN. Very well, Mr. Paul. Now, Mr. Thompson, you
may come forward and we will have your statement.
Mr. THOMPSON. All right, Mr. Chairman.
The CHAIRMAN. Mr. Thompson, whom do you represent?
Mr. THOMPSON. Mr. Chairman and gentlemen of the committee:
I represent the Associated Stock Exchanges as their president, the
membership of which is composed of 18 local exchanges throughout
the United States, plus the Louisville, Ky., Stock Exchange; the
Eichmond, Va., Stock Exchange; and the Seattle, Wash., Stock
Exchange. I will be glad to furnish the committee reporter with
a list of our membership.
The CHAIRMAN. All right.
Mr. THOMPSON. Shall I now proceed?
The CHAIRMAN. Yes. You have examined this revised bill, known
as H.E. 8720,1 take it?
Mr. THOMPSON. Yes.
The CHAIRMAN. Very
well. You
ment.
Mr. THOMPSON. My remarks will
much as that is the subject which
consideration at the present time.
The CHAIRMAN. Very well. You
ment.
may go ahead with your statebe directed to H.E. 8720, inasI understand you have under
may go along with your state-
STATEMENT OF EUGENE E. THOMPSON, PRESIDENT OP THE
ASSOCIATED STOCK EXCHANGE, WASHINGTON, D.C.
Mr. THOMPSON. On the occasion of a former recent appearance
before this committee, I ventured to assert, in behalf of the Associated Stock Exchanges, of which I am the president, that the then
pending bill to regulate the securities exchanges of the country was
unworkable; that it would operate to destroy the usefulness of the
essential market places for corporate capital; that it would retard
materially if not actually prevent the realization of the President's
recovery program; that it would tend to turn the corporate securities
business of the greatest industrial country in the world into the
hands of racketeers and bootleggers, and that instead of being a
measure for the protection of the investor it likely would prove to
be the most damaging legislation of its character ever enacted by the
Congress.
Now a new securities bill has been prepared, or rather the old bill
has been rewritten in some of its particulars; but in all the essentialities and insofar as original intents and purposes are concerned
the measure remains as it was at the beginning. The form only has
been slightly disguised; the substance is apparent and unchanged.
Those of us who have devoted years to deep and earnest study into
the problems of the stock exchanges and the securities business have
not felt that the bill as drawn in the first instance met, or came anywhere near meeting, the requirements of rational legislation. We do
STOCK EXCHANGE PBACTICES
7525
not consider that the amended bill is better or worse than the original. If we should admit for the sake of argument that the stock
exchanges are wholly bad, then we should still be compelled to say
in candor that the legislation which is proposed here furnishes only
an easy means of jumping the corporate securities business of the
country out of the frying pan and into the fire.
Oh, well, some of you might say, this witness and those whom he
represents would be antagonistic to any kind of a regulatory law.
That would not be an accurate assumption at all. We are not
opposed to, but would rather welcome a law of practical design that
contemplates and takes into account only those features and phases
of the business of handling corporate securities which are in need
of and which are susceptible of regulation. Naturally we would not
favor a law which we believe would destroy the stock exchanges as
institutions; and when I mention stock exchanges in this sense you
will understand, of course, that I am speaking only for those located
outside of New York City. We would not favor a law which places
in the hands of a Federal agency, as this bill does, the power and
means for controlling, absolutely and minutely, the business of the
country.
Statements have been made to the effect that the general business
of the country will not be retarded or affected adversely by the passage of this legislation. Such assertions can only come from those
who are ill-advised or ignorant. The stock exchanges are the economic barometers—the business pulse of the country. Those of us
who by the circumstances of our lives have been thrown intimately
into touch with the stock exchange do not merely thing that general
business will be hit hard—we know it will be. There will be an
immediate recession of business with the advent of this legislation.
There will be deflation and there will be credit chaos. You gentlement at this moment surely sit in a position of exceedingly grave
responsibility. Even a favorable report by you on this measure as
is now written is a matter fraught with dangers of a nature the
nation can ill afford to have thrust upon it at this critical period.
The attempt at control of corporations through the medium of
a stock exchange regulatory bill cannot be judged otherwise than
as misplaced legislation. If there is to be control of that kind, then
surely it should be out in the open—a frank measure providing for
such control as may be deemed advisable and proper under a national
incorporation act; and that is where it belongs if it belongs anywhere.
We have already had a forerunner of what may happen as a result
of this proposed law. Cabled solicitation for American orders in
securities already have come from London, and Paris advises are to
the effect that recently, in anticipation of what is expected to be done
here, there has been an increase of listings in the Paris market.
You have all read in the papers that within the last few days stock
exchange memberships at Montreal and Toronto, in Canada, have
increased in value, while seats on the New York and other exchanges in our own country have been quoted on a basis of a greatly
reduced valuation.
May I say that these facts are not to be dismissed as propaganda.
If they represent propaganda, then they are the propaganda of
7526
STOCK EXCHANGE PRACTICES
serious truths which cannot be overlooked or treated lightly by any
citizen, whatever his position may be in the country's affairs, who
has the good of the United States at heart.
In a general sense—because I do not care to dwell again upon those
points which were covered m my previous appearance here—the proposed legislation attempts to reach too far. I t seems to grope about
in the maze of its own complications and in the darkness of its own
confusion. As a layman, I should say it needs to be a simpler law
and a shorter one.
Let me single out just a few of the provisions changed in the rewriting of the bill which are still in our opinion objectionable.
Now, as to page 8, paragraph 13: This exempts only such securities as are direct obligations of or obligations guaranteed as to
principal or interest by the United States; such securities as are
issued or guaranteed by corporations in which the United States has
a direct or indirect interest and which shall be designated for exemption by the Secretary of the Treasury, and such other securities as
the Commission, by such rules and regulations as it deems necessary
or appropriate in the public interest or for the protection of investors, may exempt from the operation of any one or more of the
provisions of the act.
The placing in the hands of the Federal Trade Commission of
authority over the securities of States and their political subdivisions which, if the provision is actually enacted into law as worded
in the bill, may have far-reaching results, and in addition may force
the States and their political subdivisions to pay much higher prices
for borrowed funds than they have been in the habit of paying, this
being due to the uncertainty which will be created as to the qualifications of the securities as " exempt securities."
With reference to page, 13, section 6, item ( a ) : This item, while
amended in several particulars, still makes no change over the old
bill with respect to loans upon securities, other than exempted
securities, which are not listed upon a national securities exchange.
We submit that this item would work an undue hardship upon those
owning the securities of many small corporations which are entirely
solvent and have satisfactory ratings.
Referring to page 19, section 7, item ( a ) : When the broker or
dealer in the course of business is prohibited from borrowing on
any security—other than exempted security—except from a Federal
Reserve bank, or in accordance with rules and regulations prescribed
by the Federal Reserve Board to permit limited loans between members and brokers or between members and dealers who transact a
business in securities through the medium of a member, or to permit loans from or through others than member banks m localities
where there are no member banks, or to meet emergency needs—
under these conditions it is apparent that the broker will be forced
to do business with a member bank of the Federal Reserve System
unless there should happen to be no member bank in the locality
where he conducts his business. It is unfair to force upon a broker
or dealer the obligation of borrowing through a member of the
Federal Reserve System; it is likewise unfair to banking institutions which are not members of the Federal Reserve System to take
from them the privilege and opportunity of making such loans.
STOCK EXCHANGE PBACTICES
7527
Going to page 21, section 8, subsection 2, lines 22, 23, and 24, attention is called to the words, " or a false or misleading appearance in
respect of the market for such security or securities." In its import
and its operation this language is unfair to brokers. A broker may
act in the purchase or sale of securities, and in so doing, but not by
his design or purpose, there is created a false or misleading appearance in respect to the market. Why, under such circumstances the
broker be held accountable when he has only been given orders to
purchase or sell? In the case of limited markets, there is almost
certain to be that which might be described as false or misleading
appearances in respect to the market in the minds of many persons*
The vagaries of the human mind are not often changed by legislative enactments. In this connection, in the same section, on page 22,
subsection 3, line 5, are the words, " for the purpose of raising or
depressing the price." It would be exceedingly difficult for a broker,
or for anyone else for that matter, to interpret the meaning and the
intent of a customer when he has been called upon to execute either
a buying or selling order which is bound to have the effect of raising
or depressing prices m limited securities markets.
In subsection 5, line 24 on page 22 and lines 1 and 2 on page 23.
we read that it will be unlawful to make any statements inducing a
securities transaction which is, in the light of the circumstances
under which it is made," false or misleading in respect of any matter
sufficiently important to influence the judgment of an average investor." If this language is allowed to remain in the bill, there will
be many days of anxiety on the part of brokers and dealers until
they can feel that they may do business without this liability hanging over them.
We direct attention to subsection 8, page 23, line 21, which deals
with the proposition of " pegging, fixing, or stabilizing the prices of
securities in contravention of such rules and regulations as the Federal Trade Commission may prescribe as necessary or appropriate
in the public interest or for the protection of investors or without
having prior thereto reported to the Commission such information
regarding the purpose and nature of such transactions or operations,
the details thereof and the person or persons interested therein as
the Commission by rules and regulations may prescribe as appropriate or necessary in the public interest or for the protection of investors." There is likelihood here of great harm being done, perhaps
where not intended, by denying an investor the right to support securities in which he has a particular interest, or against which he may
have loans, or in the purchase of which he is moved by a desire to
accumulate the securities for investment purposes.
As to subsection 9, items (i) and ( n ) : These provisions fail to
give to a broker or dealer the right to acquire options for the purpose
of liquidating large blocks of securities held, say, by estates, or
against bank loans, et cetera, where the work of distribution involved is considerably greater than if the broker were merely selling
stock on the exchange ior a commission. Unless proper provision is
made to care for such classes of transactions there will be many instances where estates and banks holding large loans will suffer
through inability to obtain the services of dealers or brokers in such
liquidations.
7528
STOCK EXCHANGE PBACTICES
On page 27, section 10, item (b): This item provides that the rules
of the proposed national securities exchange may permit a member
to be registered as an odd-lot dealer and as such he will be permitted
to buy and sell for his own account so far as may be reasonably
necessary to carry on such odd-lot transactions; it also provides that
it shall be unlawful for an odd-lot dealer to act as a broker. Evidently in this particular no consideration has been given to the
character of business conducted on the smaller exchanges throughout
the country and on which nearly every broker does an odd-lot business. As a matter of fact the great bulk of transactions on the local
exchanges are in odd lots. This section should be changed or clarified so that the business now transacted on the smaller exchanges
will not be taken away from them. Some of the member exchanges
already have advised us that if this provision becomes a law they
will be forced out of business.
As to section 10, line 6, page 28: I t provides here that it shall be
unlawful for any member—meaning a member of a national securities exchange—either with or without the privilege of acting as a
dealer—except an odd-lot dealer or a specialist dealer—and, while on
the trading premises of an exchange, to effect any transaction for
his own account, or, as a broker, to give an order to another member
to be executed for his own account. The Commission is given the
power, when it has been shown that the rules of the exchange prevent
excessive trading bj members, to permit exchange members to effect
transactions for their own account, subject to such terms and conditions as the Commission may prescribe as necessary or appropriate
for the protection of investors. I cannot see why the facilities of
an exchange should be denied to its members unless it is able to show
that its rules prevent excessive trading by members. Just what is
meant by excessive trading certainly is not clear. Such a law would
undoubtedly tend to drive legitimate trading from the exchanges.
With reference to page 30, section 10, item (e): The rules of the
proposed national securities exchange bill may permit the registration
of a specialist as a dealer or as a broker; but it shall be unlawful
for a specialist registered as a dealer to act as a broker, or for a
specialist registered as a broker to act as a dealer. I t should be
understood that brokers who now act as specialists do not devote
their entire time to that line of activity; they act as sepcialists in
certain classes of securities only and this occupies, usually, merely
a small portion of their time. The rest of the time they act, of course,
as brokers. Due consideration should be given to this class of business which apparently was not clearly understood by the framers
of the bill.
On page 34, section 11, item (f): The Commission, by this provision, is directed to make a study of trading in unlisted securities
on the exchanges and to report the results together with its recommendations to Congress on or before January 23, 1935, but it also
appears that in the event Congress does not take action before that
time, the exchanges may continue unlisted privileges only until
March 1, 1935, unless an earlier date is prescribed by law. It is
quite evident that what has been developed into a publicly quoted
market for certain unlisted securities will be destroyed unless the
Commission is given authority to extend the time until Congress
has
had an opportunity to act upon, the recommendations.
STOCK EXCHANGE PEACTICES
7529
As to page 36, section 12, item (b) : It is noted that the present
bill retains the provision requiring the Commission to prescribe
methods to be followed in the preparation of accounts, in the appraisal and valuation of assets and liabilities, and m the determination of depreciation and depletion. We heartily endorse full and
free statements, but we submit that the Federal Trade Commission,
or any other regulatory body, should not have the power to appraise
and determine the valuation of assets and liabilities or to determine
depreciation and depletion. Such authority as given undoubtedly
would cause many corporations to de-list their securities from the
smaller exchanges.
Going to page 38, section 14, line 20: Regulation and control of
over-the-counter transactions appear too indefinite for a dealer to
have any comprehension of just what he may or may not be permitted to do. The whole regulation is left in the hands of the Commission and as a guide in this conection the Commission is to use
such necessary protection as is comparable in the case of national
securities exchanges. We cannot see the fairness of attempting to
regulate those engaged in the business of buying and selling securities while allowing those who are not engaged to go out and conduct
transactions without any restrictions.
At page 41, section 16: We submit that the business of selling securities should not be subjected to any more outside examinations than
other lines of business. The expense for income tax information and
other reports is already a burdensome charge upon the business, and
to levy further charges for additional examinations is beyond the
realm of fairness. The exchanges are amply able themselves to
cover the matter of examinations and have always been foremost over
other lines of business m such efforts.
In summarizing let me say that we have not attempted to go into
many features of the bill which we still feel are vitally objectionable
to the continued existence of the local stock exchanges.
We have dwelt upon these in a previous statement, and the fact
that they are not again being stressed should not be construed as
indicating that our protest is thereby minimized
We wish to emphasize our serious objections to the placing of the
regulation of the stock exchanges under te Federal Trade Commission, even though it is to be an enlarged commission; we do not
believe that the Commission, or any other commission or body which
is not specially organized and its personnel carefully selected for
the character of work it will be called upon to perform, is constituted
to deal with a business so highly technical and surrounded by so
many ramifications requiring prompt specialized treatment.
We wish again to go on record as favoring a coordinating authority
in which the stock exchange shall have a voice m their own management. It is our belief that any regulatory body made up entirely
of those not representative of the stock exchanges cannot and will
not function in a way that will be to the best interests of the public
and certainly not to the best interests of the stock exchanges.
Senator BARKLEY. Mr. Thompson, do you think the Interstate
Commerce Commission ought to* be composed of presidents of railroads inasmuch as it has to deal with railroad regulations?
Mr. THOMPSON. NO, Senator Barkley, and we do not suggest that
here either.
7530
STOCK EXCHANGE PRACTICES
Senator BARKLEY. Well, I take it that would be a parallel situation.
Mr. THOMPSON. NO. With all due respect, I do not think so.
Senator ADAMS. Well, do you think they ought to have any considerable representation on the Commission?
Mr. THOMPSON. We think they ought to have a voice in it, or certainly to the extent of having on the membership those who are
acquainted with railroad matters
Senator BARKLEY. Well, even if you thmk they should have a
partial voice in it, by the same theory in setting up any commission
to regulate any industry you think it ought to be composed, in part
at least, of those engaged m such industry, do you ?
Mr. THOMPSON. Well, I think you will agree with me that the
Interstate Commerce Commission has been composed at times of
some former railroad presidents.
Senator BARKLEY. Well, perhaps once in a while but not often.
Mr. THOMPSON. Well, this is starting out on a new path where
some intimate knowledge of the subject is quite needful.
Senator ADAMS. Well, in the case of any active railroad men, when
they go on the Interstate Commerce Commission they certainly sever
their relations with the railroads.
Mr. THOMPSON. That may be so, but the knowledge is there.
Senator BARKLEY I do not recall that any member has been taken
from any important railroad itself.
Mr. THOMPSON. I cannot cite you at this time a case in point, and
of course the Interstate Commerce Commission was organized many
years ago.
Senator COUZENS. Well, certainly any such man was not put on
the Interstate Commerce Commission as representing railroad management.
Senator ADAMS Mr. Thompson, your proposition seems to be that
members of stock exchanges should be made a part of the regulatory
body proposed here to be set up.
Mr. THOMPSON. Not altogether, but I would suggest
Senator ADAMS (interposing) At least you suggest that there
should be some of them on such a body.
Mr. THOMPSON. I mean along the lines of Mr. Whitney's suggestion
made to this committee some days ago, that those to compose such
a body might be selected as lepresentmg, possibly, one from the
New York Stock Exchange and possibly one representing the local
exchanges throughout the country.
Senator ADAMS HOW do you mean to have them selected ?
Mr. THOMPSON TO have them designated by the exchanges.
Senator ADAMS Then you would propose to have the exchanges
designate the membership of a Government commission ?
Mr. THOMPSON NO, sir. We do not suggest that at all. But we
do thmk there should be on such a commission those who are acquainted with the intricate details of the business, and that the
members, as ufual m the case of any Government commission, would
be selected by the President of the United States.
Senator ADAMS. Then you are not m favor of any regulations of
stock exchanges, are you?
Mr. THOMPSON. 1 am m favor of some legulation if we may have
some voice in it.
STOCK EXCHANGE PEACTICES
7531
Senator ADAMS. I take it on the theory that you would furnish
the voice and when that voice would come forward with a statement
the rest of them would follow.
Mr. THOMPSON. Oh, no.
Senator COTTZENS I suppose
the utilities would desire the same sort
of regulation.
Senator ADAMS. That, it seems to me, would be worse than no
regulation at all.
Mr. THOMPSON. I would not go that far. If a majority of the
members of the commission are others than members of stockexchanges, there would certainly be regulation.
The CHAIRMAN. In other words, if you could regulate the regulators you would be satisfied, is that it?
Mr. THOMPSON. N O ; I do not even ask that. If we had 1 voice
out of 7, let us say, I would not say that that 1 voice would regulate
the 7.
Senator BAKKJLET. Well, in case of a tie vote of the other six
members that voice would have the deciding vote.
Mr. THOMPSON. That would be true, too.
Senator MCADOO. Under the Constitution the President is the
appointing power of all commissions and bodies representing the
general public interest. Now, you wouldn't advocate the giving of
that power to any private organization or body, would you?
Mr. THOMPSON. Not altogether, no. But when some one is selected
who is familiar with stock exchanges that would give assurance
of some knowledge within the board of the intricate workings of
this business. Even though the exchanges themselves could not
nominate some one, if there were some one selected who is familiar
with stock exchange practices it would go a long way toward assuring a general knowledge of the business.
Senator ADAMS. I suppose the membership of the United States
Senate should have the opportunity to select, then, 1 out of the
7, inasmuch as theyare passing the legislation and dealing with it.
Mr. THOMPSON. Well, the Senate passes the legislation to create
such a body, and they usually have the opportunity of confirming
those who are nominated by the President to serve on such a body.
Senator GORE. Does the Federal Reserve Act require that men
having knowledge of banking shall be placed on the Federal Reserve Board?
Mr. THOMPSON. I am not familiar with the act, but I know it has
been done.
Senator ADAMS. Oh, yes, but the banks do not select the members.
Senator COUZENS. There is nothing to prevent the President from
putting some stock exchange man on the proposed board if he
wants to do it.
Senator MCADOO. The President has the power to select a member
or members of the proposed board from your organization if he sees
fit. He has a perfect right to take some one who is qualified. Don't
you think there is just as much protection there in the make-up of
such a body so far as you are concerned as any other interest has
in the Interstate Commerce Commission or any other governmental
commission B
7532
STOCK EXCHANGE PBACTICES
Mr. THOMPSON. Senator McAdoo, I might say it is my recollection
that even in the case of some commissions that have been provided for
by law, there has been provision made by the Congress that the men
selected for such positions should have a knowledge of and general
acquaintance with the work to which they were to be assigned. I
cannot point out at the moment what they are, but I think there are
some nevertheless.
Senator GORE. I think the Federal Reserve Act requires that some
one having a knowledge of agriculture shall be placed on the Board.
But there are a lot of farmers who vote, of course.
Senator MCADOO. Business organizations might select a business
man, and bankers might select some banking man, whose names
would be presented to the President for consideration.
Senator GORE. Mr. Thompson, don't you think your statement is
a sort of impeachment of the brain trust?
Mr. THOMPSON. Well, it might be so coneidered, but it was not
intended as that.
Senator GORE. I t would seem that way to me.
Senator ADAMS. Mr. Thompson, in the opening part of your statement you referred to the decline in value of stock exchange seats.
What bearing does that have on the bill we are considering here?
Mr. THOMPSON. Well, I think the decline in stock exchange seats
has been brought about by the fear that the exchanges will ,be so
handicapped it will be difficult for them to do business as it has
been done in the past, and that there will not be the usual demand
for seats on stock exchanges.
Senator ADAMS. Isn't that begging the question? For instance,
if there is any illegitimate business being profitably conducted,
necessarily the shutting off of that business, or such portion of it as
may be illegitimately conducted, will have an effect upon those engaged therein. Let us take Monte Carlo: If the Prince of Monaco
should change the dice on the game, the franchise there would be
worth considerably less.
Mr. THOMPSON. I agree with you, Senator Adams, so far as illegitimate things may be concerned. And we do not stand for those
any more than you or anyone else. Certainly those whom I represent
would not attempt to condone such things.
Senator ADAMS. Well, if the bill merely eliminated illegitimate
practices and that resulted in reducing the price of stock exchange
seats, that is no argument to be offered against the passage of this
bill.
Mr. THOMPSON. I think it goes further than eliminating illegitimate practices. The bill as now drawn hinders legitimate practices.
Senator ADAMS. Well, that is the thing we are interested in knowing about.
Senator BARKLEY. What decline in stock exchange seats are you
talking about?
Mr. THOMPSON. I am referring more particularly now to the newspaper accounts of the New York Stock Exchange and the New York
Curb Exchange seats.
Senator BARKLET. Well, before this bill was ever prepared, yes,
long before the matter came up seriously at all, I might say, seats
on the New York Stock Exchange declined from a price over
$600,000 to less than $200,000.
#
STOCK EXCHANGE PRACTICES
7533
Mr. THOMPSON. Well, whenever there is anything that will scare
the people into the belief there will be a reduced amount of business
you will find a decline in stock exchange membership.
Senator BARKLEY. But it was not a Government scare that
brought about that decline. It was the debacle on the stock exchange
and the general situation.
Mr. THOMPSON. That is true, but we have a worse decline in
the last month or two as it affects seats on stock exchanges since
this scare here.
Senator BARKLEY. Well
Senator MCADOO (interposing). Well, Mr. Thompson—but pardon me, Senator Barkley. I did not mean to interrupt you.
Senator BARKLEY. GO ahead.
Senator MCADOO. I can ask my question later.
Senator BARKLEY. Well, never mind. I am through sometimes
when I don't know it. [Laughter.]
Mr. THOMPSON. That might be better for some of us, Senator
Barkley, outside of the Senate, too.
Senator MCADOO. I am the same way. I just wanted to ask
a question along the line that I started out on a moment ago.
Senator BARKLEY. GO ahead, Senator McAdoo. I am through.
Senator MCADOO. Mr. Thompson, you do not mean seriously to
argue that we should not perform a public duty here in the enactment of necessary legislation to correct abuses because the proposal
to do so might result, even if it did, in a reduction in the value of
stock-exchange seats, do you?
Mr. THOMPSON. Not at all. But are you stopping there?
Senator ADAMS. YOU realize that throughout the country right
now there is some lack of confidence in the stock exchanges, some
apprehension of manipulation, don't you?
Mr. THOMPSON. There is no doubt about that, but
Senator ADAMS (continuing). Might it not result in reinstating
your values if the public could be reassured, could feel that they
were going to get a square deal if they went into the market to
invests
Mr. THOMPSON. When you speak of the public being assured
of getting a square deal, that is true. That is what we want them
to have. That is what we try to give them. But on the other side
of the question, we representing stock exchanges feel that we
should bring forward to you the things we see in the proposed
legislation which would hinder stock exchanges in the conduct of
legitimate business; in fact, which may drive many of them out of
business. I am just as serious as I can be when I say that we do
not come to you with a threat, but simply to draw to your attention
the fact that local stock exchanges—and I can only speak for them—
cannot live under this bill. I t is impossible for members of local
stock exchanges to conduct a profitable business if they are restricted
as section 10 alone of this bill would restrict them.
Senator GORE. That has to do with the dealer-broker aspects of
the matter.
Mr. THOMPSON. Yes, sir.
The CHAIRMAN. We have
amendment.
opened that door already by this
7534
STOCK EXCHANGE PEACTICES
Mr. THOMPSON. Only partially. It still closes the door to us in
many things we are doing, as we think legitimately and propertly
and to the satisfaction of the public.
Senator COUZENS. Mr. Chairman, have we any more witnesses
this morning?
The CHAIRMAN. Kepresenting these local exchanges, Mr. Thompson, do you concede that there is a real need for Federal regulation
of stock exchanges?
Mr. THOMPSON. I think, Senator Fletcher, that some kind of
regulation would be welcomed by the exchanges, but you must
remember that
Senator BARKLEY (interposing). It is not so much a question
whether they would welcome regulation or not, but it is a question
whether such regulation is wise or necessary.
Mr. THOMPSON. DO you mean, do I feel that there is any real
need for it?
Senator BARKLEY. Yes.
Mr. THOMPSON. NO, sir; I do not. But I think when you consider
the frame of mind the public has gotten into, it is necessary to have
it.
Senator GORE. Mr. Thompson, do you think that some of the
abuses which characterize the New York Stock Exchange characterize other exchanges?
Mr.
THOMPSON. NO, sir;
I do
not.
Senator BARKLEY. Mr. Thompson, assuming that the big bad wolf
up in New York needs regulation, what would you do toward minimizing the restrictive influences of any regulatory bill that would
cover them as it might apply to local stock exchanges?
Mr. THOMPSON. Well, I would say that in general the business as
conducted in local stock exchanges is practically the same as conducted on the New York Stock Exchange, but there are so many
things done in New York that are not done on local exchanges by
reason of the fact that the New York Stock Exchange is primarily
a large national market, upon which there is, quite naturally, a
great deal more speculation than there is upon the local markets,
which are more semi-investment markets, or I might say perhaps
three fourths of the business done is semi-investment to one fourth
speculation. Yes; I should say that three fourths of the business
done on all exchanges outside of New York is a cash business
Senator GORE. Did you say three fourths of the business?
Mr.
THOMPSON. Yes,
sir.
Senator BARKLEY. I suppose it is a recognized fact that the evils
which brought about, to the extent to which they did bring about the
collapse in the market, the nefarious practices that a lot of so-called
financially respectable men engaged in, do not to any large extent
attach to the small local stock exchanges, and that in large measure
they were not responsible for the evils that brought about this whole
pestiferous situation.
Mr. THOMPSON. I think that is quite a fair statement.
Senator BARKLEY. But I do not know how we are going to reach
the general practices of the big one without in some way including
the smaller ones.
Senator ADAMS. Mr. Thompson, have you prepared or can you
prepare amendments to the bill which will permit the regulation
STOCK ElCHAtfGE PBACTICES
7535
of the big Exchange, of the evils t^hich ytfu confess are there, and
at th6 same tim£ not destroy the local exchanges?
Mr. THOM£SON. Mr. Whitney yesterday stated that he would confer with the associated stock exchanges, and so forth, in preparation
of the amendments they were bringing in. May I say to you that
one of th.€ftiostdifficult sectioiis to whip into shapfc, and the one that
will perhaps be delegated more to the exchanges to whip into shape
will be seeti&n 10, and that is the big one that involves so much on
the local exchanges, which are not comparable with New York.
Senator ADAMS. YOU recognize that the committed probably does
not want to release the big exchange from proper regulation in
order to protect the little exchanges'.
Mr. THOMPSON. I quite agree with you. That is what I am speaking to you about. I think section 10 applies more to our local exchanges than it does to New York. I think in trying to correct the
large evil, if I may so call it, that is apparent in New York, consideration has not been given to the damage that is going to occur to
the local exchanges.
Senat6r GORE. YOU think that in killing the big bad wolf we are
going to kill some of the lambs.
Mr. THOMPSON. I am positive of it.
Senator GORE. The problem is to knoiv* where to draw the line.
Senator MCADOO. AS a matter of fact, the listed securities on the
Washington Exchange are very few in number, are they not?
Mr. THOMPSON. Relatively few in Washington, because we have
not an industrial market here.
Senator ADAMS. YOU have a good many gamblers here.
Mr. THOMPSON. Not on the Washington Stock Exchange.
Se$at6f GOB&. Let us £as& a law to stop that.
The CHAIRMAN. Have you any figures or statistics sustaining jrour?
view that thrfce fourths of the business on the local exchanges is cash
Mr. THOMPSON. NO. I am merely giving that as my opinion, based
upon knowledge of the business only, I think it is a fair statement,
and I believe an inquiry made of the local exchanges would show
that I am a little under, rather than over. It may run as much as
80 or 85 percent cash.
Senator GORE. DO you think it would be better to let the exchanges
initiate rules and regulations in the first instance, subject to revision
and approval by the National Commission, or to vest the Commission itself with the power to initiate, prescribe, and fix rules and
regulations.
Mr. THOMPSON. I would not want to say that, Senator, for I have
not given that as careful study as I would like to in order to answer
you intelligently. It is a very broad and serious question.
Senator GORE. That seems to me to be the real question that is
running through and dividing the two schools of thought on this
whole business.
Mr. THOMPSON. I do want to say, Mr. Chairman, that we will cooperate with Mr. Whitney in bringing m to you the suggested amendments and those amendments that we particularly have in mind. I
mean those that will deal particularly with the local exchanges.
They will be embodied and will be so indicated to the committee.
The CHAIRMAN. Mr. Whitney, you remember, discussed section 10
quite fully and proposed certain amendments to it.
175541—34—PT 16
9
7536
STOCK EXCHANGE PEACTICES
Mr. THOMPSON. Yes, sir. We are in accord with those, but we
feel that they should go even a little further than mentioned there
Senator GORE. Insofar as stock market transactions affect and
react upon credit, do you not think control of those activities ought
to be vested largely in the Federal Reserve Board?
Mr. THOMPSON. I should think so, Senator, yes. I think that is
the proper place for them to be.
Senator GORE. Theoretically that is undoubtedly true, but in practice I do not know whether they have made sufficient use of the
powers they have or not.
Mr. THOMPSON. I S there anything else, Mr. Chairman?
The CHAIRMAN That is all, I believe, if there are no further
questions.
Mr. THOMPSON. Mr. Chairman, may I say that I understood that
Mr. Ladd of Pittsburgh was unable to get here ?
Senator BARKLEY. Have you extra copies of your statement?
Mr. THOMPSON. They are on the way up here. I will see that you
get one.
The CHAIRMAN. I S there anyone present who wishes to make a
statement now?
Senator GOLDSBOROTXGH. May I inquire if the Assistant Secretary
of Commerce, Mr. John Dickinson, was asked to appear before the
committee?
The CHAIRMAN. He will come down later and appear before the
committee.
Senator TOWNSEND. I move we adjourn.
The CHAIRMAN. We will meet Monday at 10:30.
Senator COXTZENS. Will the hearing on Monday be an open hearing ?
The CHAIRMAN. SO far as I know. There are some doubts as to
whether Mr. Whitney would be ready Monday.
Senator GORE. I have a notion Secretary Dickinson will want to
appear in executive session.
(Whereupon, at 11:20 a.m., Saturday, March 24,1934, an adjournment was taken until Tuesday, Mar. 27,1934, at 10:30 a.m.)
STOCK-EXCHANGE PBACTICES
TUESDAY, MABCH 27, 1934
UNITED STATES SENATE,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.C.
The committee met at 10:30 a.m., pursuant to adjournment on
Saturday, March 24,1934, in room 301 of the Senate Office Buildings
Senator Duncan U. Fletcher (presiding).
Present: Senators Fletcher (chairman), Glass, Barkley, Gorey
Costigan, McAdoo, Adams, Goldsborough, Tpwnsend, WalcottT
Carey, Couzens, and Kean.
Present also: Ferdinand Pecora, counsel to the committee; Julius
Silver and David Saperstein, associate counsel to the committee;
Frank J. Meehan, chief statistician to the committee; Roland LKedmond, counsel to> the New York Stock Exchange; William A .
Lockwood, counsel to the New York Curb Exchange; and Eugene
E. Thompson, president of the Associated Stock Exchanges.
The CHAIRMAN. The committee will come to order, please. Mr.
Whitney, you were to submit a further statement this morning by
way of suggested amendments to the bill. We will be very glad
to have you proceed.
STATEMENT OF EICHAED WHITNEY, PRESIDENT OF THE NEW
YORE STOCK EXCHANGE—Resumed
Mr. WHITNEY. Mr. Chairman and gentlemen of the committee r
First of all I should like to submit to the committee some additional
documents with regard to the aviation stocks. They are supplemental lists, giving addresses missing in our original reports of
transactions in aviation securities, as well as corrections covering
errors which we have found. If I may merely submit them as
exhibits as has been previously done, I will now be glad to do so.
The CHAIRMAN. They will be received and marked for identification.
(A document entitled " Supplementary List of Addresses Not
Shown m Original Reports ", was marked " Whitney Exhibit No40 for Identification, March 27, 1934 ", and will be retained in the
files of the committee.)
(Another paper entitled " Curtjss-Wright Corporation, First Sup>plementary Report", was marked "Whitney Exhibit No. 41 for
Identification, March 27, 1934", and will be retained in the committee's files.)
7537
7538
STOCK EXCHANGE PEACTICES
(Another document entitled "Wright Aeronautical Corporation
Capital Stock, First Supplementary Report", was marked " Whitney
Exhibit No. 42 for Identification, March 27, 1934", and will be
retained in the committee's files.)
(Another document entitled "Aviation Corporation of Delaware,
First Supplementary Report", was marked " Whitney Exhibit No.
43 for Identification, March 27, 1934 ", and will be retained in the
committee's files.)
(A document entitled " Curtiss-Wright Corporation Class 'A',
First Supplementary Report", was marked " Whitney Exhibit No.
44 for Identification, March 27, 1934 ", and will be retained in the
committee's files.)
(Another document entitled "Douglas Aircraft Co., Inc., First
Supplementary Report ", was marked " Whitney Exhibit No. 45 for
identification, March 27, 1934", and will be retained in the committee's files.)
The CHAIRMAN. YOU may proceed With your statement^ Ml*.
Whitney.
Mr. WHITNEY. Mr. Chairman, I should like to read a very brief
statement first, if I may.
The CHAIRMAN. YOU may do so.
Mr. WHITNEY. I am entirely in
accord with the thought that
great speculative excesses ate an economic evil and that Siey can
and should be prevented.
I am not in accord with the thought that the speculative excesses
of 1929 and preceding years were to a material extent caused by or
due to our stock exchanges or the way in which they were operated.
I am not in accord with the thought that the stock-market panic
of 1929 was the cause, instead of one of the earlier restilts of the
industrial depression.
I do not believe that the use of credit m connection with forward commitments, whether in the purchase of securities, of commodities, or of homes, or in the sowing of crops in the expectation
of harvest can be- otherwise than benefiicial when wisely and reasonably employed.
I am not in accord Tfath the provisions of this bill which seem
designed to punish stock exchanges for imaginary offenses*, nor am
I in accord with those provisions which would throttle industry,
contract credit, diminish the liquidity of securities, and postpone
the return of prosperity.
I believe that MR. 8720, in its present form, would prevent excessive speculation but only by seriously interfering with that great
system of industry, commerce, and finance without which there can
be neither speculation nor prosperity.
I believe that the evils which this proposed legislation seeks to
remedy can be cured without risking the dangers inherent in this
bill of delaying the return of prosperity.
From this standpoint I have caused to be prepared, within the
framework of tliis bill, certain amendments which will eliminate its
most dangerous features while increasing its effectiveness in the promotion of those objects which are vital in the public interest. I
submit these amendments as a matter of practical expediency and
solely because the stock exchanges of this country—and I am speak
STOCK EXCHANGE PRACTICES
7539
ing on behalf of substantially all of them—feel that every possible
effort .should be made to preserve for the benefit of investors and the
public our organized security markets.
The CHAIRMAN. M>. Whitney, is this memorandum of proposed
amendments to H.E. 8720 in addition to those you proposed here the
other day?
Mr. WHiT?NEfr. These amendments contain all amendments as
suggested by us to H.R. 8720, and contain the amendments submitted
to you the other day as well.
The CHAIRMAN. AH right. We are very glad to have them.
Mr. WHITNEY. NOW, Mr. Chairman, it is our desire to go ovei
these amendments with you in detail. There are certain points with
respect to various sections that in our opinion would be defective m
their operation if allowed to exist as now in bill H.E. 8720. Therefore we should like to go over these with you in detail, either now
in public hearing or later, after you have had an opportunity to
discuss them among yourselves; as I say, either in public hearing or
in executive session as you may desire. But we do wish to have the
opportunity to go over them with you, and particularly do I wish
Mr. Redmond to sit with us and take up, section by section, the
legal, technical, and defective parts of the present bill; and to explain
also, Mr. Chairman, the reasons for our proposed amendments.
The CHAIRMAN. If it is agreeable to the committee I think we
might proceed to hear you just as we are sitting here now. I think,
perhaps, we would make better progress in that w$y.
Mr. WHITNEY. All right, Mr. Chairman, just as you may wish.
The CHAIRMAN. These amendments cover pretty nearly all portions of the bill, do they not?
Mr. WHITNEY. Very nearly so; yes.
The CHAIRMAN. I think you may proceed.
Mr. WHITNEY Then may I ask that Mr. Redmond be permitted to
come up to the committee table?
The CHAIRMAN. Certainly.
Senator CAREY. I will move over so you may sit next to Mr. Whitney, Mr. Redmond.
Mr. REDMOND. I thank you.
Mr. WHITNEY. I think if Mr. Redmond will go along with the
various sections IIJ. our proposed amendments we will make better
progress, and I will interpolate occasionally if I may.
The CHAIRMAN. Very well.
STATEMENT OF ROLAND I . REDMOND, ATTORNEY FOR THE NEW
YORK STOCK EXCHANGE
The CHAIRMAN. Mr. Redmond, I see in your memorandum that
you propose no change to sections 1 and 2 of the bill.
Mr. REDMOND. NO, Mr. Chairman, we are offering no amendments
to sections 1 and 2 of H.R. 8720.
The CHAIRMAN. Then you may go to the next section.
Mr REDMOND. &S to section 3 of the bill, subsection (6) paragraph (a)
The CHAIRMAN, On what page of the bill does that appear?
Mr. REDMOND. That appears on page 6 of, H.R. 8720.
7540
STOCK EXCHANGE PRACTICES
The CHAIRMAN. I think we might mark the bill as we go along.
Sections 1 and 2 are agreed to, subject to any change heretofore agreed
to be made or which may hereafter be thought desirable.
Senator COTTZENS. Mr. Redmond, may we understand that when
you make no comment on other sections of H.R. 8720 that you approve
of them?
Mr. REDMOND. Or that such section then falls entirely without the
seope of our criticism.
Senator COUZENS. All right.
Mr. REDMOND. We propose an amendment of the definition of the
term " bank " so as to clearly cover private banks, of which there
are a good many in New York, Massachusetts, Pennsylvania, and the
Western States, which are not necessarily in corporate form, although they are banks subject to State supervision. They are likewise banks which are subject to Federal supervision but which are
not members of the Federal Reserve System, and which were not
heretofore covered. So we have inserted as paragraph (b) a provision reading:
A person engaged in the business of banking pursuant to tne laws of any
State, who is subject to examination or regulation by Federal or State banking
authorities
We have likewise included as paragraph (c):
A banking institution oiganized under the laws of a foieign country, or any
agency or branch thereof, authorized to engage in business in a State and
which his subject to the supervision of State banking authorities.
That refers to foreign banks, many of which have been established
in this country and are operating here subject to State supervision.
That is particularly true of many Canadian banks that have
branches not only in New York but also along the Canadian border.
We have stricken out old paragraph (b):
A member bank of the Federal Reserve System
Inasmuch as it was clearly redundant, all members of the Federal
Reserve System being either banking institutions organized under
the laws of the United States or banking institutions organized
under State laws.
Senator ADAMS. Then your proposed amendment would be in addition to and not in any way a subtraction from that section of the
bill?
Mr. REDMOND. I t is an addition, so as to take care of unincorported State banks and branches of foreign banks
The CHAIRMAN. All right. You may proceed.
Mr. REDMOND. Next, on page 8 of the bill, subsection (12) of section 3
Senator MCADOO (interposing). Mr. Chairman, may I ask if it
is your purpose to pass on these suggestions as we hear them made
to us here ?
Senator BARKLEY. I don't think we should do that.
The CHAIRMAN. NO : I think we better hear the explanation offered,
and then consider the matter later.
Mr. WHITNEY. May I interpolate that we would, quite naturally,
like to have the members of the committee ask any questions as these
proposed amendments are presented?
STOCK EXCHANGE PRACTICES
7541
The CHAIRMAN. Oh, certainly. That will be quite in order if any
member of the committee desires to ask anjr questions.
Mr. REDMOND. We here suggest an addition to the definition of
the term " equity security."
Senator BAREXEY. On what page of the bill do we find this?
Mr. REDMOND. On page 8 of the committee print.
Senator BARKLEY. All right.
Mr. REDMOND. By inserting in line 9 after the words "similar
security " the following:
Other than a preferred or guaranteed stock which is entitled to receive only
a fixed or limited dividend
In other words, this definition of equity securities is intended to
cover those stocks which may be rather free from speculation. In
other words, we have a great many preferred stocks and some guaranteed stocks which are not only nonspeculative but actually are less
speculative than bonds. There seems to be no good reason why such
preferred and guaranteed stocks should not be exempted from the
term " equity security."
Senator CAREY. That is to go in where in the bill?
Mr. REDMOND. Line 9 after the words " similar security." I have
read what we suggest be inserted.
Senator CAREY. I should like to get that clear in my mind.
Mr. REDMOND. The memorandum furnished to you, Senator Carey,
shows our proposed amendment of the entire section. But the only
change we have made is the insertion of preferred and guaranteed
stocks, among the classes of stocks which are not to be considered
as equity securities.
Senator MoApoo. In other words, this is a substitute which you
offer for subsection (12) of the bill, but it is in fact merely an amendment of the section?
Mr. REDMOND. Yes.
Senator MCADOO. And
you have rephrased the entire subsection
(12) in order to cover your proposed amendment?
Mr. REDMOND. Yes.
Senator BARKI^EY. That
would, of course, include the exempting
of many preferred stocks which draw specified dividends, we will
say 6 percent or less. That would not be included within your definition, as I take it.
Mr. REDMOND. Precisely. As long as the right to a dividend is
fixed and limited we can see no difference between a preferred or
guaranteed stock with a fixed and limited dividend and the obligation or a bond which may bear a fixed rate of interest.
Senator BARKI*EY. But there is more speculation, or perhaps I
should say a greater number of transactions in guaranteed and preferred stocks, or certainly in the case of one with no fixed rate of
dividend, than there would be in the case of a bond.
Mr. REDMOND. I think on the contrary, Senator Barkley, it is the
other way round. But Mr. Whitney can answer that as a practical
question.
Mr. WHITNEY. Certainly not on the stock exchange, Senator
Barkley.
Senator BARKLEY. I notice on lists of stock-exchange transactions
as carried by the daily papers certain preferred stocks that are
7542
STOCK EXCHANGE PRACTICES
bought and sold on the New York Stock Exchange, some of which
have fixed dividends and some do not; and some have fixed dividends
that have not been paid but they are nevertheless cumulative.
Mr. WHITNEY. That is true.
Senator BARKTJEY. And frequently one reads of action taken by
boards of directors ordering payment of 2 or 3 years' of accumulated
dividends on preferred stocks, all of which has to come before the
common stockholders get anything.
Mr. REDMOND. That is true.
Senator BARKLEY. Why should they be exempted from this definition, then.
Mr. REDMOND. Because they fall into the same category as bonds.
There are many bonds that are in default in payment of interest but
which have accumulated interest to become payable.
Senator MCADOO. Like income bonds, for instance?
Mr. REDMOND. Exactly.
Senator BARKLEY. They are only technically in the same category.
There are many preferred stocks of that sort where the company has
no bonds outstanding. They are a part of the original capital set
up. But bonds are obligations or notes, that have been issued from
time to time after the business has been started. The capital stock,
either preferred or common, has already been sold and distributed.
I do not see exactly an analogy between a preferred stock that has a
fixed income and a bond in the form of a note bearing a certain
rate of interest payable over a period of years.
Mr. REDMOND. I t depends upon the type of stock or bonds, Senator Barkley. But if it is felt proper to exempt all bonds from this
definition of "equity security" then logically preferred stopks,
and more particularly guaranteed stocks bearing a fixed dividend,
should be exempted.
Senator ADAMS. Your preferred stock in that case doesn't have
the speculative range, so that speculation does not run wild in such
a case, is that it?
Mr. REDMOND. They are not subject to anything like the speculation in common stocks. And in many instances I think bond§ are
more speculative than preferred stocks, particularly bonds of a
company in the hands oi a receiver, for they then often have very
large fluctuations.
Senator MCADOO. I take it that you have in mind particularly
those guaranteed stocks, preferred or common, of railroad corporations, let u$ say, that are guaranteed under the lease of one railroad
by another. I am now just thinking of one type of corporation in
order to illustrate the point.
Mr. REDMOND. I see, and
Senator MCADOO (continuing).
Which are generally dealt in in
over-the-counter transactions and which are not very frequent.
They are looked upon as prime investments.
Mr. REDMOND. They are.
Senator MOADOO. In fact, they are better investments than many
bonds sold on the exchanges.
Mr. REDMOND. I agree entirely with that.
Senator MCADOO. And with respect to such securities I think it
is clear an exemption should be made if you are going to exempt
bonds.
STOCK EXCHANGE PRACTICES
7543
Senator BARKLEY. Well, I merely wanted to inquire about it so as
to understand what is proposed.
Mr. WHITNEY. And, you will remember, they are not capable of
receiving any more than the fixed dividend, whereas an equity
stock is capable of receiving anything over and above the fixed
charges.
Senator BARKLEY. After the preferred stock has got its portion.
Mr. WHITNEY. Or the bonds; any fixed charges.
Senator WALOOTT. Would it include prior preference stock?
Mr. REDMOND. Only if it carried a fixed and limited dividend.
We have not sought to include any preferred stock that is entitled to
participate.
Senator WAiiCOTT. I think you make that clear in this provision
here, that it must be a fixed and limited dividend.
Mr. REDMOND. All right, if that is now clearly understood?
The CHAIRMAN. The language now is quite broad, it seems to me.
It means any stock or similar security or any security convertible,
with or without consideration, into such a security, and so forth.
Mr. REDMOND. That is very broad, Mr. Chairman, in defining the
term " equity security." That is really the difficulty with the definition, because it takes in these guaranteed stocks, which, as Senator
McAdoo has well said, sometimes are very much better than bonds.
It takes that class of stocks and throws them into the same category,
as though they were a speculative security.
The CHAIRMAN. Very well. We will consider that suggestion.
Senator MCADOO. A S I recall it I think the Pittsburgh, Chartiers
& Youghiogheny Railroad, or some name of that sort
Mr. REDMOND (interposing). The Pattsburgh, Fort Wayne & Chicago is the great one.
Senator MCADOO. Those are guaranteed stocks under leases by the
Pennsylvania Railroad, and with strictly limited dividends. They
are looked upon with greater favor by investors than the bonds of
many railroads.
Mr. REDMOND. That particular company owns the main line of
the Pennsylvania Railroad from Pittsburgh into Chicago, and has
no bonds ahead of it, and the stock is guaranteed under lease by
the Pennsylvania Railroad. I t is a little better than practically
all of the Pennsylvania Railroad Co.'s own bonds, and yet because
technically a stock it would have been treated as an equity security
not available for loans by banks under this bill, except on very
heavy margin restrictions.
The CHAIRMAN. Very well. We will consider that suggestion.
Mr. REDMOND. We will now take up subsection (13) which deals
with the definition of " exempted security ", and we have included
in that a provision exempting obligations of States and all political
subdivisions of States or any agency or instrumentality of a State
or any political subdivision thereof, as follows:
(13) The term " exempted security " or " exempted securities*' shall include
securities which are direct obligations of or obligations guaranteed as to principal or interest by the United States, such securities issued or guaranteed
by corporations in which the United States has a direct or indirect interest
as shaU be designated for exemption by the Secretary of the Treasury, securities which are direct obligations of or obligations guaranteed as to principal
or interest by a State or any political subdivision thereof or any agency or
instrumentality of a State or any political subdivision thereof, and such other
7544
STOCK EXCHANGE PRACTICES
securities and instruments as the Commission may by such rules and regulations as it deems necessary or appropriate in the public interest or for the
protection of investors, either unconditionally or upon specified terms and
conditions or for stated periods exempt from the operation of any one or
more of the provisions of this act, which by their terms are inapplicable to an
" exempted security " or to " exempted securities ",
That we put in simply because of the expressed sentiment of the
committee the other day that State and municipal obligations ought
to be treated as exempted securities. We express no personal opinion
on the merits of that idea.
The CHAIRMAN. Your amendment would include State and municipal bonds, or bonds of subdivisions of cities.
Mr. REDMOND. Precisely.
Senator WALCOTT. YOU do not use in your suggested amendment
the word " municipal." You say " subdivisions thereof." Do you
think that is inclusive enough?
Mr. REDMOND. We thought it would include them.
Senator MOADOO. All municipal or political subdivisions thereof
would cover it.
Mr. WHITNEY. That is the accepted phraseology.
Senator WALCOTT. Well, a city or a county is certainly a political
subdivision of a State.
Mr. WHITNEY. Yes; and so as to a school district.
Senator ADAMS. And you follow the language: " State or any
political subdivision thereof ", with this language: " or any agency or
instrumentality of a State or any political subdivision thereof."
Senator WALCOTT. I think that is satisfactory.
Senator MCADOO. I do not see any objection to putting the word
" municipal" in there. I t might be considered more satisfactory if
you say " any municipality or other political subdivision thereof."
Senator BARKLEY. Of course there is no city now in existence except as the result of the passage of a law of the State authorizing it
to become such subdivision.
Mr. WHITNEY. Yes. There are also included in that category, for
instance, school districts, or lighting' districts, or water districts,
which are political subdivisions as we understand the accepted
phrase.
Senator WALCOTT. Well, they would be a subdivision of a city
in some cases. The question is whether we should use the wora
" municipal."
Mr. WHITNEY. I t might possibly be a borough, too. I t might be
almost any other subdivision.
Senator WALCOTT. That is true.
The CHAIRMAN. Very well, Mr. Redmond, you may resume your
explanation.
Mr. REDMOND. We propose to omit subsection (c) of section 3 in
toto, which appears on page 10 of the print. That purports to give
the Commission the power to define accounting, technical, and trade
terms used in the act. And it says that such definitions shall have
the force of law. Under amendments we suggest later on there
would be no necessity for any such defining of technical terms.
Senator MCADOO. Well, now, do you say that is covered by what
you have to offer later on by way of suggestions?
Mr. REDMOND.
Yes.
STOCK EXCHANGE PBACTICES
7545
Senator MCADOO. I should like to make a note of that here on my
copy of the bill.
Mr. KEDMOND. That will be shown when we come to sections 10
and 11
Senator MCADOO (interposing). One minute. Do you say sections 10 and 11 ?
Mr. REDMOND. Or I mean sections 11 and 12 of the committee
print. They are sections 10 and 11 of our suggestions.
Senator MCADOO. All right. I will make a notation of that on
my copy of the bill here.
Mr. REDMOND. A S to section 4 of the bill we suggest no change.
As to section 5 of the bill we have redrafted it in toto so as to
simplify it. That section purports to require national securities
exchanges to file a registration statement with the Commission and
allows the Commission, after examining the conditions of the exchange, to either grant registration or not grant registration. I t
seemed to us to be an unduly complicated section, and we have redrafted it purely with the idea of simplification and the carrying
out of the fundamental idea that there should be an application by
the exchange with right of examination by the Commission, and then
for a granting or refusal of registration.
Mr. PECORA. There is no change in the substance ?
Mr. REDMOND. There is a change in substance as to some of these
provisions. For instance, subdivision (1), on page 11 of the bill,
requires an exchange to file an undertaking to comply and to enforce.
If by that language it was intended that a penal bond should be
required of exchanges, why, then we feel it is an entirely unfair
provision. On the other hand, exchanges would be bound to comply
with and to enforce the rules and regulations of the Commission
without any such provision. Our proposal is:
SBO 5.* (a) Any exchange may be registered as a national securities exchange by filing with the Commission an application in such form as the Commission may prescribe, containing all relevant information in regard to the
history, organization, membership, and the lules and regulations of such
exchange and a list of the securities in which dealings are permitted on such
exchange
(b) Unless such application shall be withdrawn b> such exchange, the Commission shall within thirty days after the filing theieof or within such further
period as may be agreed upon, either register such exchange as a national
securities exchange hereunder if the Commission shall be satisfied that the
rules and regulations of such exchange are adequate to insure fair dealing
and to protect investors, or enter an order, after appropnate notice and opportunity for hearing, denying such registration and stating the reasons theretor.
Any order denying such registration may be reviewed as hereinafter provided
in section 22 hereof
(c) Any national securities exchange may by appropriate notice to the Commission withdraw its registration
The CHAIRMAN. Your proposed amendment is set out in section
5 (a)?
Mr. KEDMOND. In section 5 in the paper which we have submitted
to the committee.
The CHAIRMAN. All right. We will consider it. You may proceed.
Mr. KEDMOND. Section 6, dealing with margins, we make the same
suggestion we made the other day, and that is, that unlimited power
7546
STOCK EXCHANGE PBACTICES
be given to the Federal Reserve Board to determine the margin
requirements and to change them at will.
SEC 6. It shall be unlawful for any member of a national securities exchange
or for any broker or dealer transacting a business in securities through any
such member, directly or indirectly, to extend or maintain credit to or for
any person in contravention of such rules as may be adopted from time to
time by the Federal Reserve Board for the purpose of preventing the excessive
use of credit for speculation
If such broad power is not acceptable to the committee, I should
like to take a minute or two to point out the holes or errors in the
presnt draft of the committee bill, because there are some very
fundamental difficulties with the draft of section 6 as it exists today.
I do not know whether the committee would want me to go into
that now or to continue going through with our suggested amendments.
The CHAIRMAN. I think you might go on through with them.
Mr. REDMOND. Very well. I will go right through with them,
then.
Senator BARKLEY This section 6 as you have it written here, comprising only 6 or 8 lines of typewriting, is to take the place of all
the subdivisions of section 6 of the bill ?
Mr. REDMOND. Precisely.
Senator MOADOO. Then you cut out several pages of the bilL
Mr. REDMOND. Yes, sir. We jump from there over to page 19 of
the committee print.
Mr. WHITNEY. I t would leave the entire control of the matter
io the Federal Reserve Board.
Senator MCADOO. YOU want to reduce the range of senatorial
oratory, do you ?
Mr. REDMOND. I am afraid that was not our desire. We wanted
to see flexibility in the control of these margin and credit conditions.
The CHAIRMAN. HOW do you leave it now? Do you leave the
whole subject of margins and credit control to the Federal Reserve
Board?
Mr. REDMOND. Precisely.
The CHAIRMAN. Without any limitations at all ?
Mr. REDMOND. Without any limitations at all.
Mr. WHITNEY. Except as they may put them in force.
Mr. PECORA. There is no limitation on the exercise of their discretion; is that it?
Mr. REDMOND. Exactly, Mr. Pecora. And if at this point
Senator BARKLEY (interposing). In view of the fact that this bill
puts the enforcement of this act in the hands of the Federal Trade
Commission, why do you divide the authority by turning over to
the Federal Reserve Board the question of margins 8
Mr. REDMOND Well, margins, you see, affect the credit control
rather than the control of exchanges or practices on exchanges.
And it seemed to us that the Federal Reserve Board, which today
under the law is charged with the control of the credit of the
country, ought to exercise this control if any administrative body
is going to do so.
Senator MOADOO. Well, you did not draw the bill as it appears
now to leave that matter to the Federal Reserve Board, did you ?
STOCK EXCHANGE PBACTICES
7547
Mr. REDMOND. We have h$d no handing in the drafting of the
present print.
Mr. PEOORA. Mr. Eedmond, in your proposed revision of section
6 of the bilj. you did not give any consideration at all to existing
margin accounts, did you?
Mr. EEDMOND. NO. We felt that
Mr. PECOKA (continuing). And the preservation of your present
status.
Mr. EEDMONP. We felt that the Federal Eeserve Board would give
due> consideration to existing accounts when it came to framing its
rules and regulations.
Mr. PECORA. Don't you think that ought to be specifically set
forth in the statute ?
Mr. EEDMOND. I do not think you could do it.
Mr. PECORA. I mean that some declaration ought to be made in
the statute concerning present margin accounts.
Mr. ESMOND. A declaration might be made, but there is no provision I know of that you could draft that would actually preserve
existing margin accounts, or loans held by banks against security
collateral.
Mr. PECORA. HOW about the provision as now written into section
6, subsection (f) ?
Mr. EEDMOND. Well, quite frankly, they just won't operate in that
way. In the first place, take your, roughly speaking, $1,400,000,000
of customers' debit balances which are carried todayby brokers who
are members of the New York Stock Exchange. Those brokers m
turn are borrowing from banks, and 80 or 90 percent of such balances are made on demand rather than on time loans. Now, a bank,
wh,eix it needs to bring up its reserves, the first thing it does is to
call some of those demand loans. Upon the calling of such a loan
the broker has got to pay off that loan, and while he can nearly
always immediately secure credit from another bank, if that change
in the loan would mean a new loan it would have to be brought
up to the new margin requirements, as between the bank and the
broker* Therefore, the broker in turn would have to call upon his
customers to put up additional margins, so that those customers
would not get the benefit of the theoretical 5-year extension.
Senator MCADOO. I think it is clear that to put this power in the
Federal Eeserve Board is much the better disposition of it. I t gives
the necessary flexibility, and, besides, here is the governmental agency
dealing with credit and thoroughly competent to handle the matter
and to meet all the mutations and intricacies that undoubtedly will
surround the general transitions that this bill will necessitate.
Mr. EEDMOND. And, Senator McAdoo, I might say in that regard
we are very conscious of the fact that a rule which might be applicable to certain financial centers would certainly not be applicable
to other financial centers; and this rule which purports to give a
5-year extension is overgenerous possibly in the case of conditions
that might exist, let us say, in New York, but not overgenerous to
conditions that might exist in the smaller financial centers throughout the country. We believe that flexibility as between centers is
another thing that you gain by giving the power to the Federal
Eeserve Board.
7548
STOCK EXCHANGE PEACTICES
Mr. PECORA. This section 6 is one of the fundamental provisions of
the entire bill.
Mr. REDMOND. Yes; and
Mr. PECORA (continuing).
Because dealing with margin means
dealing directly with the question of limitation of speculation.
Mr. REDMOND Yes; and
Mr. PECORA (continuing). Have you considered, in drafting your
proposed revision of section 6 of the bill, the question of whether or
not the Congress might not, in this very broad function that you
propose, be giving to the Federal Reserve Board a power that might
be regarded as power to legislate?
Mr. REDMOND. Well, I do not think it is any broader than the
power vested today in the Federal Reserve Board.
Mr. PECORA. But did you consider that question at all?
Mr. REDMOND. Yes; and you will notice that there is stated an
indication of the legislative intent. I think you will see it if you
will read the section as we have drafted it. There is stated the
congressional
purpose in granting the power to regulate the Federal
Reservek Board.
Senator MCADOO. I presume, Mr. Redmond, that you have noticed
in the bill there is given the affirmative power to the Federal Reserve Board to make such regulations?
Mr. REDMOND. There is such a provision, but I have forgotten the
exact section. I think it is in section 23 or 24 of the bill.
Mr. PECORA. DO you think that section 6 as you have drafted it
will meet the constitutionality question?
Mr. REDMOND. Well, it will do it as well as section 6 as it exists
today.
Senator COSTIGAN. Speaking as a member of the bar, do you regard
that as giving undue power under the Constitution ?
Mr. REDMOND. I do not; or certainly any more so than you have
it there.
Mr. WHITNEY. Mr. Chairman, for fear of repetition, with regard
to subsection (f) of the present bill, under section 6, that says that
those, various types of loans, renewals, or extensions thereof, may
be so treated, but it cannot, or does not, at least, enforce or make
mandatory that they shall be so treated. That power rests entirely
with banks that have made the loans, and with brokers who have
made loans to their customers. The law does not pretend to say,
nor does it say, that banks or brokers must so treat those loans.
I t merely says they may. As we know the practice is, and it should
be the practice, that banks must protect the money of their depositors
in a way that they believe is safe. So, unless they so believe, or
unless the brokers so believe, in regard to the credit they are extending, then this subsection (f) will mean nothing, because it is permissive.
Mr. PECORA. Mr. Whitney, are you quite sure of that? The language of subsection (f) of section 6 specifically is:
The provisions of this section shall not apply on or before January 31,
1939
That is mandatory.
Mr. WHITNEY. I am just as clear as I can be, Mr. Pecora, that it
is mandatory by means of the use of the word, but that it is only
STOCK EXCHANGE PBACTICES
7549
permissive in relation to the actual fact as it may exist in the case
of a particular loan, extension of it, or renewal. And it is entirely
up to the bank and to the broker as to whether they will follow what
is allowed under this particular clause.
Mr. PECORA. I doubt if any court would interpret this provision
that it shall not apply to a permissive loan.
Mr. WHITNEY Supposing I am the customer, do you believe I
could get recourse from a court by way of insisting on a bank carrying my particular account?
Mr. PECORA. That is a matter of private agreement between broker
and customer.
Mr. WHITNEY. I do not believe it is a matter of private agreement. I think it is at the discretion of the broker and of the bank,
only at their discretion.
Mr. PECORA. That is a matter of agreement between them. But
this provision as now worded would continue in force the present
margin accounts up until the 31st of January 1939, if the interested
parties were willing to have it so continue.
Mr. WHITNEY. That is true, but, as I say, the banks and brokers
are those who have control, and they would not so continue them
if they thought it detrimental to their interests.
Mr. PECORA. That would be simply a case of the wishes of the
parties interested but not because of the language of the act.
Mr. WHITNEY. I understand.
Senator BARKLEY. Regardless of subsection (f) and regardless of
any other provision of this bill, any broker or any bank can refuse
arbitrarily to extend any credit to anybody if they do not want to
extend it.
Mr. WHITNEY. Exactly so, or to continue extending an existing
credit.
Senator GORE. I S it your point that you cannot freeze these existing loans and put them on cold storage for 5 years ?
Mr. WHITNEY. That cannot be done because that is at the discretion of the banks only as I see it.
Senator BARKLEY. YOU make it unlawful for a broker or a dealer
to extend credit in violation of any rules made by the Federal Reserve Board, for instance, and how do you propose to enforce it?
Suppose somebody does that, how will you handle it ?
Mr. REDMOND. Well, a rule or regulation can be evaded, but
Senator BARKLEY (continuing). Is there any penalty provided in
this provision?
Mr. REDMOND. We have not attached a criminal penalty to that
provision, but we feel if a member of an exchange violated such a
rule under the set-up as we have it the Commission could require the
expulsion or the disciplining of that member, and your effective
control would be through the exchanges.
I might say in that connection that this section as drafted, particularly where it fixes the maintenance of ratios for loans, attaches
to a violation of them a criminal penalty that runs, to force any
person to comply. And there is no leeway granted. If a loan once
got below the required ratio it is an extremely complicated thing
to figure; in any event the broker would be liable to go to jail. The
result of that is going to be the liquidation of a great many customers'
7550
STOCK EXCHANGE PRACTICES
accounts long before you reach the lower ratios referred to in the
act.
Senator BAI$KI*EY. In other words, the broker would rather stay out
of jail than to keep his customer out of bajikruptcy ?
Mr. REDMOND. I think he would. If the committee wishes, as I
say, I will discuss the technical problems involved, with the committee's draft, of which there are many, and the effect of some of
them is quite surprising and quite contrary, I think, to wh^it was
intended.
Senator WALCOTT. I think it would be useful to the committee if
you did give us briefly your objections to this paragraph.
Mr. REDMOND. Well, in subsection, (a) there is a prohibition
against advancing any credit without collateral
Senator GORE (interposing). What section is that?
Mr. REDMOND. Section 6, subsection (a).
Senator GORE. All right.
Mr. REDMOND. NOW, almost
Senator MCADOO (interposing). What page and what line?
Mr. REDMOND. Page 13. Almost every transaction may involve the
use of credit temporarily, even a cash transaction, because the broker
is, we will sav, directed to buy 100 shares of stock for cash. He has
a customer who he knows is sending him a check, but that check may
not arrive in time so as to be banked and collected before the broker
in turn—and that is the practice on the exchange—has got to take
up and pay for the stock he has been directed to purchase. Therefore, in that interval of time, which is very common, in a cash purchase there is a technical advancing of credit without collateral.
You have it in what are known as "delayed deliveries ", where by
reason of the fact that a man cannot physically deliver the securities
at 2:15 p.m. on the date of delivery it goes over for 24 or 48 hours.
And you have it almost always in out-of-town transactions where
the securities being sold are in transit to New York, or where checks
drawn on out-of-town banks cannot be collected until the lapse of
2 or 3 days. So that with that clause as it now stands almost every
cash transaction would be stopped, and your out-of-town transactions would be greatly lowered. I t certaiiuy needs some clarification.
On page 14 of the bill, the clauses dealing with extension of credit
initially, it is provided that you shall not extend credit unless a, certain ratio is maintained. Now, in the case of any brokerage account
at the end of each month interest is charged and added to the existing
debit balance. Are these interest charges a further extension of
credit withm the meaning of the act? If so a purchase of securities
Strictly in accordance with the provisions of this act would immediately become open to question at the end of one or more months as
interest charges accrue.
Next, subsection (2) deals with the lowest price at which a security
is sold during a period of 36 months. But there is no definition as
to what constitutes lowest price. Even in case of well-known securities dealt in on the New York Stock Exchange, they are also dealt
in on other exchanges, and sometimes the lowest price may be on an
exchange in California, or on an exchange in Cleveland, rather than
on the New York Stock Exchange. If it goes further than that and
lowest price means actually the lowest price that has been paid, you
STOCK EXCHANGE PRACTICES
7551
might haye to have recourse to transactions over the counter, emergency transactions, and cash transactions, which normally sell at a
lower cjifffcren^iai than regular transactions. But there is no definition as to what constitutes lowest price, which would mean, if this is
to be tU© formula, that it becomes one of the critical facts in determining exension of credit,
Senate GTORE. Well, would you fix it so that the lowest price on
the New York Stock Exchange would be the standard?
Mr. REDMOND. Qui^e frankly, Senator Gore, I think the whole idea
of tying things into the lowest price is so fundamentally unsound
that I haven't attempted to draft even in my own mind a definition
of ^h^t would be lowest price.
Senator GORE. Well, any definition would be better than none if
you are going to have it in there.
Mr. REDMOND. I think it should be defined if it is going to, stay
in the bill.
Senator COTJZENS. In other words, you feel that the Federal Reserve Board could draft this better than the Congress can ?
B|r. REDMOND. I think they could make and apply rules and regulations in a, particular situation in order to meet the need for
flexibility.
Senator COUZENS. In other words, you would have a regulation
promulgated by the Federal Reserve Board that would be different
in one State from that m another State.
]Jk£r. REDMOND. Very probably so.
Senator MCADOO. Where conditions might justify it.
Mx. REDMOND. That condition exists today. Many banks in
smaller communities carry securities on quite different ratios as to
collateral than is the case in the more active centers.
Senator MCADOO. I think often, or as a rule, it is much better
not to provide in a statute an inflexible provision of this character,
which may be most difficult of administration anyway because 01
the difficulties involved, but to leave it to a public body, like the
Federal Reserve Board, to from time regulate it and to prescribe
rules, and regulations under which these transactions may be
conducted.
Senator COUZENS. Senator McAdoo, the only difference between
you and me is that I want Congress to set a limitation or give the
scope within which they can operate rather than to leave all of that
to a commission.
Senator MCADOO. I am speaking of the details of these loans.
That is all.
Mr. REDMOND. In connection with this provision dealing with
lowest price, I assume that the intention was to prevent appreciating
securities having as large a value for credit purposes as stable
securities.
Senator GORE. Will you state that again?
Mr. REDMOND. I assume the intention was to give securities which
were appreciating a lower value for credit purposes than would be
given to stable securities. But this provision would not necessarily
operate in that way. For instance, suppose a stock which had been
appreciating steadily and had got down to where the 40 percent
was applicable, that stock could immediately be thrown into the
175541—34—PT 16
10
7552
STOCK EXCHANGE PBACTICES
75-percent class by the declaration of a stock dividend, because the
stock dividend would mean that the stock would sell then at a less
price, within 36 months, and the 75-percent clause would apply.
Senator GORE. That is on this 3-year business?
Mr. REDMOND. That is on this 3-year business, Senator Gore.
Senator GORE. I S there not a provision in here which says 3 years,
and then it says it does not mean that? I t seemed to me like a
contradiction in terms.
Mr. REDMOND. There is such a provision, Senator, and I assume
that it was inserted because it was realized that a 3-year period
would carry back to the low prices of 1932.
Senator GORE. That is why I wondered why they did not fix July
of last year as the datum line or date from which to figure and let
it go at that.
Mr. REDMOND. The second paragraph on page 14 allows transfers of accounts between brokers. I t does not, apparently, allow
transfers of accounts between brokers and banks, or vice versa. If
such transfers are permissible as between brokers, it would seem
natural to allow them also between banks and brokers or brokers
and banks.
The same general comment could be made in regard to subsection
(c) on page 15 that I have made in regard to subsection (b), because
that again involves the use of arbitrary ratios tied down to the lowest
price arrived at within 3 years.
Page 16, subsection 2: There is a provision there which says that
no credit initially extended shall be increased by reason of any payment to or withdrawal by the borrower. The obvious purpose of
that section was to prevent credit that was initially extended being
immediately brought down to the more easy ratios which are allowed
for maintenance. But that section will not prevent that practice.
For instance, if I directed my broker to buy 100 shares of stock
subject to the 40-percent ratio, the most that he could advance me
would be $4,000. I may the next day, however, go to him and say,
"Give me 25 shares out of my 100 shares." There would still be
the advance of $4,000; he would not increase the credit extended to
me, and yet the remaining 75 shares would comply with the maintenance ratio of 60 percent.
So the clause is obviously defective, if it is intended to prevent a
customer making use of the more lenient maintenance ratios instead
of the initial ratios. Quite frankly we want to call the attention of
this committee to every error. We do not want to see a bill with
" jokers " in it any more than anybody else.
Senator MCADOO. With reference to these margin requirements,
assuming that the bill should be reported with specific provisions of
this kind, I have a letter this morning from a gentleman whom I
have known for many years and who is quite familiar with stockexchange practices in New York, and his suggestion strikes me as
having some merit. Since we are going into these details, I would
like to ask a question after reading the letter, which is very brief.
He says:
Would it not be worth consideration to place a margin on a sliding scale
governed by the total amount of secured loans outstanding? As you know, loans
today are approximately $700,000,000, the highest being some $8,000,000,000 in
the year 1029.
STOCK EXCHANGE PEACTICES
7553
He says, further:
Today and ever since I have been m the street, the percentage of margin has
been operating by the relation ot the equity to the debit balance on loans For
instances, securities cost $15,000. The amount furnished by the customer is, say
$5,000. The loan is $10 000 An equity of $5,000 divided by the loan, $10,000
equals a 50 percent margin.
He says, further:
With our loans at $700,000,000, would it not be reasonable and practical to
hold the present requirement of the New York Stock Exchange at the minimum
when the total loans reach $900,000,000, to raise the requirement by 5 percent,
and so on in steps of $200,000,000, or something on that order? I feel sure that
if a formula of this character had been exercised in the years 1926 to 1929 much
of the present suffering would have been avoided.
I submit that thought, not as a suggestion of mine, but as having
been presented to me, and I was wondering what your view of that
would be.
Mr. REDMOND. I think, Senator, our view would simply be this,
that there are many banks that go into the determination of what
is a proper margin, and a pure percentage of market value is not
really sufficient. Let me cite an instance of what I have in mind.
There are periods in which certain types of securities are apt to appreciate more rapidly than at others. Quite recently you had a very
large speculation in brewery stocks because beer was legal before
wines and other alcoholic liquors. Obviously, those securities for
margin purposes ought to have been put into a quite separate category. Normally, banks handle that by writing down the market
values of what they call volatile or quickly appreciating securities
and maintain the same percentage ratio on all other securities.
Furthermore, margain accounts contain in large part sometimes
bonds as well as stocks, and it is obvious that if you want to stimulate the purchase of bonds it is better to allow them to go into
margin accounts at a lower margin ratio than you would apply to
•equity stocks. There are dozens of factors of that kind which really
ought to be given consideration, and we have no doubt that the Federal Reserve Board will give consideration to all those factors and
will make use of its power to prevent any excessive use of credit.
The CHAIRMAN. The point is that in case these brokers' loans increase whether you could not then increase the margins.
Senator MCADOO. I t is a general formula for increasing margin
requirements that is proposed. Under your suggestion of permitting
the Federal Reserve Board to deal with this by rules and regulations
to be prescribed by it, violations of which would be penalized under
the law, the Federal Reserve Board could consider such a formula
as this ?
Mr. REDMOND. Or any other such formula which seemed to be in
the public interest.
Senator BARKLEY. Would it be effective with reference to loans
by others than banks?
Mr. REDMOND. That question is covered, Senator Barkley, in the
next section; but it would, of course, to a certain degree nave an
effect, because loans for the account of others normally are not made
through banks that are subject to be controlled by the Federal Re-
7554
STOCK EXCHANGE PBACTICES
serve System or through brokers who would become subject to the
rules of the Federal Reserve JJoard under this proposed bill.
Mr. WHITNEY. Both of them are now prohibited.
Senator GORE. By your amendment is it contemplated that the
rales and regulations be approved by the Board or that the Federal
Reserve Board shall take the initiative and prescribe rules and
regulations ?
Mr. REDMOND. I t would allow the Federal Reserve Board to take
action whenever it saw fit.
Senator ADAMS. I think section 6 ought to be mandatory on the
Federal Reserye Board, thq,t it shall adopt rules rather than that it
may adopt rules.
Mr. REDMOND. We made it as broad as possible, because at present
the amoipit of credit employed in speculation, i.e., brokers' loans, is
less than 2 percent of the value of listed securities. I t is at least an
open question as to whether that is an excessive use of credit. If it
is not, the Federal Reserve Board might well feel that it could allow the existing condition to go along, and after that, if it felt it
was excessive, it would have the power to act.
Senator ADAMS. But it seems to me that it should be directed to
provide rules which they could change from time to time, under
your draft, rather than to make it merely permissive.
Mr. R,EPMOND. We would personally, I think, have no objection to
that.
Senator GORE. But under your plan the exchange can initiate
rules and submit them to the Board, and the Board can approve or
reject them or revise them? Is not that the point?
Mr. REDMOND. Yes; absolutely.
Senator BARKLEY. Under that language, of course, the board could
go along; and the stock exchange could go along for 5 or 10 years
without any regulation at all, and then, if the conditions seemed
to justify it, in the opinion of the Federal Reserve Board, it could
initiate some margin requirements. But do you think, in view of
the fact that margin requirements have had a part in creating the
situation which calls for any legislation at all, it would be wise to
drift along for years without any rules at all if the Federal Reserve
Board saw fit not to make them?
Senator MOADOO. I understood, from the question I asked you
some time back when you read this substitute of yours, that there was
a mandatory provision that the Federal Reserve Board shall provide
rules and regulations?
Mr. REDMOND. I t is a grant of power to it.
Answering your question, Senator Barkley, I would hope that
the Federal Reserve Board would not immediately have to adopt
any rules, but that by going to the exchanges and saying, " It is our
idea that your margins ought to be raised ", the exchanges would
voluntarily raise the margins at the request of the Federal Reserve
Board, thereby avoiding the necessity of the Federal Reserve Board's
issuing a rule or regulation. But they have the power to do so if
they feel it is necessary.
Senator BARKLEY. But I understand you to say a moment ago that
you were quite willing to have a mandatory provision and I can see
no objection to that.
STOCK EXCHANGE PBACTICES
7555
Mr, REDMOND. We have no objection to that whatsoever.
Senator BARKLEY. That they must prescribe rules and regulations ?
M!r. REDMOND
Yes.
Senator GLASS. HOW many members of the Federal Reserve Board
would have any information whatever about stock-market transactions &
Mr. REDMOND. That is rather a difficult question for me to answer,
Senator; but having read this bill which the Federal Reserve Board
has approved, my guess would be that very few of them know anything about stock-market transactions.
Senator MCADOO. We have got to educate them at some time, have
we not?
Senator GLASS. Why would it be desirable to mix the Federal
Reserve Board and the Federal Reserve System up m this matter,
anyhow? When we enacted the Federal Reserve law we took care
to exclude the system from stock-market transactions, and although
the language is as plain as English could make it, the Federal Reserve Board and the Federal Reserve banks ignored the prohibition
and furnished nearly a billion dollars of Federal Reserve facilities
to stock-market transactions within a period of 6 months. I do not
see why the Federal Reserve Board should be mixed up with it at
all; and it is my judgment that there is not a single member of that
board of eight members who knows anything on earth about stockmarket transactions.
Senator GORE. D O you make any point of that, Senator Glass?
Senator GLASS. Well, I just make that bald statement, that it is
my judgment they do not know anything about it, and I do not
think they ought to be allowed to know anything about it.
Senator BARKLEY. Senator, the question was raised a while ago
based upon the fact that all credit facilities ultimately have to come
through the banks, anyway
Th.6 CHAIRMAN. The board has control of credit.
Senator GLASS. They ought not to have it. The Board was not
set up for that purpose. It was set up to respond to the requirements of credit, not to control credit. I t was not set up to control
the stock market, and certainly it was not set up to be controlled by
the stock market, which it has been for a long time.
Senator TOWNSEND. DO you feel that the Federal Trade Commission should have control ?
Senator GLASS. I do not think they know anything more about
it than the Federal Reserve Board.
Mr. WHITNEY. We are very glad to leave ourselves in the hands
of the Federal Reserve Board. We believe they can acquire that
knowledge because of their present connection with credit conditions.
Senator GLASS. DO you mean, Mr. Whitney—or I guess you mean
that you can tell the Federal Resetve people what to do, as you
have "been telling them what to do for a long time, and maybe! you
could not tell somebody else ?
Mr. WHITNEY. NO, sir; I don't mean that at all. I have nevet
told them anything.
Senator COTJZENS. That is the reason that I disagree with Senator
McAdoo.
7556
STOCK EXCHANGE PRACTICES
Senator MCADOO. I do not know what our disagreement is. I am
simply speaking of the placing of a flexible power in the hands of
some governmental body instead of leaving it to the stock exchanges
themselves.
Senator GLASS. YOU do not think it was ever intended by the proponents of the Federal Eeserve System to have them either control
or be controlled by the stock market, do you ?
Senator MOADOO. N O ; certainly not. I agree -with you I t was
not intended that the Federal Trade Commission should do it, either,
but the draftsmen have incorporated certain powers in the bill for
them to exercise.
Senator GORE. I think this matter of who shall initiate the rules
and regulations is the fundamental point underlying this and gives
rise to the two schools of philosophy in this whole regulation. I
want the stock exchange to initiate the rules and regulations, subject to approval, so that if they fail the primary responsibility
would be on the stock exchange. I do not want Congress or any
agency of Congress to take the initiative in originating these rules
and regulations so that the responsibility will be on them. I do
not want to get into that position.
Mr. WHITNEY. A S the bill is written, the responsibility is clearly
on Congress.
Senator GORE. Yes; and if it results in a crash, we get the blame
for it.
Senator BARKLET. I S it because of the fundamental wisdom of it
or just from a desire to get out from under ?
Senator GORE. Congress passed a law like this once and repealed
it in 14 days.
Senator KEAN. Germany and England tried it.
Mr. REDMOND. Subdivision (e) on page 17 is simply a minor
matter, Mr. Pecora, but the way it reads at present, the transaction
referred to on page 18, that is, a loan made by any person other than
m the ordinary course of business, loans on exempted securities,,
loans to dealers to aid in financing the distribution of securities,
and any loan by a banker on security other than an equity security
is not subject to any control whatsoever, even by the Federal Reserve Board.
The CHAIRMAN. What page is that?
Mr. REDMOND. Page 18.
Senator GLASS. Loans by a bank may not be subject to control inthis bill that we are considering, but they are very decidedly subject
to control under the Banking Act of 1933.
Mr. REDMOND. They are, Senator Glass. But loans upon equity
securities are likewise subject, even when made by banks, to the provisions of this bill, so that even a bank cannot extend credit against
equity securities as defined in the bill except on the same terms that
a broker can extend it. It ties the banks and the brokers together in
one bundle.
Senator GLASS. I just want to untie them. I do not thmk they
have any business being tied together. We have in the Banking Act
of 1933, with regard to bank loans for speculative purposes, given
the Federal Reserve Board almost unlimited power. We require the
Federal Reserve banks to acquaint themselves in detail with the ae
STOCK EXCHANGE PEACTICES
7557
tivities of all member banks, National and State, and to report their
transactions to the Federal Reserve Board; and the Federal Reserve
Board is authorized to put a stop to any and all excessive loans for
speculative purposes. We prohibit underwriting; we have separated
the affiliates from the national banks, and on 15-day paper we provide the severest sort of penalty for the continuation of loans by
banks to brokers for speculative purposes. We authorize the Board
to deny them rediscount facilities for as long as 12 months or more.
I do not think tha this bill ought to treat of bank loans that would
conflict with the provisions of the act of 1933, which were so severe
that all of you Wall Street people opposed the bill for 16 months
and liked to have worn the liie out of us who had it in charge.
Mr. REDMOND. I, for one, was not a party to opposing that bill.
We are fully conversant with the very broad powers which the Banking Act of 1933' gives to the Federal Reserve Board. This bill, however, seems to go much further, and as originally drafted purported
to place a part of the power to control credit in the hands of the Federal Trade Commission with power to raise or lower margins, the
margins so raised or lowered to become applicable to the banking
system
Mr. PECORA. That was all changed in the revised draft.
Mr. REDMOND. The revised draft has substituted the Federal Reserve Board, and that is when it came into this draft and why our
suggestion includes the Federal Reserve Board. But it seemed to us
to be fundamentally unsound that another administrative department of the Government, other than the Federal Reserve Board,
should be given the control of margins which in turn became pledged
to banks, because that might bring a conflict of action between two
administrative departments in carrying out any control
Senator GLASS. That is the point I am making. I do not want
anything in the bill which we are now considering to conflict with
the very severe restrictions provided.
I would like to ask you, Mr. Pecora, if you have acquainted yourself with the provisions ox the Banking Act of 1933.
Mr. PECORA. Yes, sir; we have had them in mind, sir.
The CHAIRMAN. I t seems to me that it is in accord.
Mr. PECORA. I t was a desire to supplement that and coordinate
this power with the power of the Federal Reserve Board given to it
under the Banking Act of 1933.
Mr. WHITNEY. We have suggested an amendment along the same
lines, except simplified, and giving the Federal Reserve Board more
discretionary power than is in the bill as now written.
Mr. REDMOND. I think we have discussed section 6.
Section 7, which deals with the restrictions on members borrowing, we believe was intended to supplement the power of the Federal
Reserve Board to prevent corporations and others lending money
for speculation in the securities market. That as the apparent purpose of subsection (#), and indeed we feel that a broad grant of
power to the Federal Reserve Board, if it does supplement the
powers they already have, cannot be amiss.
The other subsections of section 7—I am referring now to page 20
of the committee print. Subdivision (&) purports to require that
the capital of a broker shall not be less than 10 times his aggregate
7558
STOCK EXCHANGE PRACTICES
indebtedness to all other persons, including customers' credit
balances
Senator GORE. YOU mean 10 times or one tenth?
Mr. REDMOND. One tenth; I beg your pardon. Excluding indebtedness on exempted securities. Quite frankly that forihula completely disregards the fact of brokerage accounts being affected by
open contracts much more than by ordinary assets and liabilities,
and as a basis for determining1 the necessary capital for th6 brokerage business subsection (6) quite frankly has no meaning. Under
it a bucket shop could operate perfectly satisfactorily, whereas a
brokerage house with ample capital to conduct its business might
find itself technically under the restriction of this section.
Finally, let me point out that the exclusion of indebtedness on
exempted securities .illustrates the absurdity of the provision. Suppose you had a broker whose capital was slightly insufficient to meet
the required ratio to his liability. If he could persuade one of his
customers to give him $100,000 of Government bonds instead of
$100,000 of stock as margin in that customer's account, the broker
might then pledge his customer's exempted securities at a bank, get
$100,000, pay off $100,000 of the loans that figure in his ratio, and
then his capital conceivably would comply with thig provision,
although obviously that transaction would not have increased or
decreased the broker's capital by 1 cent.
Mr. PECORA. What is the rule now on the stock exchange, if it
has any, regarding the ratio between indebtedness and capital ?
Mr. REDMOND. The existing rule is as follows, that the net working capital, that is, cash working capital, shall be sufficient to margin
any securities by 80 percent, any securities that are carried for the
account of the nrm or for any partner in the firm and, in addition,
have enough to margin all of the customers' debit balances, gross,
bf 5 percent.
That formula in many instances works out to more than one teiith
of the liabilities that are referred to in this subsection; but you
cannot reduce our rules to a formula because of the determination
of what constitutes net working capital that may affect judgment
as to the liquidity of the assets of the firm. For instance, if you
have a customer's account that may have, let us say, on current
market values, 20 percent or 25 percent margin, not up to the Required
standard, you have got to examine those securities to see whether
they are sufficiently active to make sure that the broker would be
able to count that debit balance as one of his assets. We fery often
throw out securities and say we will not treat them as of any value.
We place no value on stock exchange memberships or furniture and
fixtures or assets of that kind. It is an application, in each case,
of judgment rather than of a fixed formula. I might say that we
have in the past on different occasions changed our requirements
ag conditions seemed to warrant.
Senatdr GORE. I S this the point where that phrase " a thousand
percent" occurs ?
Mr. EEDMOND. Exactly, Senator Gore.
Senator GORE. Would it not be better, as a mere matter ai phraseology, to say 10 times instead of a thousand percent?
Mr. REDMOND. I think probably you are right, Senator Gbi*e. I
had not thought of that, as a matter of draftsmanship; but I think
STOCK EXCHANGE PEACTICES
7559
probably 1Q times would be more easily understood than a thousand
percent
Senator GORE. Some say there is no such thing as a thousand percent. I don't know about that.
Mr. ESMOND. Subsection (c) on page 20. We are doubtful as to
the meaning of that. I t can be interpreted so as to mean that a
broker would have to carry only one loan at each bank and not have
any other liabilities at that bank. The clause reads as follows
[reading]:
To hypothecate or arrange for the hypothecation of securities carried for
customers* accounts except free and clear from the liens of other creditors.
And so forth. A bank, when it has a loan, of course has its general
banker's lien on any equity in that loan for any other liability of the
maker of the loan. Therefore when a brokerage firm carries 3, 5, or
10 loans in a bank the equity in one loan is applicable to the other;
and as I see it here, you might have a situation in which the pledging
of one such loan would be subject to the liabilities of the other creditor. That would be particularly true where the broker was using
his principal bank for what is known as " day-loan accommodation."
In regard to section 8 we make no suggestion in regard to subsection 1. This is the section of the bill dealing with the prohibition of
manipulative transactions.
In regard to section 2, which Mr. Corcoran, when he appeared before the committee, said was to cover match orders, we believe that
the section as drafted does not cover technically matched orders, and
we have redrafted it so as to clearly cover that.
Senator GORE. Subsection 2?
Mr. REDMOND. Subsection 2 of section 8 (a).
Subsection 3 of section 8, which appears on page 22, Mr. Corcoran
said was intended to prevent pools and manipulative transactions of
that character. We believe it could be more clearly expressed so as to
show its intent, and we suggest, therefore, that it be amended to read
[reading]:
To effect, either alone or in conjunction with one or more other persons, a
series of transactions for the purchase and sale of any security, for the purpose
of creating a false or misleading appearance of the volume of trading in such
security or of establishing price quotations therefor which do not truly reflect
the market value of such security
This suggestion tends to make perfectly clear the intent of that
provision.
Subsections 4, 5, 6. and 7, which deal
Senator ADAMS. At that point: You have a qualification at the
closp of the section. You suggest that these transactions, these crosstransactions, would not be forbidden if they did properly reflect the
market value. Ought they to be permitted even if they do truly
reflect actual market conditions at the time?
]Mr. ESMOND. Senator Adams, what is prohibited is a series of
transactions made for the purpose of showing price quotations which
are not properly reflected
Senator ADAMS. But it is also, beyond that, " for the purpose of
creating a false or misleading appearance of the volume of trading
in such security." .
Mr. REDMOND. Either one.
7560
STOCK EXCHANGE PBACTICES
Senator ADAMS. We might add to it the actual true market figure.
You could under this section have a very large volume of transactions
without violating the section if they truly reflected the market value*
That last qualification might well be stricken out
Mr. KEDMOND. But, Senator, I think possibly you have misread
the section. What we intended to cover was either one of those
transactions—if a man made a series of transactions either for the
purpose of creating a false or misleading appearance of the volume of
trading or for the purpose of establishing price quotations.
Senator ADAMS. Then the last clause does not relate back to the
earlier part?
Mr. REDMOND. N O ; but it has sufficient affiliation so that a man,
under the example you gave, could be considered subject to this
clause.
Sections 4, 5, 6, and 7, dealing with the circulation of rumors and
false information are intended, 1 believe, also to cover tipster sheets.
We have redrafted two sections. I will read only the first one. The
second one dealing with tipster sheets is highly technical, Mr. Pecora,
but I invite your attention to it because I think it will be more
effective against that type of unfair practice than what is in the
bill today.
Senator GORE. I t relates to tips, you say?
Mr. REDMOND. Tipster sheets, Senator—newspapers that are published for the purpose of leading people to buy and sell securities.
Senator GORE. I S there any way in which we can make that retroactive? [Laughter.]
Mr. REDMOND. I am afraid it is beyond even the power of Congress, Senator Gore.
In regard to the circulation of rumors we provide as follows:
To circulate or di&seniinate, with intent to deceive, any false or misleading
infoimation in regard to any security, foi the purpose of inducing the purchase or sale of such security
As we read and interpreted some of these sections, particularly 4
or 5, it seemed to us that even fair comment by people engaged in
the security business might subject them to criminal liability. We
did not believe that that was the intention of this act; but many
orgamzations, like some of our statistical organizations, which might
be considered as dealers or brokers because they use facilities, are
daily expressing opinions as to the value of securities, and we thought
they should not be considered criminal unless they did it purposely
with the intent to deceive.
Section 8, which we have in our draft renumbered, deals with
transactions for pegging, fixing, or stabilizing the price of a security
in contravention of rules and regulations as the Commission may
prescribe—this being in the alternative—or without having prior to
such transactions reported the same.
I t seemed to us that a mandatory provision that you would have
to report might place an enormous burden on the Federal Trade
Commission; and if it felt that such reports were necessary it could
cover them by its rules and regulations.
So we have limited that section to read:
To engage in any series of transactions for the purchase and sale of any
security registered on a national securities exchange or any security not so
STOCK EXCHANGE PRACTICES
7561
i?egistered for the purpose of pegging, fixing, or stabilizing the price of such
security in contravention of such rules and regulations as the Commission may
prescribe as necessary or appropriate to pevent unfair practices
Section 9 appearing at the top of page 25 refers to the guaranteeing
of puts and calls by members of an exchange. I t was not clear
that that provision was subject to the limiting language contained
in the opening part of section 9, that is, that these put and call transactions should not be executed or guaranteed in contravention of such
rules and regulations as the Commission might prescribe; so we
^clarified that by making it clear that the power of the Commission
to make rules applied also to the guaranteeing of puts, calls, and
straddles.
Subsection (b) deals with the civil liability of any person who
violates any 01 the subsections contained under subdivision (a) of
this section.
It reads now. [Reading:]
(b) Any person who willfully participates m any act or transaction—
"Willfully participates" did not seem to us to be the test, but
it was the question as to whether a person willfully violated any
such provision, and to make that clear we redrafted it to read.
[Reading:]
(b) Any person who willfully violates any provisions of subsection (a) of
this section and any person who knowingly participates in any such violation
shall be liable to any person who shall purchase or seU any security, the price
of which was affected by such violation, and the person so injured may sue in
Jaw or in equity in any court of competent junsdiction to recover the damages
sustained as a result of such violation
Then the proviso which appears in the last part of that subsection,
we believe, can be omitted.
Subsection (d), which appears on page 26, limits the period m
which actions can be brought under this section to 2 years after the
cause of action occurs. If it was intended to mean 2 years after the
violation, we then suggest that that provision be specifically put in,
but if it was intended that the action could be brought 2 years, let us
say, after discovery, then we believe there should be some limited
period beyond which no action could be brought. There was, I
believe, discussion before the committee some weeks ago, and general
agreement that there should be some maximum limitation beyond
which no action could be brought.
Mr. PECORA. There was such discussion, as I recall it. The suggestion was that action must be brought within 2 years after the
discovery of the violation, but in no event could it be brought after
6 years xrom the commission of the violation.
Mr. REDMOND. There was discussion of that. This "cause of
action " language, we felt, was not quite clear, and we were fearful
that it might bring about an absurd condition, in that the laws of
some States might allow an action at a much later date than other
laws, and even if the action were brought in the Federal courts,
following the local practices with regard to limitations might result in varied rules of law as to the liability. We feel that it should
be made definite or certain one way or the other.
We suggest that section 9 be omitted entirely. As to subdivisions
(a) and (b), you will find them incorporated in our redraft of
section 18.
756?
STOCK EXCHANGE PRACTICES
As to subsection (c), which seemed to be a general gr^nt of
power to the Commission to define as a crime any practice which
they thought was manipulative, it seemed to us to be an altogether
too" broad grant of power to any administrative body. It is a
criminal provision there, which the Federal Trade Commission
might, by rule or regulation, interpret in common practice, and
suddenly announce that it was a violation of that, subjecting the
violator to 10 years in jail. I t seemed to us to be going a little far,
and we suggest its omission in toto.
Section 10 deals with the segregation and limitation of the functions of broker, specialist, and dealer. We have simply recommended,
as Mr. Whitney did the other day, that subdivisions (a) and (b)
be combined into subsection (a), and subsections (c) and (d) into
subsection (b). There is one slight change in language, Mr. Pecora,
simply so as to make it clear that a member of the exchange, under
subsection (b), who has not been granted the privilege of acting
as a dealer and a broker, cannot do so without violating this provision.
Senator GORE. A specialist, you say?
Mr. EEDMOND. The specialist provisions are left to such rules
Senator GORE. I did not catch the first part of that last sentence.
Mr. REDMOND. Under subsection (b) provision is made for the
granting of the privilege to brokers to engage in business as dealers
and brokers off the floor of the exchange, on certain terms and conditions. We simply put in the provision that it would be unlawful for
a man to engage in such business until he had been granted, the
privilege, which was not in our original draft.
Senator BARKLEY. My attention was called yesterday by some gentlemai* tp the provisions of this biU as applicable to the members
of the exchange who deal in bonds, somewhat after the fashion of the
specialist.
Mr. REDMOND. That is true, Senator.
Senator BARKLEY. Have you dealt with that situation in your suggested amendments ?
Mr. JREDMONJD. We would leave full power to the Federal Trade
Commission to prescribe rules and regulations as to the way that
business is carried on. Our subsection (a) simply says [reading]:
SEC 9 (a) It shall be unlawful for an Individual member of a national
securities exchange while on the trading premises of such exchange to act as
a dealer and broker in contravention of such rules and regulations as the Commission naay prescribe as necessary or appropriate in the public interest or
for the protection of investors
Senator BARKLEY. YOU have changed the number. You have
eliminated one section.
Mr. REDMOND. We have eliminated one section.
Mr. PECORA. He has eliminated section 9, and section 10 become?
section 9.
Mr. REDMOND. Section 11 deals with the registration requirements
for securities. We suggest that these two sections, 11 and 12 of the
committee print, which are quite long and quite detailed, be very
substantially changed, so that the listing requirements of the ex
changes shall be subject to the control of the Federal Trade Commission, but that the securities of those corporations that comply with
those listing requirements shall be considered as registered securities
STOCK EXCHANGE PEACTICES
7563
under the act. In other words, that insofar as the corporations
ate
concerned, the regulation of listing by the1 Federal Trade1 Gotafmission would be through the exchanges rather than by si direct control
over the
Corporations.
Also4, in the interest of fyr^se^ving a? market tipoii the gffecftive
date of this bill, we have provided that securities which aite listed1
at the time that the exchange itself ltegistei's with the Federal Trade
Commission shall be deemed to be registered securities uiid6r this
act, subject, however, to the full right of the Commission ttf suspend
dealing, or to require theit delisting if that should becortie necessary.
We also provide that securities admitted t a dealing on April 1 of
this year should have the same st&ttis When ari exchange which has
admitted securities only to dealing, and not listing, makes its application for registration, but again with the full right of the Commission t6 remove those securities if it is necessary.
Senator GORE. That is the Curb.
Mr. REDMOND. That would cover the existing situation in the
Curb. We give power to the! Federal Trade Commission to pdrmit
dealings in securities that are not technically listed, so as to" take
care of situations which we know will exist in the future1 whete1, for
instance, let us say, you Will have a split-up, and a " when issued "
security of large moment. Our experience m the past has indicated
that where that security is listed on an exchange, unless the exchange
m willing to deal
in the " wheti issued " a large market Will develop
for the " when1 issued " stofck over the counter, which will have a
very detrimental effect on the market of the exchange; whereas, if
the " when issued " is brought on to the exchange, so that the two
are traded in, one alongside the other, then the market Will be very
close and very1 orderly. The same thing applies to rights to subscribe,
which are often " when issued ", and to other siiiiilar securities.
Senator BARKXBT. At the bottorb. of page 32 of the bill, subsection
9, among other things whidh may be required to be filed, specifies
material contracts not made in the ordinary course of busiftefcs, and
material patents. Of course, we all know that patents are a matter
of public record in the Patent Office here in Washington. I aril
wondering whether that language might be construed to authorize
the Federal Trade Commission to require the filing of contracts of
such a nature as to reveal secret processes and trade secrets that any
concern might not wish to reveal to its competitors. For instance,
a chemical company that manufactures some commodity by a secret
process of its own that it has worked out would not want to divulge
it, especially to foreign competitors. Have you given any thought
io the possibility—and I am directing the same question to Mr.
Pecora—whether that language might not be construed, if the
Federal Trade Commission saw fit, to require the filing of secret
information with reference to formulas, processes, and contracts—
contracts between the company and some person, some inventor? Or
some expert, or some company that was manufacturing a certain
thing that the company needed for the manufacture of its chemical
processes, or any other? Have you thought anything about that?
Mr. REDMOND. We feel that it is a yfcry dangerous provision,
largely because of the doubt as to what is included iii it. In the
same way, if you look at subdivision 7, which includes management
7564
STOCK EXCHANGE PEACTICES
and service contracts, it is rather difficult to say precisely what might
be included in your service contracts. You might, for instance,
retain a very well-known engineer, if those services mean personal
services, but you might retain him to manage a particular plant, with
some description as to what purposes he was going to aim at. If
the publication Qf that was necessary, the whole value of the attempt
to get a better process might be thrown away.
Senator BARKLEY. I do not quite understand what the language
means there u material contracts" and " material patents." I do
not see the necessity for putting in there any requirement as to material patents, or any kind of patents, all of which are a matter of
public record in the Patent Office in Washington.
Mr. PECORA. The Federal Trade Commission, as I understand it,
has required considerable information of the secret nature to which
you have referred. So far as I know there has been no public disclosure of it made. This bill imposes upon the Federal Trade Commission the duty of making such requirements only, as the language
of the bill says, where it may be necessary or appropriate in the
public interest, or for the protection of investors. In view of the
experience of the Federal Trade Commission in dealing with such
secret information, I do not think any apprehension need reasonably be felt as to their laying down requirements that would not be
consistent with the public interest or with the protection of investors.
Senator BARKLEY. There is a theory which is entertained by a,
good many people, that all records in Governmental offices are public records, and that any interested party may have a right to go m
and demand that he be allowed to see them I t is difficult for that
to be done unless the Commission or the officer m charge is willing.
But I am wondering whether, under that section, we are authorizing
the compiling of records that might be deemed public, so that things
like this, that have been worked out for years and years as a secret
process of manufacture, might be divulged to some competitor whomight like to take advantage of it.
Mr. PECORA. Thejr have not heretofore been divulged by the Federal Trade Commission, so far as I know, and yet they have requiredsuch information in the discharge of their duties. I think that they
can be trusted to exercise the kind of judgment this bill calls upon
them to exercise, that is, make such rules and requirements with
respect to furnishing such information as may be necessary or a p propriate in the public interest or for the protection of investors.
Senator BULKLEY. Where do you find secret processes involved?
Senator BARKLEY. Not by language, but take material contracts.
I do not know what is meant by that, unless it is contracts for
material. That might include anything. That might include
Mr. PECORA. I think that would mean contracts considered material.
Senator BXJLKLEY. Considered important.
Senator BARKLEY. I do not know whether that is the interpretation
to be placed upon that or not.
Mr. WHITNEY. AS applied to material patents, that would signify
that they would be of importance.
Mr. PECORA. Patents, as the Senator has remarked, are a matter of
public record anyway. There is no concealment about those.
STOCK EXCHANGE PBACTIOES
7565
Senator BVUEJJBY. This is different. This requires them to set
forth which ones they regard as important. That adds something
to the public record in the Patent Office.
Mr. REDMOND. I S it not true that every corporation, to be on the
safe side, will have to submit every patent they have? How can
they tell, looking at it in retrospect, that any particular patent is not
an important one? They would not dare take the risk.
Mr. WHITNEY. I think the American Telephone & Telegraph Co.
has 5,000 or more.
Senator CAREY. Why have it anyway? Cannot the Commission
demand anything like that if they are passing upon securities?
Mr. REDMOND. We have omitted any specific provision m our suggestions, because we felt that there was some danger in the disclosure
of secret information, but, much more, that you would collect a great
mass of information of no practical value to investors. There is no
point in having a great list of contracts, management, service, and
material contracts of one kind and another, compiled in some place,
because investors are not going to read them. It will be the competitor who will go and read them, the very fellow who ought not to
get the information.
Mr. PECORA. He probably has the information anyway, through
the system of espionage.
Mr. REDMOND. I do not think that exists. I know that statement
was made before the House by Mr. Pressley, and, quite frankly, I
do not believe it. Having looked over the financial results of Mr.
Pressley's management of his own companies, if there is such a
system then he certainly did not make good use of it.
Senator GORE. The management contract would include a situation where one concern buys another concern, a public utility, for
example, and enters into a contract to manage it as a large stipulated
price and really does nothing on earth, just covering up a charge
of that sort.
Mr. REDMOND. I think that was the intention, Senator Gore, to
cover both that type of management contract and possibly another
type, where a corporation is actually hired for a stipulated fee to
operate or manage some other company.
Senator GORE. It seems to me that is one of the abuses, the "bug
under the chij)." They make these contracts for management or
service, or advice, and charge a large fee for it, and do nothing in
return.
The CHAIRMAN. YOU propose an amendment for that?
Mr. REDMOND. We do.
Senator GORE. And yet
they drain the local concern they buy, and
it results in high rates to the consumers of the service.
Mr. REDMOND. I will not discuss the technicalities unless the committee wishes me to, of the listing requirements. That is a highly
specialized field.
Section 13 appears on page 37 of the committee print, and our
references appear on page 18 of our print. That deals with the
granting of proxies, and makes it a crime for a person to solicit a
proxy without filing information with the Federal Trade Commit
sion, and including in the application, or the solicitation, such part
of the information as the Feaeral Trade Commission may require by
7566
STOCK EXCHANGE PRACTICES
rules and regulations. I am aware of the fact that this provision
was^ put in with the idea that it would facilitate minority stockholders getting in touch with each other in a possible content for control, but, quite frankly, I think it is going td Operate almost the other
way abound, because under this provision the first thing that a
minority stockholder would have to do before he could solicit the
other stockholders would be to get a complete list from the company
and file it with the Federal Trade Commission, and thetepfcmsethat
would be imposed upon the minority stockholders by that p^rivision
might be s6 great a& to prevent the soliciting of any proxies. Quite
frankly, we feel that this provision has no part in a stock-e*xch&iige
bill.
'We do suggest, however, in the line that we have takei* right
straight through of making these provisions flexible, that if any provision is retained it should be made simply to the effect that it shall
be tinlawful to solicit or permit the use of his name to Solicit any
proxy in contravention of such rules and regulations as the Commission may adopt for the protection of investors. That, at least,
would allow the Federal Trade Commission to study the problem
and to adopt rules and regulations, if it becomes necessary.
In like manner we have changed subdivision (b) so as td give the
Federal Trade Commission power to make regulations in feg&rd to
brokers granting proxies on securities held by them. A f>rombition
of that practice would, I am afraid, in many instances pteVeiit corporations from securing a quorum fot stockholders' meetings. That,
in effect, would result in tne perpetuation of existing management,
which might be quite contrary to the interests of stockholders. I t
is a ve'ry considerable problem, one which we hatve wrestled With,
because we have a provision in the rules of the New York Stock Exchange in regard to the granting of proxies, and even that, which is
much less restrictive than the one proposed in the bill, has in many
instances caused grave difficulty.
Section 14, which appears on page 38, deals with the over-thecounter markets. We believe this Section will, as a practical matter,
be unenforceable. In any event, we think it should be restricted so
as not to apply to commercial ^aper or bankers' acceptance^ o»r commercial bills, even though they might have a longer maturity than 9
months, and other similar obligations incident to commercial and
industrial activities, all of which are included in the very broad definition of the te^rm " security " which now appears in the bill.
Senator GORE. This is what section?
Mr. EEDMOND. Section 14, dealing with over-the-cotinter markets.
As a practical matter, if it were possible to arrive at another definition that would include simply what are normally considered to
be the securities which would be traded in on an exchange, that, I
take it, is what ought to be regulated in the over-the-counter market.
I t is primarily your stocks and bonds rather than these very Sweeping definitions of securities which it was necessary to include in
the drafting of the act.
With respect to section 15—we make a comment
at the &ndr in
!
regard to certain of these sections which seem to fall outside the
scope of our particular criticism, but we would like to poirit out that
the 5 percent provision in regard to stockholders', as drafted today,
STOCK EXCHANGE PRACTICES
7567
might prevent arbitrage transactions, because it is very common, in
arbitrage, for a man to buy one security and at the same time sell
against it an equivalent security. While that process of the arbitrage is going on he might conceivably accumulate more than 5
percent of this security, and he would be the beneficial owner of
that 5 percent. He would, of course, have off-setting contracts or
obligations against it, but they are not reflected in the definition,
which imposes penalties upon a stockholder owning 5 percent or
more of a registered security.
Senator GORE. YOU mean in that sort of transaction he might
be buying one security and selling another?
Mr. REDMOND. Very often, Senator Gore, he actually buys and
pays for a security, and then sells, let us say, an equivalent security
for future delivery, or " when issued ", as in the case of rights to
subscribe.
Senator GORE. Of some other concern?
Mr. REDMOND. Sometimes of the same concern, and sometimes of
another concern. Arbitrage is possible when securities, if not presently equal to each other, will become presently equal to each other.
In cases of merger and consolidation it is very common to have an
arbitrage between the securities of the consolidating corporations,
and we suggest, therefore, the addition of a small subsection at
the end, which would allow the Federal Trade Commission to adopt
rules and regulations to prevent the abuse of arbitrage transactions, but otherwise would permit both foreign and domestic arbitrage.
The CHAIRMAN. Are you talking now of section 15 ?
Mr. REDMOND. Section 15, Mr. Chairman.
The CHAIRMAN. YOU propose a substitute for that section?
Mr. REDMOND We propose simply the addition of a short final
paragraph.
Mr. PECORA. It excludes arbitrage transactions of the operations
of the section, except in accordance with rules and regulations to be
adopted by the Federal Trade Commission.
Mr. REDMOND. Precisely.
The CHAIRMAN. Did you have a substitute for section 14?
Mr REDMOND. We simply expressed our feeling that it probably
was an unenforceable section, and suggested the possibility of its
being limited in scope, but we did not attempt to redraft it.
Mr. PECORA. Limited so as to exclude bankers' acceptances, commercial bills, and so forth.
Mr. REDMOND. And even further, if possible, so as to get down
to what are commonly known as stocks and bonds.
We suggest that section 16 be omitted entirely, the substance of
the right of the Commission to investigate the books and records
being included in our proposed draft of section 18.
Mr. PECORA. YOU will come to section 18 ?
Mr. REDMOND. Yes,
sir.
Section 17 covers the liability for misleading statements. We feel
that that should be redrafted so as to make it perfectly clear that
it is a liability for a misstatement in regard to a material fact, and
not for a misstatement or a false or misleading statement in regard
to a matter sufficiently important to influence the
175541—84—PT 16——11
7568
STOCK EXCHANGE PBACTICES
average investor. Quite frankly, we feel that this imaginary creature known as the average investor is not a standard which ought
to be used in legislation to determine the liability of anybody. Nobody can tell precisely
Senator KEAN. I would like to ask you a question in regard to
that section. Do you think that a director of a corporation would
be liable under these circumstances? Suppose a man walked up to
him in the street and said "Are you going to vote for a 6-percent
dividend today on your stock? " Suppose he said, " Well, I do not
know ", and he did know all the time that he was going to, but he
had no call on him, and the man had no business to ask him the
question. Under this section would he be liable?
Mr. REDMOND. NO, Senator Kean. This section is limited, as I
see it, to a person who shall make, or be responsible for making, any
statement in any application, report, or document filed pursuant to
this act.
Senator KEAN. Only a document? No verbal statement?
Mr. REDMOND. This apparently is limited. That is correct, is it
not, Mr. Pecora?
Mr. PECORA. Yes.
Senator KEAN. He would not be liable for any oral statement?
Mr. REDMOND. I t would not apply to an oral statement.
Senator KEAN. People come and ask you questions about your
companies very often, which you do not care to answer, and there is
no reason why you should answer.
The CHAIRMAN. YOU would not be liable under this section.
Senator WALCOTT. I t says here " any statement in any application." What would an application cover?
Mr. PECORA. Any application, report, or document filed pursuant
to this act. That refers to written statements, reports, and so forth
Senator KEAN. Everybody who is a director in any corporation
knows that people come and ask him questions which they have
no right to ask. They are not even stockholders in the company
They just come and ask him some question in regard to the company,
which they think he might tell them, and they have no business to
ask it.
Senator BARKLEY. That would not apply here.
Senator WALCOTT. That might be a written request, and the reply
might be in writing.
Mr. PECORA. It must be a statement or report required to be filed
Senator CAREY. Filed with the Federal Trade Commission.
Mr. PECORA. With the Federal Trade Commission.
Mr. REDMOND. In section 18 we suggest no changes to the first
four subdivisions, which appear on pages 43 and 44. We suggest,
m the manner, and I think in almost the exact detail suggested by
Mr. Whitney the other day, the amendment of subsection 5. I think
there may be some small changes in language. If there are, they
were made to clarify and make more certain the provisions, but not
with any attempt to change the substance of what Mr. Whitney
said. I take it the committee is familiar with that section.
Senator BARKLEY. YOU offer a substitute for subsection 5?
Mr. REDMOND Precisely.
Mr. WHITNEY Adding to this general section various subsections
from other prior sections, Senator Barkley.
STOCK EXCHANGE PEACTICES
7569
Mr. REDMOND. It includes also the matters from section 9 and section 16.
With respect to section 19, we refer to oui comment, which I will
read in a moment. We suggest no changes in sections 20, 21, and
22; no change in section 23, but it is subject to comment.
With respect to section 24, we suggest that subsection (a) of that
be amended, as that deals with the right of persons to review by
court proceedings the orders of the Commission. I t is limited, however, in its present draft, to " any person aggrieved by an order issued by the Commission in a proceeding under this act to which
such person is a party." I t is very possible that a person might be
aggrieved by an order ofgeneral application to which he would not
expressly be a party. We felt that if he were so aggrieved, he
should be given the right of review, so we have redrafted the clause
for that purpose.
Mr. PECORA. YOU say in your redraft [reading] :
Any person aggrieved by an order issued by the Commission in a proceeding under this act to which such person is a party and any person aggrieved by
any rules or regulations of general appUcations made effective as prescribed
in section 20 may obtain a review of such order
Do you intend by that to subject the rules and regulations which
may be adopted under the act by the Federal Trade Commission to
court review?
Mr. REDMOND. Where a person is aggrieved.
Mr. PECORA. Then you are not giving the Federal Trade Commission the discretionary power that you maintain is being given to, it.
Mr. REDMOND. Yes; I think we are, Mr. Pecora.
Mr. PECORA. If you make its rules and regulations subject to>
court review
Mr. REDMOND. But these rules and regulations
Mr. PECORA (continuing). You will put the Federal Trade Commission, then, in the position of making rules and regulations for
which a court may provide a substitute. You are giving the court,
then, the power to make the rules and regulations in the final
analysis, are you not?
Mr. REDMOND. N O ; I do not think so, because the term " rules and
regulations " is used throughout the bill, that the exchange mightT
by rules and regulations, do thus and so. Let us take an example:
We referred a moment ago to the question of foreign and domestic
arbitrage. Suppose the Commission should adopt rules and regulations which literally prohibited that. Do you not think a person
engaged in the business of being an arbitrageur should have the
right to review the question of whether those*rules and regulations
were necessary to carry out the provisions of section 15 ?
Mr. PECORA. If you are going to do that by what you designate as
section 22 (a), the clause you have in there, now, I am afraid you are
going to ma'ke all the rules and regulations which the Federal Trade
Commission is presumably empowered to make, subject to court review. You are going to make the court, in the final analysis, the
arbiter of the rules and regulations which the Federal Trade Commission is required to make.
Mr. REDMOND. But, Mr. Pecora, you are using the words u rules and
regulations." The only necessity for putting that in is that through
7570
STOCK EXCHANGE PEACTICES
out this draft of the bill we have not attempted to redraft all the
language of the bill. The term " rules and regulations " is used precisely as if they were orders of the Commission. In other words, the
Commission, by rule and regulation, says the bill can accomplish the
same thing that they could by an order.
Mr. PECORA. At the same time, the Commission is empowered to
make rules and regulations with regard to many, many things. As a
matter of fact, you are entrusting to the Federal Trade Commission
powers in addition to those that were entrusted to it in the printed
draft of the bill.
Mr. KEDMOND. True.
Mr. PECORA. NOW you say "We propose that the Federal Trade
Commission be given that much broader power than was originally
contemplated," but by this clause you are virtually saying " The Federal Trade Commission's rules and regulations, however, are subject
to review by some tribunal."
Mr. EEDMOND. But was not this section intended to allow citizens
who were aggrieved by the action of the Commission
Mr. PECORA By an order, which 1^ different from a rule or regulation.
Mr. KEDMOND. Quite frankly, I thought the intent of the section
was to allow to citizens who would be affected by the action of the
Federal Trade Commission the normal right, which is the right of
citizens to review the action of an administrative body m the coutts.
Mr. PECORA. If the Federal Trade Commission should, by order,
determine that an individual has violated a rule or regulation, the
right to review is given, but not the right to review the making
of the rule or regulation.
Mr. KEDMOND. But if, Mr. Pecora, the making of the rule or regulation would have the same effect—it does under this bill—as an
order, should the Federal Trade Commission be able to escape a court
review by making a general rule or regulation rather than a specific
order & I know of no administrative proceeding which is not subject to some form of court review, and, quite frankly, it never occurred to me that this bill was intended to establish an administrative
authority that would not be subject to court review. In fact, I
think Mr. Corcoran
Mr. PECORA. There is not any such purpose revealed in the printed
bill.
Mr. KEDMOND. I t is limited here
Senator TOWNSEND. What page?
Mr. REDMOND. Page 50. I t says [reading] :
Any person aggrieved by an order issued by the Commission in a proceeding
under this act to which such person is a party
Mr
PECORA.
Yes.
Mr. KEDMOND. That is the only type of act of the Fe4eral Trade
Commission which, under this bill, would be subject to court review.
Take the case
Mr. PECORA. YOU propose to extend that by giving the court the
power to review rules and regulations which the Federal Trade Commission is authorized by other provisions of this act to formulate
and prescribe from time to time for the purpose of carrying out
the provisions of the act, so that are you not virtually making the
STOCK EXCHANGE PBACTICES
7571
court the final arbiter of what rules and regulations are to be made,
and not the Federal Trade Commission?
Mr. REDMOND. Only insofar as the rules and regulations directly
and adversely affect the rights of a citizen. I t is because the form
of this bill has used the term " rules and regulations " for all sorts
of things, which are not really rules and regulations at all.
Take the incident I gave you, of the man engaged in foreign or
domestic arbitrage. The Commission could adopt what it might say
was a rule or regulation, prohibiting foreign arbitrage. Those men
would be put out of business, and would have no right to review
in the courts the order of the Federal Trade Commission, because
the Federal Trade Commission would not have entered an order. I t
would have adopted a rule or regulation.
Senator BARKLEY. YOU have two classes of people here, one who
are parties to any proceeding
Mr. REDMOND. True.
Senator BARKLEY. In that case there is no question under either
language. They can go into court.
Mr. REDMOND. Correct.
Senator BARKLEY. Your language, however, makes it possible for
anybody to go into court and make a general attack.
Mr. KEDMOND. Anybody who is aggrieved.
Senator BARKLEY. Anybody who thinks he is going to be aggrieved. If he has been aggrieved, he can easily become a party to
a proceeding that would enable him to appeal to a court.
Mr. REDMOND. But there are no proceedings here.
Senator BARKLEY. This language is broad enough to enable anybody who thinks he is liable to be aggrieved by the specific application of the regulations to go into court and attack the whole body of
regulations.
Mr. REDMOND. If my language is so broad as to allow that interpretation, clearly it should be limited. But I was trying to cover
the point that because of the way the bill is drafted, the term " rules
and regulations " was made of general application, and effectively
destroyed the rights of citizens, and no opportunity would be given
them to review that action in the courts.
Senator BARKLEY. Of course, it is easy for any person to become
a party to a proceeding by violating any of the rules or regulations,
and then having proceedings instituted against him so that he may
come within the language of the bill as written. Then he can get an
appeal to the circuit court.
Mr. REDMOND. I beg your pardon, Senator. The purpose of this
provision, and it is the same type of provision that is in all of our
administrative acts, is to allow a person who is affected by the
administrative commission's action to have an orderly review of
that proceeding before he has got to subject himself to criminal proceedings.
Senator BARKLEY. I t seems to me you have subjected the language
to the danger of involving some attack on the general body of rules
and regulations made without regard to the possibility of them
affecting him in all their ramifications. He might undertake to
relieve a lot of others besides himself of the binding effect of the
regulations by some proceeding of his own.
7572
STOCK EXCHANGE PEACTICES
Mr. REDMOND. That is not my intention, and if the language is
•capable of that construction, I will be the first to amend it so as to
limit it to what I really had in mind, and that is that a person who
was aggrieved could have a right to review.
Senator BARKLEY. I do not know just what the proceedings will be
under this bill. It is like a new court of appeals being established.
I t has to work out its own rules over a period of time. Anybody
who is aggrieved by any regulation or rule of the Commission can
go before the Commission in a proceeding to have that rule or regulation modified or abandoned entirely. In such a proceeding, if
the decision is adverse to him, he can then go into court, so that, as
I said a moment ago, it is easy for anybody to make himself a party
to a proceeding under which he can go into court and attack it.
Mr. REDMOND. I think I am right in stating—Mr. Pecora will correct me if I am wrong—^that this bill allows the Federal Trade Commission to adopt rules and regulations without any proceeding whatsoever. It can just adopt them and promulgate them.
Senator BARKLEY. I understand.
Mr. REDMOND. Then there is no way in which that can be reviewed.
Mr. PECORA. HOW about invoking the injunctive power of the court
to prevent the enforcement of a rule or regulation?
Mr. REDMOND. Then, Mr. Pecora, we might drop the entire section 24. The same argument would apply.
Mr. PECORA. We are giving a person aggrieved by an order the
right to review that order. You propose to give not only that right
but also the right to any person who claims to be aggrieved by a
rule or regulation adopted by the Commission, to go to court and
have the court review that rule or regulation; and at the same time
you are entrusting to the Federal Trade Commission the power to
make rules and regulations for the purpose of administering the
entire act. You, yourself, piopose, for instance, with regard to the
provisions of section 10, having to do with segregation of dealers and
brokers, that that whole question be left to the discretion of the
Federal Trade Commission through the adoption of rules and
regulations.
Mr. REDMOND True
Mr PECORA. NOW, you say that any person aggrieved by a mle
or regulation may go to court and obtain a review or regulation.
I n other words, you are giving the power to the Federal Trade Commission in one breath, and in the next breath you are transferring
that power, m the final analysis, to a court.
The CHAIRMAN. I think we can take that up later.
Mr. REDMOND Section 25 deals with the criminal liabilities. We
firmly believe that the criminal penalties of the bill ought to be
restricted to what are really in their nature crimes, and not violations
of rules and regulations or other provisions of the act where a man
literally might violate them through no affirmative act of his own.
For example, under the bill as drawn the maintenance of credit, unless certain rules are complied with, is declared to be unlawful, and
therefore the maintenance of such credit would be a violation of the
act. Take a broker, or even a banker; he may have a loan to a
customer amply collateralled according to the requirements of the
bill, but on a certain day that stock or security mav drop rapidly, and
STOCK EXCHANGE PRACTICES
7573
it may get below the fixed limits of this law. The net result is that
through no action on the part of the lender he has become a criminal.
We do not feel that that is a proper criminal provision. We feel
that strict criminal provisions
Mr. PECORA. IS not that going to be covered by rules and regulations adopted by the Federal Trade Commission prescribing the
manner and method of closing out margin accounts 2
Mr. KEDMOND. I know of no such provision. Under the present
draft there is no provision, so far as I know, allowing the closing
of margin accounts in any particular matiner
Senator GORE. YOU figure, under that, that if a stock were to take
a sudden drop and then rally and break through this limitation,
that would be a crime.
Mr. WHITNEY. It could be so construed.
Mr. PECORA. If you will turn to page 17 of the printed bill, section 6, beginning with line 15
Mr. REDMOND Mr. Pecora, would you read the whole sentence.
I know that power exists in the Federal Reserve Board, but it is
limited to a certain particular type of condition It may be a
mistake in draftsmanship.
Mr. PECORA. It would cover the very situation you have assumed.
Mr. REDMOND. I do not think so Suppose we read the section.
I t says. [Reading:]
Although the limitations oi this section 0 upon the extension and maintenance of credit shall, except in the extraordinary ciicumstances hereinafter
referied to, be strictly adheied to by the Fedeial Rcseive Boaid as the consideied policy of Congress, the Fedeial Re»ei>e Boaid may, notwithstanding
the othei provisions of this section 6, m situations where it deems such action
vitally essential to the accommodation of commeice and industry and with
regai d to its beaung on the geneial credit situation of the country, by rules
and legulations peimit lower maigm lequirements foi particulai securities
or transactions oi classes of securities or transactions and for particular
periods
They cannot adopt any rules and regulations lowering the margin
requirements unless they are in situations wheie the Federal Reserve
Board deems such action vitally essential to the accommodation of
commerce and industry, and with regard to its bearing on the general
credit situation of the country.
The CHAIRMAN YOU propose a substitute ?
Mr. REDMOND. We were discussing the criminal provisions. I do
not feel that a man should be made a criminal for something which
happens really through inaction, or by reason of somebody else's
action, and yet that is the effect of many of the provisions of this
bill.
Mr. PECORA. Mr. Redmond, the provisions on page 17 of the printed
bill, commencing in line 15 and continuing down to and including
line 21, may easily be clarified so as to require the Federal Reserve
Board to make rules and regulations, or empower the Federal Reserve
Board to make rules and regulations covering the carrying and closing out of margin accounts.
Mr. REDMOND. But even so, Mr. Pecora, that does not cure my
fundamental objection.
Mr. PECORA. They certainly would take care of a supposititious case
such as the one you referred to.
7574
STOCK EXCHANGE PRACTICES
Mr. EEDMOND. I t simply means that you are going to make it possible for a man to be a criminal and be faced with a jail sentence of
10 years, although he has done nothing.
Mr, PECORA. Oh, no.
Mr. REDMOND. I t is the
fact that he fails to take action to liquidate
a loan that will make him a criminal.
Mr. PECORA. Only willful violations may be dealt Tyith.
Senator GORE. AS a matter of draftsmanship, do you think the
word "vital" adds anything to it in the way of certainty or clarity?
Mr. REDMOND. I really do not, Senator Gore. We make our suggestion here for consideration.
The CHAIRMAN. On your page 25, have you any suggestion to make
as to the amounts there?
Mr. REDMOND. NO, Senator. We frankly feel that the present
amounts proposed in the bill are excessive, but we leave it to the
discretion of the committee to determine what would be more appropriate and lower amounts.
Mr. PECORA. YOU must remember, Mr Redmond, that the penalty
provisions of the bill are the teeth.
Mr. REDMOND. I am not unaccustomed to seeing teeth in a bill,
Mr. Pecora.
Senator BARKLEY. YOU do not want them to have false teeth.
Mr. REDMOND. No; I do not want them to be false teeth at all.
I want them to apply to what is really a crime, but I do not want to
see innocent people made liable as criminals.
The CHAIRMAN. I am just wondering whether you had in mmd
what the fine should be, and what the term of imprisonment should
be.
Mr. REDMOND. NO, Senator. I think those matters should be fixed
with relation to the other Federal statutes determining what is a
proper penalty for different types of offenses.
Mr. PECORA. YOU think there should be something more than a slap
on the wrist for a violation, do you not?
Mr. REDMOND. Absolutely; and I would expect substantial penalties, Mr. Pecora, but not these provisions of 10 years and $25,000,
which, so far as I know, exceed the Federal penalties for many
felonies.
Mr. PECORA. YOU talk of 10 years as if that were the only penalty
the court could impose. That is the maximum.
Mr. REDMOND. I know; but is it not true, m the criminal law, that
very few penalties are mandatory A man may be sent to prison
for 10 years for forgery, and that is the maximum
Mr. PECORA. That is the maximum There are very few maximum
terms of imprisonment imposed by the courts anyway.
Mr. REDMOND. If you are trying to give me comfort, Mr. Pecora,
that I will not languish in jail as long as I might otherwise, I am
afraid it is cold comfort [Laughter J
The CHAIRMAN. Very well.
Mr. REDMOND. Section 30 deals with the registration fee. We suggest its omission because of our feeling that it is merely a further tax.
With respect to section 31 we have no suggestions.
Section 32 deals with the members and employees of the Federal
Trade Commission. We renew our statement that we feel that the
STOCK EXCHANGE PRACTICES
7575
authority in charge of regulation of exchanges should be a separate
body, thoroughly familiar with the operation of stock exchanges and
the security business.
With respect to section 34 we would like to point out that the
effective dates suggested by the bill will make it absolutely impossible, as a practical matter, for the machinery which the bill itself
proposes to be put into effect There are approximately 900 corporations listed on the New York Stock Exchange Even with the best
wish in the world to comply with the registration requirements of
the bill it would be physically impossible for them to do> so.
Of course, if our amendments weie accepted to sections 11 and 12,
that matter would be cured automatically, because those corporations
which are now listed would be allowed to continue listed, at least
temporarily.
There is a comment here m regard to certain sections of the bill
which do not directly affect the work of stock exchanges. There
is one thing
Senator TOWNSEND. DO you want that inserted m the record9
Mr. REDMOND. Suppose 1 read it. It is very brief. [Reading:]
A number of sections deal with subjects which do not directly affect ttie
work of stock exchanges We have refrained trom making any comment on
such sections but this fact must not be consideied as indicating approval
by stock exchanges of the substance of these sections This is particularly
true of section 15 insofar as it deals with the liability of principal stockholders, of section 19 which deals with the liability of controlling persons,
and of section 23 which deals with the public character of information
Senator GORE. What was the first section ^ I did not get it.
Mr. REDMOND. Section 15, Senator Gore. [Continuing reading:]
The first two of these sections will impose liability upon persons merely
because they are the owners of property and will almost certainly interfere
with the free flow of capital into industry The last will require corporations
whose secunties are dealt in on exchanges to disclose highly confidential
information which will be of value only to competitors, both foreign and
domestic
There is one other. It came in late, and is therefore an addendum, showing that even persons like ourselves, who think we have
some knowledge of stock exchanges, do not always remember all the
details. Counsel for the San Francisco exchanges, who came on
from the coast, has pointed out to us that under thejr rules they
have today certain banks which are literally members of the exchange. Therefore they would be swept in under the definition of
a member of the exchange under many provisions of this bill which
would not normally be considered applicable to banks For this
reason he suggests that there be added to paragraph 3 (a) 3, at
the beginning, the following:
Subject to paragraph 7
That is to be added to the definition of members of the exchange.
Also the following language m subsection 7- [Eeading:]
(7) The term "broker" or "dealer" shall not include a bank, except as
hereinafter set forth, or any person insofar as he buys or sells securities for
his own account and not as a part of a regular business, the term " member "
shaU include a bank member of a national securities exchange but only to
the extent that it shall act as broker or dealer
7576
STOCK EXCHANGE PBACTICES
Thereby putting a bank, when it acts as a broker or dealer, sub
ject to the same restrictions as members of the exchange, but otherwise exempting them from the provisions of the act and puttang
them in the category with banks.
The CHAIRMAN. IS that all? Are there any questions?
Mr. WHITNEY. Mr. Chairman, I would like to add this one word:
That these amendments have been approved—if I state anything
that is inaccurate, the gentlemen are here, so that they can contradict
me if they wish. These amendments have been approved by the
representatives of the Boston Stock Exchange, the Chicago Stock
Exchange, the New York Curb Exchange; by Mr. Thompson, president of the Associated Stock Exchanges, as members of which there
are 18 exchanges, and he has been authorized as well to represent
the Louisville Stock Exchange, of Louisville, Ky.; the Seattle Exchange, of Seattle, Wash.: and the Richmond Exchange, of Richmond, Va
Separately we have been instructed to represent, by members in
the Associated Stock Exchanges, the Baltimore Stock Exchange and
the Philadelphia Stock Exchange.
There are present here representatives of the four California
stock exchanges, m Los Angeles and San Francisco. They also approve these amendments as suggested, with the one reservation made
by San Francisco which Mr. Redmond has just referred to.
That covers, by and large, almost all the exchanges of this country
with the exception of some of the smaller ones or exchanges on which
particular securities are dealt in.
Senator GORE. Mr. Redmond, did you say that the changes which
you have suggested cover the case of transactions and dealings in
bonds, which are not speculative, and that they would not be involved
in these regulations? Somebody was talking to me a day or two
ago, and said there ought to be a differentiation between transactions
or dealings in bonds and dealings m stocks. Do your amendments
cover that point?
Mr. WHITNEY. The matter in section 6, Senator Gore, leaving
it to the Federal Reserve Board as to rules and regulations would
enable them to accommodate that situation. Also section 10, which
is section 9 in our amendments.
Senator GORE. What section do you leave out?
Mr. WHITNEY. We leave out section 9, and section 10 deals with
segregation. Again, that is left to the Commission to determine the
function of dealer and broker. Under that come bond brokers as
well as all other types of brokers.
Senator GORE. YOU kept section 2 in there?
Mr. WHITNEY. Yes, sir.
Senator WALCOTT. There is no change in section 2.
The CHAIRMAN. I S there anything else?
Senator WALCOTT. Mr. Chairman, just one question.
With regard
to section 6, Mr. Redmond, in presenting that, on the matter of
exempted securities, in which he now includes Federal and State
securities and securities of subdivisions thereof, made the remark, I
think, that he did not object to that change. I t was a half-hearted,
rather lukewarm advocacy of that, as I recall it. How do you feel
about that?
STOCK EXCHANGE PBACTICES
7577
Mr. REDMOND. I think our feeling is that it is not a subject really
on which the exchanges ought to express a very definite positionVery few of the municipal bonds are actually listed and dealt in.
The committee has heard, of course, from the representatives of the
bond traders who deal in such securities over the counter, and I
believe also from persons representing municipal interests.
Senator WALCOTT. DO you not feel that there are a great many
that are really vitally interested in dealing in municipal securities
and securities of other State subdivisions who would be very
seriously hurt if they were not included in the exemptions?
Mr. REDMOND. I think there is no question about that.
Senator WALCOTT. I would like to make that clear, because T
thought, from the fact that you were rather lukewarm, you merely
meant by what you said that the stock exchanges are not particularly interested in this particular thing.
Mr. WHITNEY. It is merely outside their province, as such, although of great and most vital interest to many of their members.
Mr. PECORA. But insofar as you would permit yourself an expression of opinion on that, you think exemption could be provided
for in the bill for all issues of States and political subdivisions of
States.
Mr. WHITNEY. I certainly do.
Senator GORE. Under your suggested amendments, could a person
who does not know a thing on earth about securities or slock exchanges make money every time he ventures in 2
Mr. WHITNEY I wish it were true, sir.
Senator GORE If it is not I am against it. [Laughter.]
The CHAIRMAN. I S there anything else, gentlemen. (No response.) If that is all, then you may be excused, Mr. Whitney We
are very much obliged to you We will take up these matters and
consider them carefully.
I want to submit for the record a communication and have it
read. Mr. Pecora will read it, and let it go into the lecord.
Mr. PECORA (reading):
THE WHITE HOUSE,
Hon DUNCAN XJ FLETCHER,
Washington, Ma) oh 26, 1984.
Chairman Banking and Currency Committee,
United States Senate, Washington D C
MY D»EAB MB CHAIRMAN Befoie I leave Washington for a few days holiday,.
I want to write you about a matter which gives me some concern
On February 9 1934, I sent to the Congress a special message asking ior
Federal supervision of national traffic in securities
It has come to my attention that a more definite and more highly organized
duve is being made against effective legislation to this end than against any
similar recommendation made by me during the past yeai Letters and telegrams bearing all the earmarks of ongin at some common source are pouring
in to the White House and the Congress
The people of this country are, in overwhelming majority, fully aware of the
fact that unregulated speculation in securities and in commodities was one of the
most important contributing factors m the artificial and unwarranted " boom "
which had so much to do with the terrible conditions of the years following
1929
I have been definitely committed to definite regulation of exchanges which
deal in securities and commodities In my message I stated, " It should be our
national policy to restrict, as far as possible, the use of these exchanges for
purely speculative operations"
7578
STOCK EXCHANGE PBACTIOES
I am certain that the country as a whole will not be satisfied with legislation
unless such legislation has teeth in it. The two principal objections are, as I
see it—
First, the requirement of what is known as " margins " so high that speoi
lation, even as it exists today, will of necessity be drastically curtailed; and
Second, that the Government be given such definite powers of supervision
over exchanges that the Government itself will be able to correct abuses which
may arise in the future
We must, of course, prevent insofar as possible manipulation of prices to
the detriment of actual investors, but at the same time we must eliminate
unnecessary, unwise, and destructive speculation.
The bill, as shown to me this afternoon by you seemsi to meet the minimum
requirements I do not see how any of us could afford to have it weakened
in any shape, manner, or form.
Very sincerely,
FRANKLIN D. KOOSEVELT.
The CHAIRMAN. The bill to which the President refers is the
redraft we have been considering in this committee for some time
past.
Senator GOLDSBOROUGH. I would like to submit for the record a
letter from Mr. George A. Lambell of New York City, chairman of
the committee of put and call brokers and dealers in the city of
New York; also a telegram from Mr. Jacob France, chairman of
the board of the Equitable Trust Co., of Baltimore.
The CHAIRMAN. They may be entered in the record.
(The communications referred to will be printed at the conclusion
of today's proceedings.)
The CHAIRMAN. If there is nothing further, this closes the open
hearings. We will not adjourn until 2:30 this afternoon, to meet
in executive session.
(Whereupon, at 1 p.m., Tuesday, Mar. 27, 1934, the committee
recessed until 2:30 p.m. of the same day, to meet in executive
session.)
[Telegram]
BALTIMORE, M D , March 24, 1984
Hon
PHILLIPS LEE GOLDSBOBOUGH,
Umted States Senate
As chairman of board of one of Maryland's largest State banks I earnestly
request your full cooperation and support in opposing paragraph A, section 7,
National Securities Exchange Act, 1964, because of its unfair discrimination
against nonmembei State banks I feel I am likewise voicing the sentiment of
Maryland's 119 nonmember State banks whose total deposits are approximately
$147,000,000
JACOB FRANCE,
Chairman of Board, EqmtaMe Trust Go
NEW YORK, N Y, March 23, 1984
Hon
PHILLIPS LEE GOLDSBOROUGH,
Umted States Senate, Washington, D G
DEAR SIR On March 7, 1934, we submitted to the committee of the United
States Senate a brief in regard to the National Securities Exchange Act of 1934
The committee of put-and-call brokers at that time pointed out and tried
to make plain the economic importance of puts and caUs and endeavored to
show the difference between the so-called " manipulative options" and those
dealt in openly by the put-and-call brokers and dealers in this country
We were then, and are now, of the opinion that section 8. paragraph 9, as
it appears in the proposed law, as well as in its revised form, only applies to
such options which are acquired in conjunction with the actual purchase or
STOCK EXCHANGE PRACTICES
7579
sale of stock Such puts, calls, and straddles are clearly manipulative options
It seems to us that for the sake of clarity and sharper distinction that this
paragraph should be drawn so as to leave no doubt as to the intention of
allowing dealings in and the guarantee of legitimate puts, calls, straddles, etc,
eliminating puts, calls, straddles, etc, used for manipulative purposes
We also call your attention to the last part of section 8, paragraph 9, third
subdivision, reading as follows:
"Or if a member, directly or indirectly, to indorse or guarantee the performance of any put, call, straddle, option, or privilege in relation to any
security registered on a national securities exchange The terms put, call,
straddle, option, or privilege as used in this paragraph shall not include any
registered warrant, right, or convertible security"
We submit that this wording should be clariiied so that there can be no
doubt that the foregoing subdivision was meant to refer to manipulative
options only.
We further recommend that the National Securities Exchange Act of 1934
shall provide that the Federal Trade Commission will have the power to
require, after an appropriate hearing, that all put-and-call dealers and brokers
conform with rules and regulations adopted by the Commission, and that the
effective date of section 8, paragraph 9, be changed from August 1, 1934, to
some later date.
We therefore respectfully request that such changes be made
Very tiuly yours,
THE COMMITTEE OF PUT AND CALL BROKERS
AND DEALERS IN THE CITY OF NEIW YORK..
GEO A LAMBELL, Chairman
MEMORANDUM OF PROPOSED AMENDMENTS TO
Hit 8720
Section 1. No change.
Section "2: No change.
Sections: Amend subsection (a) (6) to read:
"(6) The term 'bank' means (a) a banking institution organized under
the laws of the United States, (b) a person engaged in the business of banking
pursuant to the laws of any State, who is subject to examination or regulation
by Federal or State banking authorities, (c) a banking institution organized
under Hie laws of a foreign country or any agency or branch thereof authorized to engage in business in a State and which is subject to the supervision
of State banking authorities, or (d) a receiver, conservator, or other liquidating
agent of any institution included in clause (a), (b), or (c) of this paragraph **
Amend subsection (a) (12) so as to read
"(12 The term * equity security' means any stock or similar security, other
than a preferred or guaranteed stock which is entitled to receive only a fixed
or limited dividend; or any security convertible with or without consideration
into such a security and any warrant or right to subscribe to or purchase such
a security, or any other security which the Commission shall deem to be of
similar nature and consider necessary or appropriate by rules and regulations
to treat as an equity security "
Amend subsection (a) (13) to read
"(13) The term 'exempted security' or 'exempted securities' shall include
securities which are direct obligations of or obligations guaranteed as to
principal or interest by the United States, such securities issued or guaranteed
by corporations in which the United States has a direct or indirect interest
as shall be designated for exemption by the Secretary of the Treasury,
securities which are direct obligations of or obligations guaranteed as to
principal or interest by a State or any political subdivision thereof or any
agency or instrumentality of a State or any political subdivision thereof,
and such other securities and instruments as the Commission may by such
rules and regulations as it deems necessary or appropriate in the public interest
or for the protection of investors, either unconditionally or upon specified
terms and conditions or lor stated periods exempt from the operation of
any one or more of the provisions of this Act, which by their terms are inapph
cable to an ' exempted security' or to * exempted securities'"
Omit subsection (c) of section 3 in toto
Section 4 No change
7580
STOCK EXCHANGE PRACTICES
Section 5 Amend section 5 so as to read
" SEC 5 (a) Any exchange may be legistered as a national securities
exchange b^ filing with the Commission an application in such foim as the
Commission may prescribe, containing all lelevant information in regard to
the history, organization, membership, and the rules and regulations of such
exchange and a list of the securities in which dealings are permitted on such
exchange
"(b) Unless such application shall be withdrawn by such exchange, the
Commission shall within thuty days after the filing theieof or withm such
further period as may be agreed upon, either register such exchange as a
national securities exchange hereunder if the Commission shall be satisfied
that the rules and legulations ot such exchange are adequate to insure fair
dealing and to protect investors, or enter an order, after appropriate notice
and opportunity for hearing, denying such registration and stating the reasons
therefor Any older denying such registration may be reviewed as hereinafter piovided m section 22 hereof
"(c) Any national securities exchange may by appropriate notice to the
Commission withdraw its registration"
Amend section 6 so as to lead
" Six? 6 It shall be unlawful for any member of a national secunties exchange or for any bioker or dealer transacting a business in securities through
any such member, directly or indirectly, to extend or maintain ciedit to or for
any person in contravention of such lules as may be adopted from time to
tune by the Federal Reserve Board for the purpose of pi eventing the excessive
use of credit for speculation "
Amend section 7 so as to read.
" SEC. 7 It shall be unlawful foi any member of a national secunties exchange or ioi any brokei or dealer who transacts a business in securities
through the medium of any such member, directly or indirectly, to borrow any
money, the repayment of which is secured by the pledge or hypothecation of
any security (other than an exempted security) registeied on a national se
cunties exchange, in contravention of such rules and legulations as may be
adopted from time to time by the Federal Reserve Board for the purpose of
preventing the excessive use of credit for speculation "
Section 8 (a) (1) No change
Amend section 8 (a) (2) to read as follows
" (2) To enter ordeis by piearrangement with any othei peison or persons,
for the purchase and sale of any security at substantially the same time at
substantially the same price for the purpose of creating a false or misleading
appeal ance of the volume of trading in such security or of establishing price
quotations therefor which do not truly reflect the maiket value of such
security "
Amend section 8 (a) (3) to read as follows:
" (3) To effect, either alone or in conjunction with one or more other persons, a series of transactions for the purchase and sale of any security, for
the purpose of creating a false or misleading appearance of the volume of
trading in such security or of establishing price quotations therefor which do
not truly reflect the market value of such security "
Amend section 8 (a) (4), (5), (6), and (7) to read as follows
"(4) To cuculate or disseminate, with intent to deceive, any false or misleading information in regard to any security, for the purpose of inducing the
purchase or sale of such security "
"(5) To pay or causei to be paid, in connection with any attempt to purchase or sell, at prices which do not truly reflect the market value, any security
in which the person making such payment or causing the same to be made is
directly or indirectly interested, any consideration to any person to circulate
or disseminate, as news or disinterested opinion, any information intended oi
likely to induce the purchase or sale of such security at such prices, or to
receive knowingly any consideration for such circulation or dissemination"
Amend section 8 (a) (8) to read as follows:
"(6) To engage in any series of transactions for the purchase and sale of
any security registered on a national securities exchange or any security not
so registered for the purpose of pegging, fixing, or stabilizing the price of such
security in contravention of such rules and regulations as the Commission may
prescribe as necessary or appropriate to prevent unfair practices "
STOCK EXCHANGE PRACTICES
7581
Section 8 (a) (9) . Amend last six lines to read as follows
" Or if a member, directly, or indirectly, to endorse or guaiantee in contravention of any such rules or regulations the performance of any put, call,
straddle, option, or privilege in relation to any security registered on a national
securities exchange The teims "put", " call", "straddle", "option", or
" privilege " as used in this paragraph shall not include any wairant, right or
convertible security registered on a national securities exchange "
Amend section 8 (b) so as to read:
"(b) Any person who willfully violates any piovisions of subsection (a)
of this section and any person who knowingly participates in any such violation shall be liable to any person who shall purchase or sell any security,
the price of which was affected by such violation, and the person so injured
may sue in law or m equity in any court of competent jurisdiction to recover
the damages sustained as a result of such violation "
Section 8 (c) No change
Amend section 8 (d) to read as follows
"(d) No action shall be maintained to enforce any liability created under
this section unless brought withm 2 years after the violation upon which it
is based."
Omit subsection 8 (e)
Section 9. Omit entire section The substance of subsections (a) and (b)
will be included in section 16, formerly section 18
Amend section 10 to read as follows •
" SEC 9 (a) It shall be unlawful for an individual member of a national
securities exchange while on the trading premises of such exchange to act
as a dealer and broker in contravention of such rules and regulations as the
Commission may prescribe as necessary or appropriate in the public interest
or for the protection of investors
"(b) Subject to such rules and regulations as the Commission may prescribe
as necessary or appropriate in the public interest or for the protection of
investors to ensure compliance with the provisions of this subsection, the rules
of a national securities exchange may provide for the registration of members
with the privilege of acting as dealers, and any member so registered shall
have the privilege of acting as a dealer and as a bioker within the limitations
of this subsection It shall be unlawful foi a member without such privilege
to act as a broker and as a dealer or for a member with such privilege who
acts as a broker to act as a dealer to effect any transaction in a security by
use of any facility of a national securities exchange or otherwise, (1) if in
connection with any such transaction he directly or indirectly extends or maintains or arranges for the extension or maintenance of credit for a customer on
any security (other than, an exempted security)' which was a part of a new
issue offered to the public by him as a dealer or distributor within six months
prior to such transaction or (2) unless, if the transaction is with a customer,
he discloses to such customer in writing at or before the completion of the
transaction whether he is acting as broker for such customer or is acting as a
dealer for his own account or as broker for some other person"
Amend section 11 so as to read
" SEC 10 (a) It shall be unlawful for any person to effect any transaction
on a national securities exchange m any security, other than an exempted
security, unless a registration is effective as to such security in accordance
with the provisions of this Act} and the rules and regulations thereunder
(b) A security may be registered with a national securities exchange upon
application by the issuer, by filing with such exchange and with the Commission
(I) A listing application in such form as the exchange, with the approval
or upon the order of the Commission, may require as necessary or appropriate
for the protection of investors,
(II) Such/ information as to the issuer and affiliates as the exchange, with
the approval or upon the order of the Commission, may require as necessary
or appropriate for the protection of investors in respect of—
(1) The organization financial stiueture, nature, and operation of the
business,
(2) The terms, position, rights, and privileges ot the different classes of
securities outstanding;
(3) Terms on which securities have been oi are to be offered to the public,
7582
STOCK EXCHANGE PEACTICES
(4) The names of directors, principal .officers and underwriters and the
remuneration paid 01 to be paid underwriters m connection with the issuance
of the security to be registered and a statement of any contracts, other than
contracts oi employment, between directois or officers on the one hand and
the issuer or its affiliates on the other,
(5) A statement of the terms and provisions of all bonus and profit-sharing
plans and the aggregate amount of payments made thereunder during the
last three fiscal years of the issuer,
(6) Options in respect of securities existing or to be created,
(7) Balance sheets for the three preceding fiscal years or foi such portion
of that period as the issuer shall have been in existence, certified, if required
by the exchange or by order of the Commission, by independent public accountants If the balance sheets for preceding fiscal years have not been
certified by independent public accountants, only the balance sheet for the
last preceding fiscal year shall be so certified;
(8) Profit and lossi statements for the three preceding fiscal years or for
such portion of that period as the issuer shall have been m existence, certified,
if required by the exchange or by order of the Commission, by independent
public accountants If the profit and loss statements for preceding fiscal years
have not been certified by independent public accountants, only the statement
for the last preceding fiscal year shall be so certified;
(9) Any further financial statements which the exchange, with the approval
or upon the order of the Commission, may deem necessary or appropriate for
the protection of investors.
(Ill) Copies of articles of incorporation, bylaws, trust indentures, or corresponding documents, whatever the names, underwriting arrangements, and
other documents of the issuer and affiliates which the exchange, with the
approval or upon the order of the Commission, may require as necessary or
appropriate for the protection of investors
(c) If the exchange shall determine that any report or reports requiied
under subsection (b) are inapplicable to any specified issuer or class of issuers
or unnecessary for the protection of investors, it may require, in lieu thereof,
the submission of such reports, if any, as it may deem appropriate The exchange may receive and act upon listing applications, subject to the right of
the Commission to enter an order requiring such additional statement or information from the issuer as the Commissioner shall determine is necessary
or appropriate for the protection of investors
(d) If the exchange shall certify to the Commission that the security has
been approved for listing, the legislation shall become effective upon the filing
with the Commission of such certification The Commission may, however,
suspend dealing in such security or after appropriate notice and opportunity
for hearing, enter an order revoking the registration thereof if it shall determine that such secunty is not suitable for registration, or if the issuer shall
have failed to comply with the registration requirements of this Act Securities
representing an interest in registered securities or growing out of registered
securities may be listed by an exchange or admitted to dealing m advance of
registration upon request m writing from the issuer accompanied by assurance
that a listing application in form required by the exchange will be made within
a reasonable time
(e) Notwithstanding the foregoing provisions of this section, all securities
listed on a national securities exchange at the time the registration of such
exchange as a national securities exchange becomes effective shall be considered securities " registered on a national securities exchange " within the meaning of all the sections of this Act, and all securities admitted to dealing on such
national securities exchange prior to April 1, 1934, shall be considered securities
'* registered on a national securities exchange " withm the meaning of all the
sections of this Act, other than sections 10 and 11 The Commission may, however, require any national securities exchange to suspend dealing in any such
security or securities, or may, after appropriate notice and opportunity for
hearing, enter an order requiring any national securities exchange to remove
the same from the list of securities listed or admitted to dealing thereon whenever it shall determine that such action is necessary or appropriate for the
protection of investors
"(f) The Commission is directed to make a study of trading in unlisted
securities upon exchanges and to report the results of its study and its recommendations to Congress on or before January 3, 1935 If the Commission
deems such action necessary or appropriate for the protection of investors it
STOCK EXCHANGE PBACTICES
758S
may by rules and xegulations piescnbe the terms and conditions on which a
national securities exchange may admit to dealing unlisted securities. An
unlisted security admitted to dealing pursuant to any such rules and regulations shall be consideied a security registered on a national securities exchange within the meaning of all the sections ot this Act, other than sections*
10 and 11
"(g) Any national securities exchange may, and upon the order of the
Commission shall, suspend dealing in or, after appropriate notice and opportunity for hearing, remove from the list of securities dealt in thereon, any
registered security 01 any securitiy admitted to dealing thereon "
Amend section 12 to read as follows
" SEC 11 (a) Any national securities exchange may requiie the issuer of
a security registered thereon to file with the exchange, in such form and detail
and at such times as may be pi escribed by such exchange, with the approval or
upon the ordei oi the Commission:
"(1) Such infoimation and documents as may be required to keep reasonably
current the information filed pursuant to section 10,
"(2) Such annual reports, certified if required by the exchange or the Commission by independent public accountants, and such quarterly or other reportsas may be necessary or appropriate for the piotection of investors, and
"(3) Such separate and/or consolidated balance sheets or income accounts
as shall be necessary to truly reflect the financial condition of the issuer
"(b) The methods to be followed in the preparation of accounts and financial
statements to be filed pursuant to this section and sec 11 in the appraisal or
valuation of assets and liabilities, in the determination of depreciation and
depletion, in the differentiation of recurring and nonrecurring income, and in
the differentiation of investment and operating income shall be in accordance
with any punciples of accounting which are generally accepted as proper by
the accounting profession at the time of the preparation of such accounts or
financial statements, and each issuer shall adopt and make binding upon its
officers and employees the accounting and reporting methods to be employed by
it in the preparation of its accounts and financial statements If any change
is made in such methods the first accounts presented thereafter shall contain
a statement of the nature of such change
"(c) If the issuer of any security registered on a national securities exchange
fails to file information, documents, or reports as required by this section such
exchange may, and upon the order of the Commission shall, after notice and
opportunity for hearing, remove the securities of such issuer from the list of
securities admitted to dealing on such exchange "
SEC 13 This section should be omitted It has no proper place in a
stock exchange regulatory bill However, if it is decided that some provision
with regard to the solicitation of proxies is necessary, we believe the section
should be amended so as to read •
" SEC 12 (a) It shall be unlawful for any person, by the use of the mails
or by any means or instrumentality of interstate commerce or of any facility
of an;y national securities exchange or otherwise to solicit or to permit the
use of his name to solicit any proxy or consent or authorization in respect of
any security (other than an exempted security) registered on any national
securities exchange in contravention of such rules and regulations as the
Commission may adopt for the protection of investors
"(b) It shall be unlawful for any member of a national securities exchange
or any broker or dealer who transacts a business in securities through the
medium of any such member to give a proxy, consent, or authorization in respect
of any security registered on a national securities exchange and carried for
the account of a customer in contravention of such rules and regulations a»
the Commission may adopt for the protection of investors.'1
Section 14 We believe this section will, as a practical matter, be unenforceable In any event, it should be restricted so as not to applv to comipercial paper, or to bankers* acceptances, or commercial bills, although of a longer
maturity than nine months, and other similar obligations incident to commeicial
or industrial activities, all of which are included m the very sweeping definition of the term "security", contained in section 3 (11) The number should
be changed to section 13
Section 15 • Subject to reservations contained in comment below No change
except to amend section number to read " SEC 14 " and to add the following •
"(d) The provisions of this section shall not apply to foreign or domestic
arbitrage transactions unless made in contravention of such rules amd regula175541—34—PT16
12
7584
STOCK EXCHANGE PBACTICES
tions as the Commission may adopt m oidei to cany out the purposes of this
section."
Section 16. Omit entue section
The substance of this section will be included in section 16 foimerly section
18
Amend section 17 so as to read •
" SBO 15 (a) Any person, including any directoi, officer, accountant, or other
expert, who, with intent to deceive, shall make or be responsible for the making
of any statement in any application, report, or document filed puisuant to this
Act or any rule or regulation thereunder, which statement is false or misleading
in respect of any material fact, shall be liable to any person (not knowing that
such statement was false or misleading) who shall have suffered loss by reason
ot having purchased or sold a security in reliance on such statement and the
peison so injured may sue in law or in equity in any couit of competent jurisdiction for the damages caused by such false or misleading statement
"(b) (No change.)
"(c) No action shall be maintained to enforce any liability cieated under
this section unless brought within two yeais aftei the violation upon which it
is based "
Section 18 Subsections (1), (2), (3), and (4) no change, except to renumbei
section as " SEC 16 "
Amend subsection (5) to lead as follows
"(5) If aftei appropriate request in wntmg to a national securities exchange that such exchange effect on its own behalf specified changes m its
rules and practices, and alter appropriate notice and opportunity for hearing,
the Commission deteimmc that such exchange has not made the changes
so lequested, to require such exchange to adopt and enforce such mles and
regulations as are necessaiy for the protection of mvestois oi for the msuimg
of fair dealing in securities tiaded in upon such exchange, and to this end
the Commission maj lequne any national securities exchange to adopt rules
and regulations with respect to:
"(a) Market letters, adveitismg, or other publicity and the solicitation of
business by its members oi their employees,
"(&) Pools, syndicates, and joint accounts foimed tor the puipose of stabilizing or otherwise influencing the maiket puce of any secunty registered on
a national securities exchange, and also with lespect to options, puts, calls,
straddles, oi other similar privileges,
"(c?) The amount and nature of the capital employed in his business by a
member of such national securities exchange carrying margin accounts and the
ratio which must be maintained of such capital to the liabilities of such
member,
"(d) The short sale of any security upon such national securities exchange,
"(e) The acceptance and execution ot stop-loss orders by members of such
national securities exchange,
"(f) The hypothecation ot securities earned for the account of any customer
by a member of such national securities exchange or the lending of such
securities without the written consent of such customer oi the use of such
securities foi delivery on any contract m which such member is, directly or
indirectly mteiested,
"(g) The fixing of a fair settlement puce in respect of any contracts in
any security registered on such national secunties exchange which has been
cornered or of which a.«\ peison or peisons have acquired such a control that
such security cannot be obtained for delivery on existing contracts except at
prices or on teims aibitiarcly dictated by such person or persons,
"(ft) The books and records to be maintained by members of such national
securities exchange and ihe leports to be filed by the members of such exchange
and the duty of such members to peimit the officers or representatives of such
national secunties exchange and ot the Commission to examine such books
and records "
Section 19 Subject to the leservation contained in comment below No
change except to amend section number to read section 17
Section 20 No change except to amend section number to read section 18
Section 21 No change except to amend section number to read section 19
Section 22 No change except to amend section number to read section 20
Section 23 Subject to the reservation contained in comment below No
change except to amend section number to read section 21
Section 24 Amend section number and first two sentences of (a) as follows:
STOCK EXCHANGE PRACTICES
7585
SEO 22 (a) Any person aggrieved by an ordei issued by the Commission
in a proceeding under this Act to which such person is a party and any peison
aggrieved by any rules or regulations of general application made effective as
pi escribed in section 20 may obtain a review of such order oi of such rules
and regulations in the Circuit Couit of Appeals of the United States, within
any circuit in which such person resides or has his principal place of business,
or in the Couit of Appeals of the Distuct of Columbia, by filing in such court,
within sixty days after the entry ot such order, a written petition praying
that such oicjer or such rules and regulations of the Commission may be
modified or set aside in whole or in part A copy of such petition shall be
forthwith served upon the Commission and thereupon the Commission shall
eeitify and file in the court a transcript of the recoid upon which such oidei
was entered or such rules and regulations were adopted "
Section 25 Amend to lead as follows
" SEC 23 Any person who with intent to deceive makes anv false or misleading statement as to a material fact in any application, leport, or document
lequired to be filed under this act, or any rule or regulation adopted by the
Commission theieunder, and any person, including a director, officer, or accountant, who willfully and knowingly is responsible for the making of anv
such statement, and any person who willfully violates any provision of section
8 (a), subsections (1) to (5), inclusive, shall upon conviction be fined not more
than $
, or imprisoned not more than
years, or both, except that
when such person is an exchange a fine not exceeding $—
may be imposed "
The penalties provided by the bill are manifestly excessive and should be
made more reasonable
Section 26, section 27, section 28, and section 29 No change except to amend
section numbers to read, respectively, section 24, section 25, section 26, and
section 27
Section 30 Omit section entirely
Section 31 No change except to amend section number to read " SEC 28''
Section 32 • Amend section number to read section 29 No other amendment
is suggested although we believe that the commission or authority charged with
the regulation of stock exchanges should be a separate body having no other
function and composed at least in part of persons who are thoroughly familiar
with ,the operation of stock exchanges and the security business
Section 33 No change except to amend section number to read section 30
Section 34* Amend section number to read section 31 The effective dates
proposed by the act should be extended This is essential unless the amendments we propose in regard to sections 11 and 12 are adopted It will be practically impossible for the nearly 900 corporations listed on the New Yoik Stock
Exchange to prepare and file registration statements prior to August 1, 1934
A number of sections deal with subjects which do not directly affect the woik
of stock exchanges We have refrained from making any comment on such
sections, but this fact must not be considered as indicating approval by stock
exchanges of the substance of these sections This is particularly true of section 15, insofar as it deals with the habilty of principal stockholders, of section
19, which deals with the liability of controlling persons, and of section 23, which
deals with the public character of information The first two of these sections
will impose liability upon persons merely because they are the owners of property and will almost certainly interfere with the free flow of capital into industry. The last will require corporations whose securities are dealt in on exchanges to disclose highly confidential information which will be of value only
to competitors both foreign and domestic
ADDENDUM
The following is an addendum suggested to the pioposed amendments by
counsel for the San Francisco exchanges which is designed to make provision
for banks which are members of exchanges The suggested addendum meets
with the approval of all exchanges*
Add to paragraph 3 (a) 3 at beginning, "subject to paragraph 7"
Amend section 3 (a) (7) to read
"(7) The term * broker' or ' dealer' shall not include a bank, except as1 heiemafter set forth, or any person insofar as he buys or sells securities for bis
own account and not as a part of a regular business; the term * member' shall
include a bank member of a national securities exchange, but only to the extent
that it shall act a<* broker or dealer "
7586
STOCK EXCHANGE PRACTICES
(The following is a telegram received by the chairman and submitted for the record:)
NEW YORK, N Y, March 28, 1934.
Hon
DUNCAN U
FLETCHER,
Chaiiman Senate Committee on Banking and Currency,
Senate Office Building, Washington, D C:
The new bill for the regulation of stock exchanges, introduced by Mr, Baybum (HR 8720) on March 19 is a substantial improvement over the original
bill (HR 7852)
The investment house gioup, of which the undersigned is chairman, being
concerned primarily with the maintenance of the existing broker-dealer organization has directed its efforts mainly toward improving the broker-dealer
provisions of the proposed stock-exchange legislation The original bill, by its
drastic segregation clauses would have largely destroyed the long-established
broker-dealer organization in the United States The new bill permits the conImuation of this organization, and its provisions, relating to the broker-dealer,
with some changes in phraseology designed primarily to claufy what seems to
be their intent, would be satisfactory to this group
The amendment of section 10, suggested by Mr Richard Whitney on March
22, insofar as it relates to the broker-dealer, with some adjustment of phraseology, would also be satisfactory This group has not concerned itself with
section 10 as it relates to floor traders, specialists, and odd-lot dealers
It seems to us unwise to make rigid margin requirements and certain other
matters by statute, except to such extent as may be necessary to remedy existing evils which are to be prohibited by law
The margin requirements ot the new bill while apparently bettei and more
elastic than in the original bill have elements of inflexibility which are unavoidable if the margin requirements are to be embedded in statutory law.
Furthermore, it is feared that these complicated requirements will prove impracticable in operation
We are, theiefore, m accord with the viewpoint of Mr Whitney's statement
oi March 22 that margin requirements would be more wisely left to the Federal
Reserve Board This course would piovide the requisite flexibility and would
insure that this margin problem, which is of great importance to our national
economy and to the recovery program, would be dealt with by governmental
authority in harmony with the broad banking and monetary policies of the
country and without the embarrassment of the rigidity and inflexibility inherent in the fixation of margins by statute
Certain of the provisions of the new bill, very unwisely it seems to us, become
effective on July 1 or August 1, 1934 This has an important bearing on section 14, which throws the whole over-the-counter market into the control of
the Federal Trade Commission. The Commission may feel compelled to establish rules for the regulation of this large and important market for a huge
mass of outstanding securities by August 1 of this year. It will be impossible
propei ly to prepare these rules within so short a space of time The uncertainty as to what regulation may be established makes for unsatisfactory market
conditions which would largely deprive holders of unlisted securities of their
market, for people will not readily buy unlisted securities when the future
market for these securities is clouded with uncertainty This uncertainty
will in itselt tend to occasion the liquidation of unlisted securities while a
free over-the-counter market still exists It would seem wiser to postpone
legislation as to the over-the-counter market until regulation can be considered
in the light of operation under the new investment banking code which is
about to be put into effect
Trowbridge Callaway, chairman of investment-house group consisting of the following • Chas D. Barney & Co, Callaway, Fish &
Co Cassatt & Co, Clarke, Dodge & Co., Field, Glore & Co.,
Hallgarten & Co, Hemphill, Noyes & Co., A Iselin & Co, Kidder, Peabody & Co, Ladenburg Thalmann & Co, Laurence M.
Marks & Co, G M P Murphy & Co, Riter & C o , L F Rothschild & Co, Edward B Smith & Co, Speneer, Trask & Co,
Tucker, Anthony & Co, White, Weld & Co.
STOCK-EXCHANGE PEACTICE8
MONDAY, APRIL 2, 1934
UNITED STATES SENATE,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.C.
The committee met in executive session at 10:30 a.m., pursuant to
adjournment on Thursday, March 29,1934, in room 301 of the Senate
Office Building, Senator Duncan U. Fletcher presiding.
Present: Senators Fletcher (chairman), Barkley, Costigan, Eeynolds, McAdoo, Adams, Townsend, Walcott, Carey, Steiwer, and
Kean.
Present also: Ferdinand Pecora, counsel to the committee; Julius
Silver and David Sa^erstein, associate counsel to the committee; and
Frank J. Meehan, chief statistician to the committee.
The CHAIRMAN. The committee will come to order, please. This
is a resumption of our executive-session hearings, and wfc have asked
Judge Healy, chief counsel of the Federal Trade Commission, to
come down this morning to give his views about certain phases of
H.K. 8720.
Judge Healy, will you give your name, connection with the Government, and residence?
Mr. HEALY. My name is Robert E. Healy I am chief counsel of
the Federal Trade Commission.
STATEMENT OF HON. ROBERT E. HEALY, CHIEF COUNSEL OF THE
FEDERAL TRADE COMMISSION, WASHINGTON, D.C.
The CHAIRMAN Judge Healy, how long have you held that position?
Mr. HEALY. I came to the Federal Trade Commission in February
of 1928.
The CHAIRMAN. Judge Healy, as chief counsel of the Federal
Trade Commission have you had to do a good deal with the handling
of securities, accounting, and that sort of thing, particularly I might
say with reference to sections 12 and 12 (b) of this bill?
Mr. HEALY. Yes; but I think I ought to say
The CHAIRMAN (continuing). Your experience has been in connection with that sort of question, I suppose ?
Mr. HEALY. I think I ought to say that since the Securities Act of
1933 was passed I have had very little to do with the administration
of that act. But I have had charge of the public hearings on SJRes.
83, the resolution which authorized the investigation of utility companies and holding companies; and in connection with that investigation I have seen a great deal of the accounting methods of cor7587
7588
STOCK EXCHANGE PEACTICES
porations by which asset statements, income statements, and surplus
statements are built up.
I do not pretend to be an expert about stock-exchange procedure,
or even about accounting, but I have seen some things about accounting methods of various corporations which seem to me to support certain provisions of this bill.
Senator ADAMS Referring to your expression about accounting
methods and how assets are " built up ", that is quite an accurate
statement, is it, Judge Healy?
Mr. HEALY. Yes, sir; that is also true of surplus statements and
income statements of corporations. I do not know, Mi Chairman,
how much the committee wants to hear from me, but I will go along
and if you are not interested in something I say, if you will just
tell me I will stop
The CHAIRMAN That JS all right You may proceed with your
statement.
Mr. HEALY. One of the most striking things we have come across
m our utilities investigation, so far as it relates to market operations,
was m the case of the Cities Service Co. The Cities Service Securities Co. staged a campaign for the selling of common stock of the
Cities Service Co*, and the securities company made contracts with
various dealers, with distributors throughout the country, and it also
made many of its own employees distributing agents, or salesmen.
For example, there were 399 employees of the Cities Service Refining
Co., including oil-station attendants, and so forth, in Massachusetts alone who were licensed to sell securities They had literally
hundreds, perhaps thousands, of them all over the United States.
These salesmen or distributors sold the stock of the Cities Service
Co by going into people's homes and into offices all around the
country. The arrangement was that if a commission man sold the
stock to an investor who resold his stock within a certain period of
time the commission agent lost his commission. They were
encouraged by means of literature put out by the company and by
contract provisions not to sell m large lots but in small lots, and
that is why we have been getting letters from people who write in
pencil and who misspell words, people who bought 10 or 15 or 20
shares, and some of them put all the money they had into that stock
because these salesmen and distributors solicited them. For instance, if a man anticipated his installment payments he could not
get delivery of his stock until the time provided, the 10 months'
period, was up So that I think our record indicates that every
effort was made to keep the stock off the market.
Senator ADAMS In connection with that, Judge Healy, did you
include within your investigations their campaign for selling stock
to employees of the Cities Service Co. and its various subsidiaries?
Mr. HEALY. Just far enough to learn, as I believe the evidence
showed, that the stock was peddled around by employees But you
are talking about sales to employees, I believe ?
Senator ADAMS. Yes.
Mr. HEALY. Yes. There is no doubt that employees were expected
to invest a part of their earnings in Cities Service Co. securities We
have had information to that effect. But one of the effects of this
particular manner of selling securities, with this provision about com
STOCK EXCHANGE PRACTICES
7589
missions and the fact that purchasers could not get delivery of their
stock until the time was up, and so forth, was to keep the stock off
the market.
Now, at the same time that this was going on we should remember
that the contracts provided that sales should be made at the preceding
day's closing price on the New York Curb. Now, how was the price
on the Curb made? I have told you of the methods employed by
which the agents kept the stock from coming onto the market, or
restricting it as much as possible from coming onto the market; and
yet at the same time the Cities Service Securities Co. was buying
immense quantities of stock on the market—yes; immense quantities
of the stock, and I will give you those figures in just a minute. Nowy
in some years, or in some months, purchases by the Cities Service on
the Curb accounted for over 95 percent of all the stock bought on the
Curb. And for the stock-selling campaign period, I believe 3 years
and 8 months, those purchases accounted for over 73 percent of all
purchases made of the stock on the Curb. Therefore the law of supply and demand was not operating naturally in that stock. They
were keeping the shares off the market on the one hand, and on the
other hand they were making the demand for the stock, with the
result that the stock had the appearance of great activity. And one
of the very striking things about the campaign was that the money the
people paid in on those various contracts was the very money which
was used to make the market at which they bought their securities.
Senator ADAMS. HOW much did the Cities Service Co in the aggregate put into the market 2
Mr. HEALY. Let me give you another figure first, and then I will
give you that figure.
Senator ADAMS. All right.
Mr. HEALY. In the period from April 1, 1927, to the last day of
December 1930 a subsidiary of the Cities Service Co., a wholly controlled subsidiary, known as the " Cities Service Securities Co.",
which carried on those operations, took in from the people of this
country $1,146,518,000, and something over.
Senator COSTIGAN. Quite a staggering figure in one stock.
Mr. HEALY Yes. Now, how much of that did they spend, and
what did they do with it ? In the first place, they spent $965,000,000
in market purchases of the stock. And that answers your question,
Senator Adams. In addition, they paid out over $32,000,000 for the
cost of shares issued in the exercise of warrants, including premiums
that they paid in buying warrant-bearing debentures, warrants
entitling the holder to subscribe to common stock at stated prices.
Now, these big figures I have given of the amount of money that
they took in, of more than a billion of dollars, do not include anything for the money that they took in in selling debentures to other
people. I allude to convertible debentures from the sale of which
they took in many millions of dollars.
Senator KEAN. The result of that was that they sold to the public
the stock and then bought it back from them; is that true ?
Mr. HEALY. NO, sir; I do not think so.
Senator KEAN. Well, then, what was it?
The CHAIRMAN. What was the reason that prompted them to go
and sell to the public stock of an amount exceeding a billion dollars
and then to buy their own stock to the extent of $965,000,000?
7590
STOCK EXCHANGE PRACTICES
Mr. HEALY. The stock they were selling was being sold to individuals around in the cities and the country districts.
The CHAIRMAN. At what price?
Mr. HEALY. Oh, at prices that got to be as high as $60 and $65
a share.
Senator KEAN. What was the Curb market?
Mr. HEALT. Approximately that amount at the time when the sales
were made and when the Cities Service Securities Co. helped to make
the Curb market.
Senator KEAN. What I am getting at is this: They sold stock to
the public exceeding a billion dollars, and then they bought back
stock from the public at practically the same price, aggregating
something like $965,000,000.
Mr. HEALY. NO, sir. But the effect of their market purchases was
to help to make the price at which they were selling the stock to the
public. And you have not allowed me to finish my story.
Senator KEAN. All right. Go ahead.
Mr. HEALY. I was trying to tell you what they did with the $1,146,518,000. They took $965,000,000 and put it into market purchases,
but that was not a buying back of the stock from the same people it
was sold to. A lot of those people, out in the sticks, that bought
this stock to the extent of more than a billion dollars still have it. The
deal as planned, the whole plan, worked out in such a way that they
restricted the amount of shares coming onto the market, and then
they created a great big demand by buying this vast quantity of
shares themselves.
Senator BARKLEY. But didn't they sell a lot of that stock by ped<Hmg it around, door-to-door, on the installment plan, and requiring
the buyer to agree not to put it on the market for sale for a certain
period of time?
Mr. HEALY. Yes, sir.
Senator BARKLEY. SO
that the stock could not be dumped back on
the market after it had been purchased by the public.
Mr. HEALY. That is right. And if a fellow who purchased the
stock resold it within a certain period of time the salesman was
penalized by having to forfeit his commission.
Senator 6ARKLEY. I know that one of the salesmen came into my
office in spite of the rule here against peddling in this building, and
sold some of the stock to one of the young ladies in my office, on the
installment plan, and she hasn't finished paying for it yet.
Mr. HEALY. Oh, yes. Now let me give you the next item, showing
what they did with the $1,146,518,000 that they took in.
Senator BARKLEY. Excuse me right there for one minute.
Mr. HEALY. Certainly.
Senator BARKLEY. And this young lady
Senator KEAN (interposing). Of course if the people had been
n little market-wise they could have sold that stock short, couldn't
they?
Senator BARKLEY. Well, if they had sold it short, they would have
had to deliver the stock. They could not receive the stock until
they finished paying for it, and how would they have delivered the
stock in case of a short sale?
Mr. HEALY. That is it.
STOCK EXCHANGE PEACTJCES
7591
Senator CAREY. AS I recall the situation at that time a great many
people bought the stock on the installment plan and had to wait to
get the stock, like the voung lady in your office.
Senator BARKLEY. Oh, yes.
Mr. HEALY. Well, gentlemen, if you could see the letters that come
in to us you would find an indication that they sold a great deal of
the stock to illiterate' people, to people who knew nothing about
the market for securities. The local representatives of the Cities
Service Securities Co. talked those people into buying the stock.
And those representatives were expected to do it, were urged to do it.
The CHAIRMAN. What did those local representatives get for
selling the stock?
Mr. HEALY. They got commissions, but I do not recall the amount*
The CHAIRMAN. All right.
Mr. HEALY. NOW, the next item that I have referred to in telling
you what they did with the $1,146,518,000, shows that they paid
$20,500,000 of it to Henry L. Doherty to buy shares he had. When
that campaign had reached a certain point they took the opportunity
to market some of Mr. Doherty's shares Now, on those sales Mr*
Doherty made a profit of $17,700,000. They paid $2,800,000 to a
company known as the " Gas Securities Co", which was wholly
owned by Mr. Doherty, on which transaction that company made a
profit of about $2,000,000. So that Mr Doherty's personal profit
exceeded $19,000,000.
Now, this may not be quite in point but you may be interested to
know that after they did that he caused the Cities Service Co., or at
least somebody caused the Cities Service Co. to create a new class of
stock, of 1,000,000 shares of $1 a share; each share having full voting
rights, and he bought back, or rather he bought those 1,000,000
shares, with the result that after he had sold certain of his shares and
made profits of more than $19,000,000, he ended up with a bigger
percentage of control of the Cities Service Co. than he had before
he made the profit.
Now, in fairness to Mr. Doherty I must say that the whole arrangement was described in circulars and proxies sent out to the stockholders, and the stockholders voted the creation of that new class of
stock. But they were not told anything about Mr. Doherty's selling
of his own securities.
Now, I do not want to take up too much of your time in accounting
for this sum of $1,146,518,000 that they took in. There were certain
shares purchased from Harris-Forbes & Co., and Halsey, Stuart &
Co. There was a cancelation of employees' subscriptions, and there
were expenses and losses to the Cities Service Securities Co. in their
market operations of more than $14,000,000. But, the Cities Service Co. itself received as new capital through the issuance of original
shares that were fed into the market in this connection only about
$77,000,000.
Looking at it from the point of view of whether this method of
obtaining capital is economic and well advised, it is interesting to
note that the average yield per share to the Cities Service Co. from
the stock it put out during this period was something less than $25
a share. But many people paid much more than that.
Senator ADAMS. What is the present market for the Cities Service
stock?
7592
STOCK EXCHANGE PRACTICES
Mr. HEALY. The last time I noticed it the price was around $2 a
share. And it has been lower than that. If some of those folks had
purchased those securities direct from the company when this elaborate work was carried out on the New York Curb, the Cities Service
Co. itself would have realized more capital and the purchasers would
have had a very much smaller loss.
The CHAIRMAN. Under the laws of what State was the Cities
Service Co. incorporated?
Mr. HEALY. I don't remember.
Senator KEAN In Delaware, I think
Mr. HEALY The point I would make in connection with this matter is that this bill now being considered by your committee I believe
should be drawn and I think is drawn so that activities of this character on exchanges, the making of prices by this sort of process,
would be ended.
Senator KEAN. I think that is right.
Mr. HEALY. I am informed that the Cities Service Co is a Delaware corporation.
The CHAIRMAN. All right.
Mr. HEALY. NOW, I have here a mimeographed copy of the summary that accompanied our examiner's report when it was presented
for our public utilities record, and I would be very glad to leave
copies here if you would like to read it.
Senator ADAMS. I should like to have a copy of it.
Senator KEAN. And I would like to have one.
Senator MCADOO. Please give me one, if you will.
The CHAIRMAN. Let it go into and be made a part of our record.
(A paper entitled " Summary of the Report of the Federal Trade
Commission Examiner, placed in the record of the Commission's
investigation of power and gas utilities, Tuesday, Apr. 25, 1933,"
will be found at the end of the day's proceedings )
The CHAIRMAN. YOU may proceed with your statement, Judge
Healy.
Mr. HEALY. The complete report, that is, Dr. Mitchell's report,
and my examination of him, in which I tried to demonstrate, through
him, what the report meant, has been printed in Senate Document
No. 92, part 53, which is your print of our utilities investigation
That report goes into the matter in a much more detailed manner
than does this mimeographed statement, which is merely a summary.
The CHAIRMAN. YOU referred to Senate Document No 92?
Mr. HEALY. Yes.
Senator ADAMS. I S
there contained in that report a copy of the
contract with the employees who bought Cities Service Co stock?
Mr. HEALY. I do not remember.
Senator ADAMS. YOU see, an employee bought under a 5-year contract which tied up hi£ stock for that length of time.
Mr. HEALY. Of course, the striking thing about it from my point
of view is that those large dealings by the Cities Service Securities Co. on the market made the price, or at least helped to make the
price, at which the stock was being sold to the public throughout
the country.
Now, there is one other phase of this matter which I should like
to talk about
STOCK EXCHANGE PRACTICES
7593
Senator KEAN (interposing). This was over what period of time?
Mr. HEALY. This period ox time ran from the first of April 1927 to
the last day of December of 1930, 3 years and 8 months if I have
figured it correctly.
Senator KEAN. Because during that time the people were a little
•crazy.
Mr. HEALY. Yes. Of course, we cannot ascribe all of the rise in
Cities Service Co stock to this activity. I presume the activity in
the stock attracted speculator^ and also aroused the cupidity of many
people. It may be that this campaign was calculated to do that.
Mr. PECORA. Judge Healy, did you come across any evidence as
to the issuance of new securities by the Cities Service Co, not for
the purpose of utilizing the proceeds in the business but to take advantage of high rates offered for the use of money in the call-loan
market 2
Mi. HEALY. I cannot say that I did, Mr. Pecora.
Mr. PECORA. There was some reference to that made recently
before this committee by an officer of the Cities Service Co., whom
you will recall, Mr. Chairman, was subpenaed by us and who appeared here about a month or a month and a halt ago.
The CHAIRMAN. Yes.
Mr. PECORA. That the
Cities Service Co. made very extensive
loans during the year 1929 in the call-money market of New York,
and that they got the money from the sale of securities.
Mr HEALY. We have in process of preparation a detailed report
on the Cities Service Co., which will be presented the latter part of
this month, and m which we expect to analyze their fixed capital
accoupt, their earnings statements, and their surplus statements.
Mr PECOJRA. I will say while on the subject that when I first
became counsel to the committee, a year ago in January, the very
first inquiry I intended to make was into the operations of the Cities
Service Co. Senator Norbeck, who then was chairman of the committee, entirely agreed to that; in fact, he was one of the gentlemen
who originally suggested it to me. And I had just barely got started
on it when it seemed quite apparent to everybody that an inquiry
into the Cities Service Co. at that particular time might be attended
with very, very serious consequences in the tottering stage of the
economic structure, m January and February of 1933, and for that
reason we withheld our comments. And I haven't really had the
time to get back to it since.
The CHAIRMAN. Also it was along about that time understood
that the Federal Trade Commission was making an investigation
of the matter.
Mr. PECORA. Yes; that is true, too.
Mr. HEALY. Of course, gentlemen of the committee, I can only
refer to just a few high spots of this situation There is much more
of value in our record than I have the time to tell you about.
The CHAIRMAN Just go ahead with your statement, Judge Healy
Mr. HEALY. NOW, I should next like to say that it is our observation, as a result of our work in these utilities investigations, that
a balance sheet or an income statement of a corporation may be a
very misleading thing; if not misleading intentionally it is at least
not a proper disclosure. I t often fails to show things that ought
7594
STOCK EXCHANGE PRACTICES
to be shown. So that I very earnestly urge upon you gentlemen of
the committee this point, that if you are going to enact such a bill
as this, and if you are going to give the Federal Trade Commission
jurisdiction, and if you are going to require a corporation whose
securities are registered to make reports, then by all means give
the Commission sufficient authority to the end that we may get
leports that will really disclose the facts.
As proof of why you cannot depend entirely upon a balance-sheet
statement I should like to tell you that in our investigation we have
iound a great many of these so-called " write-ups " of investments
and in fixed capital accounts. It is not always done in as simple a
form as that which I will try to describe for you, but in its simplest
form it means that a corporation strikes out from its books the cost at
which a particular security or property has been recorded and substitutes somebody's idea of value, which is always, or nearly always,
far in excess of the book figures We have found up to date,
according to the last compilation L saw, over $1,150,000,000 of
write-ups.
Senator MCADOO. Did you say $1,550,000,000?
Mr. HEALY. N O ; I said $1,150,000,000.
Senator MCADOO. Well, that is a pretty big sum
Mr. HEALY. I should like to refer to a few specific instances I do
not want to burden you by too much detail, but one of the most
striking instances was m the case of the Appalachian Electric Power
Co That was a subsidiary of the American Gas & Electric Co., and
it operates in Virginia and West Virginia. The American Gas &
Electric Power Co. at $139,000,000, or a write-up of $66,000,000,
Appalachian Electric Power Co was organized by the American
Gas & Electric Co. m March of 1926 Now, all or the constituent
companies making up the Appalachian Electric Power Co were
owned by the American Gas & Electric Co. at the time of their
consolidation. A dummy intermediary was used. The American
Gas & Electric Co. sold the properties to that dummy, or the securities were sold to him, and he sold them to the Appalachian Electric
Power Co., the newly formed company.
Now, those properties had had a book value on the books of constituent companies of $72,621,000, but they were recorded on the
books in the fixed capital account of the newly formed Appalachian
Electric Power Co. at $139,000,000, or a write-up of $66,000,000,
which did not represent a single additional dollar of investment by
anybody in the Appalachian Electric Power Co. I inquired of one
of their officials about it, and it appeared that a man rode over the
property, and I don't know how long he took, but not very long,
and he made some figures on the back of an envelop that expressed
his idea of the value of the property being put together. I t was
never approved by any public service commission nor submitted to
any public authority, but it was used to mark up the fixed capital
account of those companies $66,000,000.
Now, the American Gas & Electric Co. in that process got all the
common stock of the Appalachian Electric Power Co., and according to a computation made by our man, they owned that stock at
$5,000,000 less than nothing. In other words, through the manner
m which it was handled they got all the common stock plus a profit
STOCK EXCHANGE PRACTICES
7595
of $5,000,000. According to their claims the common stock cost
ihem about $2,000,000, or possibly $3,000,000, and the pai value of the
stock was $50,000,000.
Now, we have numerous items of that character
Senator KEAN. NOW, in that case suppose they had written it
down, would you have objected?
Mr. HEALY. My information is that conservative accountants, conservative business men regard a writing down as necessary and
proper sometimes, but there doesn't seem to be very much support
for writing up, especially when the write-up is carried over into a
stated value of nonpar stock or in par value of par stock, or to create
surplus accounts, or depreciation reserves, or other reserves, which
under such circumstances are nothing but bookkeeping entries.
What we want to say is that the actual cost of that company's capital was $66,000,000 less than those figures indicate.
That sort of thing is not confined to the Appalachian Electric
Power Co.
Mr. PECORA. I think in the case of the Insull corporate structure
it was shown where investment trusts and holding companies that
were units of the Insull scheme, issued securities and transferred
or sold them to one another at an inflated valuation, which created
large paper profits on the books of the companies that issued and
sold those securities to other units of the Insull system On the
statements or balance sheets they were able to so reflect those large
profits that they sold to the public millions of dollars of other
securities, consisting principally of debentures, which speedily became worthless. That was another scheme of corporate financing
that we were able to bring to the attention of this committee last
year.
Mr HEALY. We saw an instance in the case of one of the Insull
companies, the name of which escapes me for the moment but it was
an operating subsidiary, which had an operating deficit. I t had
some securities m its treasury which it sold to another Insull company, and the second Insull company paid for those securities in its
own stock. The first company took the stock of the second company
onto its books at the par value thereof and that par value was large
enough to wipe out the operating deficit and to create a surplus of
about $700,000. Our records show instances in the Insull outfit
where stock dividends were kited as people kite checks, where a company paid a stock dividend to a second company, which took it on
into surplus, and paid a stock dividend, charged against surplus.,
back to the first one
Now, as to earnings statements which do not disclose the source
of the earnings and do not give the Commission an opportunity to
learn whether the earnings statements submitted are built up in
such a fashion, or whether the fixed capital accounts are built up
in such a fashion, if we do not have the proper authority the Commission will not accomplish what ought to be expected of it under
this bill.
Senator STEIWER. Are you going to suggest an amendment?
Mr. HEALY. NO ; that is merely suggested to you as an important
matter It seems to me that the authority will be given if the bill
is passed in its present form
7596
STOCK EXCHANGE PBACTICBS
Senator STEIWER. YOU are, then, speaking in behalf o± the bill
as it is before us now ?
Mr. HEALT. Yes,
Senator ADAMS.
sir.
What section or sections of the bill contain that
authority ?
Mr. HEALY I think sections 11 and 12 of the bill.
Mr. PECORA. That is page 35 of the bill H.R. 8720. I n other
words, you advocate that these corporations be required to file statements that not only tell the truth, bi}t the whole truth.
Mr. HEALY. That is exactly it.
Senator CAREY. I presume the Commission would set up a form,
that they would have to follow.
Mr. PECORA. The Commission is empowered to do it under section
12 (b).
Senator STEIWER. In your opinion, Judge Healy, would there be
any advantage m requiring two reports, that is to say, reports m
two forms, one for the information of the Commission, and the
other a simplified form to be published for the information of the
public? Would there be any advantage in that^
Mr. HEALY. I would think there would be much advantage in this,
in having the detailed statement, attaching to it a simple summary
which should be informative. There would not necessarily have to
be two separate statements.
Senator STEIWER. I S it not true that many of the corporate returns
have been so complicated and difficult that the average layman
would get no meaning out of them at all ?
Mr. HEALY. Yes, sir; I can agree to that immediately.
Senator STEIWER. Can the Commission devise a way to obviate
that, and to bring about a system of simplified reports from which
the average business man would get at least some meager information?
Mr. HEALY. I should think that would be very desirable.
Senator ADAMS I t is not merely the average layman that could
not get anything out of it, but the expert could not get anything out
of a good many of these balance sheets.
Mr. HEALY. I give you my word that in interpreting these accounting examinations that the expert accountants of the Commission turn
in to me, I have sweat blood trying to understand some of them. Before I get through, if you want to hear it, I am going to show you
some things connected with the Associated Gas & Electric Co. that
I think will disclose the complicated nature of many of these transactions. A lot of it grows out of the fact that these groups can
create corporations almost at will, and use them almost as they
please. They have artificial beings that they create, that they can
buy things from and sell things to, and by the time they get through
I do not believe the men who started it can unravel it themselves*
Take the Insull instance I do not believe that the human being
has ever lived that could know enough to run that whole Insull outfit. To adopt an expression of Mr. Richberg's, it would require
" double Napoleons.''
Mr. PECORA. Mr. Owen D. Young testified before this committee
a year ago about the Insull structure, that he was absolutely helpless
in contemplation of it, to try to understand it; that it was a veritable
labyrinth.
STOCK EXCHANGE PEACTICES
7597
Senator ADAMS. I think we had one gentleman before the committee for a very few moments one day who said he was a director of
some 300 companies.
Mr. PECORA. He said they had simplified the Associated Gas. &
Electric organization by reducing its units to some two hundred odd..
That was the simplification.
Mr. HEALY. I think the Associated structure is extremely complex, and the dealings inside the system have been very complex.
Senator MCADOO. fieferring to the very pertinent questions asked
by Senator Steiwer and Senator Adams a moment ago, about this
simplified statement, I think if we are going to give the investor any
protection at all, there must be adequate provision in this bill to
require some such simplified statement that will give the ordinary
layman some sort of comprehension of the game he is getting into.
You think sections 11 and 12 are sufficient for that purpose ?
Mr. HEALY. It strikes me so, Senator. I confess that I had not
thought particularly about this very point.
Senator MCADOO. I wish you would give some thought to that,
because I realize that it is imperative. Take the ordinary layman
who wants to buy stock or make an investment in any one of these
corporations. I know that I, myself, am incapable of following these
structures. I have tried to at times, and while I do not pretend to
have any more intelligence than anybody else, I refer to it simply
as showing that even where a man has been accustomed to examining
statements and analyzing corporate structures, as you said a moment
ago, it is almost impossible for any man to follow the meanderings
and devious trails of many of these institutions.
Is it possible, in your opinion, under those sections, as I have said
before, for the Commission, m the administration of this act, to
compel such statements as will be informative and give the investor
some idea of what it is that he is getting into ?
Mr. HEALY. The Commission is empowered by sections 12 and 13
to prescribe the forms in which information shall be given, and it
seems to me that if the Commission does well with the act, it will
try to sum up, so to speak, what these reports show in sucn a way
that the average business man can understand them. Of course,
these securities have not been sold to the average business man. A
great many of them have been sold to people who will rate much
below the average business man
Senator MCADOO. It is those people that I am afraid very little can
be done for, so far as analysis of these statements is concerned.
Mr. HEALY. YOU can do this for them. You can stop manipulations on the market that give an appearance of false activity and
false values at a time when shares are being peddled from door to
door around the country by employees, ex-ministers, and others. In
getting up this simplified statement, however, I think care should
be taken that you do not prevent the Commission from getting the
complicated details that carry the truth.
Senator KEAN. Judge Healy, I would like to ask you this question. One of the great difficulties with forming any scheme for investment, or studying any of these companies, is that you cannot
get any information that is not about 6 months old.
7598
STOCK EXCHANGE PRACTICES
Mr. HEALY. The bill gives the Commission the authority to get
reasonably current the information and documents filed. This is
found in section 12 (a) 1.
Senator KEAN. That does not mean anything.
Mr. HEALY. But the corporations themselves have to have a little
interim in which to compile this information.
Senator KEAN, The trouble is that every statement you get out of
them is about 6 months old. A great deal may happen in 6 months.
Mr. HEALY. That is true.
The CHAIRMAN. That is better than having nothing.
Mr. PECORA. Subdivision 2 of section 12 specifically requires these
corporations to file such annual, quarterly, monthly, and/or other
reports, the annual reports to be certified by an independent public
accountant or otherwise, as the Commission may prescribe. The
fulfilment of that requirement by the corporations would necessarily
cause them to file reports periodically which would enable the Commission to keep itself currently posted.
Senator KEAN. I am not as much worried about the commission
as I am about the investor.
Mr. PECORA. These reports are to be made public.
Senator KEAN. My experience is that you never can find out until
about 6 months afterwards, what has happened in a lot of these
corporations.
Senator MCADOO. What are you going to do if the security is not
registered?
Mr. HEALY We are going to try to handle it under the Securities
Act of 1933
Mr. PECORA. I wonder if I may ask Judge Healy his opinion on
this suggestion* The suggestion has been advanced here—I do not
at the moment recall by whom—that section 12 (b), which is the
provision that empowers the Federal Trade Commission to prescribe
the form and content of these reports, be amended, in line 20 on page
36, by adding the words u or any State " after the words " United
States ", so that that section would read:
But insofar as the accounts relate to any person whose accounting is subject
to the provisions of any law of the United States or any State, or any rule
or regulation made thereunder, the rules and regulations of the Commission
with respect to accounts shall not be inconsistent therewith
The purpose of the provision in its original form, that is, without
the inclusion of the words " or any State " was to make it unnecessary
for railroad corporations, for instance, whose accounting is prescribed by the Intei state Commerce Commission, largely, to have
to make reports inconsistent with the reports they are required to file
under the Interstate Commerce Act. Do you think the addition of
the words " or any State " would be helpful, or do you think it
might tie the hands of the Federal Trade Commission in prescribing
rules and regulations with respect to the form of these corporate
reports, by such laws as any one of the 48 States might enact with
regard to corporation accounting?
Mr. HEALY. I do not see offhand how the inclusion of that statement would affect the accounts of railroads, the form of which is
prescribed by Federal law and by the Interstate Commerce Commission, and not by State law.
STOCK EXCHANGE PRACTICES
7599
In answering your question as to the effect of the inclusion of a
reference to State laws, I would omit any reference to railroads.
The public-utility commissions, many of them, have a classification
of accounts pursuant to which the operating companies are required
to report. There is no such provision, generally speaking, for holding companies and sub-holding companies.
Senator KEAN. The law, if it is amended as suggested or spoken
of by Mr. Pecora, would leave you free to regulate all these holding
companies throughout, would it not?
Mr. HEALY. NO, sir; not in my opinion. I t would leave us free to
require information from them, and to exercise the other authority
in this act, but this act does not give the Commission authority to
regulate holding companies, as I read it, at least.
(Senator KEAN. YOU can make up the form of accounts that holding companies have to give you under the act.
Mr. HEALY. We can prescribe the forms on which they shall report to us, yes. I do not think that the Commission is undertaking
or is authorized to undertake to tell them how they shall keep their
books, although I have not any hesitation in saying—and I am quite
willing to go on record to this effect—that it will not be long before
business itself will be advocating the establishment of uniiorm accounting systems If you drop down to the N.R A., you will see the
difficulty that they are having with the definition of cost, for example. Everybody has a different definition for cost, and Mr. Filene's
committee this morning, the Twentieth Century Fund, advocates the
establishment of uniform rules for accounting. This bill does not, as
I understand it. But this bill does permit the Commission to prescribe the forms on which the information shall be furnished. I
think that is a perfectly reasonable thing.
I have not answered Mr. Pecora's question.
Mr. PECORA. Before you proceed to do it, may I call to your attention the fact that the portion of the section that I have already
read, while it is intended to obviate the necessity for railroad corporation to file one form of report with the Interstate Commerce
Commission and another form of report with the Federal Trade
Commission, is, nevertheless, applicable to all corporate reports, and
if the phrase " or any State " were to be inserted here, I apprehend
that the hands of the Federal Trade Commission, in its desire to
require corporations to submit proper reports, might be tied by some
State law, or laws, thus defeating the very purpose of this provision.
Mr. HEALY. There is no telling what the Btates will enact, or what
the public-service commissions of the States will enact My own
view is unfavorable to the inclusion of such a provision I would
like to tell you why.
In the first place, I am suspicious that the uniform classification
of accounts gotten out and now in use in the United States by many
public-service corporations is more the product of the utility companies than of the commissions. In the next place, the New York
Commission and the Wisconsin Commission have both found occasion to criticize the uniform classification, and one of our examiners,
Mr. Dickerman, who came to us from M.I.T., and who is very skilled
and very impartial, points out many defects in the uniform classification of accounts.
175541—34—PT 16
13
7600
STOCK EXCHANGE PBACTICES
Take the case of the Appalachian. The Appalachian Electric
Power Co. report to the public service commission will not disclose the facts regarding the write-up that I have just spoken of.
While I think that the uniform classification of accounts in use
by operating public-utility companies is quite informative, quite
disclosive, I do not think it is the last word on the subject, and I
think that if the commission, through experience, learns that additional information is required, it ought to be allowed to get it.
I would like to give you an illustration of how an account made
according to the uniform classification may be misleading. The
Public Service Co. of Colorado was a Doherty-owned company, and
it undertook to build a new steam plant just outside of Denver, at
a place called Valmont. I t made a contract for the building of it
with the Lakeside Contruction Co., which was not a Colorado corporation. Under the contract the Public Service Co. of Coloradowas to pay $10,000,000 for the Valmont steam station, and it was to
pay it in securities, and it did pay it in securities, and it entered the
cost of the plant at $10,000,000. In a way, that was a perfectly
truthful entry, but when you come to look at the books of the Lakeside Construction Co., which is also controlled by the Cities Service,
what do you find^ You find that the Lakeside Construction Co.*
through Doherty & Co., marketed the bonds that they got from the
Public Service Co. of Colorado for $6,000,000 or thereabouts. You
find that the actual cost of building the Valmont station by the Lakeside Construction Co. was about $4,000,000, so they sold the bonds
and built the plant with a $2,000,000 profit, and in addition owned
$4,000,000 of securities for nothing.
Very much the same thing happened in the Niagara Falls Power
Co. at Niagara Falls, a plan that was put through many years ago*
with the assistance of Francis L. Stetson and his firm, where the
Cascade Construction Co. undertook to build the property for a
stated consideration, for a company which in effect it owned and
controlled. When you examine the accounts of the Cascade Construction Co. you see that it got a large profit on the building. So r
' there is that type of inflation that is hidden, and that you will not
find until you examine the construction company's books, especially if
the construction company is an allied corporation, as it very often is.
We have a number of instances of that character that make me feel
that the State classification is not quite enough.
The CHAIRMAN. The point was made before the committee that
these companies are required by State laws to make certain reports
and returns and accounting, and upon those reports the rates are
fixed in the States for the power and light companies. They are
required by the commissions of the States to make certain forms of
reports. Now, they raise the question, Should we require them to
make another form of report to the Federal Trade Commission?
They claim that their method of accounting in nearly all the States
is in accordance with the accounting required by the Interstate Commerce Commission from the railroads, and on those reports and that
finding by the commissions of the different States, their rates are
fixed.
Mr. HEALY. SO far as the railroads accounting to the Interstate
Commerce Commission are concerned, I offer no suggestion; but
STOCK EXCHANGE PEACTICES
7601
so far as the forms on which the operating utilities report to the
State commissions are concerned, I think, for the reasons that I
have just given at some length, that the Commission should be free
to supplement that information with further information. In other
words, the Commission should not be bound by those State forms.
I will say that there is much to be said in favor of the State forms,
but they are severely criticized in some quarters. The public utility companies themselves had a large hand in getting them up,
and certain State commissions are changing them. You do not
know what will be done in these State commissions and in the State
legislatures.
Senator KEAN Might not that be true of your Commission, tool
Mr. HEALY. Yes, sir.
The CHAIRMAN. D O you
find that they are comparatively uniform
throughout the country, or do they differ m different States ?
Mr. HEALY. There is a uniform classification of accounts that the
National Association of Public Utility Commissioners have pretty
much agreed on, that is in quite general use. I t is not m universal
use. The New York State commission is changing it, and so is the
Wisconsin commission. I understand the California commission
is considering doing so, and I think our final report, when it comes
to the Senate, in our public utilities investigation, will make some
further suggestions about it.
Senator COSTIGAN. Judge Healy, m the bill as now before you,
have you discovered any undesirable restrictions on the authority
of the Commission to require reports ?
Mr. HEALY. Nothing of that sort occurred to me as I read it
through, Senator.
Senator COSTIGAN. Have you suggested any amendments to enlarge the authority of the Commission?
Mr. HEALY. NO, sir.
Senator MCADOO. I was
interested in your observations about the
limitation which you say the insertion 01 the words in line 20, page
36, "or any State" after "United States" would bring out. I
agree with you fullv that that would put a decided limitation upon
the powers of the Commission which ought not to be put there. Do
you think that the language as it is in the bill now gives you ample
authority, regardless of the laws of the States, to accomplish the
desired object?
Mr. HEALY. I believe it does. I would like to say, though, that
I did not help to write this bill, and I have studied it as much as
I could in the time I have had.
Senator MCADOO. I just wanted vour opinion, as to whether you
think the omission of the woids "or any State" leaves you m a
position to get what you want.
The CHAIRMAN. Proceed, Judge Healy.
Mr. HEALY. I fear I shall weary the committee if I give you all
the instances of write-ups that we have found, but if I am not taking
too much time, I will call attention to a few more.
The CHAIRMAN. GO ahead.
Mr. HEALY. In the case of the Florida Power & Light Co., that
company was the result of a consolidation of a number of companies
7602
STOCK EXCHANGE PRACTICES
all owned by the same interests. Before the consolidation the property stood on their books at $28,000,000. After the consolidation the
properties were recorded at $58,000,000, a write-up of $30,000,000,
or 103 percent.
Senator KEAN. HOW did they write it up?
Mr. HEALEY. They entered the properties on the books
Senator KEAN. I mean to say, did they have expert engineers,
and so forth, to go over the property and revalue it, or how did
they write it up ?
Mr. HEALEY. My information is that they did not. It was not
approved by any State commission.
Senator KEAN. Would you think it fair if they had competent
engineers and competent bookkeepers to go over it and say that the
value when they bought it was so much, and the present vslue, according to the estimate of the amount of money they had spent,
and the amount of money they had put into the company, and the
present-day value, was so much—would you think it fair, under
those circumstances, to write it up ?
Mr. HEALY, I should say it was unfair. I should think it was
improper. I agree that in a rate case the rate base is the present
fair value of the property, to be arrived at in some such manner as
you have described. I do not agree that present values should be
substituted on books in place of cost. The evil of it is that when
these accounts are written up on books of account, the inflation is
carrried over into the liabilities side of the balance sheet, to create
surplus accounts, or false retirement reserves, or to balance new
security issues.
The CHAIRMAN. Does that represent water *
Mr. HEALY. Nothing but water.
Senator KEAN. When they come to put down so much a year for
obsolescence, that writes that off, does it not?
Mr. HEALY. If the company keeps its accounts properly, the annual depreciation charges tend—but only tend—to write out the
written-up and inflated value from the records. I would like to
say, however, that it has been our observation that a great many
of these companies do not properly depreciate their properties.
Many of them are so eager to pay dividends and keep the public
buying their securities that they disregard depreciation to a great
extent. One of the first things the Insull receivers had to do was to
set up a big reserve on their books to take care of depreciation that
never had been entered.
Senator KEAN. I think they all ought to write off depreciation.
Mr. HEALY. We have several instances in our records where these
companies abandon property and then do not write it out of their
books. They carry the property in fixed capital, which sometimes
does not actually exist at all, or has been completely abandoned.
Mr. PECORA. YOU referred to a write-up of 103 percent a few
minutes ago.
Mr. HEALY. Yes.
Mr. PECORA. There
is evidence before this committee that in connection with the organization of the General Theatres Equipment
Co. there was a write-up of its assets from $4,000,000-odd to some
$24,000,000-odd, and that write-up was reflected in the balance sheet
STOCK EXCHANGE PEACTICES
7603
submitted to the New York Stock Exchange when that company
made application to list its shares on that exchange. Mr. Harley
Clarke was the witness who was identified with the General Theatres
Equipment and its creation, and who admitted that fact very blandly
here.
Mr. HEALY. We showed in our report on Mr. Harley Clarke's
company, the Utilities Power & Light Corporation, a few weeks ago,
that he had something like $4,500,000 of write-up in the accounts
of that company, but if you want a really big figure let me tell you
that the Electric Bond & Share Co. wrote up its investment in
American & Foreign Power Corporation $399,000,000.
Mr PECORA. That is another corporation whose officer admitted
here recently that in 1928 and 1929 they had outstanding a daily
average of $100,000,000 or, more in call loans, and that they got
much of that money through the issuance and sale of securities.
Senator WAGNER. What does the three hundred million-odd represent ?
Mr. HEALY. The American & Foreign Power Corporation stock at
that time was selling on the market at a very high figure, and Electric Bond & Share struck out the figures at which the investment in
that stock was being carried on its books, which was approximately
cost, and substituted a higher figure, which approached, but did not
equal, the market value or the stock
Senator WAGNER Was that during the 1929 period?
Mr. HEALY. It was back about 1927. [After conferring with associates :] I am told by one of the men with me that it happened in
March 1929. That was carried over into the surplus account, and,
of course, the public seeing that surplus, the average man, even the
average business man, thinks that surplus represents earnings We
have learned down at the Commission that very often it does not
represent earnings; it represents something e?se
Senator KEAN. And very seldom represents cash.
Senator MCADOO. Mostly deficits probably, we will say, transferred by some devious process.
Mr. E&SAiiY. Deficits are concealed through such a device as I described in the case of the Instill Co The Central Public Service
Corporation, which is now in bankruptcy and which sold securities
all over the country, had a deficit in its earned surplus account during the very period—3-year period—when it was selling preferred
stock to the public all over the country.
The Central Public Service Corporation followed another practice which is very interesting and which is one of the things that
makes me believe that if the Commission is going to administer this
act it ought to be allowed to get the real facts, and that is this:
They followed the practice—so does the Associated Gas & Electric
Co. and several others—of taking onto their books the earnings of
their subsidiaries, which the subsidiaries do not distribute in any
form, as dividend or credit to the parent company or anything else.
In the case of the Central Public Service Corporation it had
over $8,000,000 of that kind of income on the books of that company which it never received. Then there was a reorganization,
and bankruptcy; there were losses, and it never will receive them.
In fact, the Central Public Service Corporation does not even own
those subsidiaries any longer.
7604
STOCK EXCHANGE PRACTICES
That is done too much. I t may be proper to reflect earnings of
subsidiaries in the consolidated statements, but I do not believe that
it is proper to take those earnings without receiving them into a
surplus account and then pay out cash dividends against them.
Mr. PECORA. And sell securities on the showing?
Mr. HEALY. Yes, sir; I think that is quite wrong. And they were
selling securities to the public in a very intensive campaign. We
have a lot of their literature in our record.
Here is the American Water Works and the Electric Co., Inc.,
which has recently filed a statement under our Securities Act. It
shows a write-up of $51,000,000 in excess of the amount at which
the same assets had been carried on the books of a predecessor company, controlled by the same interests, and one of its own directors
made the valuation. I will not weary you by reciting the write-up in
the case of the Oklahoma Gas & Electric Co. or the Carolina Power
& Light Co,
Senator REYNOLDS. HOW much was it?
Mr. HEALY. Which one?
Senator REYNOLDS. The Carolina Power & Light Co.
Mr. HEALY. The present Carolina Power & Light Co. was created
through an agreement adopted by the stockholders of Asheville
Power & Light Co., Pidgeon River Power Co., Old Carolina Light
& Power Co., Adkm River Power Co., and Carolina Power &
Light Co.
In the process of the merger the assets were written up $19,100,478 23. There is a report in our records that gives all of the detail. What I have said, means that the properties of the new Carolina Power & Light Co. were recorded on the books of that company
at a figure $19,100,000 in excess of the figures at which they appeared
on the books of the predecessor companies.
Senator REYNOLDS. That is before they were consolidated ?
Mr. HEALY. Yes, sir.
Senator KEAN. DO you
take into consideration whether a company has earned for a long period of years and put the money
into the company?
Mr. HEALY. Yes, sir. If that occurs, it is not a write-up. If a
company earns a million dollars and invests it in fixed capital, the
million dollars will appear m the fixed-capital account. That is
a legitimate figure.
I would like to say, however, that there have been a lot of fixedcapital accounts built up through some pretty big earnings, and it
makes one wonder if the State public service commission laws had
been enforced if any such earnings could have come about.
In the case of the Minnesota Power & Light Co. there was a
write-up of something over 21 million dollars, 126 percent. And
that company did an interesting thing that helps to show us how
important it is that the accounting details should be known. It had
certain lands that it was keeping for development purposes in its
power business. The lands were not being used and were producing
nothing. I t was costing the company something to carry its investment in the property. It put that property into its fixed-capital
account at a figure above cost. I t wrote it up, and then computed
interest on it and added the interest to the fixed-capital account, and
STOCK EXCHANGE PRACTICES
7605
then carried that interest, which it never received, of course, which
is just imputed interest, as the accountants call it, over into the
income account and reported it to a trustee under a bond indenture
under which the amount of bonds that it could take down was
influenced by earnings, controlled by the earnings. In fairness to
that company let me say that after our report was brought out at
the Commission it abandoned doing that sort of thing.
We have a write-up in the case of the Oklahoma Gas & Electric
Co. of about $2,300,000. The Public Service Co. of Oklahoma shows
about $6,700,000 of inflation.
Senator WAGNER. Were the same methods employed in all of
them that were used in these ?
Mr. HEALY. NO, sir; it is not always done the same way. Sometimes they just strike out cost and substitute this larger figure.
Senator WAGNER. Arbitrarily ?
Mr. HEALY. I think, in many instances, arbitrarily. There are
some instances where the write-up is passed upon and approved by a
State commission.
This whole trouble, in my opinion, grows out of the decisions of
the Supreme Court in which reproduction cost new is made one of
the elements in determining present fair value in rate cases. What
they have done in practice is to make that the only element in a rate
case, or the controlling element. Even by the Supreme Court decisions it is only one of the elements that ought to be considered
in fixing present fair value in a rate case.
But they do not confine themselves to determining reproductioncost new ior rate-making purposes. They will have an appraisal
made and then put it on the books to balance security issues, or to
create surplus accounts. Sometimes a surplus account so created
has dividends charged against it, or you will find that the corporation having unamortized discount on bonds that it has sold, instead
of amortizing the discount or, in other words, meeting its annual
interest payments, will write the whole thing off against a surplus
account which has been created out of just a matter of opinion and
this has the effect of overstating the earnings, because over the life
of the bonds there should be annual charges against earnings or
earned surplus large enough to provide for the discount, which the
courts say is merely deferred interest.
Senator WAGNER. What is it in the cases where the new construction falls below in value what they regard as the actual investment?
Mr. HEALY. There are many instances where they have written
down their properties. They are in the minority, the amounts are
small, and you must remember that most of this writing up was
done during a period of high prices.
Senator WAGNER. Yes; that is right.
Mr. HEALY. We have found more write-ups than write-downs. I
should say, having referred to the Electric Bond & Share Co., that
since March 1929 when they reported that big write-up m American
& Foreign Power Corporation, they have written that down. They
have taken that out of their books by charge against surplus.
Mr. PECORA. Written down the full amount of the write-up 390
million dollars?
Mr. HEALY. Yes, sir; and something more besides.
7606
STOCK EXCHANGE PRACTICES
Senator KEAN. In other words, the stock went down so that it was
not worth that and they wrote it off?
Mr. HEALY. Yes. But I thmk it cannot be right to keep books on
that basis.
Mr. PECORA. Books kept on that basis reflect a false book value?
Mr. HEALY. I think they have bad effects. I am not an accountant,
but I think the proper function of accounting is to make a historical
record of events as they happen.
The CHAIRMAN. This loss really fell on the people who bought
their stock, didn't it?
Mr. HEALY. I cannot say yes to that. It is not an actual loss.
They had an investment which had cost them a certain sum. They
wrote it up and credited it, added it to surplus. On the basis of that
showing it is probable that some people bought stock, and those that
brought I presume have lost, or some of them have.
Senator KEAN. That was the market value at that time?
Mr. HEALY. I t was an approach to the market value. I t was
actually less than the market value.
Senator KEAN. Then, the market has gone down and they have
written it down?
Mr. HEALY. They have written it down again. But they never
actually had in my opinion such a surplus as they reported after
that write-up.
Now, we have a write-up of something over 5 million dollars in
the case of the Arkansas National Gas Corporation.
Senator WAGNER. Judge, my last question is, That hardly would
happen again?
Mr. HEALY. That is pretty hard to say. If proper legislation is
enacted it cannot happen again without the security-purchasing
public knowing it.
Senator WAGNER. That is what I was after.
Senator KEAN. They would know it long after it was done.
Senator REYNOLDS. HOW do you propose to get this information
initially to the man who is in contemplation of making a purchase
of stock on the exchange?
Mr. HEALY. That is by giving publicity to the statements to the
extent permitted by this statute. Also it is hoped that the purchasing public will learn that this information is available and can
be had.
Senator REYNOLDS. DO you really think that the people who contemplate making purchases of stock would write to the Commission
prior to making an investment? Do you think enough publicity
could be given to it? Do you think the press of the country would
reveal to their respective readers information pertaining to the
write-up of these various companies?
Mr. HEALY. Not now, no; but it is hoped—at least, I hope—that
in time the purchasing public will come to learn to do that.
Senator REYNOLDS. The fundamental idea of this whole thing is to
protect the investors?
Mr. HEALY. That is one idea. That is not the only idea.
Senator REYNOLDS. The question is whether you are going to get
this information to the people who invest. Now, you made mention
a moment ago to Senator Wagner of some three-hundred-and-some
STOCK EXCHANGE PRACTICES
7607
odd stock salesmen who were employees of a certain company going
from house to house and making sales of these shares in blocks of
10 upward on the installment basis. Those people who make those
purchases, there is sold5 to them what is known in the securities world
as a " one-turkey call. ' They sell them there. They never go back
the second time. They are the people who buy all these securities to
make the millions for the people who write them up, as a matter of
fact. The man who makes a purchase of that is not going to the
trouble to ascertain as to the real value or worth of the stock, and
I venture this, to say that in this matter here, if you will put that
in language as simple as you) can that man would never be able to
understand it. You could not get it through his head what a writeup means.
Mr. HEALY. Senator, may I make a suggestion, if I am not interrupting you ?
Senator REYNOLDS. Yes.
Mr. HEALY. Don't you think that some of the people who bought
Cities Service Stock, for example, were shown by these stock salesmen the amount of sales and the prices on the curb ?
Senator KEYNOLDS. Surely; unquestionably; a great many of them.
Mr. HEALY. Don't you think that the activities of the Cities Service Security Co. had "a direct effect on the price at which the shares
sold on the curb?
Senator REYNOLDS. Yes; I do.
Mr. HEALY. And on the number that were sold?
Senator REYNOLDS. Yes.
Mr. HEALY. SO in that way those people, those ignorant people
that you refer to, were influenced by a thing that had been done
on the curb exchange, and that may have been done for the very
purpose of influencing them.
Senator REYNOLDS Yes. That is, the volume of shares traded in
had its effect?
Mr. HEALY. Yes, sir.
Senator REYNOLDS. Compelling
effect upon those who were thinking about the matter ?
Mr. HEALY. Yes; and the price, too.
Senator REYNOLDS. And the price.
Mr. HEALY. Because you do not get a free operation of supply
and demand when the company that is issuing the securities is buying them to the extent of 92 percent of all those that are offered,
or when the company is spending, as the Cities Service Co. did,
$965,000,000 in a 3^-year period on purchases in the market. In
that respect there is some help here.
Senator REYNOLDS. One question, Mr. Chairman, I want to ask
there in the presence of Mr. Pecora: Take, for instance, the Carolina
Power & Light Co.; they have a write-up of $19,000,000. Take, for
instance, the American & Foreign Power Co.; they have a write-up
of $399,000,000.
When they have those various write-ups on their statements and
they go, out and deliberately sell stock upon those statements, which
are false, in truth and in fact, are not those people violating the
criminal law by obtaining money by false and fraudulent representations, and could they not be prosecuted under out present statutes ?
7608
STOCK EXCHANGE PRACTICES
Mr. PECORA. Yes; Senator, they undoubtedly could. At least that
is my opinion. But the necessity of proving the falsity of the representation would present a genuine difficulty. If you compel these
corporations to file the reports that are contemplated under this act
your proof would be readily at hand; and those prosecutions would
be calculated to be much more successful, and I think a few prosecutions successfully along that line would have a most salutary effect*
Senator REYNOI^S. In a sense, the burden of proof would somewhat shift in that case where they are required to make a report.
Mr. PECORA. I had something to do with prosecutions for a number
of years in the city of New York, and we came to many instances
where persons had undoubtedly been victimized by false representations and where, because of the inherent difficulty of obtaining the
necessary legal proof to prove the falsity, prosecutions were
unsuccessful.
Senator REYNOLDS. But in this I understand you have it in written
form.
Mr. PECORA. Yes; and that would afford a great measure of protection to the investing public, and I think, as I remarked before,
a few successful prosecutions along those lines would go a long ways
toward cleansing the market of these practices.
The CHAIRMAN. I t would have a very good effect on the issuing
company.
Mr. PECORA. Oh, yes; it would have a determining effect on the
company.
Senator WAGNER. A very important factor in all these manipulations is the publicity.
Mr. HEALY. That is apparently an important part of it. But of
course the protection of the investor is not the only purpose of this
bill, as I read the preamble.
Senator WAGNER. But I am speaking generally of all these manipulations and all that sort of thing; publicity plays a very important
part.
Senator KEAN. What are the other purposes?
Mr. PECORA. Since publicity, I think, as Senator Reynolds has remarked, might not reach the eyes of the average investor.
Senator WAGNER. I don't say that is the only thing necessary,
but I say that is a very important consideration.
Mr. PECORA. Yes, there is no question about it.
Mr. HEALY. The bill devotes nearly four pages to the preamble
giving the reasons why the framers of it think such legislation is
necessary. It speaks about the adverse effect on credit and interstate commerce and the general welfare from excessive speculation,
and bad practices on exchanges. I number myself among those who
think that the orgy of speculation that we came through is in part
responsible for some of our present difficulties.
Senator KEAN. Well, now, Judge, I would like to ask you this:
Suppose this bill passes as is; then you get these reports. Those
reports will come to you. A report will be a month or 6 weeks
late. That is reasonable, isn't it?
Mr. HEALY. Yes, sir; very reasonable.
Senator KEAN. Probably more than that?
Mr. HEALY. Probably a little more.
STOCK EXCHANGE PEACTICES
7609
Senator KEAN. Then it will take you another 3 weeks to get it
out, won't it ?
Mr. HEALY. We have a 20-day period for examination under the
Securities Act, and, as I said at the outset, I have had no contact
with the administration of the Securities Act, but our accountants
and examiners, by working day and night, have been able to keep
up with that work.
Senator KEAN. We work day and night, too. But you cannot get
that out possibly in a month. That would be 4 or 5 months. In
4 or 5 months a lot can happen. That is what I am talking about,
as far as the investor goes. What I am talking about is that he
cannot get any information for 4 or 5 months. Isn't that about
right?
Mr. HEALY. I should think that that was something of an overestimate of the time required, Senator,
Senator KEAN. Not much.
Mr. HEALY. When a corporation closes its books at the end of
the year it takes it some time to get out its statement, its annual
statement, and it takes the Commission some time to analyze these
statements that come to it. But I don't see any way of avoiding
that. Necessary time has got to be taken.
Senator KEAN. The point that I am getting at is for the investor.
He wants the information of what is happening when he buys the
stock.
Mr. HEALY. All the investors are not going to buy the stock between the 1st of January and the 1st of March.
Senator KEAN. NO ; but he is 4 or 5 months behind when he does
buy the stock, always 4 or 5 months behind. That is what I am getting at.
Mr. HEALY. Properly analyzed fixed capital or investment accounts,
for example, will give him information that will always be good.
That is, the first disclosive statement that one of our corporations
gets up as to the content of its fixed capital account, will make a record which may be always referred to.
Senator KEAN. Of course that is true, but what has happened in
the last 6 months you would not be able to find out.
Mr. HEALY. NO, sir; I presume not, unless the Commission under
the—well, let me amend what I have said. The Commission has
authority to try to keep these accounts current.
Senator KEAN. I know.
Mr. HEALY. But of course the Commission cannot keep these corporations making reports and accounts all the time.
Senator KEAN. NO.
Mr. HEALY. The Commission has got to be reasonable in what it
exacts of them.
Mr. PECORA. But the investor today has no information available
to him within a shorter period of time, and if he has records only on
the kind of information that Judge Healy has alluded, being quite
prevalent, he is going to get misleading information.
Senator KEAN. He has the annual reports.
Mr. PECORA. If he has the information called for by this act he
will get reliable information.
Senator KEAN. What he will do, he can today take 5 years back,
10 years back, and he can compare or have compared those reports,
7610
STOCK EXCHANGE PRACTICES
which is done, I think, by most people that are a little careful; they
take a period of 5 years and they take their annual report and they
just find out what the differences are between those annual reports,
and then they try to find out where those differences originated and
what they are.
Senator REYNOLDS. Under this act how many different concerns
which file reports would have to make an audit of and an examination of, for instance on the New York Stock Exchange?
Mr. HEALY. I am informed that there are about 800 listed on the
New York Stock Exchange.
Senator KEAN. That is very small.
Mr. HEALY. Let me suggest that these reports that are filed with
the Commission will also be analyzed by the financial writers and
the financial departments of the various newspapers and also by
certain concerns such as Poor's and Moody's, and I think that they
will have available more information than they have ever had before.
Senator REYNOLDS. In other words, that is where the majority of
the publicity would come from relative to these securities initially?
Mr. HEALY. I am not sure that I understand you.
Senator REYNOLDS. In other words, Moody's and financial writers
would make an analysis of the report rendered by the Federal Trade
Commission. They would give considerable publicity as to the value
of the securities in that way?
Mr. HEALY. Yes, sir.
Senator REYNOLDS. Isn't
it a fact that the man who buys securities
on the New York Stock Exchange in average intelligence is far
beyond that of an individual who makes a purchase of stock from
salesmen like you mentioned a moment ago?
Mr. HEALY. I would think so; yes, sir.
I would like to call the committee's attention to the case of
the Nebraska Power Co because of one rather striking feature
There was one corporation which succeeded another, and the new
corporation became the Nebraska Power Co I t was controlled by
the same interests that controlled the old company. The transfer
from the old company to the new company was made through an
intermediary who had no financial interest of his own in the transaction. In the process of the transfer from one corporation to the
other the plant and franchise accounts were written up. On the
books of the predecessor company they stood at something like
$6,400,000, and on the books of the new company are something like
$13,500,000.
The holding company, which was the American Power & Light,
one of the Bond and Share group, owned the common stock, and there
were several years that the American Power & Light Co. owned the
common stock of the Nebraska Power Co., when, as a result of these
transactions, it owned that stock at no cost to itself; in fact, at
something less than cost, if I may put it crudely.
Now, during the time that it owned that common-stock equity in
the Nebraska tower Co., the Nebraska Power Co. was making earnings that were applicable to that common-stock equity, and our accountants, of course, under those conditions could compute no rate
of return on the investment to the American Power & Light Co,
because, although the American Power & Light Co. owned the stock
was receiving income from it, it owned it at no cost.
Digitized forand
FRASER
STOCK EXCHANGE PRACTICES
7611
But by 1926 the accumulated earnings of the Nebraska Power Co.
had gotten to such a point that by leaving those earnings on the books
of the Nebraska Power Co. instead of taking them, the American
Power & Light Co. then did have a cost of the investment. But
the cost was not through putting any new money in but because it
left in the Nebraska Co. the earnings which it might have taken out
in dividends.
And the rate of return in 1926, which was the first year that we
could compute it, was 338 percent. In 1927 it was 212, and in 1928,
175 percent. You see, it dropped every year, and I presume it will
continue to drop as the surplus continues to accumulate.
The CHAIRMAN. What did you say was the write-up of that?
Mr. HEALY. The write-up of that company was $6,432,000.
Mr. PECORA. There was a write-up of a little over 100 percent.
Mr. HEALY. I t was nearly $7,000,000.
I would like to spend a few minutes talking about what our
records indicate as to Associated Gas & Electric Co. The corporate
structure of that company is intricate, and it has been with great
difficulty that we have been able to get some understanding of the
accounting methods. They have a subsidiary corporation, among a
great many others, known as "Associated Gas & Electric Securities
Co., Inc.", which carried on the distribution of the securities of the
Associated Gas & Electric Co.
They not only sold the securities of the Associated Gas & Electric
Co. to the public, but when Associated paid dividends in stock the
Securities company distributed the stock dividends. Then there
were a great multitude of exchanges and conversions within the
Associated system. That is, the Associated company would say,
" If you will turn in such a security we will give you such a security
m return ", and a great many of those exchanges and conversions
were made through the Securities Co.
The stock of the Associated Gas & Electric Co., which figured most
frequently in those transactions, was the class A stock. That was
nonpar stock. The directors assigned a stated value of $35 a share to
that stock. When the stock was handed over to the Securities Co,
to distribute to the public in stock dividends it was handed over
at $20 a share. And thereupon the Associated Gas & Electric
Co. carried $15 a share into an asset account which it styled " Cost of
Acquiring Capital", and carried the same $15 over into a surplus
account. In other words, the greater the discount on a sale of the
stock the more their surplus grew to be. Parenthetically, I should
add this practice has been abandoned.
< Now, the Securities Co., having taken the stock at $20 a share,
at the end of every month determines how many shares of class A
stock it is carrying regardless of how they were acquired. That included securities delivered for exchange, stock delivered to be paid
out as stock dividends. And when they came to the end of the
month and determined that they had so many shares of class A on
hand they wrote up the class A shares to the market value at that
time and carried the amount of the write-up over into a surplus
account on the books of the Securities Co.
So that in the case of the class A stock that was delivered to the
Securities Co. to be distributed as stock dividend there! was a
write-up from $20 to a higher figure, often a good deal higher.
7612
STOCK EXCHANGE PBACTICES
In the meantime, as I told you, the Associated Gas & Electric Co,
had carried the difference between $20 and $35 into an asset account
entitled " Cost of acquiring capital" and had carried it into a surplus account in its own books.
Certain of the class A stock that Associated Gas & Electric Co.
carried over to the Securities Co. was turned over at $35 a share,
during the period when the stock was being sold at $50 a share and
sometimes higher.
When the Securities Co. sold that stock at $50 a share it counted a
$15 profit on it, but the Securities Co. was just the alter ego of the
Associated Gas & Electric Co. itself.
Thus I have tried to describe two kinds of profits that the Securities Co. counted on its books, due largely to the arbitrary valuation
assigned to class A stock when it was issued by Associated Gas &
Electric Co.
In the course of time the Securities Co. built up a large surplus in
that way. I have forgotten the year, but I think it was in 1929—yes;
it was in 1929—that this Securities Co. paid a $22,000,000 dividend to
another Associated company which passed it through its surplus
account and paid a $21,000,000 dividend to the Associated Gas &
Electric Co., which went into the surplus account of the Associated
Gas & Electric Co. When the Associated Gas & Electric Co. issued
its stock, if it had sold its class A stock out to the public at $50 a
share it could not have put any part of that $50 into surplus account,
according to my understanding, but when it sold to the Securities
Co. at $35 and the Securities Co. sold to the public at $50 per share
and counted the difference as profit and carried it into surplus and
paid a dividend out of it, then it came back to the Associated Gas &
Electric Co. and went into its surplus account.
The Associated Gas & Electric Co. has followed the practice of
taking onto its books the undistributed earnings of its subsidiaries.
Let me explain this. A subsidiary has some earnings. The parent
company picks them up and carries them into income and thence to
surplus account. They are not actually received at all by the parent
company. Also they have another practice. Most of the subsidiary
companies have nonpar stock. When the subsidiary has had some
earnings that it is carrying in its surplus account, it transfers a sum
from surplus to the stated value of its nonpar stock. I t does not
distribute any part of the surplus. The next company in line above
it in the Associated set-up writes up its investment account in that
particular stock by the amount transferred from surplus to stated
value of nonpar on the subsidiary's books and carries it into surplus.
That process is repeated over and over again until it finally gets to
the Associated Gas & Electric Co.
It is a long and complicated story to tell you what our records show
about Associated Gas & Electric Co., and I cannot undertake to
do it; but I have tried to indicate how the surplus account is built
up, and in one instance I think I have shown that about $21,000,000,
or a very large part of it, was received into surplus account of the
Associated Gas & Electric Co. which really came from capital which
stockholders paid into the company. So that it is not an earned
surplus.
Senator KEAN. In other words, they bought the stock at a
premium?
STOCK EXCHANGE PEACTICES
7613
Mr. HEALY. I would not want to say that it was at a premium,
Senator.
Senator KEAJ*. YOU said that the directors had valued the stock at
$35 a share?
Mr. HEALY. Yes, sir.
Senator KEAN. And that
they swore that that was the worth of the
stock?
Mr. HEALY. I do not know that they swore that, but I think they
fixed that value.
Senator KEAJST. They fixed that value, and the public bought it at
50 a share?
Mr. HEALY. Yes; but the public did not buy it direct from the
Associated Gas & Electric Co.
Mr. PECORA. They bought it from the securities company ?
Mr. HEALY. They bought it from the securities company, and the
securities company treated the $15 as profit or earnings and carried
it into surplus. I t is not earnings; it is paid-in capital.
Senator KEAK. Yes; but it is the profit that they made on selling
the stock and a profit above what they valued the stock at.
Mr. PECORA. is not that a paper profit?
Senator KEAN. NO ; it is a little different from a paper profit, because it is actual cash.
Mr. HEALY. Under the laws of the State of New York it is at least
very doubtful whether under the Associated's charter the Associated
in selling that nonpar stock could have carried any part of it into
surplus, because the charter, by State statute, as I read it, says that
they shall carry as stated value of nonpar stock what the subscribers
pay for it.
Senator WAGNER. I was going to ask you whether any of these
•things have come within the scrutiny of the State commission; 1
onean, these financial transactions.
Mr. HEALY. In the case of holding companies and subholding companies, no; in the case of operating companies, yes; in the States
in which there are State commissions.
Senator KEAN. There are State commissions in practically every
State.
Mr. HEALY. There are some few States that have no commissions.
There are quite a number in which the State commissions have
authority over rates but have no authority over securities.
Senator WAGNER. New York has authority over securities; has it
jiot?
Mr. HEALY. Yes, sir.
Senator WAGNER. I S
not the State under their charter permitted
to explore the activities of a holding company if their transactions
relate in some way to the fixation of rates that the public utilities
charge the public?
Mr. HEALY. I am not entirely clear, but my memory is that the
State commission of New York has had some rather intensive litigation with the Associated Gas & Electric Co.
Senator WAGNER. Very recently?
Mr. HEALY. Yes, sir.
Senator WAGNER. The
tempted it.
older commission I do not think ever at-
7614
STOCK EXCHANGE PEACTICES
Mr. HEAL?. NO, sir. The New Hampshire commission was taken
into the Federal district court by the Associated interests when it
undertook to learn what the books of certain Associated companies
showed as to companies operating in New Hampshire, and the State
commission was defeated.
The CHAIRMAN. This way of passing the earnings of affiliated
companies or operating companies, for instance, on to parent companies and holding companies deprives the stockholders of the affiliated companies of the benefit of those earnings, does it not?
Mr. HEALY. NO, sir. I t results in the parent company taking into
its earnings account and its surplus account earnings of subsidiaries
which it does not receive, which does not mean that those earnings
are diverted to interests outside of the system; it does not mean that
they are embezzled or wasted. The difficulty is that the parent company takes into its earnings account and into its surplus account
earnings which it may never receive.
The CHAIRMAN. The stockholders of the affiliated company did not
actually lose that money?
Senator KEAN. Oh no.
Mr. HEALY. The earnings of the subsidiary company will appear
in the surplus account of the subsidiary. They also appear m the
surplus account of the parent company.
Mr. PECORA. It is all a piece of bookkeeping legerdemain.
Mr. HEALY. I have here the balance sheet of the Associated for
December 31, 1929, and on the assets side, page 26, we read: " Plant,
property, franchises, and cost of acquiring capital, $634,000,000."
The operating subsidiaries of the company, of course, have fixed
capital. The Associated Gas & Electric Co. itself has very little
fixed capital, such as buildings and power plants. I t is more or less
of a holding company. If you were to go to the books of all of the
subsidiary companies of the Associated Gras & Electric Co. whose
fixed capital is supposed to be reported in its balance sheet—that is,
the consolidated balance sheet—you would find that the fixed capital,
according to Mr. Nodder, our witness at the Commission who examined the books, appears on the books of those subsidiaries at about
$402,000,000.
Mr. PECORA. AS against six-hundred-odd millions?
Mr. HEALY. AS against six-hundred-odd millions, as shown by the
consolidated balance sheet.
Now, the question is, What does the difference represent? Here
is a little memorandum that Mr. Nodder gave me in this connection,
which I wall read [reading] :
The significant thing about this entire balance sheet is the fact that there
has been counted in fixed capital an amount of around $2500,000,000, representing excess cost to Associated Gas & Electric Co of investments in subsidiaries over and above the par or stated value of the investments in those
companies, as recorded by the books of the subsidiary companies, as well as
an item of Cost of Acquiring Capital exceeding $18,000,000 In other words,
what appears to the reader on the printed balance sheet as fixed capital,
which he naturally presumes to be of the value fixed by the balance sheet,
includes a highly intangible amount in excess of $200,000,000.
Senator KEAN. In other words, if they bought an electric company
at $150,000,000 and the value of that company, according to its books,
and so forth, was $100,000,000, they put it in at $150,000,000?
STOCK EXCHANGE PEACTICES
7615
Mr. HEALY. I t is very nearly that If thev paid $150,000,000 for
a company whose fixed capital was stated as $100,000,000, when they
reported fixed capital in the consolidated balance sheet it went in at
$150,000,000.
Senator KEAN. Of course the earnings of the company may have
warranted that price.
Mr. HEALY. They may have. I am not here to criticize the price
that the Associated Gas & Electric Co. paid for its properties.
Senator KEAN. I say, it may have.
Mr. HEALY. I think that during the years 1927, 1928, and 1929
these holding companies paid some absurd prices for properties
which they bought.
Senator KEAN. There is no doubt about that.
Mr. HEALY. But the point is that the balance-sheet statement does
not disclose the facts that I have mentioned; and when you turn
to the other side of the balance sheet you will find 3urplus reported
in this fashion [reading] :
Class A (5,817,371 shares), Class B (500,000 shares), Common stock (1,703,538
shares)—Capital and surplus $261,266,024 80
In other words, the capital, except the preferred stock, and the
surplus are all thrown in together m one item. There is nothing
that discloses the difference between earned surplus, capital surplus,
or paid-in surplus, or surplus created through write-ups, or surplus
created through the type of dividends that I tried to describe a few
moments ago that arose through the Securities Co. taking Associated
Gas & Electric stock at arbitrary values and then selling them out at
higher values.
Just a few more words, and I will finish.
Senator KEAN. I would like to call attention to the fact that you
are quoting statements and statistics of 1929.
Mr. HEALY. Yes, sir
Senator KEAN. That
was many years ago. Are we supposed to
assume that if you get this authority, the best you can do is to furnish us with statements 7 or 8 years old?
Mr. HEALY. NO, sir. I picked this statement for several reasons.
I have got printed balance sheets for the Associated for every year
since 1929. I took this one first because I happened to have it handy.
I have only used it to illustrate or to try to prove the necessity of
disclosing the content of these fixed capital and surplus accounts.
My argument is that the Commission should have authority to get
the facts that underlie figures like these.
A second reason for taking this statement was that in our utilities
investigation we cut off investigation of this company as of the end
of 1929, and I wanted to use this statement because Mr. Nodder,
who made the study of the Associated Gas & Electric Co., had given
me a breakdown of the information as to how these particular figures
were made up. If the committee wishes information as to the Associated Gas & Electric Co. as of a later date, we have the annual
reports and can give you some information about it.
Senator WAGNER. IS there not some very recent information?
Mr. HEALY. Yes, sir.
Senator KEAN. If this
bill provided—and it does not so provide—
that you should have authority to pass on the accountants and
175541—34—pr 16
14
7616
STOCK EXCHANGE PEACTICES
engineers where an outside report is made, it seems to me that you
should have authority to say that these accountants are satisfactory
to us or that they are not satisfactory, or that the engineers are
satisfactory to us or they are not satisfactory.
Mr. HEALY. I hope the day will come, Senator, when we will have
in this country chartered accountants who will be licensed by the
Government and who will be punishable for false statements, and
who will make their reports to stockholders and not to directors.
Senator KEAN. At the present time, under this bill, if you had
that authority you could license accountants and you could license
engineers; but under these circumstances you are not going to be
able possibly to do this work. To make a general report on all the
corporations of the United States is just foolishness.
Mr. HEALY. Of course, under the terms of the bill accountants
incur a civil liability if they are not accurate within certain limits.
Senator KEAN. I know that. But what I thought was that you
ought to have authority in this bill to license accountants and engineers. What do you think of that? I have just put it to the
witness, Mr. Chairman, as to whether the Commission ought to have
authority to license accountants and engineers.
Mr. HEALY. My first reply was—some of the committee were busy
with something else—that I would be very pleased, as far as I am
concerned, if the day would come when public accountants would be
licensed and would have to report to stockholders instead of to
directors and would have a dignified position of responsibility under
Federal laws. Whether or not public sentiment and the sentiment
of Congress is at the point where they are willing that engineers and
accountants should be licensed by the Federal Trade Commission
I do not know. I have some doubt about it.
The CHAIRMAN. We have enough to deal with now without going
into outside questions. The complaint about this bill is that it goes
too far.
Senator KEAN. Yes; it does in some respects; I agree to that. I
am opposed to the bill in some respects, but I am in favor of haying
accountants that are responsible and engineers that are responsible.
For instance, if I make an issue of securities I hire the highest class
and the best people that I can get, and I do not restrain them in any
way. They are to make a report of the situation. I take their
report and publish it, and I am bound more or less by that report.
I issue securities by it, and I pick the very best I can get. If they
make mistakes, I suffer.
The CHAIRMAN. Would it be any better if they were licensed?
Licensed men make mistakes.
Mr. PECORA. I t would not add to their knowledge or efficiency.
The fact that a lawyer has a certificate of admission to the bar
does not improve his knowledge of the law.
Mr. HEALY. I should like to interject an observation, if the committee will permit, which is not particularly apropos of anything,
that eventually the solution for many of these problems is going to
come from a compulsory incorporating or licensing of all corporations
engaged in interstate commerce.
The CHAIRMAN. YOU mean, to give them Federal charters ?
STOCK EXCHANGE PRACTICES
7617
Mr. HEAIIY. Yes, sir; either Federal charters or Federal licenses.
There is hardly a State in the United States today that will permit a
foreign corporation incorporated under other laws to come in and
do business in that State without complying with the State requirements. But Congress permits anybody or anything or any kind of
a corporation to engage in interstate commerce almost without let
or hindrance. There is considerable support in rather conservative
quarters for this view. Mr. Whitney has favored it, and Attorney General Wickersham favored it and President Taft favored it,
and there are in existence bills that were drawn that represented the
views of some of those gentlemen.
A second thought that I wish to express, which is a little out of
line, is that many of the present difficulties will never be met until
there is created an authority which has the right to decide at what
figures properties shall go on to the books of corporations. Watered
stock and inflation of all kinds depend, according to my observation,
upon the figures that corporations are allowed to put on their books,
particularly in recording assets. Some day, in my opinion, there will
have to be some supervision of that sort of thing in the case of all
corporations who are selling their securities to the public, just as in
certain States today there is that kind of supervision over publicservice operating companies.
I have just one other small matter that I will refer to in connection
with the Associated Gas & Electric Co. and then will conclude, unless
you have some further questions to put to me.
Mr. STodder, our accountant and examiner, made up a revised balance sheet of the Associated Gas & Electric Co. as of December 31,
1929, and then he undertook to eliminate from it all matters of
write ups, nonreceived income, and certain received income which? in
his view, the Associated Gas & Electric Co. was not entitled to receive.
As a result of his revision making these eliminations the corporate
surplus which was stated at $1,886,000 shows a deficit of $24,056,000.
The capital-surplus account which, according to the statement that
he made up based on the books of the company, stood at $11,167,000,
after his revision had but $4,395,000 left in it. The stated value of
common stock which, according to the books of the company and
Mr. Nodder's interpretation of them, stood at $21,685,000, after his
revision stood at $2,025,000.
The net result of all of his revisions was to reduce the total of
assets by $50,387,000 out of a total of $641,000,000. The company
contests his revision.
A few brief words as to some of the reasons that actuated him in
making these adjustments and eliminations. First, he eliminated
about $8,900,000 to eliminate the cost of acquiring capital account;
the principal items comprising the same consisting of capital and
surplus created for several classes of stocks; and that was done in the
way that I have attempted to describe, in the first instance, earlier
in my testimony.
Senator KEAN. What did he do with the $15?
Mr. HEALY. That is left in capital and surplus. You mean, if I
understand you, the difference between $35 and $50?
Senator KEAN. Yes.
7618
STOCK EXCHANGE PRACTICES
Mr. HEALY. Yes; he did not eliminate that, as I interpret his
statement. He eliminated $17,800,000 from corporate surplus to
eliminate from corporate surplus amounts received as dividends from,
subsidiary companies and other sources. He eliminates by this process certain dividends that they received but which, when he had
traced them back through several layers of corporations, were originally paid, not out of earnings, but out of write-ups.
He next eliminates from corporate surplus a total of $7,110,000;
$1,640,000 of this was compensation for management and construction services in return for which, according to Mr. Nodder, the
Associated Gas & Electric Co. never rendered any management or
construction service.
He next eliminates $3,400,000 and something over for current net
earnings of subsidiaries transferred to the stated value of nonpar
capital stock and never actually distributed
Senator KEAN. Excuse me. Go back one item. The company
received that money, did it not?
Mr. HEALY. Which money?
Senator KEAN. Money for managing.
Mr. HEALY. Yes, sir.
Senator KEAN. Then they have got the money?
Mr. HEALY. Yes, sir. The basis of Mr. Nodder's
elimination of
that item was that they were not entitled to receive it, that they
rendered no construction or management service.
Senator KEAN. Yes; but they got the money?
Mr. HEALY. They did.
Senator KEAN. Therefore it is part of their assets.
Mr. HEALY. That is true, in that respect. That is agreed to
Senator KEAN. I t is not a fair statement, so far as that goes,
because they have got the money.
Mr. HEALY. I think it is a fair statement, because I said at the
outset when I began to talk about it that he eliminated, among other
items, items that they actually received but which, in his view, they
were not entitled to receive.
The CHAIRMAN. In other words, did they have to return it to*
somebody else?
Senator KEAN. NO. I do not think there is any chance of their
returning it.
The CHAIRMAN. If they have something that they have no right
to, why not return it?
Senator KEAN. The witness says that they did not have any right
to it, that they did not render proper service for it; but they have
the money in their account, and the only one that could sue them
would be one of the subsidiaries that they own.
Mr. HEALY. One of the State commissions having supervision over
the subsidiaries that paid this management fee may take a hand in it.
I t is not absolutely certain that none of this money will
Mr PECORA. Rates are fixed on the basis of such expenditures ?
Mr. HEALY. Yes, sir; because such expenditures are charged
against income before the return permitted by law is computed.
Senator KEAN. But if they had this money and they earned it and
they charged this in
Mr HEALY. They had it, but they did not earn it.
STOCK EXCHANGE PRACTICES
7619
Senator KEAN. At all events, they have it ?
Mr. HEALY. They have got it, but can they keep it ?
The second item, however, in this group that I have been dealing
with is $3,490,000, which is simply a transfer of earnings on the
books of the subsidiary company from surplus account to stated
value of nonpar stock and has never been paid over.
Senator KEAN. They are not entitled to that.
Mr, HEALY. The next item is a very interesting one. I wonder
if they are entitled to this one: This is $1,978,513.12, which is Federal income taxes received from subsidiaries in excess of current
deduction for Federal income taxes. Let me explain what that
means
Senator KEAN. I do not think they are entitled to that.
Mr. HEALY. The practice in the Associated Gas & Electric Co.
system, as in several others, is for each company to accrue and set
up on its books the Federal income taxes which it would have to
pay if it made a return as an individual company and did not figure
in a consolidated return. The holding company for that group
makes a computation of what it would have to pay on a consolidated basis if it made one return for itself and all of its subsidiaries. Thereupon the Associated Gas & Electric Co. takes on to its
books what the subholdmg company accrues for taxes. But the Associated Gas & Electric Co. does not pay it to the United States Government. It gets out a consolidated return, and the amount that
they pay being less than the amount that is in effect paid over to
them by the subsidiaries, they pocket the difference. As a matter of
fact, there have been several years in which this kind of income was
taken up by Associated Gas & Electric Co. when they did not pay
any Federal income taxes. Mr. Nodder has eliminated $1,978,000 of
that kind of income.
The CHAIRMAN. Has that been brought to the attention of the
Treasury 8
Mr. HEALY. Yes, sir. A man named Davison from the Treasury
Department has worked for many weeks in that connection. This
is not the only company that does that. There are quite a few of
these companies that make a profit out of their consolidated return
by assessing each company what it would pay if it made an individual return, and then keeping out what it saves by making a consolidated return. There is an item of $1,900,000 shown right here
[indicating]
The next adjustment of corporate surplus was $958,000. I will not
stop to give the detail about that, because by comparison the amount
is small and the hour is getting late.
Also, Mr. Nodder removed $15,520,000 from capital surplus to
write off from the capital surplus account certain items, in view of
the fact that the principal items therein consisted of write-ups of
security investments.
That picture, I submit, as of December 31, 1929, can be contrasted
with this one which appears in the published annual report of the
Associated Gas & Electric Co. for 1929, and it seems to me it goes a
long way toward proving the point that I hoped to prove when I
•came up here, and that is that by the provisions of sections 11 and 12
you should give the Commission power enough to learn the content of
7620
STOCK EXCHANGE PEACTICES
these statements. Give it authority to get the information so that i t
can analyze balance sheets and income statements.
It is suggested that I ought to state that some of the appraisals
reflected m the books of Associated Gas & Electric Co. have not been
approved by State commissions. Many of the appraisals upon which
many millions of dollars of write-ups have been recorded on the
books of operating subsidiaries of the Associated Gas & Electric Co.
have been made by a man named Cheney m New York; and the
controlling influences in Associated Gas & Electric Co., as I think all
of you know, are Mr. Hopson and Mr. Mange.
I had one of Mr. Hopson's associates on the stand the other day,
a young man named Stix, and I inquired of him as to the relations between Mr. Hopson and Mr. Cheney because I wanted to
know whether Mr. Cheney's appraisals were independent, and what
his connections were with the system, because, as stated, there had
been many million dollars of write-ups put on the Associated's books
to reflect the appraisals made by Mr. Cheney. Mr. Stix said—I did
not ask him this, because I do not ask witnesses for hearsay testimony, but Mr. Stix said—and he is very close to Mr. Hopson—that
it was common gossip in the Hopson office that Mr. Cheney divided
with Mr. Hopson one half of all the profits that Cheney made from
the operation of his engineering department. We hope that before
many days have passed we will be able to develop with some particularity just what the lelations between Hopson and Cheney are
Senator WAGNER. I S the appraisal for the State 2
Mr. HEALY. NO, sir; for the company. He is represented as an
independent appraiser.
Senator WAGNER. It is supposed to be a detached appraisal ?
Mr. HEALY. Yes, sir.
Mr. PECORA. Did you
not find two companies were in existence,
the stock of which is held solely by Hopson and his associate Mange?
Mr. HEALY. Yes.
Mr. PECORA. And
those two companies purport to render management and financial service and advisory service of some kind to the
subsidiaries of the Associated Gas & Electric Co. for which they
receive fees that guarantee a million or more dollars a year, which
go simply to those two men?
Mr. HEALY. NO, sir; my memory is not quite that way. The principal management companies in the Associated group are subsidiary
to Associated Gas & Electric Co., so that their earnings ordinarily
will oo up to the Associated Gas & Electric Co. However, H. C.
Hop on & Co., and a corporation owned by him and his sisters which
has hucceeded the old H. C. Hopson Co. partnership, does render
financial service and income-tax-return service for which they get
pay. They also render service in connection with the issuance of
various securities; and it is my impression that those services have
been rendered at a profit to Mr. Hopson and his corporation. But
let me say this, that in the report of Associated Gas & Electric Securities Co., Inc., which we put into the record just about 2 weeks
ago, we do show dealings between corporations owned whollv by
either Mr. Hopson or Mr. Hopson and Mr. Mange together, where
the dealings were to the profit and advantage ox the corporations
wholly owned by them and where the profits that they made entailed
STOCK EXCHANGE PRACTICES
7621
some expense or loss to the companies that were subsidiaries to Associated Gas & Electric Co. I recall one such corporation that made
profits through dealings with the Securities Co., and this was the
Associated Securities Corporation, which is owned through a series
of trusts or holding companies by Hopson and Mange. There is full
detail on that in our record, giving the amounts to a penny.
I would like also to say—and this is pertinent in view of Ms\
Pecora's question put to me regarding the insertion of a clause relating to accounts kept according to State requirements—that as you
know, the Associated Gas & Electric Co. is not subject to the State
public service commission and their accounting methods are not prescribed by State authority.
Senator KEAN. If that were put in there, it would not affect your
authority to go into it, would it?
Mr. HEALY. NO, sir; it would not, as the State law now stands.
Senator WAGNER. What do you mean by saying that they are not
subject to the State Public Service Commission?
Mr. HEALY. That the company itself is a holding company and is
not subject to the State Public Service Commission of New York.
Mr. PECORA. Judge Healy, the contention has been advanced here
by opponents of the bill that the provisions of section 12 vesting
the Federal Trade Commission with authority to require certain
corporation reports and prescribe the form of them, and so forth,
would virtually give the Federal Trade Commission absolute domination and control of the business of these corporations. Do you
see anything in the provisions of section 12 or anywhere else in this
bill that would so opeiate?
Mr. HEALY. I do not. The Commission is not seeking any such
authority. The Commission, if I may speak for it—I have no authority to speak for it, but I am sure the Commission feels that you
should have such provisions in the bill as to make the bill effective.
Senator KEAN. If you have authority to remove the officers at will,
do you not absolutely control the company?
Mr. HEALY. In the first place, the bill does not purport to give
the Commission authority to remove the officers of corporations.
Senator KEAN. I t does as to the stock exchange.
Mr. HEALY. It gives authority as to the officers of the stock exchange, but only in the event that they violate the law.
Mr. PECORA. Where they fail m the duties imposed upon them
by the bill. The objection advanced to this bill, among other things,
was that section 12 clothes the Federal Trade Commission with a
power equivalent to control and domination of the affairs of corporations, merely because that section gives the Federal Trade Commission the right to prescribe the form of reports which such corporations are required to make.
Mr. HEALY. In section 18, subdivision 3, there is a provision that
after notice and opportunity for hearing the Commission may
suspend or may expel any member or officer who violates the law or
the rules and regulations thereunder.
Senator KEAN. YOU might make very unreasonable rules. Suppose
you omitted the words "rules and regulations " Would you consent to that?
Mr. HEALY. I should think if the Commission made unreasonable
rules and regulations, the courts would set them aside.
7622
STOCK EXCHANGE PEACTICES
Senator KEAN. Probably they would, but in the meantime you have
cut off the other fellow's head.
Mr. HEALY. I think we could not cut of his head under an invalid
regulation; and certainly rules and regulations cannot be made in
excess of the power bestowed by the act.
Senator KEAN. Yes; but suppose you omitted the words " rules
and regulations " ? If they violated a law as passed by Congress,
which they will all know about, that is one thing; but if you make
new rules and regulations every day, that is different.
Mr. HEALY Very different; and I do not think that they could be
penalized for violating a rule or regulation that they did not know
about. I should think the Commission would be wise enough to
make its rules and regulations take effect at such a time that everybody on the exchange would know about them.
Senator KEAN. Yes; but the trouble is that you make these regulations that you think are wise, and perhaps the Commission might
not always be so wise.
Mr. HEALY. That is the chance we take with the administration of
any law, either in the courts or elsewhere. However, I should hope
that the Commission would take counsel of those members of the
New York Stock Exchange and other exchanges in whom it has
confidence, to see that the rules and regulations are fair and reasonable. I do not mind saying at all that I have had correspondence
with a man named Hoxsey, who is on their listing committee, and
the trend of his views as shown in the subject of his correspondence
with me was very pleasing to me.
Mr. PECORA. That is the Mr. Hoxsey who is executive assistant to
the stock-list committee?
Mr. HEALY. Yes,
sir.
But to answer the Senator's question, I do not think that the
provision by which men may be suspended or expelled if they violate
the rules ought to be taken out. I think if rules are promulgated
inside the authority of the act, those who violate them should suffer
some penalty. We cannot get effective regulation without it.
Senator KEAN. Yes; but that is a very drastic penalty, because it
gives you exactly the same authoritv as if that were put into the
bill, does it not?
Mr. HEALY. NO, sir; not precisely. So far as rules and regulations are concerned that are reasonable and that are authorized by
the act, you are correct, in my opinion, and only to that extent.
Mr. PECORA. The court has injunetive power to restrain the enforcement of a rule that is unreasonable or invalid?
Mr. HEALY. Yes,
sir.
Mr. PECORA. After all, is this power any greater, if indeed as
great as that invested in the governing authority of the stock exchange over its own members for violation of its own rules?
Mr. HEALY. I should judge not, from what I have heard, although
I have very little first-hand knowledge.
Senator KEAN. That is a self-governing body. The members of
the exchange vote for those people to govern them, and they have
their consent. They have given them that power. We take it without consulting them. We put this bracelet around their necks.
STOCK EXCHANGE PBACTICES
7623
Mr. PECORA. I t is not a bracelet. It is just simply giving a
desirable disciplinary power over those who are subject to its rules
and regulations and who are guilty of an infraction.
Senator WAGNER. When I was a judge on the bench I issued a
temporary injunction to restrain the stock exchange, until the matter
could be heard by the court, from expelling a member who had,
they claimed, violated their rules by some wash-selling operation,
and when the matter came before the court eventually I was compelled by the evidence to sustain the stock exchange. The man was
expelled, but he had his day in court absolutely.
Mr. PECORA. He will have it here.
Senator WAGNER. That is what I say.
Mr. PECORA. I t provides for notice and opportunity for hearing.
The CHAIRMAN. I was just going to ask the committee to allow
your testimony to be incorporated in the hearings. This is a very
important statement, and I think it should go into the hearings.
Mr. HEAIIY. If that is done, may I have an opportunity to revise it?
The CHAIRMAN. Yes.
Mr. HEALY. Because, speaking here under tension, it is sometimes
difficult to make oneself clear.
The CHAIRMAN. Without objection, it will be inserted in the hearings.
Senator KEAN. The other day Mr. Pecora produced a statement
which he wanted to substitute for one made by Mr. Redmond.
Mr. PECORA. Relating to section 10?
Senator KEAN. Yes. I suppose it was in the record.
Mr. PECORA. SO did I.
Senator KEAN. And so did
The CHAIRMAN. That may
he.
be inserted in the hearings also; and
we will insert your statement in the record of the hearings so it will
be printed.
Mr. HEALY. I think that is a matter that is up to the committee
entirely. I would be glad to have it appear, however, that I came
here at the committee's request.
The CHAIRMAN. YOU will be given an opportunity to revise the
proof.
(The statement of Mr. Redmond, referred to, was handed to
Senator Kean to be returned by him to the clerk of the committee
for insertion in the record.
The CHAIRMAN. I wanted to ask you one more question. Please
turn your attention to page 52, section 25. As the bill now reads
[reading]:
Any person who willfully violates any provision of this act or any rule or
regulation made thereunder, or any undertaking filed thereunder, or any person
who willfully and knowingly makes, or any person, including a director, officer^
accountant, or other expert thereof who willfully and knowingly is responsible
for any statement in any application, report—
And so forth.
What I have in mind is that expression," Who willfully and knowingly is responsible for any statement." I t seems to me that that is
rather ambiguous and indefinite. Can we not explain that in some
way? Can we not make that clearer? You, as a lawyer, would
know how difficult it is going to be to show that someone is responsible for a thing, and whether that definition is sufficiently clear.
7624
STOCK EXCHANGE PBACTICES
What da you say, Senator Wagner?
Senator WAGNER. I usually like to have a man responsible for his
t
The CHAIRMAN. HOW can you show that anyone is responsible for
the statement? Ought we not to express clearly the idea that he
must have participated in it in some way?
Senator KEAN. I think so.
Mr. PECORA. The idea, I think, was not to subject anyone to any
penalty for an honest mistake.
Senator WAGNER. " Willfully and knowingly " is all right.
Senator KEAN. I think "responsible" might be left out. How
would it read then?
Mr. HEALY. In reading that I did npt know why it was put that
way, but it occurred to me that it might be for this reason, that
there might be people who did not make the statements themselves,
but who were responsible for them. Very often the fellow behind
the scenes who is most responsible for everything that happens does
not appear much himself in the public eye.
Mr. PECORA. I think, Judge Healy, you are correct, because the
previous part of that clause subjects the one actually making willfully, and knowingly, a false statement, to the penalties provided
for by the act.
Senator WAGNER. Where is that?
Mr. PECORA. In section 25: Any person who willfully violates any
provision, or any person who willfully and knowingly makes any
such statement, or any person, including a director, officer, accountant, or other expert who willfully and knowingly is responsible for
any statement. There are three different classifications of persons
intended to be reached, and I think the last category is intended to
apply, as Judge Healy has suggested, to those who do not themselves
make the statement, because such persons would fall within the second category.
The CHAIRMAN. Would it not be better to say "knowingly and
willfully procures or directs " ?
Mr. PECORA. I think that would be a clarification.
Mr. HEALY. I think it would be a good change. You might say,
"Any person who willfully or knowingly procures, aids, or abets "
Senator KEAN. That is a little broad.
Mr. HEALY. Yes; it is broad; but is it too broad ?
Senator KEAN. I think it is.
Mr. PECORA. That language is almost similar to the language found
in penal statutes making accessories responsible as principals; that
is, those who aid, abet, procure, or cause another to commit a crime.
Senator KEAN. I think Senator Fletcher's suggestion is much
better.
The CHAIRMAN. I t struck me that it needed a little clearing up.
Senator WAGNER. " Who knowingly procures another to make any
statement", and so forth.
The CHAIRMAN. " Who procures, directs, or aids in the making of
a statement." I merely suggest that. We will think about it.
I received this morning, in response to the request of the committee and in response to objections raised to the bill on constitu
STOCK EXCHANGE PRACTICES
7625
tional grounds, a statement from Prof. Noel T. Dowling, who is a
professor of law at Columbia University. I would like to have his
statement in the record in the open hearings.
(Statement of Noel T. Dowling, professor of law at Columbia
University, entitled " Memorandum Concerning the Power of Congress, Under the Commerce Clause, to Regulate Securities Exchanges", will be found printed m full at the end of today's
transcript of hearings)
Mr. PECORA. I have just received a communication from Mr. John
Dickinson, Assistant Secretary of Commerce, which I think might
as well go into the executive-hearing record. The letter is accompanied by a statement of the amendments which he suggested might
be made when he appeared before this committee last week. He
was then requested, if you will recall, to reduce his proposed amendments to written form. There has just been handed me that list of
amendments.
The CHAIRMAN. I have the original of that.
Mr. PECORA. I did not know you had that, Mr. Chairman.
Senator WAGNER. Judge Healy, I did not have the advantage of
listening to your entire testimony. Did you touch the question of
margins at all today?
Mr. HEALY. NO, sir.
Senator WAGNER. Have
Mr HEALY NO, sir; I
you any views about that subject ?
had no hand in the writing of the bill
and do not feel competent to talk about that subject.
Senator WAGNER. I wanted to get the benefit of your opinion if
you had one on the subject.
Mr. HEALY. I have just one opinion, which is of a very general
nature, and that is that it is in the public interest to control speculation through the control of credit in connection with margins.
Further than that I would not care to go.
Senator WAGNER. What prompted my question was that in a talk
with Governor Black the other day he suggested as part of the
control that instead of having restrictions or limitations in the act
itself, the Federal Reserve Board ought to have the authority from
time to time to fix the margin limitation. I wondered whether you
had any views about that.
Mr. HEALY I t occurs to me that it would not be wise to leave it
entirely to the Federal Reserve Board if you do something of that
sort. It seems to me that if the Federal Trade Commission is going
to administer the act it ought to have some official part in any activity relating to marginal requirements. I do not mean the sole
authority, by any means, but some part.
Senator WAGNER. None of your activities go into the area of
control of credit %
Mr HEALY. NO, sir.
Senator WAGNER. Would
Mr. HEALY. Yes, sir; but
not that be a new field for you^
of course work in connection with securities on the stock exchange is something of a new field.
The CHAIRMAN. The law might fix a minimum and draw a line of
its own and then leave the Federal Reserve Board to fix a margin
within that zone.
7626
STOCK EXCHANGE PRACTICES
Senator WAGNER. I have no very definite views about it myself,,
but I thought I would like to get Judge Healy's opinion.
(Informal discussion occurred which the reporter was directed not
to record; after which the following proceedings took place:)
Mr. PECORA. Judge Healy, will you be good enough to turn to
page 33 of the bill, H.R. 8720, at the top of the page, item no, 10,
requiring the filing of balance sheets for preceding years certified by
public accountants, and so forth?
Mr. HEALY. Yes, sir.
Mr. PECORA. I t has been
suggested, and I think it was Mr. Dickinson's suggestion, that after the words " balance sheets for " there
should be inserted the words "not to exceed the three preceding
years." That is, to have balance sheets filed for the preceding 3
years. And a similar amendment to item 11, profit and loss statements for a period not to exceed 3 preceding years. Do you think
such an amendment would be a good one?
Mr. HEALY. It would not occur to me that that was an unreasonable suggestion. However, it ought to be left perfectly clear, if such
an amendment is made, that nevertheless the commission or the
corporation reporting must disclose the content of its fixed capital
account and its surplus account, various reserve accounts, investment accounts, and so on, if necessary, in order that their content
may be known. Sometimes it is necessary, in order to get that information, to go back more than 3 years.
With that much of a reservation 1 should think that the suggestion
was rather a wise one.
Also, I would suggest that the commission should be left with
authority to require balance sheets for other years without certificate, if it wants to. I do not think anybody wants a certified public
accountant to go back and examine all the balance sheets that have
been put out for years.
The CHAIRMAN. We are very much obliged to you, Judge Healy.
The committee will now taxe a recess until 10 o'clock tomorrow
morning.
(Whereupon, at 1:25 p.m., a recess was taken until tomorrow,
Tuesday, Apr. 3,1934, at 10 a.m.)
For release Tuesday, April 25,1933, after the full report of which this i^ oiuy
the summary, has been introduced in the official record, Federal Trade Commission, Washington (This copy will not be made available until the full
report containing the summary has been introduced in the record )
The foUowing summary of the report of the Federal Trade Commission examiner, was placed in the record in the Commission's investigation of power
and gas utilities, Tuesday morning, April 25 The Examiner, Dr. Thos W
Mitchell, testified regarding this report which is based on his examination of
the books and accounts, of Cities Service Securities Co, of the Doherty group
of utilities
The Cities Service Securities Co is a securities marketing and trading
agency set up in 1927 by Henry L. Doherty & Company and is wholly owned
by Cities Service Company.
The report of which the following is a summary* sets out briefly in Chapter
I the organization and purpose of Cities Service Securities Co and the manner
of its functioning In thirteen sections of Chapters II and III are presented
the activities in thirteen typical securities marketing campaigns based on the
functions and purposes set out in Chapter I
The summary is as follows:
STOCK EXCHANGE PRACTICES
7627
SUMMABY OF BEPORT ON CITIES SERVICE SECURITIES COMPANY
Henry L Doherty & Company, managers of Cities Service Company, furnished by application of the proceeds of sales during 1927 and 1928 and up to
the stock market crash in 1929, the great bulk of that demand for that latter
company's common stock that was expressed in purchases on the New York
Curb Exchange That stock was purchased continuously in large volume over
the counter and on the New York Curb Exchange. They were enabled to do
this by applying to these " market purchases " a large proportion of the funds
and orders that were obtained through cash, short-time and installment sales to
investors in every nook and corner of the United States. The purchases and
sales were made for account of Cities Service Securities Company. The purpose claimed for these market purchases by the company was that of facilitating the sale of new blocks of original issue of the stock by providing for the
investors an active resale market in which they could readily dispose of their
holdings if occasion required However, the volume in which these market
purchases were made was not merely sufficient to support and steady the
market price but was such that the market price rose to a great height, from
which it crashed m October, 1929
This organization's market activities constitute an outstanding example of
what is believed to be a general practice in modern finance and stock market
control. The practice has far-reaching effects upon the welfare not only of the
investing and speculating public but of the entire general public. It may conceivably be carried on only in such volume as to support and steady market
prices, or, as in 1927, 1928 and 1929, it may be carried on in such volume as to
induce a continuous rise in the prices of stocks generally, and as to induce a
general orgy of speculation in which stock prices go to absurd heights, from
which they must inevitably crash to the great injury not only of the speculators
but of the entire nation.
Incorporation, Capitalization and Control —Cities Service Securities Company
is a wholly owned subsidiary of Cities Service Company. Its organization on
March 17, 1927, and its incorporation in Delaware on April 9th following were
caused by Henry L Doherty & Co, who transferred to the new company in
exchange for its capital stock ($15,000,000 par value supported by net assets
valued) at $20,000,000), the assets, liabilities and current situation that pertained to a certain function that previously had been performed by Henry L.
Doherty & Co. as Fiscal Agent for Cities Service Company and its subsidiaries.
The performance of that function had been carried on with the assistance of
funds advanced by Cities Service Company; and Henry L Doherty & Co reimbursed that company for the advances by transferring to it the Securities Company's capital stock at a valuation of $20,000,000 and by causing the Securities
Company to assume an open account indebtedness to Cities Service Company
of $21,721,175 42
Matm* Function.—The Securities Company's main function, which is the certain function referred to and which is performed for it by the staff of Henry L.
Doherty & Co. (for the Securities Company has no paid organization of its
own), is that of obtaining or facilitating the raising of additional capital funds,
and it has been variously described as follows:
To facilitate the marketing of securities of Cities Service Company and its
subsidiaries;
To supervise the market, or (in connection with syndicate operations) the
sole handling of the market for such securities;
To provide a ready resale market in which owners of securities of Cities
Service Company and its subsidiaries can readily dispose of their holdings at
retail when they desire to do so.
This function is most actively performed during those periods in which new
original issues of the securities in question are being marketed by banking
syndicates and distributing groups or in which preparation is being made for
the issuance of such new blocks. The Securities Company usually does not
itself market any considerable portion of an original issue of bonds or stocks
of Cities Service Company or of its subsidiaries, although it has occasionally
taken an additional original issue for the purpose of covering a technically
" short" position that it has created in the course of its activities in " supervising the market" When the Securities Company does participate in the
marketing of a block of original issue of securities, it usually obtains its portion
of the issue, not from the issuing company, but from the managers of the
syndicate that has undertaken the rnaiketmg of the block
7628
STOCK EXCHANGE PEACTICES
In connection with the marketing of such blocks of original issue, the Secuiities Company's function may be described as that of making the secunty m
question attractive to the public A natural effect of adding to the supply of
a given security is to depress its market price, it is important from the viewpoint of the results to the issuing company that this price-depressing tendency
be counteracted and, if possible, even be converted into a price-advancing tendency. One condition in conjunction with others, that makes a security attractive to the investing public is an active organized market in which the investor
can readily dispose ot his investment if he has occasion to do so It is therefore
important from the viewpoint of results to the issuing company that such an
active market be created and sustained for some time prior to and during the
period in which the new block of original issue is being marketed In addition
to the investment demand, a speculative demand for a given secunty may be
stimulated by a persistently rising price of the security in question, the motive
of the speculator being to obtain a profit in the purchase and resale of the
security. Such speculative purchases may be made outright; but they can be
made in greater volume on margins Such a speculative demand is likely to
be stimulated if the sustained volume of purchases on the organized exchange
is of sufficient magnitude to cause a fairly rapid and continuous rise in the
market quotations However, purchases by speculators result later m speculators' sales, which add to the Security Company's burden.
Method of Performing Mam Function—The method by which the Secunties
Company performs this function is as follows
Having regard, of course, to the volume of sales to investors effected by the
selling organization, it purchases the security day by day m considerable volume on the organized exchange These purchases are made through brokers.
They are made m such volume as to constitute a large supplement to the
public investment and speculative demand for the security as expressed in
purchases on the Curb Exchange It also purchases the security " over the
counter", which has the effect of keeping such quantities out of the supply
offered on the organized exchange All of those purchases have the following
effects
(1) They provide the ready resale market for those investors in the secunties
in question who had occasion to dispose of those investments
(2) They tend to prevent the maiket price fiom sagging under the influence
of the addition to the supply, because this added demand by the Securities
Company competes with the public demand as expressed in purchases on the
Cuib Exchange and appears or is augmented in volume just before and dm ing
the period in which a new block of original issue is being offered to the investing public This supplement to such public demand may even cause the maiket
quotations for the security in question to advance
(3), They induce investment confidence in the security in question and also
speculative cupidity The latter is stimulated especially when the Securities
Company's activities result in successive advances in the market price, which
advances offer the speculator the prospect of reaping a profit by purchasing the
security and reselling it later at a higher puce
Basis of Market Purchases and Sources of Funds —These " market purchases ""
tend rapidly to deplete the Securities Company's cash funds, and it could not
long continue to make them if it did not have means of replenishing its funds
They are provided or replenished, and the Securities Company obtains a basis
on which to determine the volume of its market purchases, by the following
means In addition to their sales offices in New York City, Henry L Doheity
& Co had, in May, 1929, district offices in 25 cities of the United States, and
802 securities salesmen reporting to these offices operated not only m those
cities and adjacent communities but in 28 others also Those salesmen were
continuously active in obtaining from their acquaintances and other sources the
names of likely individual and institutional prospects, and in following up «sueh
leads, soliciting and obtaining orders for the securities Telegraphic reports
followed by daily transmission of copies of the sales confirmations kept the
New York office continuously informed1 as to the details and volume of orders
so obtained The volume of sales orders so obtained and of sales effected " over
the counter " constituted a basis of the volume of " market purchases " made
by the Securities Company " over the counter " and on the organized exchange;
and the down payments of cash by the customers and the later collections of
cash from them constituted an important source from which were replenished
the cash funds that were depleted through the aforesaid market purchases.
STOCK EXCHANGE PEACTICES
7629
To some extent these sales orders and funds were supplemented for this purpose
by orders and funds obtained from or through investment retailers who participated in special offerings and even in syndicate distributing gioups
Thus the Secunties Company, through Henry L Doherty & Co. as agent,
functioned, to the extent of its market purchases, very much like a broker who
received from customers orders to purchase certain designated securities in
specified quantities and then purchased on the exchange or over the counter
the secunties with which to fill the orders However, it differed fiom an
ordinary broker in the following respects
(1) The customer investor did not give an order to purchase the securities
for him, but he contracted to purchase them from Henry L Doherty & Co ,
(2) The securities salesmen of Henry L Doherty & Co took the initiative
in soliciting the orders rather than waiting for orders to come,
(3) Neither the Securities Company nor Henry L. Doherty & Co is a member of the exchange, but the purchases on the exchange were executed through
broker members,
(4) The purchases of securities with which, to fill the customers' orders did
not necessarily have to be made immediately after receipt ot the orders, because of the fact that a large portion of the orders was made on account or
on 10-months installments, thereby affording the Doherty Management leeway
as to the time at which to provide the securities According to the company's
iepresentati\es, the shares sold on the installment plan during the period under
leview averaged something less than 15% of the Securities Company's total
sales of this stock The securities so sold were not deliverable until paid for
m full, and, according to the terms of the installment contract used in 1929,
those sold on such contracts weie not deliverable until the expiration of the
contract period even though the customer completed his payments before that
expiration Also securities needed for delivery to customers, particularly Cities
Service Company common stock, could be and were provided temporarily by
borrowing them from large holders This made it possible to build up sales
balances to cover which securities of new original issue were disposed of to the
lenders or to the ultimate investors The last step accomplished the ultimate
purpose of the whole process—the acquisition of new capital.
Secondary Function —The Securities Company is also a convenient instrument through which gradually to buy in those securities that are to be retired,
or that are to be tendered to sinking fund tnustees, or that are to be taken out
of the market temporarily, or that are to be modified
For example, Public Service Company of Colorado, an indirect subsidiary
of Cities Service Company, found it advantageous to issue 6% rather than 7%
preferred stock, and later to issue 5% rather than 6% preferred stock Up to
January 29, 1931, the Securities Company and Henry L Doherty & Co, who
functioned before the Securities Company was formed, purchased $3,939,21512
par value of the 7% preferred stock at a cost of $4,287,06217, exchanged
$895,000 par value of it for $966,800 par value of the 6% preferred at an annual
dividend saving of $4,634, exchanged $300 000 par value for $375,000 par value
of the 5% preferred at an annual dividend saving of $2,250, and sold $2,690,000
par value of it to Cities Service Company Also after the marketing of 5%
preferred stock was commenced, the Secunties Company gathered in 6% preferred stock, and, on August 2, 1929, sold $535,700 par value of it to Cities
Service Power and Light Company at cost, $547,500 94 The Securities Company also marketed $4,112,700 par value of the 6% preferred stock for $4,046,921,
and, during the process, spent $991,348 34 making market purchases to the extent
of $977,000 par value
Again in March, 1927, Cities Service Company sold $15,000,000 face amount
of 5% debentures maturing m 1966 to A B Leach & Co , and the Securities
Company participated in the distribution as a member of the distributing group
The issuing company had outstanding at the time 6% debentures maturing in
the same year, and the Securities Company purchased these in considerable
quantities in the market. It continued these purchases up to the end of 1928,
both in the market and from European bankers, while two other debenture
issues bearing 5% interest were being marketed More than $17,000,000 face
amount of these were sold to Cities Service Company.
Examples of buying in secunties and modifying them previous to resale are
the following On November 1, 1928, when the market price of Cities Service
Company common stock was about $70 per share, that company sold to Harris,
Forbes & Co and Halsey, Stuart & Co, who marketed them through a distributing group of retailers, $30,000,000 face amount of 5% debentures matur
7630
STOCK EXCHANGE PRACTICES
ing in 1963 at 92% and interest These debentures boie non-detachable option
warrants conferring upon the holder of each 1,000-dollar debenture the right
to purchase 15 shares of Cities Service Company common stock at prices
which, commencing at $72 per share, advanced $2 per share each 6 months
Again, in March, 1929, when the market price of this stock was about $126
per share, that company sold to the same wholesale investment bankers at
92% and interest, $50,000,000 face amount of 5% debentures maturing in
1969; and these debentures bore non-detachable option warrants whereby the
holder of each 1,000-dollar debenture had the right to purchase 10 shares of
Cities Service Company common stock at prices which increased at halfyearly intervals commencing with $122 per share if the option were exercised
within the first six months. Subsequent to the issuance of these debentures
the market quotations for the stock rose to such heights that sale of it at the
debenture warrant prices was not advantageous to the issuing company, but at
the same time the differences between the market prices of the debentures
with warrants and ex-warrants were so narrow that more proceeds could be
realized by purchasing the debentures with warrants, exercising the warrants
and re-selling them ex-warrants The Securities Company purchased these
debentures in large volume, paying high premiums It exercised the warrant
options on $10,818,000 face amount of the Debenture 5's of 1963 and on
$18,328,000 face amount of the Debenture 5's of 1969, thereby making them
available for re-sale as debentures ex-warrants. Of their total cost, $20,996,19319, representing the diffeience between their cost and their market value
ex-warrants, was treated as a part of the cost to the Securities Company of
the common shares obtained in the exercise of the warrants Some of the
ex-warrants debentures were re-sold, some were transferred to Cities Service
Company, and, at last accounts, some were still being held by the Securities
Company
Importance of The Securities Company's Chief Function —The chief function
of Cities Service Securities Company was variously designated as " pioviding a
ready resale market for securities ", " facilitating the marketing of securities ",
" supervising the market" and " sole handling of the market" for securities
Another name commonly applied to this function is " sponsoring "
Inasmuch as the Securities Company is wholly owned by Cities Service Company, its peiformance of this function with reference to the parent company's
stock virtually amounts to Cities Seivice Company's trading in its own stock.
Such activity is regarded with disfavor by the governing body of the New
York Stock Exchange However, the securities of Cities Service Company are
dealt in, not on the New York Stock Exchange, but on the New York Curb
Exchange. Even in the case of many companies whose securities are listed
on the New York Stock Exchange, however, the trading is nevertheless carried
on by the company's Financial Agent, or by pools gotten together by the Financial Agent, or by a securities company owned by the Financial Agent
These trading activities are not of mere minor and incidental importance in
modern finance They are of major importance, because of their volume and
of the effects produced through their volume. While the practice of "sponsoring" stocks has been a matter of common report over several decades, the
volume of trading mvolvid in it, the great proportion of the demand for securities on the organized exchanges that is provided by these company purchases,
the extent to which funds supplied by the investing public are used for this
purpose, and the extent and public importance of the effects are probably little
realized The description in this report of the activities of Cities Service
Securities Company m connection with campaigns to maiket common stock of
Cities Service Company and Class A common stock of Arkansas Natural
Gas Corporation furnishes outstanding illustrations that may convey such
realization
When the Securities Company took over this function from Henry L Doherty
& Co on April 1, 1927, an operation to distribute Cities Service Company
common stock was drawing to a close, and the sale of another 250,000 shares
under a special offering to dealers was under way. In the performance of its
function during the remaining 9 months of 1927, the Securities Company spent
nearly $45,851,000 in market purchases of 936,104 shares of this stock, its sales
during the same period amounting to 938,910 shares for $45,880,75938 Bv
"market purchases" is meant not only purchases on the New York Curb
Exchange but also purchases "over the counter". The latter did not, on
the whole, exceed one-sixth of the total. These market purchases amounted to
924% of the total number ot Cities Service Company common shares traded
STOCK EXCHANGE PBACTICES
7631
on the New York Curb Exchange duiing the same period and they exceeded
the number traded on the Curb in four of the nine months During that
period, the closing Curb price of this stock, after sagging from $51% to $44
in April, followed a fluctuating rise to $55% at the year end
On March 9, 1928, when the market puce was about $58 per share, Cities
Service Company offered its common stockholders a 10% pro rata subscription
for additional shares at $45 pei share. In the process of supervising the
market for the stock and the rights during this operation, the Securities Company and Pearsons-Taft Company formed a syndicate distributing group for the
purpose of effecting sales of 300,000 shares at current closing Curb prices plus
% point, and the syndicate participants sold 466,755% shares for $27,327,762 25
The purpose of this distributing group was to provide a channel through which
to sell such shares as the stockholders failed to take, but, the stockholders
having taken the entire 10% offering, the syndicate sales were utilized along
with sales effected by Henry L Doherty & Company's organization as channels
through which to dispose of the shares obtained by the Securities Company m
its market purchases to dispose of 100,000 additional shares of original issue
and to dispose of approximately 51,892 shares held by Gas Securities Company.
Preparatory to making voluminous market purchases in its process of supervising the market, the Securities Company guarded against excessive loss m
the resale of such shares by forming a Put Syndicate and paying it a commission of $300,000 for the privilege of selling to the Put Syndicate not to exceed
200,000 shares obtained m such market purchases and in the exercise of rights
purchased in the market, the " put" price to be $50 per share or cost, whichever should be the lower The privilege was exercised to the extent of 55,000
shares, of which 29,300 shares were repurchased The Securities Company also
purchased at a cost of $2,220,219 55 the rights to subscribe for 210,897}^ shares
and exercised most of the rights Also during the nine months, January to
September, 1928, the Securities Company's market purchases of this stock
totalled 1,451,890 shares, which fell short of the total number of shares of this
stock traded on the Curb Exchange by only 18,810 shares or by less than 1 3 % ,
the Securities Company's market purchases exceeded the number traded on
the Curb in five of the nine months During these nine months, the Securities
Company's sales amounted to 1,867,254 shares And the closing Curb quotations
for this stock continued their upward progress from $55% on January 1st to
$68% on September 30, 1928.
Up to September 30, 1928, the Securities Company's market purchases of
Cities Service Company common stock frequently exceeded the total number of
shares of that stock traded on the Exchange, indeed exceeded the totals in 9
out of the 18 months Thereafter the proportion of the Securities Company's
market purchases to the total trading on the Exchange was less than 100% and,
with exceptions, grew progressively less—not, however, through diminished
volume of the market purchases (which increased, instead) but through a
greater increase in the volume of purchases on the Curb Exchange by the
investing and speculating public It is probable that the spectacle of the continuous and rapid rise in the market quotations for this stock attracted speculators who purchased in larger and larger volumes, doubtless on margins to a
large extent, for the purpose of reaping large profits in the resale
On December 17, 1928, Cities Service Company announced to its common
stockholders another offer of common stock for pro rata subscription at $65 per
sha,re to the extent of 10% of their record holdings on January 8, 1929 The
Securities Company undertook supervision of the market for the rights and for
the stock during this operation. It formed another Put Syndicate and paid it
a fee for the privilege of putting to it not to exceed 200,000 " market shares "
at $75 per share or cost, whichever should be the less In order to provide
channels through which to dispose of any shares that should not be taken by
the stockholders, it joined with Pearsons-Taft Company in the formation ot
another syndicate distribution group, which was'to obtain orders at retail for
300,000 shares at the current closing Curb price plus % point. In its market
" supervising " activities the Securities Company purchased in the market at a
cost of nearly $2,489,000, rights to subscribe ior 110,880 iV shares. Also, during
December, 19(28 and January, 1929, it spent over $56,900,000 in market purchases
of approximately 649,087 shares. Its sales during the same two months
amounted to 890,068 shares with contractual proceeds of $75,079,80564 The
closing Curb quotations rose from $73 on December 1, 1928 to $89^ by January
10, 1929, and to $91 by February 1 The number of shares offered to and
subscribed by stockholders was 552,842%.
175541—34—PT 16
15
7632
STOCK EXCHANGE PEACTICES
Although, including the Securities Company's subscriptions, the pro rata subscription offer to the stockholders was a complete success, extensive sales had
been effected by the syndicate distributing group and by Henry L. Doherty &
Company's organization These sales were sufficient not only to cover the Secunties Company's market purchases but to leave a margin to which could be
applied more shares With market quotations approaching and attaining $120
per share, the Doherty Management continued the marketing campaign, also
Mr. Doherty decided to sell 200,000 shares of his personal holdings. Steps were
also taken whereby he reinvested $1,000,000 in Cities Service Company's newly
created noncumulative stock in such manner as to increase his voting power
from 144,813 votes or 619% of the total voting power to 1,104,813 votes or
33.11% of the total The company's representatives averred that there was no
connection between these two transactions. With such high prices for a 20dollar par stock, steps were also taken to change the common stock to the nonpar variety and split it four shares for one, which became effective on May 2,
1929. A new selling campaign was launched in April, 1929, and was carried on
through a dealers' special offering and through the Doherty organization until
the end of September While the market quotations held at about $120 per
share from about March 19th to the date of the split-up, their upwaid movement resumed after the split-up and continued to a maximum of $68% for the
new non-par stock (equivalent to $272 50 per share of the 20-dollar par stock)
which was attained on October 15, 1929
In this connection the Company's representatives urged that the advance in
maiket price of this stock during 1927 and the greater part of 1928 lagged
noticeably behind the upward trend of the general market for stocks They
also point out that on December 4, 1928 one of the Cities Service Company
subsidiaries brought in the discovery well in the now famous Oklahoma City
oil pool, and they claim that this discovery attracted public interest and
focused attention of investors and speculators upon Cities Service common
stock, that this interest was stimulated as other wells in this pool came in
later; and they point out that it was during this period from November, 1928
to October, 1929—particularly from July to October, 1929—that the market
price of Cities Service common stock had its spectacular rise They point
out that during the period the management was engaged in raising a large
amount of new capital with which to develop its holdings in this oil field
However, that may be, it is a fact that during the 11 months and 6 days from
October 31, 1928 to October 5, 1929, during which large additional amounts of
new capital were sought, the management spent nearly $389,250,000 in the
purchase of the equivalent of nearly 12,072,000 non-par shares of Cities Service
Company common stock over the counter and on the Curb Exchange, with which
to fill sales orders from customers.
The extent to which the Securities Company's maiket activities influenced
and contiibuted to that spectacular elevation of the market quotations for Cities*
Service Company common stock and to the general market condition that was
attained by the beginning of October, 1929, and that culminated in the stock
market crash of that month, may be judged fiom the following summary of
significant facts. The records of Cities Service Company show that, fiom November 1,1928 to October 5, 1929, that company issued, exclusive of stock dividends, new original issues of common stock to the extent equivalent to 5,763,850
shares of the present non-par variety, for proceeds amounting to $86,789,125
During identically the same period, the Dohertv Management, as agent for the
Securities Company, spent $389,248,248 77 in the purchase, mostly on the Curb
Exchange, of the equivalent of 12,071,692 812 non-par shares of Cities Service
Company common stock Of course, all of the shares so purchased and several
millions more were resold over the counter, by Henry L Doherty & Company's
stock salesmen and through other channels During that period, the market
quotations for the stock rose from the equivalent of about $17 69 to $6175 per
share The contribution of those market activities to that price elevation may
be inferred from the fact that those purchases amounted to 73 5% for the entire
reported demand on the Curb Exchange Any percentages are subject to qualification because not all transactions on the Curb Exchange may have been
reported—in fact, particularly in the early years (1927 and 1928) numerous
discrepancies occurred between quantities reported by different agencies
Prior to September 30, 1928, the Secunties Company's market purchases of
Cities Service Company common stock frequently exceeded the total number
traded on the Curb Exchange The last statement in the preceding paragraph
shows the proportion from November 1, 1928 to October 5, 1929 at 73 5%.
STOCK EXCHANGE PRACTICES
7633
The proportion from October 1, 1928 to October 5, 1929 was about 74 4% Even
this is a very large proportion, and indicates that the public market demand
of investors and speculatois for this stock was a very small propoition ot the
total* market demand expressed on the Curb Exchange It also indicates, however, that the general public had been attracted to this stock Piobably these
purchases by the general public consisted in large part of margin purchases by
speculators for the purpose ot reaping large profits in the re-sale at still higher
prices
In September, 1929, the Doherty Management planned another 10% pro rata
subscription offer to Cities Service Company common stockholders of record
November 7th, 1929 In Older to provide an alternative channel in case the
stockholders did not respond fully, another syndicate distributing group was
arranged, and marketing commenced on October 1st. The Secunties Company
undertook supervision of the market
The market condition was exceedingly piecanous, however Doubtless stimulated by the sustained upward trends of market prices of stocks which in turn
were doubtless stimulated by the large and sustained volumes of market puichases by " sponsors " such as Cities Service Securities Company, there was a
very large volume of margin holdings of stocks—10 to 12 billions of dollars—as
was evidenced by brokers loans which stood on October 3, 1929, at the stupendous total of $8,549,383,979 and which had increased during the preceding
tour months to the extent of neaily $1,868,000,000 Call loan rates were high
The prices of many stocks were so high that the income accruing to them represented yields of 2% or less on those prices, a fact that would naturally precipitate investment selling Speculatois would have to sell in order to realize
their paper profits in cash These facts invited short selling raids by " bear "
cliques in the hope of producing sufficient drops in market quotations to precipitate a large amount ot forced selling by the margin specuulators, which
would enable the "bear" operators to cover their short sales at a profit
Once such forced selling was commenced there was not necessarily any stopping point until the last speculator was squeezed out
During the fiist half of October, 1929, the Securities Company spent vast
sums of money in withstanding the selling pressure on Cities Service Company
common stock, and it was so successful that the market quotations actually
advanced trom a closing $60% on September 30 to a high of $68% on October
15th However, on Monday, October 21st, m a panic that was precipitated on
the preceding Saturday, 936,500 shares of Cities Service Company common
stock were hurled onto the market The Securities Company, m an endeavor
to allay the panic, spent more than $48,886,000 in the purchase of 784,644 of
those shares It was only partially successful, however, the price ha\mg
broken from $66% to $59% This price break was followed by even heavier
selling pressure—1,151,900 shares on October 24th, 976,700 shares on October
28th and 1,105,900 shares on October 29th During the whole course ot the
stock market crash in the latter half of October, 1929, the Securities Company
spent more than $138,000,000 in the purchase of 2,372,101 shares of Cities Service Company common stock, but, as these amounted only to about two-fifths of
the total quantity of that stock thrown onto the maiket, they were not sufficient
to uphold the maiket price, which broke to a low of $20 on October 29th During October the Securities Company sold, exclusive of the shares taken by
warrant-exercising debenture holders, 3,401,462 shares, the contractual proceeds
of which, after certain adaustments, amounted to $180,314,66310 as against
purchases duung October of 3,080,392 shares at a cost of $181,825,808
The rapid changes in market quotations duung this period resulted in
numerous price adiustments to the customeis for Cities Service Company common stock By the end of the year these! amounted to $10,605,81152 on sales
effected through the syndicate and to $2,168,658 55 on sales effected by Henry
L Doherty & Company's organization
As a result of the relatively low-market quotations prevailing for Cities
Service Company common stock after the stock-market crash of October, 1929*
the pro rata subscription offer to the stockholders was abandoned, and modifications were made in the syndicate distribution group agreement. A new
special offering to dealers was announced in February, 1930 During 1930r
the sales of this stock through all channels amounted to 7,382,69616 shares,
with a gross invoice value of $210,441,088 86 The companv made maiket
purchases aggregating 7,337,156% shares at a cost of $218,803,730 37 There
was a period of upward trend in the market price of the stock—from a low
7634
STOCK EXCHANGE PBACTICES
of $25% on December 20, 1929 to $41% on May 1, 1930 But during this
period, the Securities Company's maiket purchases exceeded its total sales
through all distribution channels A market decline set in, in May, 1930, during
which the sales exceeded 1,000,000 shares and exceeded the market purchases
by nearly 279,000 shares; and a fluctuating decline continued throughout the
remainder of that year, the maiket price at the veiy end being $14% per
share
On January 17, 1930, Cities Service Company piovidod the Securities Company with 600 000 common shares with which to make deliveries to customers
Although the maiket price at the time was about $28 per share, the gross
proceeds available from accumulated sales averaged only $15 91 per share
to be provided, and the price to the Securities Company for these shares
was $12 50, which left the latter a margin of about $3 41 per share with which
to cover commissions and expenses As of December 31, 1930, Cities Service
Company provided the Securities Company with another 633,879,206 shares
at $10 per share This price left the Securities Company with a margin of
about 53 82 cents per share with which to cover commissions and expenses
The Securities Company's accounts represented that company as selling, to
the holders of Cities Service Companv debentures, the common shares that were
issued to them when they exercised the warrant options carried by their debentures, and as obtaining the requisite shares from the issuing company at prices
from $5 50 to $7 per non-par share less than the prices paid by the debenture
holders. As the Securities Company had no function to perform in the issuance
of these shares, this resulted in counting for it a gross profit of $18,429,723 23
for which it did not render service However this made no difference in the
ultimate proceeds to Cities Service Company because the Securities Company's
net deficits from these operations were charged back to it
As of December 31, 1929, the Securities Company wrote down the book cost
of its " Trading Purchases " of Cities Service Company common stock, $21,121,097 98 This was not an inventory adjustment, as the company had no unsold
shares, its aggregate sales up to that time having exceeded its aggregate purchases by 1,946,941 shares Such bookkeeping enabled the Securities Company
a year later to count on certain classes of sales of this stock a gross profit of
$99,642 39 instead of an actual gross loss of $21,021,455 29 Profits and losses
made by trading in securities are not, however, taken into earnings but are
treated as more or less capital proceeds ficm the securities of new original issue,
which treatment is represented on the company's books bv cariymg them, not
to Surplus, but to an account called " Reserve for Cost of Distribution ".
After counting piofits and losses on December 31, 1930, the Secunties Company emerged with a deficit in its " Reserve for Cost of Distribution " of $1,956,775 71 This was charged back to Cities Service Company, as also was $12,518,998 55 of uncollectible balances of breached partial payment contracts.
MEMORANDUM CONCERNING THE POWER OF CONGRESS, UNDER THE COMMERCE
CLAUSE, TO REGULATE SECURITY EXCHANGES
This memorandum is concerned with the basic question whethei Congress,
by virtue of the commerce clause, has power to regulate secuntv exchanges
Its purpose is to show that a constitutional foundation exists upon which may
be built a statutory structure for the regulation of such exchanges For
if this power can be established, as in my opinion it can, then it becomes
largely a question of fact and of administrative judgment whether and how
far the regulation shall be extended beyond the exchanges themselves and
applied to related and collateral activities
I RFGUIATION OF SECURITY EXCHANGES IS A NATIONAL PROBLEM
The national character of the problem of the regulation of security exchanges
is shown by the facts Some of them are sub3ect to -judicial notice Others
have been brought out by the Congressional investigations or have been
gathered as a result of independent studies A few of the broader aspects
may be noted here as bearing on the national interest
Transactions upon the security exchanges may have a direct effect upon
the ability of the instrumentalities of interstate commerce to perform their
functions New secunty flotation is difficult if, because of manipulation or
loss of public confidence, existing securities have shrunk to abnormally low
STOCK EXCHANGE PEACTICES
7635
values. With this should be considered the frequent refunding operations made
necessary for the American railways by virtue of their heavy funded debt
The other carriers (air and motor transport, pipe lines) have in general a
small funded debt but their stock distribution is more limited, making speculative movements more severe No reason appeals why the burden which may
thus be imposed upon the efficient functioning of the interstate transportation
system is any less direct or real than that of low mtrastate passenger fares,
Railroad Commission of Wisconsin v Chicago, B & Q R Co , 257 U S 563
Interstate commerce in largest part consists of the movement of goods
financed by credit Without adequate credit facilities the physical instrumentalities of interstate commerce are near to useless An unrestrained
speculative activity absorbing, at times, billions of dollars of credit, at
high interest rates, of necessity increases the cost of financing and, to a significant extent, diminishes the volume of credit available for the interstate
transaction An even more serious impediment to the continued functioning
of this interstate shipment is found in the vulnerability of the commercial
banking system to extreme fluctuations in the quoted values of securities.
Thiough direct investment and through collateral required of the bnuower,
the commercial banks are so circumstanced that an abrupt decline from a speculative peak must leap a heavy toll in insolvency, with consequent attrition
of the interstate movement of commodities A Congressional power which
can reach the purchase of stock in competing businesses, Northern Securities Co.
v United States, 193 U S 197, the charging of discriminatory pi ices, Van
Ckrnip & Sons v American Can Co, 278 U S 235, and the publication o± an
" unfair " list, Loewe v howler, 208 U S 274, because of a possible diminution
of interstate commerce, hardly can be said to fall short of protecting the
essential credit foundation from the dangers presented by an uniestiamed
speculative market for securities
Since " commerce among the states is not a technical legal conception, but
a practical one, drawn from the course of business," (Sutft & Co v United
States, 196 U S. 375, 399) one must take a practical view of the nature of lnteistate commerce In commercial realty it is, in the largest part, the result
of orders placed by business hoping to resell at a profit If their predictions
of their markets fluctuate, so will fluctuate the volume of interstate commerce.
The movement of securities on organized exchanges is an important matter
in shaping the judgment of business men as to the future It seems clear
that a power to regulate interstate commerce is incomplete if it cannot seive
to guard the exchanges from, manipulated movements and speculative hysteria.
The words of Woolsey, J. are peculiarly appropriate in this regard (United
States v. Brown, 5 F Supp 81, 85, ( D C , S D N I . 1933))
"When an outsider, a member of the public, leads the pi ice quotations of a
stock listed on an exchange, he is justified in supposing that the quoted price
is an appiaisal of the value of that stock due to a series of actual sales
between various persons dealing at arms' length in a fiee and open market
on the exchange, and so represents a true chancering of the market \alue
of that stock theieon under the process ot attrition due to supply opeiating
against demand "
None but the brave could say that interstate commeice is moie dnectly
burdened by the exclusion of cooperative marketing associations from giam
exchanges, Board of Trade v Olsen, 262 U S 1, than by speculative upheavals
on the securities markets
The marketing of securities in interstate commeice has recently been sub
lected to a large measure of Congressional control See, The Securities Act of
1938, 33 Columbia Law Review 1220 This control is incomplete without control of the securities exchanges " Market support" is an almost invariable
corollary of security distribution and, in the case of stocks, is often accompanied by additional sales on the exchange made by the sponsoring banking
house or syndicate
The strength of the national interest in the pioper functioning of the securities exchanges hardly can be questioned Ouis is a credit economy, dependent
upon the exchanges for the liquidity of its fixed assets and for the solvency
of its financial institutions This national interest is a factor which of necessity colors any judicial consideration of the implications of the commerce
clause As Holmes, J writing for the Court m Missoun v Holland, 252 U S
416, 433, 435, (sustaining an Act of Congress to carry out a treaty relating to
the protection of migratory birds) said.
7636
STOCK EXCHANGE PBACTICES
" * * * it is not lightly to be assumed that, in matters requiring national
action, * a power which must belong to and somewhere reside in every civilized
government* is not to be found * * * Here a national interest of very
nearly the first magnitude is involved * * * We see nothing in the Constitution that compels the government to sit by while a food supply is cut off and
the protectors of our forests and of our crops are destroyed. It is not sufficient to rely upon the states The reliance is vain, and were it otherwise, the
question is whether the United States is forbidden to act"
While the existence of a national problem does not prove the existence of a
national power, it does at least provide a good place to begin the inquiry In
the same case from which we have just quoted and in answer to the contention
that the Migratory Bird Act constituted an invasion of power reserved to the
States by the Tenth Amendment, Mr Justice Holmes said (at 434) •
"We must consider what this country has become in deciding what that
Amendment has reserved "
II The scope of the commerce clause is largely a question of fact
That the scope of the commerce clause is commensurate with the national
interest and that in proper circumstances Congress may control situations normally considered mtrastate, is a doctrine announced by John Marshall more
than a centurj ago In discussing the power of Congress in Gibbons v Ogden,
9 Wheaton 1, he attempted to indicate something of its range by suggesting
what it could not reach
" The genius and character of the whole government seem to be, that its
action is to be applied to all the external concerns ot the nation, and to those
internal concerns which affect the States generally, but not to those which
are completely within a particular State, which do not affect other States, and
with which it is not necessary to interfere, for the purpose of executing some
of the general poweis of the government" (at 195)
Thus was the matter put in 1824 And it should not be forgotten that this
ease, with its wide suggestion concerning the extent to which the delegated
power over commeice may reach mtrastate came shortly after M'Culloch v.
Maryland, 4 Wheaton 316, with its doctrine of implied powers written into
the theory of delegated powers, and constitutes part of Marshall's general development of constitutional interpretation. Under the affirmative implications
of the words just quoted, it is permissible for Congress to regulate the internal
concerns of a State if they affect other States and if it is necessary to interfere
with them for the purpose of executing some of the general powers of the
Nation
As a corollary of the general rule that Congress has the implied power to
take such steps as may be necessary to make effective its exercise of an
express power, the Supreme Court has established the authonty of Congress
to enact whatever legislation is appropriate to "foster, protect, control, and
restrain " interstate commerce Second Employers1 Liability Cases, 223 U S 1;
Mobile County v Kxmball, 102 U S 691, 697; The Daniel Ball, 10 Wall 557, 564.
This power, when need arises, extends not only to strictly interstate matters,
but also to mtrastate matters whenever the two are so intertwined or related
as to effeet interstate commerce or its successful regulation by the Federal
Government This exertion of Congressional power is not restricted in niggardly fashion, but is recognized to be a governmental necessity and a
beneficent adjunct of Federal authority
But before examining the method by which the power may be extended to
embrace mtrastate affairs, it is well to note that, for the regulation of security
exchanges, there is a core of interstate transactions around which the power
of Congress may be built. For considerable proportions of the sales on the
larger exchanges are made by interstate communication or contemplate physical
delivery across state lines That the transportation occurs before or after
the sale does not serve to remove the transaction from the power of Congress
to regulate under the commerce clause DaJmke-Walker Milling Co v Bondurant, 257 U.S. 282, McDermott v Wisconsin, 228 US 115. That the thing
sold is not tangible property but rather the evidence of indebtedness or of
ownership does not serve to remove the transaction from the scope of the
commerce clause
188 U S 321.
United States v. Ferger, 250 U.S. 199; Champion v. Ames,
STOCK EXCHANGE PEACTICES
7637
Interstate Commerce Commission v Goodrich T. Co., 22A U S 194, is illus-
trative In that case the Commission, acting under a Congressional mandate,
ordered the Goodrich Transit Company and a number of other Great Lakes
water carriers to file with the Commission on prescribed forms a statement
of their operating revenues and expenses, their corporate organization and
financial condition, and other desired data. The required statements were to
contain information not only concerning joint rail and water business, which
was the portion of the carriers' business subject to Federal regulation under
the then applicable statute, but also concerning other aspects of the carriers'
operations, both intrastate and interstate The Supreme Court held that the
Commission's orders were valid. Separation of the total business of the cairiers into its component parts seemed impracticable, and the accounting instructions were needed in order that the Commission could inform itself *>o
as to enable it properly to regulate the matters within its authority. The decision is especially noticeable m view of the fact that, in the case of one ot the
objecting carriers, the revenue derived from joint rail and water traffic waj»
less than one percent of its entire revenue
Review of the decided cases indicates that the scope of Congressional power
is ascertainable only by reference to the facts surrounding each application of it.
The problem and its treatment are strikingly similar to the procedure in cases
involving the due process clause. For example, in Stafford v. Wallace, 258 U.S.
495, the Supreme Court sustained the Packers and Stockyards Act against attack
under the commerce clause, noting that the business regulated was interstate
commerce or so associated with it as to be within the Federal powers. The late
Chief Justice Taft there said (at 513) r
" It was for Congress to decide from? its general information and from such
special evidence as was brought before it, the nature of the evils actually present
or threatening, and to take sucih steps by legislation within its power as it
deemed proper to remedy them."
Some years later, in Tagg Brothers & Moorehead v. United States, 280 U S.
420, the Court had before it a case arising under the same statute; in this
instance complaint was made that the act, in permitting the fixing of permissible charges of market agencies, violated the due process clause The
Court again upheld the act, saying (at 439) that fixing the commission merchants' fees was reasonable because " the purpose of the regulation attacked is
to prevent their (the merchants') service from thus becoming an undue burden
upon, and obstruction of that (interstate) commerce " In each case, the ultimate question was whether there was a reasonable connection between the
means adopted by Congies& and a permissible end. In each case the question
was answered affirmatively
The Supreme Court has often indicated its adherence to the doctrine that a
declaration of a legislative body, charged with the duty of knowing public
conditions, is of great weight in determining whether a particular statute is a
reasonable and necessary exercise of power This rule, while originally applied
in due process cases (see, for example, Block v Hirsh, 256 U S 135) has also
been utilized by the Court in commerce clause cases
Of the latter class, Chicago Boards of Trade v. Olsen, 262 U S. 1, sustaining the Grain Futures Act, is of special significance. And its significance
becomes clear when the case is compared with Hill v. Wallace, 259 U S 44,
holding the Future Trading Act (a tax measure) unconstitutional After the
decision in the Hill case Congress, as a result of an investigation, concluded
that regulation of boards of trade was necessary because trading in grain futures
involved, or tended to involve, a burden upon interstate commerce; and passed
the Grain Futures Act Measured in terms of their objectives, there was no
essential difference between the two statutes But the tax statute was invalidated, the commerce one sustained. The difference in result turned on
the finding by Congress as to the effect of futures trading upon interstate
commerce.
It is apparent, then, that regulation of intrastate transactions may be embraced within the Congressional authority over interstate and and foreign commerce, if the fact is that such regulation is related to regulation of interstate
commerce and implements or perfects the latter. A declaration by Congress,
such as the declaration m an introductory section of the proposed act to
regulate security exchanges, is affirmative evidence of the existence of the
required relationship; the Supreme Court will not lightly disregard it.
7638
STOCK EXCHANGE PRACTICES
I I I . ON FOUNDATIONS OF FACT, A WIDE EXPANSION OF THE COMMEBCE POWER HAS
BEEN ESTABLISHED
The application and results of the doctrine described in Part II of this
memorandum are illustrated by a long line of cases in the Supreme Court
of the United States They show a steady and significant expansion of the
acknowledged power of Congress "to foster, protect, control, and restrain"
where interstate or foreign commerce is concerned They make manifest, in
particular, the reach of Congressional power to remove or to prevent interferences with or burdens upon interstate commerce. Such interferences or
burdens may arise from the violent actions of individuals (In re Debs, 158 U S.
574), or the peaceful activities of state corporations (Northern Securities? Co. v.
United States, 193 U.S 197), or the duties imposed on public officers by state
laws (Shreveport Rate Cases, 234 US 342). Whatever may be the source and
whatever the kind of interference or obstruction, the subject matter is one
for the consideration of Congress
The cases have arisen under various statutes the Interstate Commerce Act,
Anti-Trust Laws, Federal Trade Commission Act, and otheis. They have
covered a wide range. Aside from differences on the facts, however, all of them
stand together on a common ground, namely, that they are concerned with the
development and expansion of the auxiliary power of Congress to reach as far
into the States as may be necessary effectively to foster and protect interstate
commerce. They make an elaborate array of authority for the exercise of the
power of Congress over affairs normally considered mtrastate In addition to
those already cited, and sometimes by way of repetition in order to emphasize
the development, the most significant cases follow.
Earliest in point of time, as the first important national development, are
the railroad cases In re Debs, 158 U S 564, (removal of obstructions to interstate commerce caused by strikers) , Southern Ry vs United, States, 222 U.S
20 (Federal Safety Appliance Act applied to mtrastate equipment of interstate
railroad) ; Shreveport Rate Cases, 234 U S 342 and the Wisconsin Rate Case,
257 U S. 563 (discontinuance of mtrastate rates discriminating against interstate commerce), Colm^ado v Umted States, 271 U S 153, and Transit Comm.
of NY v United States, 284 US 360 (discontinuance of mtrastate branches
under orders from Interstate Commerce Commission) ; and Texas & N OR Co
v. Brotherhood, 281 U S 548 (compelling employers to grant free choice of
arbitrators to employees
Paralleling this expansion of federal power ovei transportation facilities has
been the growth of supervision over commercial corporations Powerful combinations threatening the welfare of commerce led successively to the Sherman
Anti-Trust Act, the Clayton Act, and the Federal Trade Commission Act. Within the scope of these statutes, practices have been deemed restraints which
concerned the organization and security structure ot the corporation, not of
themselves interstate commerce Northern Securities Co v United States, 193
U.S 197 (consolidation of competing railroads by stock transfer to a holding
company) ; Federal Trade Commission v. Western Meat Co, 272 U S 554 (acquiring stock m a competitor) ; Standard Oil Co v United States, 221 US 1
(formation of holding company out of stock of vanous petroleum corporatms) ;
Umted States v Union Pac R Co, 226 U S 61 (purchase by one railroad of
dominating stock interest in another), United States v American Tobacco Co,
221 U. S 106 (monopolizing tobacco industry by stock acquisition) , United
States v Reading Co , 253 U S 26 (holding company controlling coal companies
and their railroad facilities)
As coming closer to the present problem the following may be noted. Swift &
Co v United States, 196 U S 375 (combination of livestock commission merchants violates the Sherman Act) , United States v Patten, 226 U S. 525 (corner
of the N Y cotton market a restraint of trade) , Stafford v Wallace, supra
(sustaining the Packers and Stockyards Act) ; Chicago Board of Trade v Olsen,
supra (upholding the gram Futures Act); Bvnderup v. Pathe Exchange, 263
US. 291 ("exchange" receiving interstate shipments of films and redistributing them to local exhibitors in the same state held to be a restraint on interstate commerce).
In the light of these cases alone, it is no longer open to question that
Congress may reach and control mtrastate affairs whenever such control is
necessary to the effective exercise of its power over interstate commerce.
Ample power exists; and, as the Supreme Court has said in Florida v. United
States, 282 U S 194, it becomes only a question as to the " propriety of the
exertion" of the power.
STOCK EXCHANGE PBACTICES
7639
IV THE EXEKTION OF FEDERAL POWER IS NOT RESTRICTED TO THE INTERSTATE TRANSPORTATION OF COMMODITIES NOR IS IT LIMITED TO PERSONS ENGAGED IN INTERSTATE
COMMERCE
It is not indispensable for the exertion of federal powei that it be directed
to a specific interstate commerce transaction No commodity need move from
State to State To be sure, where an actual interstate transaction is involved
the_ exercise of power by Congress is more easily supported But Congress is
not so limited Thus, m United States v Ferger, 250 U S 199, the question was
whether the United States could impose punishment where a bill of lading had
been fraudulently issued, no goods having been offered or delivered for shipment The existence of power was vigorously objected to on the ground that
there was no interstate commerce whatever but only a fraudulent scheme.
Yet, the power was sustained In regard to the objection the Court said:
"This mistakenly assumes that the power of Congress is to be necessarily
tested by the intrinsic existence of commerce in the particular subject dealt
with, instead of the relation of that subject to commerce, and its effects upon
it We say mistakenly assumes, because we think it clear that if the proposition were sustained it would destroy the power of Congress to regulate, as
obviously that power, if it is to exist, must include authority to deal with
obstructions * * ' and with a host of other acts which because of their
relationship to and influence upon commerce, come within the power of Congress
to regulate, although they are not interstate commerce m and of themselves "
(at 203)
Probably no one would contend that the hatters (Loewe v Lawlor, 208 U S.
274) or the coal miners (Coronada Coal Co v United Mine Workers of America,
268 U S 295) or the lessors of shoe machinery (UniteS States Macfwne Go v.
United States, 258 U S 451) were engaged in interstate commerce Still,
because what they were doing had a certain relationship to and undesirable
effect upon interstate commerce in a general sense they were held subject
to Congressional power.
Further illustrations may be found in cases having to do with transactions
sometimes described as interstate contracts Here the cases are chiefly those
holding certain transactions immune from state regulation because of their
interstate character, and invalidating state statutes as applied to them To
the extent that these decisions turn upon objections under the commerce clause,
they identify transactions to which Congressional power may extend Perhaps
the most significant case in this gioup is Dahnke-Walker Milling Go, v. Bondurant, 257 U S 282 In that case there was a contract, between a corporation
of Tennessee and a person in Kentucky, under which certain quantities ot
gram were to bet purchased by the corporation and delivered by the seller in
Kentucky for transportation to Tennessee Default having occurred through
non-delivery and the corporation having brought an action in the courts of
Kentucky, a defense was interposed on the ground that the plaintiff had not
complied with the state corporation laws The defense was disallowed, the
Court holding this to be an interstate transaction which the corporation was
entitled to enter into 1without complying with the state law. To a like effect
are Lemke v Farmers Oram Go, 258 U S. 50 (state gram grading and inspection act invalid; Rabbins v Shelby County Taxing District, 120 U S 489
(state tax on interstate soliciting agent invalid) ; International Tenet Book Co.
v. Piggt 217 U S 91 (correspondence school corporation not compelled to comply
with conditions imposed by State) That the solicitation of orders for interstate shipment is part of the interstate transaction, see Weeks v. United States,
245 U.S 618 (regulation sustained under the Food and Drugs Act); and see
Hall v Geiger Jones, 242 U S 509, for the suggestion that a security, although
a chose in action, is subject to federal control as an object of interstate commerce Nor should Champion v. Ames, popularly known as the Lottery Case,
previously cited, be forgotten m considering the power of Congress over the
interstate transportation of such documents as lottery tickets.
V CASES SUSTAINING STATE REGULATION OF INSURANCE AND OTHER SUBJECTS ^ S
NOT INVOLVING INTERSTATE COMMERCE DO NOT STAND IN THE WAY OF FEDERAL
POWER.
An array of cases in which various state statutes were sustained must be
considered, for the reason that the cases are so much relied on in support
of the contention that the transactions with which they had to do are beyond
7640
STOCK EXCHANGE PBACTICES
the power of Congress Chief among them all is Paul v Virginia, 75 XJ S 168.
An insurance contract was held to be not interstate commerce and a condition imposed by the State upon the entry of the foreign insurance company
was sustained Following that case it has been repeatedly declared that
insurance is not interstate commerce New York Life Insurance Co, v. Deer
Lodge County, 231 U S 495 Of a somewhat like character and antedating
Paul v Virginia is Nathan v Louisiana, 8 Howard 73, sustaining a state tax
on the brokerage business With these cases also may be grouped Hatch v.
Reardon, 204 US. 152 (state stamp tax on stock sales), Ware & Leland vs.
Mobile County, 209 US 405 (state license tax on brokers in futures) ; and
Umted States F. & G Co, v Kentucky, 231 US 394 (state privilege tax on
commercial agencies) Moore v New York Cotton Exchange, 270 U.S 593, may
be noticed here, though it did not turn on a state statute A contention that
the Cotton Exchange was engaged in interstate commerce was denied and certain relief sought on the ground that the Exchange's monopoly of its price
quotations was a restraint of interstate commerce was refused Mi Justice
Sutherland's statement (at 604) that " there is no averment of fact in the bill
on which a violation of the Anti-Trust law can be predicated " probably means
no more than that
But thtsse cases do not stand in the way of Congressional power They may
all be put to one side. In the first place, decisions sustaining state statutes
over objections on the commerce clause are hardly in point, certainly not authoritative, on the question of the power possessed by Congress Assertion of the
contrary would in effect mean that there is a definite division of power between
the Nation and the States ins regard to interstate commerce But we know,
the cases make it perfectly plain, that sometimes Congress can regulate intrastate commerce and sometimes the States can regulate mferstate commerce.
" It does! not follow that because a thing is subject to state taxation, it is*
also immune from federal regulation under the Commerce Clause ", said Sutherland, J in Bmderup v. Pathe Exchange, 263 U S 291, 311 (federal anti-trust
litigation), as he called attention to the fact that " cases cited * * * "* upholding state taxation as not constituting an merference with interstate commerce are of little value to the inquiry here" And see the recent case of
Minnesota v Blasius, 54 Sup Ct 34 (state taxation of livestock in the " current
of commerce.")
In the second place, aside from the emphasis repeatedly put on the personal
nature of insurance contracts as taking them out of an interstate commerce
classification, Paul v. Virginia* and other eases of like character belong to a
period prior to the fullest development by the Supreme Court of the present
constitutional doctrine concerning the effect of the commerce clause on state
power It will be recalled that up to Cooley v Board of Wardens, 12 How.
299, there had been differences of opinion in the Court on the question whether
the commerce clause per se deprived the States of power to regulate interstate
commerce. In sustaining the state action (regulation of pilotage) called in
question in that case the Court announced its much discussed doctrine of
interstate commerce of two kinds, namelv, local and national As to the
former, state action was permissible in the absence of inconsistent federal
action (though as a matter of fact the case actually involved the exercise of
power by the State supported by an express Congressional permission) As to
the latter, state action was inadmissible, it being indicated that in this field
the States were deprived of power Interstate transportation of an article was
thought to be commerce of a national character
Consequently, when the Court faced the question, as it did in Paul v Virginia, where interstate transportation of insurance policies was involved, it
would have been difficult to uphold state action if the subject matter, insurance,
was conceded to be interstate commerce at all A further reason for upholding
state power came from Chief Justice Taney's doctrine, in Bank of Augusta v.
Earle, 13 Peters 519, asserting an unlimited power of the States over foreign
corporations Paul v Virginia thus belongs to a period not only of uncertainty
about the effect of the commerce clause but also of distrust of foreign corporations. Such corporations, it was assumed, must be held in subjection to state
power Difficulty in so doing would be encountered if their activities were
classified as interstate commerce But the Supreme Court long since has
pushed the development of the commerce clause to such a point that difficulties
of that kind have substantially disappeared. Not only may a State regulate
interstate commerce of local character; it may even regulate that which is
national in character, if Congress permits it so to do
STOCK EXCHANGE PEACTICES
7641
VI THE BESPECTIVE FIELDS} OF ACTION OF THE! NATION AND THE STATES AKE NOT
FIXED BY THE COMMEBOE OLAUSE BUT DEPEND UPON THE WILL OF CONGKESS
As a result of the constitutional doctrine developed around the commerce
clause and in the light of a few additional cases presently to be mentioned, it
may be said that the true significance of the commerce clause is found in
treating it, not as fixing a division of powers between the Nation and the
States, but as investing Congress with the primary powei and responsibility
to do two things, first, to determine, fiom a national estimate of interstate
commerce as a whole, the respective fields of action by the Nation and the
States, and second, to use its4 powers withm the national field for advancing
the general welfare
The second is clearly established and so well known that the citation of
authority is unnecessary. Under the first, however, a greater power than is
commonly understood is ascribed to Congress for the purpose of coordinating
and harmonizing state and national action The discernment by Congress of
national needs and its initiative (as well as its lgenuity) in moving to meet
them by means of the power exercisable undei the commerce clause have produced the vast expansion of federal regulation in part pictured in the ca<k?s cited
herein
But, an aspect of the matter not so frequently noted, Congress has also moved
in the opposite direction when the general interests so required It has restricted the effect of the commerce clause m the furtherance of state action.
Witness, the Wilson Act (sustained In Re Rahrer, 140 U S 545) and the WebbKenyon Act (sustained in Clark Dist Co v Western Md Ry Co, 242 U S
311) to enable the States to deal with the interstate aspects of the prohibition
problem, and the Hat&es-Cooper Act (validity not yet passed on) to enable the
States to deal with interstate traffic in convict-made goods
The truth of the matter is that Congress has the power to expand or contract the area of national action under the commerce clause Over against
this power is set, of course, the function of the Supreme Court to check the
expansion (and possibly also the contraction) ii Congress should become
arbitrary in dealing with the facts and attempt to go too far
The check is a real one But that the lesponsibility is after all upon the
Congress is shown by the fact that in the course of the expansion above indicated only three statutes have been held invalid As fai as two of those
statutes are concerned, it may well be doubted whether they would be held
invalid on de novo proceedings today • The Employers' Liability Cases, 207 U S
463 (holding the federal liability act unconstitutional because it included
employees injured in intrastate commerce) and Adair v Umted States, 208
U S 161 (invalidating the federal statute aimed at so-called yellow-dog contracts)
Cf Texas & N O R Co, v Brotherhood, etc, 281 US 548 Bammei
v Daffenhart, 247, U S 251, generally known as the Child Laboi Case, remains
Whatever may be thought of the soundness of that ca«e and the theory on
which it was decided, it may at least be distinguished on the facts from the
present proposal as well as on the objectives which Congress seeks now to
attain
It will be noted that the foregoing discussion is directed, not to what may
be done in "emergencies", but to the normal powers of Congress But since,
as shown in Part II hereof, the expanded range of Congressional action is
dependent upon fact foundations, there is ample room for the plav of forces
of an emergency character Ineed, an enlarging function of government to
meet new needs is indicated in a passage from the opinion by Mr Chief Justice
Hughes m the recent case sustaining the Minnesota Mortgage Moratorium
Law (Some B <& L Assn v Blaisdell, 54 Sup Ct 231)
Speaking particularly
of the contract clause, but possibly with wider implications, he said (at 239) •
"The policy of protecting contracts against impairment presupposes the
maintenance of a government by virtue of which contractual relations are worth
while,—a government which retains adequate authority to secure the peace and
good order of society This principle of harmonizing the constitutional prohibition with the necessary residuum of state power has had progressive recognition in the decisions of this Court"
In view of the national character of the problem here involved and the
method of solving such problems on the facts, on the basis of the expansion of
power described in this memorandum and on the recognized function of Congress to adjust national and state relationships, it is my opinion that Congress
may establish and maintain its regulatory power over security exchanges It
7642
STOCK EXCHANGE PEACTICES
may go further, though how far it may go in the regulation of related and
collateral activities will depend on the fact foundation laid therefor, in the
hearings and otherwise, and on the considered judgment of Congress concerning
the public needs
•
«
•
*
*
*
•
•
•
Professor Walter Gellhorn, of the Faculty of Law of Columbia University,
joins me in the opinions herein expressed. We have been assisted in the
preparation of this memorandum by Messrs W W Gardner and T E Jenks,
both of the Legislative Drafting Research Fund of Columbia University
NOEL T
DOWLING
N E W YORK, March 28, 198%.
NATIONAL RETAIL D E Y GOODS ASSOCIATION,
WASHINGTON OFFICE,
Washington, D C, March, 29, 1984
Hon
DUNCAN U
FLETCHER,
Chairman Committee on Banking and Currency,
United States Senate, Washington, DC
MY DEAR SENATOR FLETCHER This is a protest against certain of the provisions of H R 8720, a bill " to provide for the regulation of National Securities
Exchanges and of ovei-counter markets operating in interstate and foreign
commerce oi thiough the mails, and to prevent inequitable and unfair practices
thereon, and f oi other purposes "
The President forwarded to the Congress a message calling for the enactment of legislation to regulate stock exchanges to make " certain that abuses
are eliminated ", and the President further said " I therefore recommend to
the Congiess the enactment of legislation providing for the regulation by
the Federal Government of the operations of exchanges dealing in securities
and commodities for the protection of investor®, for the safeguarding of values,
and so far as it may be possible for the elimination of unnecessary, unwise and
destructive speculation "
It has been appaient to all observers that there would be definite proposals
looking toward the regulation of security delalmg on exchanges as the outgrowth of the long investigation by the Senate Banking and Currency Committee of what has been broadly termed " Stock Exchange practices " Upon
the broad principle that specific legislation was required to correct and
endeavor to prevent some of the prior evils, it would seem, there has been
universal recognition that such control was both necessary and expedient. It
can be said that there has been a national feeling that control of stock exchanges was desirable Those who were in accord with the basic idea, however, had a very shocked awakening when the bill was analyzed
The bill provides a control of credit by the Federal Trade Commission where
the credit is based upon securities as collateral loans This feature of the
bill may itself be divided into four distinct parts
1 The maximum percentage that may be loaned on any securities listed on
a stock exchange is statutorily provided for;
2 Another provision is that such loans may only be made by members of
the Federal Reserve system;
3 The prohibiting of loans on all unlisted securities; and
4 The establishment of the Federal Trade Commission as the arbiter of this
credit control
The bill goes directly to the control of corporate accounting and management,
and agavn these provisions may be d&vided into three separate categories •
1 It is provided that corporations whose securities are listed on an exchange
must not only file certain specific information with that exchange upon which
it is listed, but also with the Federal Trade Commission in Washington The
Commission is also given power to request any additional information that it
"may by its lules and regulations require in the public interest or for the
protection of investors"
It has been suggested that the powers given to the Commission are so broad
that it practically sets up the Federal Trade Commission somewhat along the
idea of the war-time " Capital Issues Committee " by providing powers to deny
a lister filing a registration statement the facilities of any exchange, if it be
decided by the Commission that such a listing of an issue was not "in the
public interest and for the protection of investors " In effect this section also
STOCK EXCHANGE PRACTICES
7643
makes the Securities Act of 1983 retroactive for' all listers, and that means
that the majority of our large corpoiations must of necessity file a complete
registration statement in such foim as the Commission may prescribe in
Washington.
It further provides penalties somewhat analagous to those contained in the
Securities Act for misleading statements, unless officers, directors, accountants,
and others can " sustain the burden of proof that they acted m good faith
and, in the exercise of reasonable caie, had no grounds to believe that such
statement was false or misleading."
2. Certain transactions by directors, officers and principal stockholders are
declared unlawful and make violators subject to heavy penalties
That 10 days after the close of each calendar month " if there has been any
change in his (an officei's, directors, etc ) record or beneficial ownership during
such month," in the securities ot a corporation, each officer, director and
principal stockholder holding 5 per cent or more of any class securities of any
issuer "shall file with the exchange and with the Commission a statement
indicating his owneiship at the close of the calendar month"
That if any officer, director or stockholdei owning 5 per cent of any class of
securities of any issuer who " purchased any such registered security with the
intension or expectation of selling the same security withm six months, and
any profit made by such person on any transaction" extending over a penod
of less than six months " shall mure to and be recoverable by the issuer "
It prohibits " any such registered security it the person selling does not own
the security sold, or if the person selling owns the security but does not delivei
it against such sale within 5 days", which means that the bill would piohibit
short selling by officials of any corporation
The requirement is laid down that each security registrant on a national
exchange shall file with the exchange and also with the Commission " in such
torm and such details as the Commission may by rules and regulations prescribe " annual and quarterly reports certified by an independent public accountant, and "monthly reports including among other things a statement of sales
or gross income", and such other reports as the Commission may prescribe
from time to time It is also provided under this section that should an issuer
fail to provide the Commission with such information as may be requested or
laid down in rules and regulations, it will be sufficient justification for the
removal of its secunties from a national exchange "by the exchange or by
the Commission "
3 We also find a provision that when proxies are solicited a list of other
persons being solicited must be sent to those who aie solicited Various corporate officials have demonstrated the folly of such a provision, and it is believed
that this provision will be coirected to provide simply that a list of stockholders
will be rendered to the exchange or the commission, or both.
The whole effect of the bill, if enacted into law without very substantial
change, would be m my opinion to clothe the Fedeial Trade Commission with
such vast powers as to make it not only the most important branch of the
Federal Government, but actually to make it the dictator of the corporate and
financial life of the nation
Those who were actively engaged in the actual writing of the bill disclaim
any hidden motives of social control of industry through the proposed measure,
and scoff at the idea suggested by a great many of our public men that the bill
has such purposes But certainly it goes far beyond what the President
specifically called for in his own words, which was the regulation of exchanges
" for the protection* of investors, for the safeguarding of lvalues, and so far as
it may be possible, for the elimination of unnecessary, unwise and destructive
speculation "
Not a word in the President's message points to any desire on his part to go
beyond the regulation ot national exchanges The bill violates the principles
laid down by experts m their studies of what is actually required to eliminate
the piactices that have been so greatly condemned
The House Interstate and Foreign Commerce Committee and the Senate
Banking and Currency Committee have both held hearings upon the proposed
regulatory measure Before these committees have appeared many of our
business leaders and representatives of the financial community have tried to
indicate the seriousness of the outcome of a measure of the character that has^
been proposed if it were enacted into law
7644
STOCK EXCHANGE PRACTICES
There is no reason why absolute, detailed control of corporate management
should be exercised through the control of the regulation of stock exchanges
The functions of stock exchanges are to piomote reasonable, honest and fair
open markets for the puichase and sale of securities and for the dissemination
of such corporate information as is necessary for the public to have in order
to pass sound judgment upon the securities of listers Beyond that it is neither
fair nor honest to endeavor to rigidly control corporations through the medium
of a proposed stock exchange regulating bill
The agency given such broad powers under these bills is the Federal Trade
Commission. This Commission has never befoie operated in this field unless
it may be said that they have gained certain knowledge of securities through
the administration of the Securities Act This, however, is hardly the type of
experience that is necessary to formulate sound judgment on credit control,
which rightfully falls in the experienced hands of the Federal Reserve Board
with the supplementing assistance of exchanges themselves, who are equipped
to supply much technical information regaiding the loan values that should be
placed upon securities
There should be no setting up of a great bureaucracy in Washington to dictate
every single detail of what a corporation may and may not do, or what sort of
accounting system they may operate under, and all of the other multitudinous
affairs it is proposed to bung under the wing of the Federal Trade Commission.
As I have pieviously pointed out, many executives have appeared before the
committees and given their views, pointing out the far-reaching effect of what
the proposed bill means to every banker, insurance company, corporation and
individual who handle securities, who issue securities or who own secuiities
It must be said, however, that industry geneially is not alive, it would appear,
to the dynamite contained in this proposed bill If this legislation is passed as
written, or even with some of the minor amendments that have been suggested
by the drafters as a peace offering to those who have raised objections, it will
mean that the country will at a future date realize that they not only have an
onerous Securities Act to contend with but also a piece of legislation that goes
far beyond anything heretofoie conceived The statutory powers set out in
this bill in almost every section of the proposal piovide the Federal Trade Commission, heretofoie mainly identified with inquisitorial investigations, with the
power to assume command over each and every corporation having securities
listed on even the smallest exchange, of not only mtoimation to be supplied in
order to keep their secuiities listed, and it is impossible to use unlisted securities as collateral, but also to operate their business in such a way that it
receives the approval of this Commission
The bill also provides for the regulation of tiansactions in all securities other
than those listed on an exchange which may become licensed, that is, where
their sale may involve the use of the mails or any instrumentality of interstate
commerce One must draw upon his imagination or personal experience to
visualize just what this means Many of us have seen to what lengths a Bureau
once established with powers to act may go in the direction of exercising those
powers
It will be seen, therefore, that the bill involves important considerations not
only to the corporations whose stock or othei securities may be listed on some
exchange, but to the securities of all other corporations regardless of their
soundness or character, and certainly every present security holder in the
nation should be genuinely interested.
Objection is not directed to the provisions of this bill dealing with the stock
market regulation except insofar as the provisions of the bill tend to put business or mercantile corporations in a straight jacket and vest in the Federal
Trade Commission or other governmental agencies jurisdiction to dictate
accounting methods and reports, the burdens of which may prove exceedingly
onerous
Respectfully,
NATIONAL RETAIL DRY GOODS ASSOCIATION,
HAROLD R YOUNG,
Washington
Representative.
STOCK-EXCHANGE PBACTICES
TUESDAY, APBIL 3, 1934
UNTIED STATES SENATE,
SUBCOMMITTEE OF THE COMMITTEE ON,
BANKING AND CURRENCY,
Washington, D.C.
The subcommittee met at 10 a.m., pursuant to call, in room 301 of
the Senate Office Building, Senator Duncan U. Fletcher presiding.
Present: Senators Fletcher (chairman), Costigan, Adams, Goldsborough, Townsend, and Couzens.
Present also: Senators Wagner, Byrnes, McAdoo, Walcott, Kean,
and Representative Francis Henry Shoemaker, of Minnesota.
Present also: Ferdinand Pecora, counsel to the committee; Julius
Silver and David Saperstem, associate counsel to the committee,
and Frank J. Meehan, chief statistician to the committee. '
The CHAIRMAN. This hearing is being held before the subcommittee of our Committee on Banking and Currency under the resolutions S. Res. 84, 56, and 9*7. Senator Schall and others have
requested the committee to hear Mr. Backus. He has some important
matter in reference to practices of banks and corporations, as well
as stock dealings, and so forth, to present to the subcommittee, and
we will let him proceed in his own way.
Mr. Backus, if you will stand, hold up your right hand, and be
sworn:
You solemnly swear that you will tell the truth, the whole truth,
and nothing but the truth, regarding the matters now under investigation by the committee, so help you God.
Mr. BACKUS. I
do.
TESTIMONY OF EDWARD W. BACKUS, MINNEAPOLIS, MINN.
The CHAIRMAN. Mr. Backus, what is your name ?
Mr. BACKUS. Edward W. Backus.
The CHAIRMAN. And your address?
Mr. BACKUS. Baker Building, Minneapolis, Minn.
The CHAIRMAN. What is your occupation, Mr. Backus?
Mr. BACKUS. Manufacturer of paper, lumber, and other forest
products.
The CHAIRMAN. HOW long have you been engaged in that business ?
Mr. BACKUS. A little over 50 years.
The CHAIRMAN. NOW, you have, I believe, a prepared statement,
Mr. Backus?
Mr. BACKUS. Yes.
The CHAIRMAN. DO
you want to submit that to the subcommittee ?
7645
7646
STOCK EXCHANGE PBACTICES
Mr. BACKUS. I do.
The CHAIRMAN. YOU
may proceed, then, with that, and we will
ask you questions as we see fit.
Mr. BACKUS. I thank you.
The CHAIRMAN. YOU may just sit down at the table there.
Mr. BACKUS. I should first like to submit a signed copy of my
letter addressed to you under date of March 17,1934.
The CHAIRMAN. All right. The committee reporter will make it
a part of our record.
BACKUS-BROOKS CO ,
MINNEAPOLIS, MINN , March 17, 1984.
Senator DUNCAN U. FLETCHER,
Chairman Senate Committee on Barikmg and Currency,
Senate Office Building, Washington, DC.
MY DEAR SENATOR FLETCHER* Your telegram of February 19 in which you
requested me to appear before your committee on Friday, Febiuary 23, was
duly received.
As it was impossible for me to respond immediately, I sent you the following
telegram:
"Telegram received I am wiring Senator Schall to explain to you the
necessity of asking for later date to appear before your committee and will appreciate your favorable consideration."
My telegram to Senator Schall was as follows:
" Senator Fletcher, chairman Senate Committee on Banking and Cuirency,
has telegraphed me to appear before this committee next Friday the 23rd
This date is practically impossible owing to decision pending in Circuit Court
of Appeals which may demand my immediate attendance in Federal court here
on our receivership matters. Kindly see Senator Fletcher and arrange tor
my appearance before this committee 1 week or 10 days later and greatly
oblige Am wiring Senator Fletcher advising that you will see him and explain
situation."
In reply, Senator Schall telephoned me that tie had conferied with you and
that I should report in Washington as promptly as possible and that your
committee would hear me at its earliest convenience I am now here subject
to your call and will be pleased to appear before the Senate Committee on
Banking and Currency to place in its records a statement of financial recketeermg (as you call it in Liberty of March 17) which has attempted to destroy
the property of thousands of bondholders in the Minnesota & Ontario Paper
Co and the Great Lakes Paper Co, Ltd. About 25,000 had invested in a
great property built up m nearly 50 years of constructive business effort and
with a fuU sense of the social responsibility which ought to underlie all business promotion and the use of natural resources The livelihood of about
7,500 workers and 30,000 dependents is involved
I therefore ask your committee and your counsel, Mr Ferdinand Pecoia, to
consider the methods through which the receivership of the Minnesota & Ontario Paper Co, which was forced in 1931, principally by the officials of the
Chase National Bank of New York and the First National Bank of Boston,
though the Minnesota & Ontario Paper Co was then solvent, the campaign
of the so-called " Bondholders Protective Committee" to depress the values
of bonds to secure their sacrifice, the waste ot capital and resources through
the unwarranted mismanagement of receivers appointed through the insistence
of the Officials of the Chase National Bank and the First National Bank of
Boston; these leceivers having no knowledge of the technical problems of
paper, pulp, and forest products manufacturing, and the persistent injection
of the International Paper & Power Co in the conspiracy to destroy my life's
work The trail of evil doing runs chiefly through officials of the Chase National Bank, First National Bank of Boston, Halsey, Stuart & Co, and Bond
& Goodwin, one of the close affiliates of the First National Bank of Boston,
and the International Paper & Power Co
It might be argued by the public, under ordinary circumstances, that your
committee should not be expected to take up the troubles of any particular
organization, to follow the trail of any wrong that has been done to it by
bankers working in harmony with the rivals4 or competitors of such an organization, yet what the Minnesota & Ontario Paper Co. has suffered is a perfect
STOCK EXCHANGE PBACTICES
7647
illustration of the greed, double crossing, and willful penetration and meddling
of banks into all lines of manufactuie, which your committee has under the
cross-questionmg of counsel and more paiticularly m recent months through
Mr Ferdinand Pecora, so fearlessly proved m the hearings from 1932 up to
the present
It will, therefore, give me pleasure to appear before your committee I shall
come prepared with a foimal statement, but I shall welcome cross-questioning,
for I have nothing to conceal in over 50 years of participation in the development of the Northwest.
Through your various articles published in the press, an immense service has
and can be done by showing how the bankers have exploited the public and
how helpless the holders of securities have been.
Permit me in closing to quote from an issue of the New Republic (Jan 3,
1934) •
"Reorganization of bankrupt or embarrassed corpoiations have been a scandal for many years The practice has been almost uniform As soon as a laige
corporation falls upon default, the bankers and insiders, who almost mvariablv have been responsible for the disaster, rush upon the prostrate carcass
and assume possession of it This they do, first, by getting their representatives named as receivers, and second, by oiganizmg protective committees of
stockholders and bondholders These protective committees ostensibly keep an
eye on the special interests of their respective groups of security holders
They exercise what in practice is more important, a controlling influence over
the reorganization of the corporation And as it is the reorganization of the
corporation m which the promoters and bankers and insiders are chiefly interested, it is a matter of great importance to them to capture the control
of these committees Anyone who wants to know what grave abuses, what
serious infractions of the simple law of trust, have been practiced by such
committees has only to read Mr Lowenthal's book "<
I can substantiate every point as to the practices that would have destroyed
us, except for your decision to hear us.
Very respectfully your,
E W BACKUS, President
The CHAIRMAN. YOU may proceed, Mr. Backus.
Mr. BACKUS. Supplementing my letter to your chairman, dated
March 17, I ask that the following statement be made part of your
records.
Pioneering Development of Northwest Resources: The Minnesota
& Ontario Paper Co. represents, in a large measure, the consummation of a constructive and well-laid plan by Backus-Brooks Co. conceived over 25 years ago to coordinate its forest products and hydroelectric properties into one operating unit and under one management. These properties had been acquired and developed, wholly
or m part, during the previous 25 years. To carry out this plan the
Minnesota & Ontario Paper Co. was duly incorporated m 1908 as
the operating organization which took over certain of these properties.
The plan also provided that from time to time additional forest
products and hydroelectric properties of Backus-Brooks Co. would
be taken over and coordinated with this organization, as and when
developed by Backus-Brooks Co. Prior to the year 1931 this company had developed several of its latent properties which from time
to time had been taken over by the Minnesota & Ontario Paper Co.
However, at the time of the Minnesota & Ontario Paper Co's receivership on February 28, 1931, one of the largest properties, and
the most recently developed by Backus-Brooks Co., namely, Great
Lakes Paper Co., Ltd., was in the process of being coordinated with
the Minnesota & Ontario Paper Co., but the receivership prevented
its final, legal consummation.
175541—34—PT 16
16
7648
STOCK EXCHANGE PEACTICES
At that time these properties had been developed, organized, and
were in profitable operation. In the year 1930, during which period
the business depression was keenly manifest, the net earnings of
Minnesota & Ontario Paper Co. (including Great Lakes Paper
Co., Ltd., which for all practical purposes was then assumed by both
companies to have been coordinated, after all charges, were substantially in excess of $1,000,000, in face of the fact that the combined
operations were at less than 50 percent of capacity. In years of
ordinary business conditions, when operating at capacity, minimum
net profits after all charges should be $6,000,000 and in prosperous
years $10,000,000 to $12,000,000.
Outstanding business structure: At that point the Minnesota &
Ontario Paper Co. and subsidiaries (including Great Lakes Paper
Co., Ltd.) had attained a poition as one of the largest organizations
of its kind in the world. Thus from a very meager beginning these
vast properties were acquired and had been developed through my
initiative and efforts covering nearly half a century, during all of
which time the active executive management was vested in me and
represented my entire life's work. The locations of these operations
are strategic from every essential standpoint; namely, natural resources, logical markets, ample provisions for further expansion, and
perpetual operation. My whole purpose and ambition was to create,
operate, retain practically the entire earnings in the business, and
build a sound, creditable, and permanent structure.
At the time of the receivership, namely, February 28, 1931, the
amount of outstanding bonds were as follows: Minnesota & Ontario
Paper Co., $24,400,000; Great Lakes Paper Co., Ltd., $10,000,000.
Several expert independent appraisers in 1930 valued these properties at a minimum of $100,000,000.
Approximately 95 percent of the combined common and preferred
stock in these companies was owned directly and indirectly by me
and my close associates, our accumulated earnings having gone into
these properties. The first-mortgage bonds of these companies then
outstanding had been purchased by our fiscal agents when issued
and were widely distributed to some 25,000 holders
The financial crash came in 1929, and I advised with several of
our company's commercial bankers early in 1930 respecting their
views on future economic conditions. The concensus of their opinion
was that the worst was over and that conditions would gradually
improve; that any expansion of plants and properties that had been
planned could be proceeded with in the regular course of business
with entire confidence. On the strength of this encouragement our
companies proceeded to carry out their plans previously made, and
expended approximately $3,000,000 on same during the year 1930.
Not the slightest thought was harbored respecting any possible default in outstanding obligations. Our companies enjoyed the highest credit standing, without the use of collateral, and our commitments had always been promptly met.
Mr. PECORA. Mr. Backus, might I interrupt you right there for
a moment to ask a question?
Mr. BACKUS. Certainly.
Mr. PECORA. Who were the commercial bankers with whom you
met and conferred as you say early in 1930?
STOCK EXCHANGE PRACTICES
7649
Mr. BACKUS. The Chase National Bank, the Northwestern National Bank of Minneapolis, the Continental National Bank of
Chicago, and two or three of the others.
The CHAIRMAN. Who, connected with the Chase National Bank,
did you confer with?
Mr. BACKUS. With Mr. A. H. Wiggin, chairman of the executive
committee.
Mr. PECORA* Chairman of the governing board was his title, Mr.
Backus.
Mr. BACKUS. Yes.
The CHAIRMAN. YOU may proceed, Mr. Backus.
Mr. BACKUS. Anticipating obligations: In the
early summer of
1930 I began to anticipate making provisions for our funded obligations maturing in 1931. I took the matter up with our fiscal agents,
Halsey, Stuart & Co., of Chicago, who then assured me that these
obligations would be provided for at the proper time, but that it
was then too early to give the matter consideration.
In the fall of 1930 several conferences were held with this fiscal
agent in reference to meeting these maturities and alternate plans
were discussed. However, they finally advised me that owing to the
unsatisfactory bond market at that time, I should arrange with our
company's commercial bankers to carry the additional $9,000,000 of
first-mortgage bonds which we had agreed with them to issue, until
they could be sold. I followed this suggestion, and as a result
secured the pledges of our bankers and fiscal agents to do this.
With this assurance I caused the Minnesota & Ontario Paper Co.
to register its mortgage for $9,000,000, which was filed in February
1931, and to issue $9,000,000 of series D, first-mortgage bonds which
were delivered to the trustee, namely, the Minnesota Loan and Trust
Co., of Minneapolis,
for certification as per agreement.
Bankers5 pledges broken: Shortly before the middle of February
1931, I discussed these matters in detail with Mr. A. H. Wiggin
of the Chase National Bank, and was definitely assured by him that
the above plan would be carried through; and further, that if there
should be any failure on the part of any of the several banks to
keep their promises, the Chase National Bank would make good
any such deficit by increasing its quota to insure that the plan would
be consummated as agreed, and he firmly reiterated this assurance.
By appointment I met our fiscal agents and our several commercial bankers in New York on February 26, 1931. At that meeting,
in addition to our fiscal agents, there were present among the others,
representatives of the Chase National Bank; the First National
Bank of Boston, and the National Shawmut Bank of Boston. However, Mr. Wiggin was absent, having gone south on his vacation.
This meeting was held at the offices of the Chase National Bank, in
New York, where a formal agreement, covering the promises already made, was to be concluded, and the funds for liquidating the
early funded maturities were to be credited to the company's account
in the various banks involved. At this preliminary meeting these
bankers promised to have an agreement prepared and in readiness
the day following, which was to embody the promises and agreements previously made. When I arrived at the Chase Bank the
7650
STOCK EXCHANGE PRACTICES
following day, February 27, 1931, at the appointed time, I found
these bankers and fiscal agents m private conference discussing our
affairs, and was requested to wait outside.
Solvency disregarded: Later in the day they came to me and informed me that they had decided not to carry out the pledges and
agreements previously made and that a receivership was the only
solution. They then inquired how much cash the company had
on hand, and further, whether, in my opinion, in case the receivership plan was adopted, one third of the $9,000,000 previously agreed
to and promised, would be sufficient to take care of the company's
needs and permit operations to continue without sacrificing any assets. The announcement was a terrific shock to me, but I finally replied that, in case of a receivership, $3,000,000 would take care of
the company's ordinary needs. I also informed them that the company then had on hand over $1,100,000 in cash, on deposit with its
several commercial banks.
Evidently to lessen the force of the blow, they then stated, among
other things, that if I would turn over to them the cash on deposit
m each of their respective banks, to apply on the company's notes
they then held, and consent to the receivership, they would have me
appointed sole receiver for the company and provide $3,000,000 for
the company's use, and allow me to work out the company's affairs.
Also that they would advance forthwith $500,000 for the Minnesota
& Ontario Paper Co. on receiver's certificates, to enable the company
to carry on; and later provide the balance of the $3,000,000 as and
when required. Also to advance forthwith $125,000 for the Great
Lakes Paper Co, Ltd., with which to carry on (which latter amount
was liquidated within 4 months). All of this was predicated on my
turning over to them the amount of cash then on deposit in each
of their banks, totaling as aforesaid over $1,100,000.
I protested putting the company into receivership and stated that
such action was entirely unwarranted, even under the then existing
economic conditions. However, in view of the fact that over $4,000,000 of funded indebtedness, including interest, would mature 3 days
later, I had no alternative, and under duress was forced to accept
their ultimatum.
The receivership followed the next day, February 28,1931. I was
appointed receiver. The court also appointed Mr. E. W. Decker,
president of the Northwestern National Bank, of Minneapolis, and
Mr. C. R. Fowler, a local attorney, as coreceivers. These bankers
had been the bankers of our companies for many years. Our relations had always been most cordial. I had agreed to their demands
respecting the receivership of the Minnesota & Ontario Paper Co.—
under protest, to be sure—but in the utmost good faith and confidence in them. I relied implicitly upon their promises that I would
be undisturbed as receiver and allowed to reestablish the financial
standing of the company, which I knew I could do. I had every
reason to believe that they had the fullest confidence in me, in my
ability and integrity, which during the long period of our business
dealings they had never had occasion to question.
I feel it is pertinent to state here that I had the fullest confidence
in the soundness of our company's financial structure and worth.
Also that I placed complete reliance m the promises of our bankers
STOCK EXCHANGE PRACTICES
7651
and fiscal agents, to provide the funds with which to meet our company's maturing obligations. As proof of this, Backus-Brooks Co.
and myself made a loan of $500,000 from the Continental National
Bank & Trust Co., of Chicago, only a short time before the bankers'
meeting on February 28, 1381, and turned the proceeds over to the
Minnesota & Ontario Paper Co. to enable it to meet maturing notes
payable pending the said bankers' meeting.
In order to secure this loan I was compelled to pledge as security
the only personal bankable collateral I owned, namely, 12,000 shares
of Northwest Bancorporation stock valued at $900,000, Which was
to be returned to me after the proposed meeting with the bankers
in New York when the promised financing was to be completed and
Minnesota & Ontario Paper Co. bonds substituted for this personal
stock. Through the failure of the financing plan this was not done,
and later my bank stock was sold for $276,000. This was my first
experience in financing the business of my companies when collateral
was required.
Bond values vitiated: However, in a comparatively short time
it became apparent that there was a marked change in the attitude
of these bankers, which indicated that they might not keep their
promises made to me and that their selfish purpose might be to
undermine the company's structure to the detriment of its many
thousands of widely scattered and helpless bondholders. Their first
move which indicated this purpose was the designation of a bank
controlled so-called " Bondholders' Protective Committee" (which
protected none but themselves), composed as follows: Two members
and the secretary are employees of Halsey, Stuart & Co., investment
bankers of Chicago; one member each is respectively an employee
of the First National Bank, of Chicago; Brown Bros., Harriman &
Co., of New York; Bond & Goodwin, investment bankers of Boston
and New York; and one associated with Minnesota Loan & Trust
Co., of Minneapolis. And one, since resigned, and which vacancy
was filled by a successor of unknown affiliation to me, of Toronto,
Canada. They were securities salesmen, having no knowledge whatever of the diversified problems involved in the operations of our
immense estate and therefore totally incompetent to serve in such
capacity, as their disastrous administration has proven.
Graustem's attempt at bribery: Their next move, as has been
brought to light by subsequent events, was the planning of a conference by Mr. Archibald R. Graustem, president of International
Paper & Power Co., of New York, between myself and my coreceivers and the executives of that company, the principal rival of
our company, for the purpose of negotiating the taking over of the
properties of the Minnesota & Ontario Paper Co. and Great Lakes
Paper Co., Ltd., by that company. That conference was held in the
early summer of 1931 at the Drake Hotel, Chicago, and accomplished
no results. Briefly, it was obvious that they did not intend to take
over our properties excepting at a fraction of their real value, to be
fixed arbitrarily by themselves.
When the conference was about to disband, Mr. Graustein expressed a wish to have a private conference with me, to which I assented. At that conference Mr. Graustein made me the following
proposition, namely: That I should exchange approximately 95 per
7652
STOCK EXCHANGE PRACTICES
cent of the combined issued and outstanding common and preferred
stock of Minnesota & Ontario Paper Co. and Great Lakes Paper Co.,
Ltd., owned directly and indirectly by myself and close associates,
for 750,000 shares of common stock in the International Paper &
Power Co. They, in turn, would then purchase from me 50,000
shares of said International Paper & Power Co. stock at $100 per
share, or for $5,000,000 in cash. The result of that transaction when
made would have been that I would still own 700,000 shares of
International Paper & Power Co. stock and would have received
$5,000,000 in cash.
Further, that in that event I would be made a high official in the
International Paper & Power Co. and would have been required to
cooperate with Mr. Graustem in making the best settlement possible
with the bondholders and creditors of the Minnesota & Ontario
Paper Co. and the Great Lakes Paper Co., Ltd., in the interest of the
International Paper & Power Co.
I declined his offer then and would decline it now if it were renewed, for the fundamental reason that during all of my business
career I have enjoyed the highest credit standing and have had the
fullest confidence of all those with whom I have had business relations. I would not put myself in a position where I could not protect
our many thousands of bondholders, funded noteholders, general
creditors, and minority stockholders. I feared they might suffer
under the proposed change in ownership. Further, the proposed
exchange was unfair from a value standpoint.
Mr. PECQRA. TO whom would the exchange you refer to that was
proposed have been unfair I
Mr. BACKUS. DO you mean unfair from a value standpoint?
Mr. PECORA. Yes. To whom do you mean it would have been
unfair ?
Mr. BACKUS. TO myself and close associates.
Mr. PECORA. And to the other holders of the securities issued by
your companies ?
Mr. BACKUS. Yes; the 95 percent of stock in both companies.
Mr. PECORA. All right.
The CHAIRMAN. YOU may resume your statement.
Mr. BACKUS. Wiggin, Chase, and Graustem in plot: Later on in
the summer of 1931 this conference was followed by another held
at the Chase National Bank in New York City, which conference
was attended by Mr. Graustein and his bankers, Mr. A. H. Wiggin
and Mr. Malcolm Chase. It was there again apparent to me, as
it had been since 1925, that these interests were determined to
secure our properties regardless of the methods necessary to be
employed to achieve that objective. This meeting disbanded without having accomplished any results other than it was arranged
that certain officials of the International Paper & Power Co. would
visit and inspect our properties, after which the negotiations would
be resumed. This inspection trip was made, but thereafter I was
ignored and all negotiations were deliberately kept from me. Matters then stood in abeyance until after the New York and Boston
bankers and bank-controlled so-called "Bondholders' Protective
Committee " had succeeded m removing me as a receiver.
I t was at this point that these eastern banks and bank-controlled
so-called " Bondholders' Protective Committee " began demanding
STOCK EXCHANGE PRACTICES
7653
my resignation. They could give me no reason for this, as I had
managed the affairs well, and they so admitted. They, however,
were determined to eliminate me from any participation in the company's affairs. Their motive could only have been that they realized
that the widely scattered 25,000 bondholders would then be an easy
prey.
There would then be no one to protect their interests and prevent
these most valuable properties from being practically confiscated
through the purchase of bonds from the widely scattered bondholders at their own convenient time and at their own price. Their
selfish purpose here began to manifest itself clearly. The deposit
agreement of the so-called "bondholders' protective committee"
was of the venomous " air-tight, ironclad " type, which conveyed
title to the bonds to the bondholders' protective committee. By
that time more than a majority of the bonds had been deposited.
That placed them in complete control of the bondholders' interest in
the estate. It put them in position to manipulate and depress the
unlisted market prices of the bonds so they could be purchased from
distressed holders at distressed prices. They planned to completely
wipe out the equity. They were determined to eliminate me, fearing
I would obstruct their plans. Therefore only a comparatively short
time elapsed before I was forced to resign, likewise my coreceivers,
Receivers ignorant and impotent: I had remained as operating receiver for 9 months and during that period, in the normal course of
business, I accumulated and had on deposit in the Northwestern
National Bank of Minneapolis a cash balance of over $2,000,000
(including $500,000 which the bankers had provided immediately
following the receivership), without sacrificing any of the current
assets or from the sale of any of the capital assets of the estate.
Messrs. E. H. M. Robinson and C. T. Jaffray were appointed
as receivers on November 30, 1931 Mr. Robinson was a former
employee of Mr. Harnman of Brown Brothers, Harnman & Co.,
New York bankers, and his affiliated interests; Mr. C. T. Jaffray
is president of the First National Bank of Minneapolis and of
the Soo Line Railway. Both were totally lacking in any qualification which justified them m attempting to manage our huge and
varied estate, and much less in meriting their excessive fees as
fixed by the court at the request of the so-called "bondholders'
protective committee", hereinafter referred to. However, I was
assured that I would be retained in the service of the estate and be
associated with the new receivers in an advisory capacity, and therefore, felt in that way I would be able to prevent mismanagement,
waste, and sacrifice of assets. Otherwise, under no circumstances
would I have resigned. I had a right to rely on the court, administering the estate, for reasonable cooperation in protecting it from
dissipation and waste, but got none. In fact Judge Molyneaux
apparently found satisfaction in vetoing all of my advice and
warnings.
At the time of their appointment, I turned over to them the
company's cash bank balance of over $2,000,000. Receiver Robinson assumed dictatorial control from the outset. He ignorantly
attempted to reorganize all departments in our various lines of
business without any knowledge of the personnel. He delegated
7654
STOCK EXCHANGE PRACTICES
the management of most departments to totally incompetent heads,
most of whom had previously had my constant guidance. He attempted to create a personal organization loyal to himself and hostile to me. His staff was not allowed to confer with me.
In short, his appointment as receiver was designed by the New
York and Boston bankers and the bank-controlled so-called " bondholders' protective committee " for the real purpose of removing me
from any association with the company as quickly as possible, and
thereby prevent me, with my personal knowledge and experience,
from protecting the interests of the company and its investors.
DELIBERATE RACKETEERING BEGUN
Then began a most deplorable campaign of mismanagement, extravagance, waste, and sacrifice of cash and other assets, which has
continued up to and is continuing at the present time. Already their
losses aggregate over $12,000,000. The receiver's last report, dated
December 31, 1933, admits a net loss in current assets alone of
$5,968,447.29. To this loss should be added the increase in current
assets, during their administration, by the liquidation of capital
assets not heretofore included in that item, but which are now automatically reflected in the current assets through cash received from
capital sales. This would automatically increase the loss to approximately $7,500,000 in current assets. The present receivers have
liquidated the cream of our quick assets, at sacrifice prices, leaving
the remaining current assets of less realizable value than stated in
said report, thereby still further increasing the loss in that item.
Further, the said receiver's report also admits a loss in total assets
of $14,510,889.26, all in the short period of 25 months.
The items of waste, extravagance, mismanagement, and dissipation of assets which I allege, are as follows:
(1) Amounts paid for receiver's fees, attorneys' fees, and expenses
during the receivership period, $700,000.
This exorbitant item includes the unjustifiable fees paid to Receiver Robinson, namely, at the rate of $70,000 per annum for the
first 13 months of his incumbency, with a reduction of only 10
percent, or at the rate of $63,000 per annum during the succeeding
period up to the present time; and to Receiver Jaffray at the rate
of $30,000 per annum for the first 13 months with no appreciable
compensating service to the estate, and at the rate of $10,000 per
annum for the succeeding period. In the receivers' report of December 31, 1933, the statements concerning these fees are erroneous
and intended to becloud the true facts and deceive the bondholders,
This item also includes the exorbitant and unjustifiable fees paid
to attorneys, and all expenses during the full receivership period
including previous receiver's fees. All of which were presented to
the court by Receiver Robinson and Jaffray and allowed by him
during my absence from the city, contrary to their assurance to me
that this would not be done.
Therefore, in this respect also the report of December 31, 1933,
is intended to deceive the bondholders. In fact, in this report of
the receivers they attempt to deny all the losses I allege, making up
the stupendous total of over $12,000,000. In some instances it is
STOCK EXCHANGE PKACTICES
7655
willful misrepresentation of the facts, in some it may be ignorance.
Nevertheless, the denials are intended as a smoke screen to cover up
the flagrant mismanagement of the receivers, which I can substantiate by the receivers' records.
(2) Unnecessary compromising of accounts receivable which could
have been collected in full (in this item an account of International
Paper Co. for $175,000 was settled for $50,000, or a loss of $125,000),
$570,000.
(3) Unjustifiable cash expenditure in National Pole & Treating
Co. refinancing, $525,000.
The above cash items total $1,795,000, which were unnecessarily
and unwisely expended or compromised. In addition are the following stupendous losses:
(1) Operating loss due to mismanagement and ill-conceived operating policies and excessive overhead expenditures, $1,095,000.
(2) Investment loss on sale of Memphis Commercial Appeal (a
morning, evening, and Sunday newspaper of high standing published
at Memphis, Teiin., wholly owned and constituting part of the assets
of the said Minnesota & Ontario Paper Co.) as appears by receiver's
report dated September 30, 1933, $1,718,570.96.
Our equity in this property was conservatively appraised at over
$3,000,000. Our cash investment was approximately $2,700,000.
Sold by receivers for $962,000 of which $300,000 has been paid in
cash and balance in deferred payments covering several years with
no guaranty of future payments. The receivers have delivered the
entire capital stock to purchaser. During my period of receivership
this publication was operated profitably, but under the mismanagement of Receivers Robinson and Jaffray it promptly dropped into
the losing class along with all other departments under their management. (An appeal has been taken to the circuit court of appeals.)
(3) Loss due to inefficient supervision and management of logging
operations of International Lumber Co. (a wholly owned Minnesota
& Ontario Paper Co. subsidiary) together with losses sustained by
reason of sale of lumber at cut prices and losses occasioned by the
wholly unwarranted and astounding voluntary destruction by fire
of a vast store of merchantable pulpwood and the intentional burning down of valuable and necessary camp buildings—mismanagement and ignorance, $1,559,000.
(4) Losses estimated if contracts entered into by receivers are
fully performed by Minnesota Forest Products Co. (a wholly owned
Minnesota & Ontario Paper Co. subsidiary) with Northwestern Paper Co. (a competitive Weyerhauser company) for the exchange of
timber located in Cook County, Minn.; for cancelation without
payment of the account of $90,000 owing by Northwestern Paper
Co. to Minnesota Forest Products Co.; contract for sale of Minnesota Forest Products Co. timber to Consolidated Water Power &
Paper Co.; and proposed contract for sale of Minnesota Forest Products Co. to United States Forestry Depaitment; and loss resulting
from receivers' failure to cut timber on Isle Royale, which timber
was deteriorating on account of insect infection; total gross loss on
account of willful surrender of property and ignorant mismanagement, $1,480,000. (Appeal taken to circuit court of appeals respecting timber sales.)
7656
STOCK EXCHANGE PRACTICES
(5) Loss to National Pole & Treating Co. (a 90 percent owned
Minnesota & Ontario Paper Co. subsidiary) due to unsound and
wholly unwarranted refinancing; operating loss during present receivership ; and unwarranted cut in inventory, $1,675,000. This large
loss is positively unpardonable.
(6) Unnecessary and unjustifiable capital expenditure in paper
mills and subsidiary properties, including loss in manufacturing operations of paper specialties and including loss in burning sawmill
materials, $750,000. This loss displays total ignorance.
(7) Losses estimated incurred through receivers joining a combination in restraint of trade, restricting newsprint paper output,
which has resulted in a huge loss in sales of newsprint paper, which
combination at the time was in contravention to Federal law and
opposed to the best interests of the estate and bondholders, $1,250,000. This loss borders on criminal conspiracy which no competent
court could permit.
(8) Lapsing of timber permits held by International Lumber Co.
(a Minnesota & Ontario Paper Co. subsidiary) without cutting
timber thereon before expiration of permits, and sacrifice sales of
timber, $95,000. Total ignorance of values.
(9) Loss to estate on account of surrender of newsprint tonnage
to Great Lakes Paper Co. and of commissions, $595,000. At this
time both companies were in receivership and legally dissolved.
These losses total the stupendous sum of $12 012,570.96. I protested vigorously the confirmation of four of the principal items
making up this loss. The items protested are as follows: Concessions made to Great Lakes Paper Co., Ltd., now in receivership;
compromise of accounts receivable; sale of Memphis Commercial
Appeal property; sale of Minnesota Forest Products Co. timber.
In the last two mentioned protests appeals have been taken to the
circuit court from the order of the district judge confirming the
receivers' sales.
With the passing of time it became necessary vto protest the acts
of the receivers more vigorously but to no avail. Mr. Robinson
stated repeatedly to the court in my presence, and to me, that he
had the approval of the so-called "bondholders' protective committee " in respect to all the transactions I protested from time to
time. This fact, therefore, involved that committee in the dissipation of assets jointly with the receivers and the court.
LIEELOUS PERSONAL ATTACKS
My watchfulness over the interest of our many thousands of bondholders, various equity holders, and other investors exasperated
Eeceiver Robinson and the conspiring bankers and bank-controlled
so-called " bondholders' protective committee" until the friction
finally climaxed in a suit brought by the receivers against BackusBrooks Co. and myself to recover approximately $7,000,000, claimed
to have been abstracted by us from the business for our own personal ends. A baser and more groundless charge was never preferred against any man. A short time previously these conspiring
eastern bankers—namely, the Chase National Bank, of New York;
the First National Bank of Boston; and National Shawmut Bank,
STOCK EXCHANGE PEACTICES
7657
of Boston—had brought suit against me for approximately $2,500,000 to enforce payment on my endorsement of Minnesota & Ontario
Paper Co. notes, in violation of their agreement on February 27,
1931, preceding the receivership. As an indication of their animus,
the receivers moved my desk and furniture from the company's office
during the night, without notice to me.
INTIMIDATION OF BONDHOLDERS
In the receivers' report to the court, dated October 31, 1933, this
$7,000,000 suit against Backus-Brooks Co. and myself was conspicuously referred to. The so-called " bondholders' protective committee" emphasized the incident in its letter dated November 17,
1933, to all bondholders, creditors, and the financial world in general.
This blow, namely, the suits mentioned above, and the wide publicity which followed, was intended to put the finishing touches to
my complete elimination and destruction and leave the path clear
and unobstructed to exploit our many thousands of bondholders.
The final step in the tragedy was nearmg completion. I was their
only obstacle and, therefore, must be effectively discredited in the
eyes of the bondholders, through whose helpless condition, these
banks and their coconspirators saw the sure and easy way to their
objective. The lawsuits brought against Backus-Brooks Co. and
myself, as related above, by the conspiring New York and Boston
banks and the receivers, then removed all previous disguise and
brought them into the open. They well knew they would realize no
money recovery even if they should secure judgment, for they knew
we had no funds. I repeat—their purpose was my final destruction
and elimination. Now, and henceforth, they must fight in the open,
for I refuse to be eliminated.
My answer to the receivers' suit discloses the true facts, namely,
that the receivers had no claim whatever against Backus-Brooks Co.
and myself, but on the contrary that we had substantial claims
against the company, which we had intended to satisfy by accepting
additional stock.
I have also answered these false charges in a libel suit for damages
in the sum of $2,000,000 and have challenged them to prove their
untrue charges before an independent and unbiased tribunal. I have
also brought suit for the removal of Receivers Robinson & Jaffray
on the grounds of inefficiency, incompetency, and maladministration.
Following the events recited in the three preceding paragraphs I
demanded from the so-called " bondholders' protective committee "
a correct list of all present bondholders—giving names and addresses—both of bonds deposited and bonds not deposited. This
they refused to give me. The reason for their refusal is obviously
significant. My only recourse then was to secure a list of such bondholders as the Federal revenue department was able to provide, which
proved incomplete. To this incomplete list of bondholders I issued
a letter of warning dated January 5, 1934, with accompanying
pamphlet giving greater detail, both of which I offer with your
approval for this record.
The CHAIRMAN. Let them be entered.
(Letter dated Minneapolis, Minn., Jan. 5, 1934, addressed to the
bondholders of the Minnesota & Ontario Paper Co. and signed by
7658
STOCK EXCHANGE PBACTICES
E. W. Backus, with accompanying pamphlet referred to and submitted by the witness, will be found printed in full at the end of
today's transcript.)
Mr. BACKUS. This brought to a partial halt the rapidly developing
plans of these plotting conspirators. Bringing them into the open
caused consternation in their camp and now they have changed their
tactics. On March 17, just past, they brought suit in foreclosure
proceedings under the terms of the mortgage, anticipating m that
process the wiping out of the stockholders' equity, and in so doing
to promptly eliminate me.
FABULOUS STAKE OF CONSPIRATORS
Now let us consider what these investment bankers have already
been paid by our companies in commissions and management fees.
Then let us review the future stake which is their objective.
Halsey, Stuart & Co.—and members of their underwriting syndicate—several of whom are now represented on the so-called " Bondholders' Protective Committee "—sold the following securities for
these companies:
Minnesota & Ontario Paper Co :
First-mortgage bonds
Gold notes
National Pole & Treating Co, gold notes
Great Lakes Paper Co., Ltd, first-mortgage bonds
$25,000,000
5,000,000
2,000,000*
10,000,000
42,000,000
Average commission and interest payment charge, 5% percent
Management fee for refunding National Pole & Treating Co
Total fees paid Halsey, Stuart & Co
Senator KEAN. What do you mean by
2,415,000
100,000
2,515,000
" average commission and
interest payment"?
Mr. BACKUS. I mean the average rate of discount on the bonds and
the interest collection charge that we paid.
Senator KEAN". What do you mean by the interest charge?
Mr. BACKUS. The interest was payable at their offices and they
made a charge for collecting.
Senator KEAN. YOU mean that the interest was payable at their
offices, but you do not say how much they charged you for making
the issue.
Mr. BACKUS. NO ; I just figured that the average was 5% percent,
discount on bonds and collection charge.
Senator KEAN. But the collection charge was a recurring charge
for services each year?
Mr. BACKUS. Yes, sir.
[Representative SHOEMAKER
This does not include the interest on
the bonds; this is just the commission they got for collecting it.
Senator KEAN. I understand that But the point is that I wanted
to know what they charged for the $42,000,000.
Mr. BACKUS. For distributing the bonds ?
Senator KEAN. They bought the bonds from you ?
Mr. BACKUS. Yes.
STOCK EXCHANGE PEACTICES
7659
Senator KEAN. And then they formed a syndicate to sell them?
Mr
BACKUS. Yes.
Senator KEAN. At what price did they buy the bonds from you?
Mr. BACKUS. They bought the bonds at an average of slightly
over 94
Senator KEAN. What were the bonds ?
Mr. BACKUS. Six's.
Now, what is the objective ? The stakes they are greedily reaching
for respecting only Minnesota & Ontario Paper Co., namely:
So-called "Bondholders Protective Committee", 5-percent fee on
deposited bonds, $20,968,700, at 5 percent
$1,048,534
Estimated reorganization management fee—
1,000,000
Total
2,048,534
(The foregoing two items of estimated cost could be accomplished
tor not to exceed $50,000 by the company's own organization.)
Through the unlisted market manipulation of these conspirators,
viz, the New York and Boston banks heretofore named; the latter's
close affiliate, Bond & Goodwin, whose representative is a member of
the so-called "bondholders protective committee"; the bank controlled so-called "bondholders protective committee" and its affiliated investment bankers; aided by deliberate or ignorant mismanagement on the part of the receivers, the price of these bonds has been
depressed to the low point of $3 25 per hundred dollars. They and
their affiliates have accumulated the bonds of the companies, mostly
under cover, in face value totaling several millions of dollars, averaging between $10 and $15 per hundred dollars. Their objective has
been to finally secure the entire outstanding issue at an average price
of approximately $200 for each $1,000 bond; then to foreclose the
mortgage and virtually confiscate this enormous estate for approximately $5,000,000 plus commissions and minor expenses. A conservative valuation of Minnesota & Ontario Paper Co. properties—
exclusive of Great Lakes Paper Co., Ltd.—would be not less than
$75,000,000 under normal conditions. Accordingly, if this conspiracy
should succeed, the huge $70,000,000 steal will be shared by the scheming banks; their bank controlled so-called " bondholders protective
committee " and their affiliated investment bankers; the bank-dominated International Paper & Power Co, and lastly Receiver Robinson (the last named in the way of continuing compensation).
BRIEF SUMMARY
The foregoing statement portrays the status of this outstanding
business structure at the date of the receivership, February 28, 1931,
the upbuilding of which covered nearly 50 years of constant, intensive effort on my part, during which period much pioneering was
necessary and much hardship encountered. I built several hundred
miles of standard-gage railroad and branches; opened up several
million acres of Federal and State lands theretofore inaccessible for
agriculture or business purposes, which has produced many millions
of dollars for them through sales and taxes. I encountered powerful opposition from competitive interests. I created a huge varied
forest products organization and operated same profitably up to the
7660
STOCK EXCHANGE PEACTICES
date of the receivership. Joseph W. Molyneaux, presiding Federal
district judge at Minneapolis, Minn., in granting the receivership of
Minnesota & Ontario Paper Co., adjudged and decreed that the defendant company was solvent on February 28, 1931.
The foregoing statement also portrays its present status; the deplorable mismanagement and huge unwarranted losses; the conspiring bankers' unpardonable violation of their prereceiver promises;
and finally the envious greed of the aforesaid conspirators to virtually confiscate the entire estate.
The foregoing statement also portrays the final chapter in the conspiracy and the objective of the plotting conspirators named. They
are greedily looking to their own interests, not those of the investors
or equity owners. If they can crush and destroy the latter they are
improving their own condition and that of the heavier debtor and
our company'^ mam competitor, the International Paper & Power
Co. If they can continue to force the distressed and discouraged
bondholders to liquidate at a mere fraction of the actual worth, they
will have accomplished their end through the ruthless sacrifice of
bondholders and other unprotected interests, including stockholders.
That is what has been going on for many months and is still
going on in devious ways. The original bondholders are the first victims for sacrifice; after that has been accomplished, the problem of
confiscating all junior equities is simple.
Obviously, if this conspiracy is successful, I will stand stripped of
my equity; likewise my close associates and minority stockholders.
I have no resources other than my stock interest in these companies.
In protecting all interests and defending this unjustifiable litigation,
we are forced to undergo heavy expense.
As previously stated, this litigation against me is not in anticipation of financial recovery but solely for the purpose of assuring the
destruction of my personal, commercial, and moral standing, which
in turn is intended to remove my protection of unprotected investors
in our company and leave them to the willful destruction of these
financial racketeers operating under the cover of the law.
APPEAL TO FEDERAL POWERS FOR SUCCOR
Finally, therefore, unless we can secure the sympathetic interest
and assistance of some Federal tribunal, which has the power to prevent the successful consummation of this diabolical steal, the innocent investors—many of whose life savings are represented in these
bonds—and other unprotected creditors will receive only a small
fraction of their original investment; and the equity of myself and
minority stockholders, which has been valued at many millions of
dollars by the Internal Eevenue Department in their valuation for
tax purposes, will be wiped out completely.
Moreover, the future welfare of 30,000 people, depending on the
income of some 7,500 workers, will be materially jeopardized, as all
plans for large future expansion contemplated by me will die, and
operations of existing plants will be materially reduced under the
control of the International Paper & Power Co., whose operation of
competitive plants already established, will be continued for the
benefit of the communities in which they are now situated.
STOCK EXCHANGE PRACTICES
7661
In the magazine Liberty, under date of March 17, 1934, in an
article entitled " Our Financial Eacketeers ", Senator Fletcher, your
chairman, has characterized them in the following words:
Men m high places have betrayed their tiust In theory the corporation
official, whether in a bank or other corporate capacity, is a trustee of " other
people's money." Investigation shows that this feeling of trusteeship has
come to be very rare in financial circles
The acts of financial crooks and racketeers make it plain that efforts must
be made to safeguard legitimate depositors and investors
This same practice over in the commercial field may likewise be made to
serve their purpose by restricting credit alternatives with the ultimate capture,
even destruction, of profitable and legitimate enterprises to the detriment of
security holders and the general public.
In conclusion, gentlemen, permit me tc say I have described to
you as simply and clearly as I could, how the financial racketeers
mentioned are plotting and scheming under the guise of legality to
virtually confiscate the life savings of many thousands of our investors, and the constructive efforts of my life's work. I have full
confidence that as a result of the comprehensive investigation to be
conducted by the honorable committees of the United States Senate,
those guilty of this diabolical conspiracy and these immoral acts will
be prevented from consummating their well-laid designs and justice
will be awarded where it is deserved.
The CHAIRMAN. Was the International Paper Co. a competitor of
the Minnesota & Ontario Paper Co.?
Mr. BACKUS. Oh, yes; the principal competitor.
The CHAIRMAN. Did you make an effort to cooperate with the
receivers?
Mr. BACKUS. HOW is that?
The CHAIRMAN. Did you make an effort to cooperate with the
receivers?
Mr. BACKUS. I certainly did everything possible, but they refused to be advised by me.
The CHAIRMAN. DO any members of the committee desire to ask
any questions? [No response.] Mr. Pecora, do you desire to ask
any questions ?
Mr. PECORA. NO, Mr. Chairman.
The CHAIRMAN. Mr. Shoemaker?
Representative SHOEMAKER. I have a question or two, Mr. Chairman.
During the time that certain of the receivers there whom you
have mentioned were in charge of the receivership the company
made money, did it not?
Mr. BACKUS. Well, they played even, at least. But I do not figure
that you are making any money if you do not pay interest. Without paying interest they were ahead.
Representative SHOEMAKER. And if this goes into the control of
1he International Paper Co. it will place about 7,500 men out of
work in the State of Minnesota as a result of it?
Mr. BACKUS. I could not say that, but the operations will be lessened and there will be no expansion; so that it will mean more than
that, as a result, in the end.
Representative SHOEMAKER. The judge handling this case, the
Federal judge, in every instance gives the receivers practically everything they ask for ?
7662
STOCK EXCHANGE PRACTICES
Mr. BACKUS. He signs on the dotted line.
Representative SHOEMAKER. In other words, this judge several
times has signed bills that they have made, not granting them the
privilege of making them, but has signed them after the bills were
made?
Mr. BACKUS. Yes, sir.
Representative SHOEMAKER. In disposing of assets?
Mr. BACKUS. Yes, sir.
Senator TOWNSEND. What is the judge's name?
Representative SHOEMAKER. Joseph W. Molyneaux.
Senator COUZENS. Why is not that a matter for the House
of Representatives to institute impeachment proceedings?
Representative SHOEMAKER. I have a resolution pending at the
present time, Senator.
I t is common knowledge, is it not, that this judge is in no way
capable, from a mental standpoint, to act as a Federal judge?
Mr. BACKUS. He has not demonstrated
The CHAIRMAN. I do not think we ought to go into that here.
Is that all, Mr. Shoemaker 2
Representative SHOEMAKER. For the present; yes.
The CHAIRMAN. Mr. Backus, the Senate Committee on Banking
and Currency have heard with interest your recital and charges of
a conspiracy between banks and the bank-controlled competitive
corporation to destroy the Minnesota & Ontario Paper Co. and its
subsidiaries.
You charge or claim, in substance, to the effect that a receivership was forced upon your company in violation of pledges made
to you; the organization of a bondholders' protective committee, controlled by these bankers; forcing a contract upon the bondholders,
giving title to this protective committee; the attempt to bribe you;
the depressing and manipulating of the market of the company's
bonds from near par to $3.25; the accumulating, under cover, of the
bonds at such depressed prices; the apparent mismanagement of the
estate to further depress the bondholders' hopes; the seemingly unwarranted sale of properties and finally the malignment of you by
the suits brought against you and against Backus-Brooks Co.; the
threatening of a final stroke, namely, the attempt at foreclosure, that
will strip every equity and inure solely to the benefit of the alleged
conspirators.
In view of the evidence you have presented and the references
to the alleged racketeering under the guise of apparent legality, it
JS my judgment, in which I feel that my colleagues will acquiesce,
that you should present the evidence in this matter to the Special
Committee of the Senate on Receiverships and Bankruptcies, as I
feel that that committee will consider the matter and has the necessary jurisdiction. That committee is under the chairmanship, ex
officio, of Senator Ashurst. He is the chairman of the Judiciary
Committee, and a comprehensive hearing may be conducted if he
so desires.
The Committee on Banking and Currency therefore respectfully
refers you in this important matter to the Special Committee on
Receiverships and Bankruptcies.
Is that the concensus of opinion of the committee ?
STOCK EXCHANGE PRACTICES
7663
Senator COXJZENS. I think so.
Senator TOWNSEND. Yes.
The CHAIRMAN. That will be our action in reference to the matter.
Representative SHOEMAKER. May I add the request that there be
inserted in the record a copy of the contract that the so-called
"Bondholders' protective committee" sent out to the bondholders
for them to sign, in which they waived practically their rights and
turned them over to this same group of bankers?
Senator GOLDSBOROUGH. That is for the consideration of the committee to which the matter is referred.
The CHAIRMAN. There was something of that kind offered in the
course of Mr. Backus' statement.
Mr. BACKUS. The contract has not been submitted, but I can
submit it.
Senator REAN. I think it should be referred to the proper committee.
Mr. PECORA. YOU have made references to it in your statement?
Mr. BACKUS. Yes; I have.
Representative SHOEMAKER. I thought it might be illuminating to
include it. It is just a short letter.
The CHAIRMAN. I think there is no real objection to that.
Senator KEAN. I t is quite a long printed document, is it not ?
Representative SHOEMAKER. NO, sir.
Senator COUZENS. It really belongs to the committee to which the
matter has been referred if they are going into it. We are not going
to do anything more about it here.
Senator WALCOTT. There is no reason to duplicate records. It
costs money, and we are on the economy plan.
The CHAIRMAN. That is all with reference to this matter, then.
Representative SHOEMAKER. May I, in behalf of my constituent,
Mr. Backus, thank the committee for its courtesy and the time that
it has given to this hearing.
(Whereupon, at 11:05 a.m., the subcommittee adjourned.)
BACKUS-BBOOKS CO.,
Minneapolis, Mtnn, January 5, 1984
To the bondholders of Minnesota & Ontario Paper Co :
This letter offers no apologies. It concerns a subject of vital importance to
you, and one which represents life and death, so to speak, to myself Broadly
stated, it relates to the process of strangulation now being administered by
Receivers Robinson and Jaffray to the vast enterprises controlled by BackusBrooks Co. and its principal subsidiary, the Minnesota & Ontario Paper Co.,
representing my life work, in the welfare of which our interests are in common.
I fully realize the dangers involved in a communication of this character.
My motives may be misinterpreted. I may even be maligned by those who
pretend they are acting in your behalf and protecting your interests. I refuse
to be deterred by any anticipated attacks which this letter may insp re at the
hands of those who are now conspiring to shape the destinies of the widely
diversified and complicated business enterprises which are now largely consolidated in the organization whose bonds you hold, and in the ultimate solution
of whose problems you are equally interested with myself.
My whole life has been devoted to a single purpose. In the accomplishment
of that purpose I have been compelled to fight powerful interests and combinations in this and other countries. We have now reached a point where a
battle to save these vast properties is imperative. I do not desire to fight this
battle single-handed. If you will read and digest this letter, together with the
facts and charges set forth in the enclosed pamphlet, you wiU understand that
my fight wiU be greatly strengthened by your cooperation. I am not asking for
175541—34—PT 16
17
7664
STOCK EXCHANGE PRACTICES
your financial assistance in waging this fight, as the necessary financing has
been contributed by a small group of bondholders, friendly to me, who have,
in their own way, investigated the deplorable mismanagement of this company
under Receivers Robinson and Jaffray and have urged me to take steps for their
lemoval Numerous other bondholders have also urged me to take this action.
I requested an up-to-date list of the Minnesota & Ontario Paper Co bondholders trom the secretary of the so-called "Bondholders Protective Committee", but to no avail I was, therefore, obliged to obtain a list from the
United States Treasury Department, which list numbering approximately
15,000 bondholders was compiled during 1931, and, therefore, not entnely
up-to-date In failing to furnish this list I believe the so-called " Bondholders
Protective Committee " desired to prevent my communicating with you I feel
certain that you will understand their failing to give me such a list after
reading this letter If you have disposed of your bonds, will you kindly pass
this letter and pamphlet on to the purchaser or the broker to whom you sold
with the request that it be submitted to the present owner
While our common enemy includes in addition to Receivers Robinson and
Jaffray, powerfully entrenched financial interests, the cold-blooded unscrupulousness of which is only matched by their available resources, they are nevertheless vulnerable because of previous public disclosures, the ignominy of which
has been flung through the columns of the press to the four corners of the
world
The Minnesota & Ontario Paper Co represents in part the consummation of
a comprehensive plan by Backus-Brooks Co of some 25 years ago intended to
bring together under a single management the widely diversified operating
properties acquired and developed through my efforts covering nearly half a
century The executive management during all this period was vested in myself Hence, the statement already made that it represented my life's work
At the time of the Minnesota & Ontario Paper Co receivership the Great Lakes
Paper Co, Ltd, another major operating company owned by Backus-Brooks
Co, was in the process of being taken over by the Minnesota & Ontario Paper
Co, but the receivership prevented its consummation
All idea of personal gam was wholly foreign to my underlying purpose during the upbuilding of these companies The properties acquired, figuratively
speaking, represented an empire The organization had been developed and
brought to the point of profitable operation The localities of such operation
had been strategically selected as a result of long years of experience The
requirements of future expansion had been thoughtfully anticipated. The
foundations of a great and prosperous business had been carefully prepared
When the crash ot 1929 swept the country, the newsprint industry was
keenly feeling the effects of overproduction However, there was neither hesitation nor fear on my part The thought of any default on outstanding obligations never entered my mind, a fact perhaps best attested in that approximately $3,000,000 was expended during 1930 in expanding our properties in
the United States, Canada, and Europe
Looking back now, I can see where I made one mistake I placed my
reliance in banks and investment bankers At that time I had no more conception of their inherent untrustworthmess than that possessed by the public
generally.
In the summer of 1930, business judgment suggested the advisability of
anticipating our requirements and making provision for our funded obligations
maturing in 1931 The subject was accordingly taken up with the investment
bankers, by whom I was assured these obligations would be cared for in due
course, but that it was then too early to consider the matter. Relying on this
promise, I returned to the duties of the active business management Later
in the fall several plans for refunding were considered Arrangements were
finally reached under which our commercial bankers and fiscal agents agreed
to provide the amounts necessary to retire all of our funded maturities and
other extraordinary requirements for 1931
Late in February 1931 I made an appointment with the bankers for a conference in New York City, where the details of what had already been promised
could be carried out At that conference I was for the first time informed that
the bankers would not keep their pledge, and that a receivership was the only
solution To lessen the force of this blow, it was then agreed that I should
be made the sole receiver, thus preserving my managerial status and affording
me the opportunity of working out the company's affairs.
STOCK EXCHANGE PBACTICES
7665
At this conference the bankers demanded that substantially all of the cash
working capital on hand, amounting to over $1,100,000, should be turned over
to them and applied on their unsecured and unmatured obligations This I
was obliged to agree to, but only after receiving assurance that $3,000,000
would be provided by issuing receiver's certificates to enable us to conduct
and operate the business Only $500,000 of this sum, however, was furnished.
Through this maneuver the banks were able to replace their unsecured notes
with receiver's certificates, which are a preferred claim and a lien prior to*
your bonds In the then conditions, with funded obligations maturing the
following week, I had no alternative but to accede to their proposals. Then
followed the original receivership with which you are already familiar
In the following 9 months, during which I was the operating receiver, I
accumulated a bank balance of over $2,000,000, including $500,000 borrowed on
receiver's certificates, after defraying all operating and maintenance expenses.
This $2,000,000 was turned over to Receivers Robinson and Jaffray upon their
appointment as receivers on November 30, 1931 Immediately a campaign
of extravagance, mismanagement, and waste began and continued until at one
time the cash balance was reduced to slightly over $600,000 With proper management the cash bank balance at this time should be at least $5,000,000, or
more than e ght times the present balance
Only a relatively short timefollowingmy appointment was required to demonstrate that unseen and unknown forces were working against the interests of
the bondholders and myself The bankers, obviously, never intended that I
should remain as receiver. Their first and underlying selfish motive was to get
possession of the $1,100,000 of cash, and the second to remove me as receiver
immediately the opportunity was afforded These unseen and unknown forces
have now been brought into the open and the maneuvering and manipulation
resorted to is now apparent The matters thus stated proved to be the initial
steps of the conspiracy herein disclosed The successive steps m its development will appear from what follows
As the first move, our bankers designated and selected the so-called " Bondholders Protective Committee." The subservience of this committee to the
interests to which its members owe their appointment has been and is apparent.
Two members and the secretary are employees of Halsey-Stuart & Co., investment bankers of Chicago, and of recent "Insull fame" One member each is
respectively an employee of the First National Bank of Chicago; Brown Bros. &
Harriman, of New York; Bond & Goodwin, investment bankers, of Boston;
Wood Gundy & Co , investment bankers, of Toronto. One member was formerly
with Minnesota Loan & Tiust Co, of Minneapolis, and one member is of affiliation unknown to me These men are securities salesmen. They have had no*
experience or training as industrial operators; their advice in such mattersis of no value in the administration of our vast properties
It was these bankers and this committee, who so soon demanded my resignation, and insisted upon the appointment of Receiver Robinson The latter'sincompetency and inexperience in the management of our estate in which the
so-called "Protective Committee" has acquiesced, is nothing less than a
stupendous tragedy
Receiver Robinson is reputed to be a man of large inherited wealth, yet, I
am told, his entire business life has been spent as an employee of others.
Receiver Jaffray is at the head of a banking organization the past transactions of which are now being investigated by the securities commission of the
State of Minnesota.
I put to you the plain question: What protection can we expect for our
interests through the office of a committee and receivership thus comprised ?
I have no personal animosity toward any of the individuals comprising this
committee or Receivers Robinson and Jaffray, but I do know from my association with these receivers, that they and the committee are utterly incompetent
to manage the Minnesota & Ontario Paper Co. and its numerous subsidiaries.
How (an we expect these receivers and this so-called "Protective Committee"
to successfully manage and rehabilitate our vast properties? Well * * *
as a matter of fact, they are not managing * * * they are destroying;
Our estate will soon be of comparatively little value if we allow the present
receivers to continue If you have read the many disclosures of protective
committees in general, I know you will have satisfied yourself that under their
misguided directions the bondholders and stockholders always lose.
7666
STOCK EXCHANGE 1>BACTICES
It is apparent that the real objective of the bankers from the outset was
to eliminate and destroy me as quickly as possible, the plan being to discredit
me in the eyes of the bondholders and creditors; and thereby clear the way
to carry out their diabolical scheme at the proper time
The first move was in the pretended interest of assumed harmony. They
prevailed upon me to retire voluntarily as a receiver, and to consent to the
appointment of Messrs. Robinson and Jaffray I would never have consented
to this radical and unbusinesslike change but for the assurance that I should
be maintained and continued by the newly designated receivers in an advisory
capacity to safeguard the estate against mismanagement and loss
The disillusionment in tins letter regard was not long postponed Receiver
Robinson immediately assumed dictatorial control, he ignorantly attempted a
leorganization of all the departments of the business without any knowledge of
the ability or capacity of the old department heads, disregarded all my advice
and suggestions on important matters of business policy, and in general inaugurated the unprecedented policy of extravagance and waste which has
characterized his operations throughout While creating his personal organization, Receiver Robinson gave general instructions that none of his newly
constituted department heads were to confer or advise with me on any matter
of business This was naturally taken by such employees to mean that if they
did consult with me they would be discharged I know you will agree with me
•when I say that any organization constructed on the above lines and without
a real leader always lesults in heavy losses and inevitably spells ruin
In the paper, lumber, and timber industry losses largely occur in the timber
and logging departments where steady waste is usually prevalent when skillful
management is lacking Neither Receiver Robinson, or Jaffray, or any of their
present advisors or staff, are capable of managing these departments and these
steady losses are mounting day by day. To meet these operating losses and
replenish the treasury, our quick assets are being sacrificed at whatever price
they will bring
I do not wish to unduly extend this letter I feel, however, that certain
outstanding facts may interest you.
The receiver's last official report, dated September 30, 1933, discloses the
fact that current assets during the receivership period have shrunk $4,677,586 01 Receiver Robinson has liquidated the cream so to speak, of our quick
assets In the remainder of the current assets will be found a very broken
lumber assortment, slow accounts receivable, and other slow items.
A few of the items of waste, extravagance, and mismanagement are as
follows (1) Amounts paid for receivers' fees, attorney's fees, and expenses
during the receivership period, $700,000; (2) unnecessary compromising of
accounts receivable which could have been collected in full, $570,000, and
(3) unjustifiable cash expenditure in National Pole & Treating Oo. refinancing, $525,000
The above items total $1,795,000, all of which was unnecessarily and unwisely
expended Taking these current items together with the other items set forth
in detail in the pamphlet herewith enclosed brings the total loss up to over
$12,000,000 during the administration of Receiver Robinson I vigorously
protested the confirmation of the principal items making up this loss. The
items protested are as follows: (1) Concessions made to Great Lakes Paper
Co, Ltd, now in receivership, (2) compromising of accounts receivable; (3)
sale of Memphis Commercial Appeal property; and (4) sale of Minnesota
Porest Products property
In the two last-mentioned protests, appeals have been taken to the circuit
court of appeals from the order of the district judge confirming sale, because
I feel that if the court had any knowledge of the real value of the properties
sold it would not have permitted them to be sacrificed as they were
Mr Robinson has stated to the court several times in my presence that his
recommendations have been referred to and approved by the so-called " bondholders' protective committee." My watchfulness over the interests of our
bondholders exasperated Receiver Robinson and those conspiring with him and
finally climaxed in a suit brought by the receivers against myself to recover
$7,000,000 claimed to have been abstracted by me from the business for my
own personal ends A baser and more groundless charge was never preferred
against any man
In the receiver's report of October 31, this $7,000,000 suit against me was
conspicuously referred to. The so-called "protective committee" emphasized
the incident in its letter dated November 17, 1933, to the bondholders, and as I
STOCK EXCHANGE PBACTICES
766?
understand to all our creditors and the financial world in general This was
intended as the finishing touch to my absolute elimination and destruction.
Their sole purpose was to make certain that I would be completely discredited
and my continued opposition eliminated.
The pamphlet enclosed herewith contains my answer to that suit and discloses the facts, viz, that the receivers have no claim against myself, but on
the contrary that I have substantial claims against the company, which I had
intended to satisfy by accepting additional stock I have answeied these false
charges in a suit which I have instituted against the receivers individually
for $2,000,000 damages for libel, and have challenged them to prove their untrue
charges before an independent tribunal
The final step m their conspiracy was my complete discharge from any con>
nection with the affairs or business of either the Minnesota & Ontario Paper
Co. or its subsidiaries, by reason of which they expected me to abandon all hoper
of realizing any recovery from my equity m this company, which has been my
life work I have publicly made all these charges in proceedings befoie the
court to remove the present receivers for mcompetency and waste of the assets
of the leceivership estate
By the time you have reached this point you will doubtless be asking yourself the question, Why things are as they are 9 The answer may be expressed
in three words, " too many bankers "
The Minnesota & Ontario Paper Co attained its position as one of the largest
organizations of its kind in the United States and Canada in the face of severe
competition of powerful money interests behind competing industries These
competing organizations, owing to prevailing conditions, are heavily indebted,
their obligations are held by certain of the banks to which' we are to some
extent indebted, these banks aie looking exclusively to their own, not our
interests If they can destroy us, they are improving the condition of the
heavier debtor, if they can destroy us, they will lessen competition; if they
can foice us to liquidate our affairs in such a way that the competitor may
acquire our property at a small fraction of its fair and actual worth, they will
have accomplished their end even though your interests and mine are ruthlessly
sacrificed m the process.
This is precisely what is going on today In the hands of your protective
committee and the present receivers you are the victims for the sacrifice Are
you going to stand by and be led to the slaughter ?
The final steps in the tragedy are near completion Do not be surpused if
shortly after the receipt of this letter there is presented foi your consideration
a plan of reorganization However, their plan may not be presented after these
disclosures
This communication may be given relatively wide publicity You will doubtless receive from your so-called " protective committee " extended communications showing their solicitude for your welfare Incidentally, these communications may center their attacks on myself You will be told that the present
receivers are men of eminence and standing, with experience in large affairs
And, finally, that the whole administration of your interests has been under the
jurisdiction of the court. As to the experience of the receivers, however broadly
it may be postulated or exaggerated, there is one inescapable fact, viz That
neither of them is possessed of any experience calculated to qualify him for
the handling and administration of the business and properties in which both
you and I are interested As to the court, it need only be said that the ordinary judge is lamentably inexperienced in practical business affairs
I only ask you, if such communications are received, to bear a few salient
facts in mmd I built the Backus-Brooks Co. organization, which owns over 90
percent of Minnesota & Ontario Co's stock, from the point where its. capital
investment was $3,000 to one where that investment was over $100,000,000 In
this fight to protect my interests I am protecting yours I believe I know far
better the needs and necessities of the situation than any syndicate of eastern
bankers or Receiver Robinson, their emissary I will welcome and extend my
full cooperation to any management which is conscientiouslv working to salvage
and reorganize our vast interests and which is not subject to banking domination
If you agree with me in the policy thus outlined, your first step should be to
withdraw your securities from the hands of the present committee; revoke its
authority to act in your behalf, and stand firm in the independent exercise of
your own rights I myself will assume the burden of the fight to protect your
interests as well as my own, and without cost to you
7668
STOCK EXCHANGE PRACTICES
One further feature exists from which you may draw your own conclusions.
There is every reason to believe that the banking interests, parties to the
conspiracy above outlined, have been systematically buying up our bonds at
sacrifice prices during the pendency of the receivership Recently, one of
these investment banking concerns, and one, whose employee is a member of
your protective committee, has bought several hundred thousand dollars of
the bonds of the same issue which you hold, for approximately 10 cents on the
dollar.
What can be expected when those in whom you are reposing your confidence,
on whom you are relying for the protection and conservation of your mteiests
are carrying on a campaign of sniping, preying upon the misfortunes of those
of your number who may be financially distiessed? What reliance may be
placed in a so-called "protective committee" designated by those who are
working in their own interests, in total disregard of yours and mine?
In conclusion, I know you will forgive my briefly displaying a sentimental
"view in connection with this enterprise In the 1890's when conducting my
logging operations in northern Minnesota, I was 200 miles from the Canadian
boundary at the point on Ramy River where International Falls, Minn, and
Fort Frances, Ontario, aie now situated There were no roads It was midwinter and a blanket of snow 3 feet deep made travel difficult Accompanied
by my head timber cruiser we covered the distance on foot and finally arrived at the Hudson Bay tiadmg post one beautiful moonlight night after
midnight with the thermometer at 40 below zero. I viewed the wonderful
waterfalls there and decided to do some constructive pioneering. The outcome was the building of 200 miles of railroad, now the Minnesota & International Railway Co , the development of the water power and paper mills
on both sides of the river, the building of saw mills, planing mills, Insulite
malls; 200 miles of additional railways, the purchase of timber holdings in
large amounts; and finally a total investment of $50,000,000 Why should
I not be sentimental and strive to rehabilitate this organization which has been
my life work and my pride?
And so, fellow bondholders, I ask you, in the same spirit created during this
past year, by our worthy leader, President Roosevelt, let us work together
and put to an end the destructive practices of the " money changers "
I invite your personal response to this letter and shall welcome all constructive suggestions you may care to make.
Very respectfully yours,
E
W
BAOKTTS,
President Backus-Brooks Co, and Mmnesota & Ontario Paper Co
BACKUS-BROOKS COMPANY—OFFICE OF THE PRESIDENT
To the Bondholde?s of Minnesota and Ontario Paper Company:
The properties of the Minnesota and Ontario Paper Company, whose bonds
you hold, is the prey of a so-called " Bondholders' Protective Committee," under
circumstances comparable to the plan so vividly portrayed in the article, " Other
People's Money," which appears on the opposite page
Every bondholder of the Minnesota and Ontario Paper Company should be
informed that the Court, in its order appointing the original receivers, specifically found the company to be in a solvent condition
The purpose ot the receivership, therefore, must have been rehabilitation and
not the liquidation of its affairs But what does the record show9 When you
have read my personal statement and this pamphlet disclosing the colossal
wastages committed, you will be convinced that the policies of the present
receivers are destined to destroy and not to rebuild
I understand that Eastern Bankers and the Receivers, in the case of the
Minnesota and Ontario Paper Company, are evolving a scheme to seize the properties of our company for a mere fraction of their value If this happens, both
you and I will be the victim® Heartless Financial Giants in the form of Eastern Bankers and their allied Newsprint competitive company have marked us
as they prey in this colossal tragedy. To accomplish their purpose, more easily
and surely, they have determined that my business life and reputation be
sacrificed on the altar of the " Money-Changers "
I accept their challenge and will fight to the finish, but I need your help
Herein is set foith the history of legal proceedings that have been instituted
by me to block this ruthless plan I most earnestly urge that you read it carefully throughout to get the facts When you know the truth of the impending
STOCK EXCHANGE PRACTICES
7669
vicious scheme, I feel confident you will heartily co-operate with me in this fight
to protect my equity and save your investment By working together we
can win.
Please write immediately that you are with me.
Respectfully yours,
(Signed)
E W BACKUS,
President Backus-Brooks Company and
Minnesota and Ontario Paper Company.
JANUARY 5, 1934
BAKER BUILDING, MINNEAPOLIS, MINN.
The Legal Proceedings herein set forth are as follows:
I. Petition asking for Removal of Receivers Robinson and Jaffray, for ineflftciency, incompetency and maladministration
II Answer of E W Backus and other defendants, to the suit brought by
Receivers, which answer sets forth that the action is based solely on desire to
destroy business reputation of Mr. Backus
III Complaint m suit brought by Mr E W Backus against R. H M. Robinson and C. T Jaffray asking $2,000,000 damages for Libel
I. PETITION ASKING FOR REMOVAL OP RECEIVERS ROBINSON AND JAFFBAY, FOB
INEFFICIENCY, INCOMPETENCY AND MALADMINISTRATION
IN THE DISTRICT COURT FOR THE UNITED STATES IN AND FOR THE DISTRICT OF
MINNESOTA FOURTH DIVISION
(Equity No. 1950)
Wirt Wilson & Company, a Corporation, Complainant,
v.
Minnesota and Ontario Paper Company, a Corporation, Defendant
Petition for removal of receivers
To the Honoraole Judges of the United States District Court m and for the
Fourth Division of the District of Minnesota'
The petitioners, Minnesota and Ontario Paper Company and Backus Brooks
Company, bring this their petition against R H M. Robinson and C T. Jaffray,
receivers in this cause, and pray an appropriate order of the court removing
such receivers and appointing a successor receiver or receivers for the administration of the properties involved in this proceeding, and thereupon allege and
state to the court as follows
1. That your petitioner, Minnesota and Ontario Paper Company, is the defendant in the above entitled cause and owner of the various properties involved
in the pending receivership administration; that your petitioner, the Backus
Brooks Company, has, at all times since the inception of the receivership, been
the owner and holder, and still is the owner and holder, of approximately ninety
(90) per cent of the total outstanding shares of capital stock of the said Minnesota and Ontario Paper Company; that your petitioners are the owners and
holders of outstanding first mortgage bonds of said Minnesota and Ontario
Paper Company, secured by that certain mortgage or deed of trust executed by
the last named company to The Minnesota Loan and Trust Company as trustee
under date of April 1, 1925.
2 That under the order of the court made and entered in this cause on or
about the 30th day of November, 1931, the aforesaid R H M Robinson and
C T Jaffray were designated as receivers of the properties and affairs of
the said Minnesota and Ontario Paper Company, and on or about the same
date said last named parties qualified as such receivers and have ever since
continued as such receivers in the handling and administration of the estate
herein, that by the order of appointment, such receivers were authorized to
carry on and conduct the business which the said Minnesota and Ontario Paper
Company was conducting and carrying on at the date of the receivership
herein and since their appointment as such receivers, they have at all times
been engaged and still are engaged in the ostensible carrying on and conducting
of such business.
7670
STOCK EXCHANGE PBACTICES
3. That in the administration of such receivership estate and the carrying
on and conduct of the husmess aforesaid by the last named receivers, such
receivers have been guilty of various and sundry acts of misfeabance, nonfeasance, and negligence, owing to inexperience, inefficiency, lack of knowledge
of the practical requirements of the business committed to their administration, misconduct and lack of business judgment, as a result whereof, the
creditors interested in said estate as well as the owners of the equity therein,
have heretofore sustained gieat and irreparable loss and damage for which
they are without adequate or any redress and which, if continued, will result
in the sacrifice and dissipation of the receivership estate.
4. That in the inception of the administration of the receivers heiem mentioned, the estate and property of said Minnesota and Ontario Paper Company
(including that of its subsidiaries), at a fair and reasonable valuation, was
largely in excess of the amount of its outstanding debts and obligations, funded
as well as current, and such Minnesota and Ontario) Paper Company and its
stockholders were possessed of a large and valuable equity in such properties
and estate That due and owing to the utter incapacity and mcompetency of
the receivers herein mentioned, such vajue has been largely dissipated and
sacrificed; the business of the Minnesota and Ontario Paper Company has been
demoralized and the standing and prestige of the last named company in the
commercial world, has been largely sacrificed and ruined
5. That up to the date of the receivership herein, the business of the Minnesota and Ontario Paper Company had been profitably conducted and no default
at any time made m meeting both the principal and interest of its obligations
as they respectively matured; that its business had been constantly expanding and the scope of its various industries enlarged in the United States, Canada, and Europe; that during the year preceding the receivership, its capital
expenditures, in the expansion of the field of its operations, amounted to
approximately $3,000,00000, and that as a result of sound progressive business
policy, it had achieved recognition and standing as one of the leading industries
of its character on the American continent
6 That, during the administration of said estate under receivers Robinson
and Jaffray, nothing of a constructive nature whatsoever has been accomplished
by said leceivers on behalf of said estate; that, on the contrary, the administration of this estate is a glaring example of mismanagement of the affairs
of an industry perhaps never equaled in the industrial history of this nation;
that, under the administration of the receivers herein mentioned, there has
been committed a colossal wastage and loss of the assets of said estate, all
of which were avoidable and could have, and would have, been saved under
competent management; that properties have been ruthlessly sacrificed to provide funds to defray the expenses of extravagant administration wholly regardless of the ultimate effect of such procedure upon the estate in its
entirety; that illy advised policies and inexperienced management have been
responsible for heavy and wholly unnecessary losses in business volume, that
the interest of all parties concerned m such estate are seriously 3eopardized,
and particularly the interest of thousands of small investors who are holders
of bonds of said Minnsota and Ontario Paper Company, and which bondholders and other creditors have suffered, and will continue to suffer, from
such misguided methods and policies; that the bondholders have been lulled
into a sense of false security and led to assume that their interests are being
adequately protected by the so-called Bondholders Protective Committee; that
said committee has utterly failed to exercise the proper initiative or attention to the affairs of said estate, and apparently has carelessly and negligently
relied upon and accepted without question the gross mismanagement of the
affairs of said estate by said receivers, Robinson and Jaffray
7. That under the unwise and wasteful administration of receivers, Robinson
and Jaffray, the monies and properties of this estate were and are being recklessly dissipated, resulting in the stupendous aggregate loss to date of
approximately
TWiELVE MILLION TWELVE THOUSAND FIVE HUNDRED SEVENTY AND 9 6 / 1 0 0 DOLLARS
($12,012,570 96) —
all of which has jeopardized and gravely impaired the interests and security
of thousands of bondholders, creditors, and owners of said estate. That said
unwarranted losses and expenditures are made up of the following major
items, to wit:
STOCK EXCHANGE PEACTICES
(a) Cash paid for receivers' and attorneys' fees since the inception of the receivership, approximately
(&) Cash loss by reason of unjustified compromise settlement
of sundry accounts receivable due Minnesota and Ontario
Paper Company, and subsidiaries
(c) Cash loss by reason of compromise settlement of account
owed by International Paper Company (a company operating in competition with the Minnesota and Ontario
Paper Company) in principal amount of $175,00000, and
which was settled for $50,000 00, a net loss, of
(d) Cash loss as a result of National Pole and Treating Company (a Minnesota and Ontario Paper Company subsidiary) gold note refunding plan, including $100,00000
broker's commissions
(From the above—total cash losses-—$1,795,00000.)
(e) Operation loss due to mismanagement and ill-conceived operating policies and excessive overhead expenditures
(f) Investment loss on sale of Memphis Commercial Appeal (a
daily newspaper constituting part of the assets of said
Minnesota and Ontano Paper Company) as appears by
Receivers' Report dated September 30, 1933
(g) Loss due to inefficient supervision and management of logging operations of International Lumber Company (a Minnesota and Ontario Paper Company subsidiary), together
with losses sustained by reason of sale of lumber at baigam prices and losses occasioned by the wholly unwarranted and astounding voluntary destruction by fire of a
vast store of pulpwood and the intentional burning down
of necessary camp buildings
(K) Losses estimated if contracts are fully performed as entered
into by Minnesota Forest Products Company (a Minnesota
and Ontario Paper Company) with Northwest Paper Company (a competitive Weyerhauser Company) for the exchange of timber between the above companies, and for the
sale of timber located in Cook County, Minnesota, to
Consolidated Water Power and Paper Company, and for
sale to the United States Forestry Department, and losses
sustained from cancellation without payment of account of
$90,000 00 owing by Northwest Paper Company to Minnesota Forest Products Company, and loss resulting from Receiver's failure to cut timber on Isle Royale which timber
was deteriorating because of insect infection, a gross total
loss of
<£) Loss to National Pole and Treating Company (a Minnesota
and Ontario Paper Company subsidiary) due to unsound
and wholly unwarranted refinancing; operating loss during
present receivership, and cut in inventory
</) Unnecessary and unjustifiable capital expenditure in paper
mills and subsidiary properties, including loss in manufacturing operations of paper specialties and including
loss in burning sawmill materials
<fc) Losses estimated incurred through receivers' joining a combination in Restraint of Trade, restricting newsprint paper
output, which has resulted^in a huge loss in sales of newsprint paper, which combination at the time was in contravention to Federal law and opposed to the best interests
of the estate and bondholders
(J) Lapsing of timber permits held by International Lumber
Company (a Minnesota and Ontario Paper Company subsidiary) without cutting timber theieon before expiration
of permits, and sacrifice sales of timber
(m) Loss to estate on account of surrender of newsprint tonnage
to Great Lakes Paper Co and of commissions
7671
$700,000.00
445,000.00
525,000 00
525,000 00
1,095,000.00
1,718,570.96
1,559,000.00
1,480,000.00
1,675,000.00
750,000.00
1,250,000.00
95,000 00
595,000.00
Total
12,012,570.96
8. That, at the time of receivership, there was cash on hand in excess of
One Million Dollars ($1,000,000.00), which amount was credited by bank creditors on notes payable held by them on the understanding that a working fund
7672
STOCK EXCHANGE PRACTICES
of Three Million Dollars ($3,000,00000) would be made available by them on
receivers' certificates and that the former management should act as receiver;
that as a result of said bankers' acts at the inception of this receivership, there
was no cash whatsoever on hand with said estate, that at the inception of this
receivership, E W. Backus was named as one of the three receivers serving
as such for a period of nine (9) months; that, because of lack of co-operation
on the part of big Eastern banking creditors m particular, the said E W.
Backus voluntarily resigned as such receiver on the 30th day of November,
1931; that during said nme months' period, the said E W Backus was acting
as such co-ieceiver, the affairs of said estate were largely under his control
and subject to his direct management, and, during such time, there was accumulated a cash working fund for said estate, by reason of the efficient management of its affairs, in the sum of ovei Two Million Dollars ($2,000,000 00)
in cash including Five Hundred Thousand Dollars ($500,00000) through receivers' certificates, that since December 1, 1931, and during the administration of said receivership by Robinson and Jaffray, the present receivers, said
Two Million Dollars ($2,000,00000) cash working fund was reduced and dissipated by mismanagement and waste by said present receivers to an amount
of approximately One Million Dollars ($1,000,000 00)
9 That neither of such receivers at the date of their appointment as such, as
aforesaid, had any practical knowledge or experience in or respecting any of
the various lines of business in which the said Minnesota and Ontario Paper
Company was engaged; that neither thereof had any familiarity with the intricate and widely diversified details of such business nor any knowledge or
acquaintance with the local conditions affecting such business in the various
localities where such business was being conducted and carried on; that neither
of such receivers had any acquaintance with the personnel of the complicated
operating organization nor as to the capacity and qualifications of the members of such organization, that shortly following the date of their appointment,
solely with the objective of creating an administrative organization beholden
and committed to themselves, said receivers substituted for the previously
existing experienced administrative organization, one, newly created by themselves, with the result that the affairs and business of the Minnesota and
Ontario Paper Company was largely disorganized and demoralized in that persons were appointed to managerial positions who were utterly lacking in capacity or experience for their new responsibilities, the business now being
largely committed to untrained and incapable individuals That as a result
of the matters in this subdivision stated, the operations of such business have
sustained losses aggregating, as petitioner is informed and believes, a sum
approximately as hereinbefore set forth
10. That during the administration of such receivers, the current cash assets
of the receivership estate have been reduced from approximately Thirteen
Million Two Hundred Forty Thousand Five Hundred Fifty-six and 88/100 Dollars ($13,240,55688) to Eight Million Five Hundred Sixty-two Thousand Nine
Hundred Seventy and 87/100 Dollars ($8,562,970 87), due to the mcompetency
of such receivers, without any commensurate return to the receivership estate.
11 That said Minnesota and Ontario Paper Company has, at all times,
expended the major portion of its monies in the Dominion of Canada; that
shortly after Great Britain went off the gold standard, your petitioner, E W.
Backus, urged upon receiver Jaffray the advisability and necessity of transferring funds of said company on deposit in banks of the United States into
Canadian Exchange; that said receiver Jaffray wholly disregarded said urgent
advice, thereby forfeiting an opportunity to gam a sum of money for said
corporation on the favorable resultant rate of exchange in excess of Two Hundred Twenty Thousand Dollars ($220,00000).
12 That your petitioners allege that receiver Robinson was, and is wholly
unqualified by reason of lack of training and experience to administer the complicated affairs and business of this estate; that said Robinson was recommended for said receivership by certain large Eastern banking interests; that
such Eastern banking interests represented that Robinson's alleged broad and
varied experience j'ustified his appointment as receiver and the payment to
him of an annual salary of Seventy-two Thousand Dollars ($72,000 00) , that
such Eastern banking interests misled the bondholders, the various protective
committees, and the court who made such appointment and approved such
salary, through creating the impression that receiver Robinson was a man
with an exceptional record of administrative ability in management of vast
industries, and that he was ideally qualified to act for the estate; that, as a
matter of fact, receiver Robinson had no actual experience in receivershjps or
STOCK EXCHANGE PEACTICES
7673
otherwise, that would qualify him for management of this or any similar
enterprise, and that such representations were false in that he had at no time
received a salary equal to that allowed him from this estate, that the loss of
over Twelve Million Dollars ($12,000,000 00) as hereinbefore set forth sustained
under his administration and policies, demonstrates beyond peradventure his
total and abject unfitness to administer the affairs of this estate, that the
removal of said receivers Robinson and Jaffray is imperative and absolutely
essential if the holding of many thousands of bondholders and the interests of
creditors are to be preserved, that receiver Robinson has not devoted a fair
share of his time in the interest of said estate and has taken two wholly
unnecessary trips to Europe paid for by the estate and bondholdeis thereof
That your petitioners, upon information and belief, allege that receiver Robinson, conspiring with Eastern bankers and with Eastern competitive paper
mill interests, has recently devoted the major portion of his time to a plan of
reorganization which your petitioners believe is designed to deliver to saidt
competitive interests, the vast properties of this estate on a basis so completely
disproportionate to their actual present market value as will shock public conscience and constitute the most brazen of many unsavory banking transactions
witnessed in the past decade; that receiver Jaffray has devoted practically none
of his time to affairs of said estate, but has submitted to the will of receiver
Robinson apparently without question, that until January 1, 1933, receiver
Jaffray was allowed a salary on the basis of Thirty Thousand Dollars
($30,00000) per annum, which, together with receiver Robinson's salary to
said date of Seventy-two Thousand Dollars ($72,00000) per annum, made a
total aggregate of One Hundred Two Thousand Dollars ($102,00000) per
annum salary to said receivers.
That said receivers approved and recommended payment of local attorneys'
fees up to January 1, 1933, on a basis of Fifty-four Thousand Dollars ($54,00000) per annum, and approved and recommended the aggregate sum of
Seven Hundred Thousand Dollars ($700,000 00) actually paid for receivers*
and attorneys' fees and traveling expenses since the inception of receivership,
all of which constitute a gross violation of the trust imposed upon them
13 That such receivers have demonstrated, by reason of the matters herein
stated, their utter disqualification for the responsibility and management of
said estate and, unless removed, will continue to mulct said estate in excessive
costs and expenditures, in unnecessary sacrifice and loss of capital assets and in
wholly unjustifiable and inexcusable losses to the receivership estate in the
active administration of its affairs
WHEREFORE, and by reason of the matters in this petition stated, petitioners pray that such receivers be cited and required to be and appear before
the court at a time and place designated and then and there make answer to
the matters alleged in this petition and then and there show cause why their
authority as such receivers should not be revoked and why they should not be
removed from the office of such receivers and successor or successors appointed
to such office.
Petitioners further pray that an appropriate order of reference may be made
herein, for the hearing and determination of the matters herein alleged and
particularly for a full and complete accounting of the administration of such
receivership and disclosure on the part of such receivers of the matters in
their petition referred to and for such other and further relief as to the court
shall appear just and equitable and consistent with the matters alleged herein
This petition will be based on the allegations hereinbefore set forth, and the
affidavits hereto attached and hereby made a part hereof as though set out
herein in full
(Signed) DAVIS & MICHEL,
Attorneys for Petitioners,
419 Metropolitan Bank Bldg,
Minneapolis, Minnesota*
Dated this 8th day of January, 1934
MORTIMER H BOUTELLE,
1500 Rand Tower
and
JOHN H HOUGEN
and
JOHN C HOLTEN,
1300 Rand Tower,
Minneapolis, Minnesota,
of Counsel
7674
STOCK EXCHANGE PBACTICES
AFFIDAVIT OF E W BACKUS, PRESIDENT OF MINNESOTA AND ONTARIO PAPER COMPANY, IN SUPPORT OF ABOVE PETITION
STATE OF MINNESOTA,
COUNTY OF HENNEPIN—as.
EDWARD W. BACKUS, being fiist duly sworn, deposes and says that he
is now and has been at all times since their organization, the president and
executive manager of the Minnesota and Ontario Paper Company kneT the
Backus-Brooks Company, respectively, petitioners in the foregoing and attached
petition, that the Minnesota and Ontario Paper Company was the outgrowth
of a general plan conceived twenty-five years ago for the consolidating of the
widely divensfied enterpuses which were organized and developed in the United
States and Canada, by the Backus-Brooks Company, which company was the
owner of the diverse industries then engaged in the manufacture of newsprint
and lumber commodities and also owned or controlled, in both the United States
and Canada, extensive power rights and properties, both developed and undeveloped, large timber interests, variously located power plants and sites,
railroads and other transportation facilities, that ownership of the major portion of the various properties thus indicated finally vested in the Minnesota and
Ontario Paper Company, a subsidiary of the said Backus^Brooks Company in
the year 1908
That from the date last mentioned, the entire executive organization was at
all times under the exclusive management and direction of this affiant and sa
continued down to the date of the receivership m<the within entitled action
That at the date of the receivership herein, the various properties and interests
of the consolidated Backus-Brooks Company organization had been developed
and expanded until the same had, at the date of the receivership herein, a
book value of over One Hundred Million Dollars ($100,000,00000) which affiant
believes, in the light of his knowledge and experience with the properties in*
volved, represented conservatively a fair valuation under normal business con*
ditions
That the operations of such consolidated organization were, for the most
part, profitably conducted with the profits in the mam retained in the business
for the purpose of enlarging and expanding its various enterprises, developing
its diversified industries and otherwise contributing to establishing one of the
largest industries of its character on the North American continent
That at and previous to the naming of Receivers R H M Robinson and C T.
Jaffray, it was understood and agreed between affiant and such receivers that
affiant should be retained in the capacity of an adviser and consultant, making
available for such receivers the knowledge and experience of affiant in all the
branches and departments of the widely diversified business of the Minnesota
and Ontario Papei Company
That shortly following their qualifying as such receivers and the taking over
by them of the conduct and administration of such business, receiver R H M.
Robinson, who assumed active management and control, repudiated such understanding and agreement and declined to generally consult with affiant respecting many matters regaidmg which the said Robinson had no knowledge or
experiece; that employees of the various branches of the business were, as
affiant is informed and believes, instructed that affiant should be kept m ignorance of matters of vital importance on the penalty of losing their respective
positions, if such instructions were disregarded, and also were instructed not
to consult with or confer with affiant on matters pertaining to the business;
that in many matters of importance business policy, in which affiant was consulted by either the said Robinson or his coreceiver or both, his advice was
ignored and disregarded and such receivers through mcompetency and inexperience adopted and followed out policies resulting in each instance to the disadvantage and serious loss of the receivership estate, many of which instances
are later herein referred to
That in addition to the matters last stated, receiver Robinson, shortly following his appointment, adopted the policy of practically reorganizing the entire
executive and administrative departments of the business, and, as affiant is
informed and believes, on such plan as would ultimately exclude all participation on the pait of affiant in any capacity whatever in connection with the
operation of such business; that as a result of the policy last indicated, departmental heads were created covering the various branches, most of whom were
STOCK EXCHANGE PRACTICES
7675
without the personal ability or experience tor assuming the important duties to
which they were severally assigned and lacking the guidance had previously
That the result of the policy last above described left the general control of
the affairs of all the various branches and departments of the business of the
Minnesota and Ontario Paper Company, and all of its subsidiaries, with the
receiver Robinson, with no practical knowledge or experience in anywise quali
tying him for the responsibilities of his position, that the administrative organic
zation was so demoralized and disorganized as to result in large losses being
sustained under the administration of receiver Robinson, as hereinafter referred
to and considered under the respective captions following, viz
(a)
NATIONAL POLE AND TBEATING COMPANY
That the first major matter befoie the present receivers was the maturing,
notes of the company indicated in the caption, aggregating $2,000,00000, the
said company being controlled by International Lumber Company, a subsidiary
of the Minnesota and Ontario Paper Company That said company had an
outstanding capitalization comprising 30,000 shares of preferred stock par value
$10000 per share, and 30,000 shares no par value common shares, with outstanding $2,000,00000 of 5 year gold notes being substantially its entire obligation ; that for the purpose of meeting the situation thus indicated, the receivers, acting upon the recommendation of Halsey Stuart & Company, investment
bankers of Chicago, evolved the plan that the capital of the company should be
modified so the only outstanding stock should be 60,000 shares of no par value
common, of which last named total, one-third should be donated to the noteholders* (deposited with option to repurchase for $1,000,000 00) assenting to the
plan ot accepting secured bonds of the company in lieu of notes and extending
maturity of their outstanding obligation, that to carry out so much of the
plan as entailed the reduction of the outstanding capital stock, the International Lumber Company was required to purchase the outstanding minority
stock interests comprising approximately 10 per cent of the total, and purchased
such minority interests for an aggregate amount of approximately $305,000 00,
that the investment bankers, Halsey Stuart & Company, above mentioned,
received a commission for carrying through this improvident, ill-advised and
wholly unnecessary adjustment, in the amount of $100,000 00, that there was
voluntarily and unnecessarily dissipated and given away by the receivers in
this transaction, the following sums:
Puichase of minority stock (approximately)
$305,000 00
Purchasing of notes from holders refusing to accept the plan
120, 000 00
Commissions paid investment banker Halsey Stuart & Co
100,000 00
Gratuitous surrender of one-third of the capital stock
1,000, 000 00
That before its consumption, the above plan was submitted to affiant and disapproved by him, and affiant proposed as a more practical solution that the
receivers seek a voluntary extension of the notes, failing in which, the affairs
of the company should be placed in the hands of a receiver pending the return
to normal commercial conditions, that during the operations by such receivers
of the affairs of the company indicated in the caption, owing to incompetent
management and administration, an operating loss was incurred, which together
with ill-advised and unnecessary cut in inventory made arbitiarily and without
leason, amounted in the aggregate to about $675,00000
That affiant verily believes there was no occasion or necessity for paying out
one dollar in cash on account of the matters indicated in this subdivision and
that the property of the company m the amount indicated could and should
have been preserved intact for the benefit of the receivership estate and the
parties interested therein.
(B) UNNECBSSABY CAPITAL AND OTHER EXPENDITUKES
That shortly following the date the affairs and business of the Minnesota and
Ontario Papr Company was taken over by the present receivers, receiver Robinson, for no good reason, conceived the propriety of remodeling the International Falls Paper Mills to provide for the manufacture of a superior grade
of Kraft paper, as well as miscellaneous other papers; that in the then diemoralized condition of the paper market, there was no plausible reason or
excuse for the receivers mcuriing any such expense in connection with the
7676
STOCK EXCHANGE PRACTICES
Administration, but, notwithstanding, the following capital expenditures were
made.
Remodeling expense (approximately)
$200,000.00
Minnesota, Dakota & Western Railway Company, Bridges and
Branch Lines expenditure
75,000.00
Paid for Refuse Burner at saw mill and sundries at other mills
75,000 00
Total
350,000.00
That all of the expense above indicated was ill-advised, unnecessary and
improvident; that the operation of the Kraft mills resulted in an operating
loss during the receivership period of over $200,00000; that the refuse burner
was and is a destructive adjunct to a saw mill, resulting in the burning and
destruction of commercial material which, in normal times, had an aonual
yalue of over $200,00000, thus making the total loss from the improvident
policy in this subdivision mentioned of approximately $750,00000.
(O) DIVISION OF VOLUME! OP BUSINESS. WITH OOHPJOiTriVJd INDUSTRIES
That shortly following the date upon which active administration was
assumed by the receiver Robinson, with affiant's disapproval, said receiver
attended a meeting in New York and there agreed with competitive companies
upon a plan on behalf of the Minnesota and Ontario Paper Company, under
which all sales efforts would be withdrawn, in consideration of which there
should be allotted to the Minnesota and Ontario Paper Company 1,000 tons a
month or a maximum of 12,000 tons a year; that the said Robinson took upon
himself m this matter the handling of a situation wholly beyond his knowledge,
experience or capacity, in dealing with some of the shrewdest and most
plausible managers of the newsprint industry in the United States and Canada,
with the result that he was prevailed upon to make the disastrous concession
above indicated; that as a matter of fact at that time the said agreement was
a conspiracy in restraint of trade and contrary to the statutes of the United
States, and undoubtedly the court supervising the administration of this receivership estate was kept in ignorance of the said agreement, that as a result of
the same, the Minnesota and Ontario Paper Company committed itself to a
plan which resulted in a loss of approximately $1,250,00000, during the present
receivership, and which will result in further losses of substantially the same
magnitude so long as this policy is continued.
(D) INTERNATIONAL LUMBER COMPANY (MINNESOTA AND ONTARIO SUBSIDIARY)
Lumber Department —That shortly following the date the business was taken
over by the present receivers, a new sales policy was inaugurated m connection with the lumber branch of the business of accepting all offers for lumber
legardless of price with the underlying objective of moving the lumber; that
this policy resulted not only in making sales at prices substantially below the
market but also in breaking the stock assortment, which is poor practice in that
once the assortment is broken the buyer is in position to name his own price,
and further entails the necessity of remanufacturing material parts of the
stock, an extra cost in resorting, duplication of handling and icpiling, thus
in many instances doubling the cost, that from this ill-advised policy, there
resulted a loss of approximately $720,00000
Pulpwood Department—That under the management of the present receivers
during slow down operations in the paper mills, the stock of pulpwood accumulated in relatively large proportions, and the oldest of this wood was
gradually depreciating, that notwithstanding, with efficient management, it was
possible to mix the older wood with that which was newer and produce a grade
of paper satisfying the requirements of the market, receiver Robinson took
apparent alarm at isolated complaints respecting the grade of paper produced
by the mills and issued instructions that the old wood, comprising approximately 50,000 cords should be burned, which order was carried out with a loss
to the receivership estate of approximately $350,00000
Loggmg Department—That the instructions of receiver Robinson to the
operating staff, forbidding reporting to or consulting with affiant on penalty
of discharge for violation as above stated, were applied in the case of the
company's logging superintendent, an operative of twenty-two years of experience, capacity and high ability in the operating field and resulted in the
STOCK EXCHANGE PRACTICES
7677
discharge of such superintendent at about the middle of the logging operations
of the years 1932-1938; that a camp bookkeeper was appointed by receiver
Robinson as successor .to the logging superintendent, with serious and costly
consequences in various departments of the active operations, the same resulting from wasting of timber, removal of branch railway lines before the
adjacent or tributary timber was cut, permitting timber permits to expire and
other details. That the loss from the ill-advised experiments referred to in this
subdivision is, as affiant is informed and believes, at least $489,00000 during
operations under present receivers. The losses total:
Lumber Department
$720,000 00
Pulpwood burned
350,000.00
Excess operating costs, 1932-1938-1934
489,000.00
(B) COMPROMISE SETTLEMENTS OF ACCOUNTS RECEIVABLE
That during the management of the present receivers, a general policy has
been adopted of settling outstanding accounts receivable, regardless of consequences to the receivership estate; that upon information and belief, affiant
states that the policy thus indicated has entailed a loss to the receivership
estate to date in the amount of over $570,000 00; that a flagrant illustration of
resorting to the policy thus indicated appears in the case of the account in
the amount of $175,000 00 owing by International Paper Company, one of the
largest competitive organizations of the Minnesota and Ontario Paper Company, and which obligation was settled for $50,00000 or a loss in the sum of
approximately $125,00000, wholly, as affiant is informed and believes, without
necessity or justification.
(F) MEMPHIS COMMERCIAL APPEAL
That the cash investment by the Minnesota and Ontario Paper Company in
the Memphis Commercial Appeal Newspaper amounted to over $2,595,000.00;
that the physical properties and going business of said newspaper was and is
fairly and reasonably worth $5,000,00000, the same being one of the biggest
and best known newsapers of the Southerly United States, as well as one of
the National Key papers; that the loss through such ill-advised sale by the
present Receivers exceeds (loss on investment account, as set out and admitted
in last Receivers* Report dated September 30, 1933) a loss of $1,718,570 96
(G) MINNESOTA FOREST PRODUCTS COMPANY
That the International Lumber Company (a subsidiary of the Minnesota and
Ontario Paper Company), owns all of the stock in the Minnesota Forest
Products Company; that the latter company has entered into a contract with
the Northwest Paper Company (a competitive company), The Consolidated
Water Power and Paper Company, and the United States Government for the
sale of timber located in Cook County, Minnesota, at a price that will not
realize more than one-fourth of the money invested therein, that Receivers
Robinson and Jaffray have urged and recommended such sale without regard
to value of said property, in which there was invested upwards of $1,500,000 00;
that the contemplated sale to the United States Government will be at a price
of approximately $172,405 00, comprising 34,481 acres, which acreage represents
approximately 60 per cent of the holdings by above captioned company in Cook
County, Minnesota, and on that basis of valuation the remaining 40 per cent
of scattered properties cannot be sold at such price as to realize a gross return
in excess of $400,00000; that as a result thereof a vast loss will result m the
sum of approximately $1,100,000 00, based on the actual worth of said properties; added losses due to failure to cut insect infested timber owned by said
company on Isle Royale amount to $300,00000; for a total loss to said company of $1,480,000 00, including settlement with Northwest Paper Company
(H)
GREAT LAKES PAPER COMPANY, LTD
That Receivers Robinson and Jaffray involved the Minnesota and Ontario
Paper Company in a contract with the company named m the caption, and
through wrongful diversion of newsprint sales and commissions allowed there
resulted a loss, as affiant is informed and believes, of approximately $595,000 00.
7678
STOCK EXCHANGE PBACTICES
(I) PREMIUM ON CANADIAN FUNDS
That shortly following the date on which the present receivers assumed
management of the receivership, Canadian exchange declined very materially;
that a relatively large portion of the operating expense of the receivership was
then, and still is, in Canada, and at the time when Canadian exchange was at
a discount of 24% per cent, affiant urged the present receivers to transfer
$1,000,000.00 of the balance then carried by the receivers in banks of the United
States, to Canada; that Canadian exchange rose rapidly and within approximately two weeks from such date was at a discount of only 10 per cent; that
the advice and recommendation of affiant was disregarded, and the present
receivers sacrificed a profit of over $200,000 00, which could have been made for
the benefit of the estate.
That under the administration of the present receivers economies have been
totally disregarded; that in the year 1931 a readjustment of the various operating departments was carried into effect, which effected a saving in operating
expense of $480,000 00 per annum; that the policy was reversed by the present
receivers with the result that the personnel of the organization was unduly
increased to the point where the operating force was far in excess of actual
needs; that the said policy of extravagance has characterized the administration of the present receivers as a whole; and, that the same will be disclosed
from a fair and impartial audit, and examination of the books of the receivers,
conducted under the direction of the court by experienced auditors, other than
those employed by the present receivers
(Signed)
EDWARD W. BACKUS.
Subscribed and sworn to before me this 5th day of January, 1934.
HARRIET M. RENSHAW,
Notary Public, Hennepin County, Minn.
My Commission Expires March 31,1936.
[NOTARIAL SEAL]
AFFIDAVIT OF LOUIS HARMON, FORMER SUPERINTENDENT OF TIMBER AND LOGGING
OPERATIONS OF MINNESOTA AND ONTARIO PAPER COMPANY
STATE OF MINNESOTA,
County of Ramsey,
Louis Haimon, being first duly sworn on oath, deposes and says
That he is a resident ot the State of Minnesota and that he is now engaged
as superintendent and in the employ ot the United States Government, having
under his direction and supervision two Civilian Conservation Corps camps
and two N R A concentiation camps, that affiant has been engaged in the
general timber and logging business for the past thirty-six years, chiefly in the
State of Minnesota, that his expenence in such logging and timber business
has consisted of cruising, river driving, laying out of logging camps and logging
railroads, and general supeivision of logging operations, that at the age of
nineteen affiant became a logging foieman, supervising the erection of camps
and in general managing all logging operations, that affiant has at various
times in Minnesota served as superintendent in charge of general logging
operations, having under his direction, control, and management from four to
twenty logging camps, with a force and ciew of men ranging from five hundred
to two thousand, that during his thirty-six years of experience in the general
logging and timber business affiant has worked for the following firms: I
Stevenson Company for a period of sixteen years, seven of which years he
served as general superintendent of all logging and timber opeiations, as camp
foreman for the H C Akley Company, and as district manager and as general
timber superintendent for the International Lumber Company for a period of
eleven years, commencing with the year 1922 and ending in the early part oi
January, 19|33, that affiant continued to serve as general manager and supervisor of logging and timber operations of the said International Lumber Company from the time the Minnesota and Ontario Paper Company went into
receivership up until September, 193J, and that from September, 1932, until
the toiepart of January, 1933, affiant served as district superintendent under
the receivership of the said Minnesota and Ontano Paper Company
STOCK EXCHANGE PEACTICES
7679
That from September, 1932, to the torepart of January, 1933, while serving as
such district manager ulndeir the receivership of the Minnesota and Ontario Paper
Company, affiant opened up six camps into complete and full operation and had
under his supervision and dnection during such period approximately nine hundred men, that during such period and under the direction of said receivers he
constructed and repaned skeleton logging railroads to serve each of the said six
camps, said roads being constructed in the timbei lands adjacent to said camps ;
under affiant's said supervision and direction operations were placed into full
swing at all camps, affiant caused all landings and necessary skidways to be
prepared at vanous points along the spurs and the main railioad tracks, that
such work and operations continued under affiant's supervision and dnection
until on or about November 1, 1932, that said logging operations were carried
forth under orders of the receiveis of the said Minnesota and Ontario Paper
Company, and which orders called for the cutting and landing of approximately
60,000 cords of pulpwood and 10,000,000 feet of saw log timber, that all camps
coming under affiant's supervrsron and drrection were fully equipped to cut, land,
and load on to cars the amount of pulpwood and saw log timber above specified,
at a minimum ot cost such equipment of material, men, and horses being adequate to handle said complete operations on all timber on lands adjacent to the
various camps, as well as such additional timbers as might be puichased from
other owners m the adjacent suirounding territones of each camp
That on or about the first of November, 1933, and after the major portion of
the pulpwood and the saw log timber had been cut and swamped out, affiant
received orders to cease operations and to disband all six camps Upon receiving such orders, affiant protested that a disbandonment of operations at that
juncture would incur to the company serious and rrreparable loss and that
said timber and pulpwood should immediately be moved to the tracks for
loading on cars in order to avoid the heavv snows and the necessary additional
cost to be encountered under more adverse weather conditions; that, notwithstanding said protest affiant was ordered to cease operations and drsband all
six of the said logging camps, and was informed that such order was necessary
for the reason that the receivers of the said Minnesota and Ontarro Paper Company were without requisite funds to complete said logging operations
That in the forepart of January, 1933, and after said fallen timber had been
heavily covered with snow, the receivers of the said Minnesota and Ontario
Paper Company ordered the resumption of the logging operations of five of the
said six camps
That affiant was m charge of said operations at the time that said order was
issued and personally supervised the reorganization of said five camps; that the
resumption of logging and timber operations, after a suspension of two months,
caused serious and irreparable loss to said receivership by reason of the
extraordinary trme requrred to perfect such reorganization and by reason of the
further fact that the removal of said fallen timber was made a far greater
expensive operation than had such timber been removed in November and
December and prior to the reorganization of sard camps
That, at intervals during the first eight mionths of the year 1932, affiant had
been warned by his superiors and other employees of the Minnesota and
Ontario Paper Company not to communicate with E W Backus, the President
of the said Minnesota and Ontario Paper Company, on any matters pertaining
to the operations under his supervision, that affiant, notwithstanding said warnings, did on different occasions properly advise with the said E. W. Backus
pertaining to the method and scope of said logging and timber operations, that
affiant is rnformed and belreves that when he was removed as general superintendent and made drstrrct manager in September, 1932, such change was made
by the receivers of the Minnesota and Ontario Paper Company because of
consultations had by him with Mr Backus
That affiant was discharged from his duties as such district manager on or
about the 10th day of January, 1933, by said receivers because of information affiant had given concerning said logging and timber operations to the
said E W Backus;
That a former auditor of said camps was thereafter placed in complete
charge and supervision of all said loggrng and trmber operatrons, that said
bookkeeper was a man wholly without trainmg and experience in the general
logging and timber business, had never had a single day's experience as a
cruiser and wholly without experience of any kind whatsoever relating to
logging and timber operations othei than as camp accountant
175541—34—PT 16
18
7680
STOCK EXCHANGE PBACTICES
That said receivers in the winter of 1983 took out part of the timber and
pulpwood which had been cut leaving a large part of said fallen timber remaining where it had been cut and also leaving large quantities of standing
timber, all of which was adjacent to the railroad spur tracks, which the receivers caused to be removed; that the removal of said spur tracks before the cutting of the balance of said virgin timber and the removal of the balance of said
fallen timber constituted a great waste and loss to the receivership estate;
that the policy of the International Lumber Company had always previously
been to contract for the purchase of privately owned stumpage on all lands
adjacent to the spur tracks; that said receivership failed and neglected to contract for the purchase of said timber so privately owned thus cutting off to the
said receivership a source of revenue which had always been realized by said
International Lumber Company m its normal operations
That the said International Lumber Company held permit to cut timber on
the West half of Section 25, Township 149, Range 28, Koochichmg County,
which permit expired on Sept 30, 1932 Affiant as superintendent of logging
operations advised the receivership to arrange for the cutting of timber on
the said West half of Section 25 before said permit expired; the said receivership wholly neglected to cut said timber before the expiration of said permit,
all to the detriment and loss of said receivership
That by reason of said mismanagement and by reason of the loss sustained
by said receivership on account of the disbandment of said camps and their
subsequent reorganization, by reason of the loss occasioned in the salvaging of
timber which had been covered by snow, rendering the removal thereof more
difficult and expensive, by reason of the extra cost of logging down timber
after the removal of the said spurs, by reason of the loss sustained by the
receivership owing to the expiration of the permit to cut on said West half
of Section 25, the total loss to said receivership occasioned by the removal of
railroad spurs, which made the removal of remaining down timber and remaining stumpage prohibitive from the cost standpoint, the failure to buy
stumpage on adjoining privately owned timber lands, the loss on Ramey Lake
operations of pulpwood logs and boom sticks by reason of careless and negligent towing and storage, all of which has resulted m an aggregate loss to
said receivership of a sum of approximately $270,000 00
That certain stumpage belonging to said International Lumber Company was
burned over in the summer of 1933, which timber, if not salvaged during the
operating season of 1933-34, will result, in affiant's opinion, in a loss of approximately $9,000 00.
That during the summer of 1933 the receivership has caused to be erected
four new logging camps in the vicinity of Lake Kabetogema; that said receivers
are also operating at full force six additional camps, three of which are the
identical camps formerly under the supervision of this affiant; that affiant has
investigated the operations of these ten camps and made as careful an estimate
as he is able to make in the absence of access to the books and records of said
Company, and states that the cost of operating all of said ten camps will be
$210,00000 for the season of 1933-34 in excess of the cost of such operations
under practical, efficient management, that the total loss to this receivership
by reason ot the toregomg is and will be at the end of the operating season
of 1933-34 the sum of approximately $489,000 00, practically all of which could
have been saved to said receivership had said properties been managed in
accordance with the best recognized principles of logging and timber cutting.
That in addition to the foregoing unwarranted expenditures and unnecessary
losses to the receivership, the receivers ordered the destruction by burning of
headquarters camp, known as camp number 29, consisting of a full and complete set of buildings sufficient and adequate to house a crew of one hundred
and seventy-five men and stables for twenty-two pair of horses, all of which
estimated loss, in affiant's opinion, was approximately $3,00000, in rebuilding
of same.
In addition to the foregoing the receivers ordered the destruction and rebuilding of a railroad bridge crossing the upper Big Fork River, which bridge was
under the constant supervision and inspection of this affiant and which bridge
was adequate for all purposes for a period of at least ten years to come The
cost of reconstructing said bridge made necessarv the abandonment of one mile
of trackage and the laying of new tracks approaching the bridge at both sides
of the nver Said original bridge was inspected by this affiant, together with a
competent safety engineer representing the Employers Liability and Insurance
Company, the Company which provided the workmen's compensation coverage
STOCK EXCHANGE PEACTICES
7681
for said railroad, and upon said inspection just prior to its destruction the said
engineer declared said bridge to be safe for all uses to which it would be
subjected.
That contrary to the advice of affiant, who had been in charge of the maintenance of what was known as the Deer River branch of the International
Lumber Company's railway, the receivers ordered the ballasting and surfacing
of thirty-two miles of said road-bed, all of which was entirely unnecessary and
placed upon said receivership estate a wholly unwarranted expenditure That
the total cost of said ballasting and surfacing, together with the destruction
of the old bridge and the erection of a new bridge and the abandonment of
a mile of railroad line, in the aggregate caused a wholly unnecessary expense
to the receivership if between $30,00000 and $50,000 00, the actual cost of
which can only be determined by reference to the books and records in the
possession of the receivers
Affiant verily believes that an examination of the books and records of said
receivership would verify the estimates set forth in this affidavit
That affiant's statements above are based upon his actual personal knowledge
of the properties, including all standing timbers owned by said receivership
and included in the operations above described.
Subscribed and sworn to before me this 18th day of December, 1933
Lams HABMON.
ADELINE G. STIEF,
Notary Public, Ramsey.County, Minnesota
My commission expires June 6, 1938
(NOTARIAL SEAL)
AIMDDAVIT CW MARK HKSSEY, HEAD TIMBER! CRUISER FOB MINNESOTA AND ONTARIO
PAPER COMPANY
STATE OP MINNESOTA,
County of Ramsey, ss*
being first duly sworn on oath, deposes and says:
That he is a resident of the State of Wisconsin and now engaged in the
business of timber cruising and supervising large farm operations; that he has
been engaged for over forty years in cruising timber, and supervising logging,
river driving, and managing other operations incidental to cutting and transportation of logs and timber, that for a period of twenty-two years he was
so engaged and in the employ of Minnesota and Ontario Paper Company and
its subsidiaries including the International Lumber Company, and seived as
head cruiser in charge of all timber estimating, outside trespassing, checking
and as adviser in connection with all their logging opeiations, that part of
his duties consisted of the supervision of locating railroad right of ways,
surveying for the same, building logging camps, and m furnishing cost estimates to the managing officers of said herein referred to companies relative
to the cost of buying and removing and delivering timber
Affiant further deposes and says that he was for many years engaged in
various phases of timber operations for himself, and was the owner of large
timber holdings; that he was employed and served with similar responsibility
and duties hereinbefore mentioned for various other large timber and logging
companies of the United States; that he was employed and acted in such
capacity for Jacob Mortinson of Chicago, Illinois for a period of seven or
eight years, and was for a period of time employed by the Alexander and Edgar
Lumber Company; that in connection with his duties for said employers he
made personal surveys and appraisals of vast timber properties, and furnished
said employers with valuations of timber, some of which timber estimates
involved approximately 500,000,000 feet of timber in the State of Florida, 275,000,000 feet in the State of North Carolina, 400,000,000 feet in the State of
Mississippi, 800,000,000 feet in the State of California, 200,000,000 feet m the
States of Washington and Idaho, and approximately 275,000,000 feet in Minne
sota, prior to his employment with Minnesota and Ontario Paper Company,
that said Jacob Mortinson relied implicitly on judgment of this affiant and
purchases of timber properties by said Mortinson were made only after the final
approval of this affiant.
Affiant further states that he has personally inspected and cruised certain
timber properties located in Cook County, State of Minnesota, owned by the
MARK HESSEY,
7682
STOCK EXCHANGE PRACTICES
Minnesota Forest Products Company, a subsidiary of the Minnesota and Ontario Paper Company; that during the months of October, November, and"
December, 1932 and January, 1933, he cruised said timber properties, and furnished estimates in connection with a contract between said Minnesota Forest Products Company and the Northwest Paper Company of Cloquet, Minnesota, and that he had prior to said recent cruising of said timber examined
said timber properties during the year 1929, with a view to determining the
best plan for logging said timber properties, that as a result thereof, he isentirely familiar and acquainted with said timber properties, with the topography of the lands therein controlled and the facilities for logging operations
on said timber lands, that in affiant's opinion the timber is in large part
easily accessible and removable at reasonable costs and that the timber located,
thereon is in the main part sound and sturdy stock, and in normal times
well woith the price paid therefore; that in affiant's opinion the pulpwpod
located thereon is very valuable, inasmuch as it is easily accessible for transportation by water on Lake Superior, and can be transported at unusually
low cost in that manner, as is the experience of other timber operators who
regularly ship similar pulpwood to Wisconsin points on the Great Lakes and
other Eastern markets; that affiant verily believes the timber situate on said'
Cook County Lands are comparable in quality and value with other holdings
of subsidiaries of Minnesota and Ontario Paper Company, practically all of
which he appraised during his long period of employment;
Affiant further deposes and says that said Minnesota Forest Products Company is the owner of valuable timber located on Isle Royale, State of Michigan,
that in his opinion the timber thereon is most easily accessible and can be
logged and delivered at below average cost, that on about January, 1932, affiant
conferred with R H M Robinson, one of the receivers for said Minnesota and
Ontario Paper Company and advised him that it would be for the best interests
of the estate to log certain portions of said timber properties, in that serious
insect infection was present in parts of said timber, and that unless said such
timber was removed, heavy losses would result; that he estimated at least
50,000 cords of timber per year should be removed and that since said advice
and counsel was given, there has been sustained an estimated loss of approximately $350,00000 through the failure to act on his advice Affiant verily
believes that the estimate stated forth in this affidavit are conservative, that
rhey are based on his personal experience in said work extending over a period*
of more than forty years
Subscribed and sworn to before me this 23rd day of December, 1933
Notary Public, Ramsey County, Minnesota
ADELINE G STIEF,
My commission expires June 6, 1938
(NOTARIAL SEAL)
MARK HESSEY
AFFIDAVIT OF EVERETT WYNNE, TIMBER CRUISER AND CAMP FOREMAN FOR MINNESOTA.
AND ONTARIO PAPER COMPANY
STATE OF MINNESOTA,
COUNTY OF RAMSEY—ss
EVERETT} WYNNE, being first duly sworn, on oath, deposes and says: that
he is a resident of the State of Minnesota, that he now is and has been engaged
in work related to timber logging and Forest Products operations, for the past
twenty-four years as a camp worker, compass man, timber cruiser and camp«
foreman, that for approximately three years he was employed by The Crookston.
Lumber Company as a timber cruiser, that for approximately seven years he
was in the employment of the International Lumber Company, a subsidiary of
the Minnesota and Ontario Paper Company; that from and after September,
1932, affiant was in charge of operations at camp number 144; that his duties
were to supervise the cutting of the right of ways and laying of the tracks; the
building of necessary bridges and of all other preparatory work necessary tothe hai vesting of the timber adjacent to said camp That on or about November 5th, affiant leceived instructions to close down said camp and was notified
that there would be no further operations conducted therefrom That as a
result of such orders being issued by R H M Robinson and C T Jaffiray,
Receivers for the Minnesota and Ontario Paper Company there resulted a
tremendous loss in preparation costs including the cost of labor, supplies, and
STOCK EXCHANGE PBACTICES
7683
material incidental to such preparations, all of which investment was almost
wholly wasted, including therein the cost of transportation of men and horses
to and from said base of operations and the wages, food and care for men and
Ihorses, during the period of non-operations. During this preparatory period a
large amount of timber was cut and left lying on the ground, and on account
of the heavy snow falls before operations were resumed, approximately onethird of all the timber cut prior to the abandonment of these opeiations was
wholly lost Additional amounts of timber were lost by reason of culling the
same by the receivers after the same had been cut and paid for That was not
only the true situation at camp number 144, but the same was true concerning
operations and the timber properties adjacent to the five other camps, in addition to the one he was in charge of, and that based on his knowledge of the
operations of all these six camps and of the properties operated therefrom
there have been huge and wholly unnecessary losses, through ill-advised and
inexperienced management and operation policies, and through utter carelessness in conserving and utilizing the timber, the camp management, the railway spur track, the temporary skidways and landings, that the cash expended
for transporting and caring of horses during the period; the cash expended in
transporting men to and from camps and1 through the careless disregard of the
value of such investment in the above preparatory work resulted in a loss to
the company and its creditors in excess of One Hundred Eighty Thousand
Dollars ($180,00000)
Affiant states as one illustration of such losses that a large investment was
anade in vegetable supplies for camp 45 which was closed down and in which
•operations were not resumed Said vegetable supplies necessary for boarding a
large crew of men in said camp were stored in a root cellar provided for that
purpose, at a cost of approximately $59000 and that when said camp was
closed down on or about November 5th, said supplies were not removed and
-were not cared for with the result that the entire supply was allowed to rot and
was a complete loss; that as another illustration, affiant pursuant to instructions, was ordered to burn the buildings at camp number 29 and replaced with
new buildings; that said old buildings were in excellent condition and most
suitable for the necessary purposes and that ill-advised orders of burning said
<?amp buildings cost a loss of at least Three Thousand Dollars ($3,00000)
(Signed) EVERETT WYNNE
Subscribed and sworn to before me this 23rd day of December, 1933
ADELINE G STIEF
Notary Public, Ramsey County, Minnesota
My Commission Expires June 6, 1938
(NOTARIAL SEAL)
II
ANSWER OF MR BACKUS TO $7,000,000 00 FRAUD SUIT BROUGHT AGAINST H I M
AND OTHERS BY RECEIVERS ROBINSON AND JAFFRAY
The answer of Mr E W Backus and the other defendants named m the
«uit brought by the receivers charging unlawful abstraction of funds from the
Minnesota and Ontario Paper Company, is hereinafter set foith The first 38
paragraphs thereof are devoted to technical pleadings Hereinafter is set forth
verbatim the defense which will reveal that this action is wholly without
merit, and brought solely with the malicious intention of discrediting Mr
Backus with bondholders of the Minnesota and Ontario Paper Company, designated in the answer as " M & O "
Thirty-ninth: Further answering, defendants allege that M & O and its
various subsidiaries in the Bill of Complaint and hereinafter in this answer
referred to, were created and organized as a part or incident in the carrying
out of a single comprehensive plan embracing widely diversified and important
industries of both national and international character. That such industries
were conceived, organized and developed by defendant, E W Backus, and
all thereof financially supported and carried to consummation by the defendants Backus Brooks and E. W Backus That the single comprehensive plan
in contemplation antedated the formal organization of M & O was continued
subsequently to its organization and its general purposes and policies consistently observed and followed at all times during the history of the operations of M & O with the consent and approval of all parties m interest and
without variation from the definitely determined purposes above stated That
7684
STOCK EXCHANGE PEACTICES
throughout practically the entire operations and history of M & O. it was
dependent upon the resources and credit of the defendants Backus Brooks
and E W. Backus, which last were made available at all times during the
expansion of its properties and the development of its constantly increasing
field of enterprise. That during the period last stated there was no time during the history of the operations of M. & O that it was not legally indebted
to the defendants, Backus Brooks or E W. Backus in relatively large sums
of money and that it continued to be so indebted at the date of the receivership in this cause That the objective purpose in the organization and creation
of M. & O was the policy of consolidating and merging the enterprises of
Backus Brooks, hereinafter more fully referred to, in M & O as an operating subsidiary of Backus Brooks and that each and every step had and
taken subsequently to the organization of M & O was directed to the consummation and carrying out of this single and at all times, well defined and
understood purposes That in the gradual development of the properties finally
brought into M & O and which constituted substantially its entire resources
at the date of the receivership herein, the properties themselves were acquired
by the defendants E W Backus and Backus Brooks and carried by them
during their development period, for the benefit of M. & O upon the understanding and agreement that when developed and operating, they should be
taken over and acquired by M & O on a stipulated appraised basis. That
many of such properties acquired by defendants, E W. Backus and Backus
Brooks were acquired with the latter's resources and turned over to M. & O
upon consideration of the latter's issuance to the transferor or its or his
appomtee or appointees, of its capital stock That in many instances, properties so acquired and developed in the interest and for the benefit of M & O.
were financed by Backus Brooks and E W Backus and the obligations resulting from such acquisition and development on the part of M & O. carried
and extended for the latter's benefit over relatively long periods of time
That throughout the history of its operations, M & O was the gratuitous
recipient of facilities, benefits and advantages derived from its affiliation with
Backus Brooks and enterprises controlled or owned by the latter, all of
which contributed in varying degrees, to the ultimately successful operations
of M & O previously to the advent of what is ordinarily and popularly termed,
the world depression, with the latter's disastrous consequences in all industrial
lines, especially the newsprint industry and building trades, in which M & O
was engaged That all moneys paid by M & O. to any of the several
defendants herein, were paid to Backus Brooks or Kenora in the
carrying out of the general purpose and policy in this subdivision mentioned and all thereof was paid for or on account of indebtedness and
obligations, which had previously been legally assumed and at the date
of such respective payments, were legally due and owing by M & O to the
last named defendants That the methods observed and followed in carrying
out the single objective plan and purpose in this subdivision referred to and
responsive to which, the ultimate obligations of M & O were assumed and
any and all payments made by M & O, in fact paid, will appear from the
matters hereinafter stated, as follows, viz*
(a) The defendant Backus Brooks resulted fiom the acquisition by the
defendant E W Backus of the interest of both partners m the early part
of the year 1884, of the firm of Lee & McColloch, then engaged in the lumber
business The initial capital investment in which firm was $6,000. The firm
name was thereupon changed to E W. Backus & Co In 1892, without the
investment of added capital, the capital structure of the last named company
had increased to approximately $600,000 The firm last indicated was succeeded in 1894 by E W Backus Lumber Co, a Minnesota corporation, which
took over the assets of the former partnership In the year last mentioned,,
the defendant Backus, organized an affiliated syndicate and incorporated the
Minnesota Logging Co, which corporation acquired large interests in standing
pine timber in northern Minnesota comprising approximately 2,000,000,000
feet and purchased and reorganized the Brainerd and Northern Minnesota
Ry Co (now the Minnesota and International Ry Co ), which, during the
same year, built approximately sixty miles of mam line standard railroad,
tapping the timber area The interest of E W Backus Lumber Co, in the
projects last mentioned was approximately one-thud During the same period
(1893 to 1896), through the efforts of the said Backus Co, and its affiliates,,
the above mentioned railway was extended from Brainerd to Bemidji, Minnesota In 1899, William F Brooks became a member of said Backus Co,
STOCK EXCHANGE PRACTICES
7685
under a working interest agreement and shortly thereafter, the corporate
name of the company was changed to Backus Brooks Co In the same year
and early in the year 1900, the corporation acquired a controlling interest
in the Koochiching Company (now Koochichmg Realty Company), making
it approximately an 80 per cent owned subsidiary of Backus Brooks Such
Koochichmg Company, at the date of its acquisition, owned water power
sites and adjoining lands at International Falls, Minnesota, on the international boundary At about the same time, the defendant, E W Backus,
opened negotiations with the government of the Province of Ontario, Canada,
to secure the water power site and adjoining lands controlling on the Canadian
side of the international boundary, which were essential in the development
from shore to shore, with the object of developing the water power from shore
to shore and ultimately to establishing pulp and paper mills on both sides
of the boundary, as well as saw mills and other wood-working industries to
utilize the vast tributary timber resources At about the same time, in furtherance of the same objective, the corporation acquired large industrial
acreage, including Townsite, Railway terminals, Storage space for logs and
lumber on the Minnesota side of the boundary and acreage sufficient for mill
sites on the Canadian side In 1902, the defendant Backus, organized the
defendant Backus Brooks Company under the laws of Maine
This corpoiation succeeded the Minnesota corporation and acquired all of the
latter's properties and rights The financial structure of the Minnesota corporation had then grown to approximately $3,000,000, with practically no outstanding obligations In 1903, the defendant, Backus Brooks Company, in
conjunction with affiliated interests, organized the Rainy River Lumber Co,
Ltd, a Canadian corporation and the Namakan Lumber Company, a Minnesota
corporation The former of the two last mentioned organizations plays no particular part in the subsequent operations and development, in this answer
refeired to The latter (the Namakan Company), however, acquired large
timber holdings in Minnesota, which entered into the later operations During
the period last referred to, as well as in later years, the Backus Brooks Company of Minnesota, and its successor, acquired large timber holdings in northern
Minnesota, in contemplation of future developments at International Falls and
Fort Francis In 1905, the defendant Backus Brooks Company, organized the
International Lumber Company, a wholly owned subsidiary of the defendant
Backus Brooks Company, with a capital of $600,000, fully paid in, afterwards
increased to $4,000,000 In the same year, the company organized the First
National Bank of International Falls and the International Telephone Company In that same year, Defendant Backus having previously acquired the
water power property on the Canadian side, organized the Ramy River Improvement Company, a Minnesota corporation, originally capitalized for
$100,000, and Ontario and Minnesota Power Company, Ltd., a Canadian corporation, with authorized capital of $3,000,000 of common stock and $5,000,000
first mortgage bonds, the latter afterwards reduced to $3,500,000 The capital
stock in the above organization was fully paid and wholly owned by Backus
Brooks Company.
Immediately following the matters last stated, and during
the years11905-1907 construction work on the development of the water power
at Fort Francis and water power and mills at International Falls, was carried
on by defendant Backus Brooks and its subsidiaries
(b) In 1906, the Keewatm Lumber Co, Ltd., was organized by the defendant
Backus-Brooks Company, under the laws of the Province of Ontario, with a
capital stock (authorized) of $500,00000, of which $250,000 00 was paid in.
This; was a wholly owned Backus-Brooks subsidiary Its manufacturing plant
was completed and put into operation during the same year This company
was intended to handle the logs acquired from the Mather Syndicate timber
limits and the interest of Backus-Brooks in the logs of Namakan Lumber Company Supplementary development in the affairs of the Canadian Company
last indicated included a tie mill and a box factory at Keewatm and a box
factory at St Boniface Contemporaneously with the acquisition of the Mather
Syndicate timber limits, an option was secured on the Norman dam at the
outlet of the Lake of the Woods in the Winnipeg River by the defendant,
Backus-Brooks Company. In the same year (1906), the Big Fork and International Falls Ry Company was organized by Backus-Brooks Company and
construction work was started immediately and completed in the fall of 1907,
the property having been sold in the meantime to the Northern Pacific Railway
Company This was made necessary by change in the proprietorship in the
Minnesota and International Ry Co., which had declined to extend the latter
7686
STOCK EXCHANGE PRACTICES
line fiom the Big Fork River to International Falls The last named development was imperative to provide transportation facilities for the completed plant
at International Falls. In 1907, the pending construction work at International
Falls and Fort Francis ceased temporarily by reason of the failure of the contractors in charge of the work. A still further delay was entailed by reason of
the vote by President Roosevelt of a bill passed by the Congress of the United
States authorizing the work The bill last indicated was passed over the veto
of the President and the development work resumed m 1908.
(c) In 1908, following the matters last above indicated, the prelimmaiy steps
were taken for financing the development projects at International Fails and
Fort Francis Negotiations weie opened by the defendant Backus with the
firm of Peabody, Houghtelmg & Company, Investment Bankers, of Chicago,
Illinois, to underwrite the financing of the joint water power development at
the points last indicated and the pulp and paper mills planned to be constructed
at International Falls and to become the fiscal agents of the defendant BackusBrooks Company and its subsidiaries At the time of these negotiations, development of the pulp and paper industry on the Canadian side of the border was
impracticable for the reason Canadian newsprint was subject to an import
duty in the United States of $6 00 per ton Pending the negotiations above mentioned, one of the partners of Peabody, Houghtelmg & Company peisonally
inspected the properties involved, examining the water powers at International
Falls and Fort Francis as well as making an extensive investigation of the tributary pulpwood resources covering a large area on both sides of the boundary
During the period last stated, defendant Backus laid before the aforesaid representative of Peabody, Houghtelmg & Company, the broad development plan he
had in contemplation, embracing the entire area contiguous to International
Falls, Kenora, Port Arthur-Fort William and Fort Francis, including the
development of the water powers, the construction of pulp and paper mills, saw
mills, planning mills, box factories and other wood-workmg industries to utilize
the vast timber resources tributary to the region mentioned The subject of
the ownership by the defendant Backus-Brooks Company and its operations of
Keewatm Lumber Company, the outstanding option on the Norman Power dam
and the projected construction and development of the pulp and paper industry
on the Canadian side of the border, whenever the customs duty into the United
States would permit, were fully discussed as were the initial steps, which had
been taken to the last stated end, including the extended negotiations said
Backus had had with the Province of Ontario, for an extensive pulp, wood and
timber concession at the head of the lakes in the territory tributary to the point
of contemplate manufacture The plan proposed by said Backus to the representative of the said Peabody, Houghtelmg & Company during such negotiations,
was to first continue the development of the International Falls property, then
under construction, this work to be started immediately
This to be followed by the development at Fort Francis, conditioned, as aforesaid, on the adjustment of the impoit duties into the United States and finally,
the development at Kenora and Great Lakes at Port Arthur-Fort William, the
last conditioned on the defendant Backus securing the government concession
already referred to Protracted negotiations between the defendant Backus
and Peabody, Houghtelmg & Company followed with the result that as a condition to the initial financing, the said banker required of said Backus, a stipulation and agreement on the part of himself as well as on the pait of the
defendant Backus-Brooks Company, that they would neither develop or operate
independent properties in the area of such contemplated development which
would compete with the parent operating company either with respect to raw
materials or the sale of manufactured products in the same market The further condition was attached by said bankers that a parent operating company
should be organized in the inception of the undertaking and before the initial
financing thereof, which should take over the water power and adjoining lands
on both the Minnesota and Canadian sides of the border and that upon the
completion of the water powers and the completion of the paper mills at International Falls and placing the same in operation, such parent operating company should acquire and take over the International Lumber Company together
with all the timber holdings of the defendant Backus-Brooks Company in northern Minnesota The further condition and stipulation was attached by the
bankers that when and as the several properties then contemplated to be
acquired and developed by Backus-Brook, were acquired and developed, the
initial plan should be expanded in such wise that all such several properties
would be brought in to the parent organization on the basis of their respective
STOCK EXCHANGE PEACTICES
7687
appraised value. The conditions thus stated were acceded to by the defendants
Backus and Backus-Brooks Company. As a final condition to the initial financing, above referred to, the investment bankers required that the entire proposed
bond issue of $5,000,000 00 should carry the guaranty of the defendant BackusBrooks Company on the bonds themselves and that defendant Backus should
execute to the fiscal agent, to be held by them for the benefit of whom it might
concern, his independent personal guaranty of the entire issue The guaranties
last mentioned were given in closing the final steps for the contemplated financing. The agreements and stipulations with the bankers in this subdivision
alleged, were at all times known to all parties in interest and from the date of
the initial financing and the preliminary steps for consolidation, as hereinafter
alleged, were followed and observed during the entire history of the operations
of the M. & O. and its subsidiaries
(d) The negotiations last mentioned led to the organization, on or about the
8th day of October, 1908, of the Minnesota and Ontario Power Company (now
Minnesota and Ontario Paper Company, termed in the Bill of Complaint herein
as M & O ). From the date of the organization of this corporation, two of the
partners of the aforesaid Peabody, Houghtelmg & Company were continuously
members of its board of directors for approximately nine years when they
resigned by reason of having secured control of a competing paper manufacturing industry The capitalization of the corporation thus organized was
$5,000,00000 of common shares, $2,000,00000 of participating 6% preferred
shares and $5,000,000 00 of first mortgage and collateral 6% serial bonds Of
this issue, the bankers underwrote $3,000,00000 of the bonds and $1,000,00000
of the preferred stock, the proceeds of such underwriting made immediately
available for the development work then in progress,* including the power dam
from the American to the Canadian shore and the mill construction at International Falls, Minnesota In carrying out this transaction, defendant BackusBrooks Company transferred to the newly oiganized corporation, the entire capital stock and bonds of the Ontario and Minnesota Power Company, Ltd, (characterized in the Bill of Complaint herein as O & M), the entire capital stock
and bonds of the Rainy River Improvement Company, heremabove referred to,
and the mill sites acquired on both sides of the International boundary In consideration of the transfers thus indicated, the newly organized corporation
issued to the defendant Backus-Brooks Company, the entire issue of its common
stock ($5,000,000 00), and one-half ($1,000,00000) of its issue of participating
preferred stock, coupled with the agreement of the newly organized corporation
to advance and pay $400,000 00 in cash, such sum to be appropriated to the recall
and retirement of an equivalent amount of the outstanding Ontario and Minnesota Power Company bonds, which had previously been sold In the public
offering by the bankers of the securities ot the newly organized corporation, it
was found that such sale would be facilitated by an offeung of common stock
as a bonus and the defendant Backus-Brooks Company thereupon donated
approximately $500,000 00 of its common stock, which was received and used by
the fiscal agents in consummating the sale by them of the securities Each and
every step m the negotiations and transactions thus detailed, including the
organization of the aforesaid Minnesota and Ontario Power Company as the
operating subsidiary of the defendant Backus-Brooks Company, were had and
carried out as a preliminary step and incident of the broader and more comprehensive plan above alleged, of consolidating and merging the various forest
products and wood and paper manufacturing industries of the defendant BackusBrooks Company as the same were successively acquired, developed and placed
in operation by the defendant Backus-Brooks Company in such newly organized
corporation Following the conclusion of the fiscal arrangements above alleged,
the various developments of water power, pulp and paper mills and saw mills
at International Falls and the water power development at International Falls
and Fort Francis continued throughout the years of 1908 and 1909 and the
manufacture of newsprint paper was commenced early in the year 1910
(e) In 1910, in accordance with the previous agreement with the bankers
above alleged, the defendant Backus-Brooks Companv sold to the newly organized operating subsidiary (M & O ), the entire issue of capital stock of International Lumber Company, and later the increased capital stock of that company, and also, all of the standing timber owned by the defendant BackusBrooks Company in northern Minnesota The obligation thus assumed for the
purchase and transfer last indicated amounted, in the aggregate, to several million dollars and the same was carried by defendant Backus-Brooks Company
over a series of years, not being finally liquidated until about the years 1925 and
7688
STOCK EXCHANGE PEACTICES
1920. Shortly following the acquisition of International Lumber Company, as
above alleged, and in furtherance of the pending program of development,
defendant Backus organized the Minnesota, Dakota and Western Ry. Co, International Bridge & Terminal Co, Ltd, and Wattrose Island Boom Company.
The development thus mentioned constituted part of the program for establishing communication between International Falls and Fort Francis It was taken
over in part by the International Lumber Company and the newly organized
operating subsidiary (M & O ). The investment in this development aggregated
approximately $1,750,000 00, and the same was financed through bank loans on
the credit of the defendant Backus-Brooks Company and the personal guaranty
of defendant Backus
(f) In 1911 the Fort Francis Pulp & Paper Company, Ltd, was organized.
Shortly following the date of its organization, the erection of mills at Fort
Francis was started and the same completed in 1914. Simultaneously, storage
dams at the outlet of Namakan Lake were built and put into operation m 1914.
The last mentioned corporation was wholly owned subsidiary of the aforesaid
Ontario and Mm m 1914 The last mentioned corporation was a wholly owned
subsidiary of the aforesaid M & O The initial capitalization of the newly
organized company was $50,000 00, which was later increased to $3,000,000 00.
The development itself was financed on behalf of the two proprietary companies, through the credit of the defendant Backus-Brooks Company and the
defendant Backus One loan of $1,000,000 00 was financed through the deposit
o£ an equivalent amount of the M & O Preferred and Common stock loaned
to that company by the defendant Backus-Brooks Company. The terms of the
loan provided the holders of the note should reserve the privilege of option of
converting the same into the stock deposited.
(g) In 1913, the defendant Backus purchased for the aforesaid International
Lumber Company the assets of the Shevlin-Mathieu Lumber Company. The
property thus acquired, included a saw 'mill plant and appurtenances, town
site, etc., located at Spooner, Minnesota, on the lower Rainy River, also, all of
that company's timber holdings in northern Minnesota; also, all of its lumber
and logs. The purchase price involved in the transaction thus indicated was
approximately $3,000,000 00. The purchase itself was made at the recommendation and with the approval of the fiscal agent above mentioned Of the initial
payment required in this transaction, the defendant Backus-Brooks Company
advanced approximately $650,000 00, which was carried by it for the M & O.
over a series of years and was not finally liquidated until the new financing
of M & O in the year 1925 Other advances made by the defendant BackusBrooks Company and its subsidiaries incidental to carrying out and developing the various properties and rights of M & O aggregated several millions of
dollars, carried by it for the benefit of M. & O in the same manner and which
has never been paid
(h) In 1913t pending the developments last above alleged, the defendant
Backus secured from the government of Ontario, Canada, the Lake of the
Woods pulpwood concession, embracing some 1,800 square miles. The condition
of this concession was an agreement on the part of the defendant Backus, to
build a pulp and paper mill at or near Kenora. The carrying out of the latter
project required the conclusion of the option agreement by defendant BackusBrooks for the purchase from the John Mather Syndicate of the Norman dam
controlling the water power at the outlet of the Lake of the Woods, heremabove
referred to. The conclusion of this option, involved the purchase of the entire
capital stock of Keewatin Power Company, Ltd, comprising $750,00000 of
common shares and $250,00000 of preferred shares for a consideration of
approximately $600,00000.
(i) In 1913, the properties of the Shevlm-Mathieu Lumber Company were
acquired, as heremabove alleged This transaction mcluded a preterence for
the purchase of the timber byproducts of Crookston Lumber Co, a Shevlm
organization havmg large timber holdings in northern Minnesota. The products covered by this preference were principally cedar and tamarack, including
poles, railroad ties, pulpwood, etc Incidental to this transaction, the defendant Backus, in 1914, with two individual associates, organized the American
Cedar Company. The Backus interest in the transaction was one-third and this
interest held for the benefit of the aforesaid International Lumber Co The
enterprise was financed through the credit of defendant Backus-Brooks Company
and defendant Backus, individually, by whom the bank loans were guaranteed.
(j) In 1914, the defendant Backus caused the International Insulation Company to be organized with a capital stock of $50,000. The objective purpose
STOCK EXCHANGE PRACTICES
7689
of this enterprise was the use of the by-products of wood pulp under a patented
process The use, however, of the product grew to such proportions it was
found necessary to manufacture the raw material direct from wood to secure
the wood fiber. The invention to which reference is thus made, was the original development in the production of wood fiber insulation board. The company was organized as a subsidiary of M & O ; was afterwards renamed the
Insulate Company and with its subsidiaries, has grown to an investment of over
$5,000,000. In 1929, its net profits were approximately $1,000,000
(k) In 1917, preparatory to the large development in contemplation at
Kenora, the defendant Backus Brooks Company purchased for the Keewatm
Lumber Company, the properties of the Rat Portage Lumber Company and
other independent operations m that district, to protect and insure the supply
of raw material for the contemplated manufacturing plants. These transactions entailed an investment of approximately $100,000 In 1920, preparations
for the actual development of the Kenora Properties were made in contemplation of starting actual operations early in 1921 Anticipating this large plan
of development, the defendant Backus secured from the Ontario government,
another valuable pulpwood and timber concession, embracing approximately
5,000 square miles At about the same time, the defendant Backus acquired
from the Ontario government, a large undeveloped water power and also purchased from the City of Kenora, its municipal water power plant The development project thus undertaken, included completely hebuildmg and modernizing
the municipal power plant; increasing the discharge area of the Norman dam
at the outlet of the Winnipeg River, the installation of water wheels, electrical
generators and transmission lines of both the Kenora and Norman Plant, and
the construction of pulp mills and paper mills with a capacity of 250 tons daily.
These projects entailed the investment by the defendant Backus Brooks of
many millions of dollars The active development work began early in 1921
and was continuously carried on thereafter until the entire project was completed in 1925.
(1) In connection with development projects previously to that last referred
to, the defendant Backus had met with many obstacles owing to the failure
of contracture, unsatisfactory work and excessive cost As an initial step in
the last above mentioned development, he concluded to establish for defendant,
Backus-Brooks Company, a complete engineering and construction department
to plan, supervise and execute the projected work. The plan last stated was
made effective in 1921, at which time,
the Backus Brooks Company construction
Department was organized under1 an efficient staff of specially employed engineers and construction managers and the best and most efficient machinery,
tools, and other necessary apparatus provided In the inception of the plan
thus mentioned, it was the intention of the defendant Backus-Brooks to enter
into the business of general contracting but, in the interim expansion plans of
M & O. and subsidiaries developed and m deference to the requirements of
the projects of these companies and others in contemplation, remunerative contracts obtainable from the outside were refused and the operations of the
newly created construction organization exclusively confined to those being
carried on in connection with and as part of the comprehensive plan above
alleged, in which the defendant Backus Brooks, through its subsidiaries, was
primarily interested.
(m) During the progress of the widely spread and variously differentiated
projects already alleged, having, as previously alleged, the single objective
purpose in view, all of the various undertakings and the subsidiary organizations through which they were carried on, were at all times treated to all
practical intents and purposes, as parts of a single enterpise, with the
controlling management vested in the defendant Backus Brooks Company as
the proprietary or parent organization
(n) Early in 1924, pursuant to the original understanding and agreement
had in 1908, as heretofore alleged and under which it was provided that M & O.
should become the parent operating organization of all the varied Backus
Brooks forest products operating companies, located in the areas mentioned,
as the respective developments thereof reached an operating stage, the subject
of additional financing was taken up with new investment bankers with whom,
as a result of extended preliminary negotiations, defendant Backus had arranged for the necessary financing preparatory to the consolidation or merger
of the Kenora and Keewatm properties above described with the general
undertakings and properties of M & O Notwithstanding all the development
work that had been undertaken and carried on in the interest and for the
7690
STOCK EXCHANGE PBACTICEB
benefit of M & O that company had made only comparatively moderate advance
to the defendant Backus Brooks Company, anticipatory to taking over the vast
properties referred to All such advances were offset and more than offset by
the large advances due to the defendant Backus Brooks Company and its
subsidiaries by M. & O which have not been liquidated up to the present
time.
(o) The details for the financing last referred to were confirmed as of
November 30th, 1924,' and carried out as next stated • In February and March,
1925, defendant Backus Brooks Company caused to be incorporated two Canadian holding companies, viz Kenora Development Company, Limited, with am
authorized capital of 10,000 no par value shares and Kenora Paper Mills-,
Limited, with an authorized capital of 500,000 no par value shares and $8,500,000 first mortgage bonds, dated April 1st, 1925, and payable on demand Following the completion of the organizations last stated, the defendant Backus
Brooks Company and defendant Backus transferred and conveyed to Kenora
Development Company the entire capital stock of Keewatm Lumber Company,
Limited, and Keewatm Power Company, Limited, the English River Pulp and
Timber Limits, the pulp and paper mills constructed and in the process of
construction and the undeveloped water power secured from the Province ot
Ontario m 1920. In exchange for the pioperties thus conveyed, defendant
Backus Brooks Company received the entire capital stock of Kenora Development Company, Limited Following the conveyances and transfers last stated,
the said Kenora Development Company transferred and conveyed to Kenora
Paper Mills, Limited, the entire capital stock of Keewatm Lumber Company,
Limited, and Keewatm Power Company, Limited The conveyance was coupled
with an agreement by Kenora Development Company and the defendant Backus
Brooks Company, for the completion of the power development at Norman
dam and increasing the capacity of the newsprint mills of the companies whose
stock had been thus transferred, reserving however, the construction plant
and organization and the undeveloped water power previously referred to*
The consideration for this conveyance was the entire authorized stock of
Kenora Paper Mills, Limited, and the $8,500,000 of bonds of that company
above mentioned Following the transaction last mentioned, Kenora Development Company, Limited, transferred to M & O the stock and bonds of Kenora
Paper Mills, Limited, together with the agreement of Kenora Development
Company and the defendant Backus Brooks Company, covering the completion
of the development work as above stated In consideration for this transfer,
M & O issued to Kenora Development Company, Limited, 17,500 shaies of
its legulaily issued preferred stock, 43,920 shares of its regularly issued common stock and $8,500,000 in cash The issue of the common shares' last mentioned was conditioned on the agreement such shares were to receive no dividends until the original 50,000 shares of common stock, issued by M & O had
received 6 per cent dividend from date of issue to November 30, 1924
During the negotiations and in the procedure of consolidating these properties
(on one side the properties of M & O and its subsidiaries and on the other,
the properties of the Keewatm and Kenora companies, respectively, subsidiaries of defendant Backus Brooks Company), experts were designated to
appraise the physical properties of both sides and to inventory and appraise
the value of all other properties involved The appraisal was had accordingly.
The minority stockholders of M. & O were permitted to designate and appoint
a prominent and experienced paper mill owner as their representatives to confer with the defendant Backus and fix the basis of valuation on all of the
various properties entering! into the consolidation As a result, the valuation
of such properties was mutually agreed upon and accepted as the basis of the
consolidation In the same connection, it was agreed that as the defendant
Backusi Brooks could not deliver control of the capital stock of Great Lakes
Paper Company, Limited, that the minority interest in that company should
continue to be held by the defendant Backus Brooks Company and that if and
when the defendant Backus Brooks Company could deliver control of the said
Great Lakes Company and the latter's paper mill in operation, the same was
to be turned over to M & O on the same basis of valuation as employed in the
M. & O. consolidation then under consideration and the basis and valuation
for which had been arrived at in the manner heremabove alleged.
(p) The transactions last alleged, brought into the merger or consolidation,
the management of the various enterprises located at Kenora, Keewatm and
Norman through Kenora Paper Mills, Limited, a wholly owned subsidiary of
M. & O Shortly previous to the transfer of these properties to M & O th&
STOCK EXCHANGE PEACTICES
7691
defendant Backus had received an offer of $20,000,000 in cash theretor, from an
outside independent competing interest This consolidation provided the basis
for the financing of M & O effected through its trust deed and mortgage to The
Minnesota Loan and Trust Company, as Trustee, under date of April 1, 1925,
securing an issue of $16,000,000 first mortgage and collateral bonds, a copy of
which mortgage is attached to the Bill of Complaint herein, as will more fully
appear from such attached copy, the security conveyed and pledged under this
moitgage included the various physical properties brought into the consolidation through the Minnesota and Ontario Company (M & O.) and International
Lumber Company, stocks of the various constituent subsidiaries and the bonds
of Rainy River Improvement Company; Ontario and Minnesota Power Company, Limited, and Kenora Paper Mills, Limited
(q) As heremabove alleged, in the preliminary stages of the negotiations
contemplating the establishment at Fort William or Port Arthur in the Province
of Ontario, of facilities for the manufacture of paper and other miscellaneous
commodities, the expediency as well as business necessity of the ultimate control of this enterprise by M & O was agreed to by all parties concerned, including the first above alleged fiscal agents In 1921, as a part of the initial step
in this enterprise, defendant Backus secured from the Ontario government, the
Negagami pulp limit estimated to contain 5,000,000 cords of pulpwood and
timber of other species Transcontinental Development Company, Limited, a
wholly owned subsidiary of defendant Backus Brooks Company (now owned by
Gieat Lakes Paper Company, Limited) was organized to hold the limits thus
acquiied During 1922 and 1923, defendant Backus acquired 600 square miles
of timber land in fee simple, to hold which, the Transcontinental Paper Company, Ltd, was organized with a capital of $5,000,000 of which 95 per cent was
owned by the defendant Backus Brooks Company (now owned by the Great
Lakes Paper Company, Limited).
(r) During the period last referred to, 1922-1923, the defendant Backus, in
affiliation with outside parties, organized the Great Lakes Paper Company, Ltd,
capitalized at 500,000 shares of no par common stock and $2,000,000 of 6 per
cent preferred stock. In the inception of this organization, the defendant
Backus Brooks Company held a minority interest, but notwithstanding, provided all the funds to finance the construction of the initial ground-wood pulp
mill; to acquire industrial sites; to acquire sites for employees' homes and for
the ultimate location of terminals' and docks In 1927, the Backus Brooks
Company acquired the entire stock ownership of the Great Lakes Paper Company, Ltd, and immediately upon such acquisition, began the erection of paper
mills, the construction of which was continuously carried on until fully completed in 1929, the ground-wood pulp mill having been in operation since 1924
and the first newsprint unit in early 1929. The timber limits previously acquired for this project were estimated to contain 18,000,000 to 20,000,000 coids
of pulpwood and located in proximity to Fort William, Ontario, where the mills
were constructed.
(s) In 1927, negotiations were opened by the defendant, Backus, with the
investment bankers who had underwritten the M & O financing m 1925, and
handled the subsequent issues of securities by M & O contemplating the immediate acquisition of the Great Lakes project by M & O without the necessity
of independent financing by Great Lakes At or about the date of the financing
under the trust deed last referred to, the basis of valuation of the properties
to be acquired on such consolidation, had been settled between the defendant,
Backus, and the representatives of approximately 80% of the M & O minority
stockholders.
This agreement provided in substance that the same basis should be employed for the purposes of the Great Lakes consolidation that was employed
when the Kenora properties were taken over. The plan of immediate consolidation was not approved by the investment bankers, underwriters of the M
& O. securities, as aforesaid, but m lieu thereof, it was proposed the Great
Lakes enterprise should, in its initial stages, be independently financed through
a bond issue of its own creation and that the ultimate taking over of the property by M. & O. should be postponed until the development work was completed
and the mills in operation and showing satisfactory earnings. There was no
change in the original plan and understanding herein above alleged, that the
property should be developed for M. & O. and be made a part of the entire
unitary organization. Jn 1030, Great Lakes Paper Company, Limited, made
satisfactory showing notwithstanding the partial operation of its mills; the
prevalence of what may be termed "cut throat" competition in the paper
7692
STOCK EXCHANGE PRACTICES
industry and the general commercial depression In deference to the last mentioned conditions with the attendant difficulties in respect to any newly proposed public financing, it was decided the consolidation should, for the time
being, be deferred, that the said Gieat Lakes Company should immediately
take ovei the Transcontinental Paper Company, Limited, and Transcontinental
Development Company, Limited, that it should increase its common capital
stock to 750,000 no par shares and its 6% preferred stock to 100,000 shares,
and that Backus Brooks Company should deliver to M & O. a sufficient number
of such preferred shares, at par, to cover substantial advances made by M. & O.
to the defendant, Backus Brooks Company, during the period of the development construction and operation of the Great Lakes project That the stock
so to be transferred was that alleged in the Bill of Complaint and that such,
stock at the date of such transfer was fairly and reasonably worth par and
more Pending the arrangements for completing the contemplated consolidation, it was agreed and understood that the Great Lakes Paper Company, Ltd,
should be handled and conducted as a part of the unitary organization, that
its manufactured product would be sold to M & O and the latter should withhold part of the payments coming to Great Lakes Company, but should remit
amounts necessary to defray Great Lakes operating costs The amounts then
withheld by M & O aggregated at the date of the receivership in this cause
approximately $2,500,000. During the development periods of both the Kenora
properties and the Great Lakes Company, the M & O company bought all of
the ground-wood, pulp and paper produced as originally agreed in 1908, thereby
obviating any competition in the purchase of raw material or in the salesmarket for the manufactured products pending the ultimate consolidation of
these properties, as above alleged.
The contemplated plan and understanding for the consolidation of the Great
Lakes with M & O was that the defendant, Backus Brooks Company, should
transfer to M & O 750,000 shares of the no par value common stock and 100,000
shares of the preferred stock of the said Great Lakes Company, together with
the latter's affiliated properties, including its' undeveloped water powers.
Backus Brooks was to receive in cash approximately $7,500,000, less advances
previosuly made by M. & O and preferred and common stock in M & O in
amounts to be determined by method of appraisal already mentioned
(t) The basis of consolidation last mentioned, wholly apart from the circumstance that its carrying out would have been a step or incident of the general
plan of unitary organization heremabove referred to, was fair, equitable, legal
and to the advantage and for the benefit of M & O and the latter's consolidated operations and properties. Following the initial financing of the said
Great Lakes through the flotation of a bond issue of $10,000,00000 and while
the Great Lakes was a subsidiary of the defendant Backus Brooks, as aforesaid
and during the final completion of the paper mill development and before the
said Great Lakes Company had acquired additional outside holdings of a value
in excess of $10,000,00000 which were taken over by the last named company
in December, 1930, defendant Backus Brooks was offered $25,000,000 00 m cash
for the equity in Great Lakes by a competitor of M & O. in the newsprint
manufacturing and related industries
(u) During 1933, the defendant Backus, as hereinabove alleged, caused the
Seine River Improvement Company to be organized and capitalized with
$3,000,00000 common stock The said Backus had previously secured leases
from the Ontario government to develop the water powers at Sturgeon Falls,
Calm Lake and Moose Lake The objective purpose in the acquisition of the
last named property was to provide for the construction of transmission lines
to both Fort William on the East and Fort Francis on the West, for the delivery
of power to Great Lakes Paper Company, Limited, and Fort Francis Pulp and
Paper Company, Limited It was intended to operate these properties independently through an independent power service corporation It developed
later, however, that the industries of M & O at Fort Francis and International
Falls lacked adequate power and that the shortage could not be provided for
from any other source than that of the development first hereinabove mentioned.
In deference to this situation, the decision was finally reached between all of
the interested parties that the defendant Backus should turn the leases over to
Seme River Improvement Company and that the company's capital stock
should be turned over to M & O and the latter's subsidiaries
Previously to the arrangement last indicated, M. & O had no interest in
Seme River One of the conditions of the transfer of the Seme River Stock and.
one of the considerations upon which such transfer was made, was that Kenora.
STOCK EXCHANGE PRACTICES
7693
Development Company should be given the contract to develop the three
water powers in this subdivision referred to and that the construction plant
and organ zation of Kenora Development Company, Limited, and Backus
Brooks Company should develop such water power and supervise and construct
the additional expansion construction then contemplated by M & O and its
subsidiaries Fort Francis Pulp and Paper Mills, Ltd, and Kenora Paper Mills,
Limited, all such construction and engineering to be earned out on the basis
of cost plus 15% The aforesaid consideration was m all respects fair and
reasonable. The understanding and stipulation last indicated was mutually
agreed upon by all parties in interest and the construction and engineering
cairied out accordingly by the defendant Backus Brooks Company and the
latter's subsidiary, Kenora Development Company, Limited Many of the
operations and dealings between the various interrelated companies were informally handled throughout the entire history of their widely expanded and,
diversified operations Whether formal contracts covering the understanding
and agreement for construction and development in this subdivision alleged
were made and entered into at the time the work was undertaken, these
answering defendants allege they have no knowledge or information sufficient
to form a belief but that it was at all times the understanding of the Executive Department of the defendant Backus Brooks Company and of its subsidiary, Kenora Development Company, Limited, that such contracts had been
formally prepared and executed by the respective parties in the inception of
the undertaking In 1929, the Executive Department of the two last stated
companies was informed by the Comptroller of M & O that m the absence of
formal contracts only memorandum construction charges had been made and
that to carry the latter to the legular books verification of the memorandum
charges should be provided by formal contract; the defendant Backus thereupon instructed the Comptroller of M & O that if such memorandum or
memorandums of agreement covering the construction in this subdivision mentioned, had not previously been made, the same should be prepared and
executed and that in accordance with these instructions, the respective memorandums attached to the Bill of Complaint herein, and therein designated as
respectively Exhibits "A" and " B " were prepared and executed under tho
directions of the defendant Backus
(v) In 1926, defendant Backus Brooks organized the National Pole & Treating Company with a capital of $30,000 00 of preferred shares and $30,000 no
par value common shares This company was organized to take over the properties of National Pole Company, the American Cedar Company and Northern
Tie & Treating Company, the last named company controlled through ownership
of stock by International Lumber Company, which also owned a one-third
interest through stock proprietorship in the American Cedar Company The
outstanding interests in the first above named company were purchased by
Backus Brooks The reorganization thus affected vested in Internatinal
Lumber Company, a subsidiary of M & O as aforesaid, approximately 90% of
both classes of stock of the National Pole & Treating Company
(w) In 1928, following the organization by M. & O. of the Insulite Company,
a wholly owned subsidiary of M & O and the development of an extended
product or commodity commercially known as insulite, mvestations of the
facilities and opportunities for establishing a similar industry in Europe were
conducted with the result of selecting Finland as the locality for this development by reason of a variety of circumstances including the availability of
timber resources, the presence of developed and undeveloped water powers, low
labor costs and world market. These investigations resulted in the acquisition
by M & O of various properties in the country mentioned and the organization
of the Insulite Company of Finland, a wholly owned subsidiary ot M & O
In connection with the same project, The Insulite Company of Finland acquired
a half interest in the Abborfore Power Company of Finland, with the obiective
purpose of acquiring the necessary power for the contemplated manufacturing
operations. Actual construction of the manufacturing plant was commenced in
the early part of 1930 and carried to completion during the same year, when
the manufactured product of the new enterprise was placed on the European
market During the years 1930 and 1931, the investment in this enterprise
aggregated approximately $3,000,000 00
Fortieth: These answering defendants further allege that previously to the
conference had with the bankers in New York City the day before the institution of the receivership proceedings herein, as hereinabove alleged, no apprehension had existed upon the part of the executive management of M & O. or
7694
STOCK EXCHANGE PEACTICES
of the defendant Backus with respect to the financial status or solvency of
M. & O or its ability to finance its 1931 maturities; as indicated from the
circumstance approximately $3,000,000 00 of new capital had been invested in
expanding its enterprises in 1930-1931; that in the late summer of 1930, the
executive management of M. & O approached the fiscal agent of the company
with a view of anticipating the requirements for such maturities in the Spring
of 1931, that at this time, the executive management was assured by the fiscal
agent that the necessary financing could be taken care of, but that it was too
early to then consider the subject, that the matter was accordingly permitted
to remain in abeyance in accordance with the latter suggestion until early in
October, when the fiscal agent suggested separating the developed water powers
of M & O from its other properties, as a basis for a separate bond issue, which
said fiscal agent agreed to underwrite The latter plan was developed by the
end of the year, but then abandoned on account of apparently insuperable legal
technicalities. Early in 1931, the commercial bankers of M. & O agreed with
defendant Backus to provide the necessary funds for meeting all maturities in
that year on the notes of M. & O with its series " D " bonds, as collateral, in
February of that year, the defendant Backus called a conference with such
bankers and fiscal agent in New York City to consummate the last mentioned
arrangement; at such conference the commercial bankers, for the first time,
informed defendant Backus that in the then prevailing financial conditions, any
new financing was impossible; the defendant Backus was further informed that
default m the obligations of M & O maturing three days later was inevitable
and that the salvation of the enterprise could only be accomplished by a
moratorium through a receivership; that in the same conference, it was further
stated by the bankers that such receivership could be effected by making the
defendant Backus the sole receiver, thus continuing his managerial capacity of
the various industries and properties, which had been built up and developed
under his personal supervision and direction.
That the conference brought out the desirability of a co-receiver or coreceivers, with the result that the parties characterized in the Bill of Complaint
herein as the original receivers, were appointed; that apart from the assurances
thus held out and given by the bankers, the defendant Backus would not have
consented to the receivership, that during such conference, the bankers inquired of the defendant Backus as to the then cash satuation of M & O. and
upon being informed the last named Company had cash on hand in the amount
of over $1,100,000 00, the bankers required that such moneys should be forthwith paid over to or appropriated by them for application and credit on outstanding obligations of M & O then held by them respectively; in response to
the suggestion of the defendant Backus that the proposed preference would
necessarily result in the cessation of all active operations for lack of the necessary cash resources; the bankers assured the defendant Backus, the necessary
funds for the receivership operations would be provided by them through the
receivership That all cash on hand was thereupon appropriated by the bankers.
That as a result, the bankers substituted for their position as general creditors
of the enterprise The preferred lien status of holders of receivers certificates
in a relatively nominal amount.
Forty-first • Fuither answering, these answering defendants allege upon information and belief, that at the time the assurance last mentioned were given
by the bankers to defendant Backus, there was no intention upon the part of
the eastern bankers that the same should be carried out; that the fact the
development of the vast properties involved had been made the life work of the
defendant Backus and that the latter's entire fortune was in the equities of
such properties and thus, in their salvation and rehabilitation, did not fit in
with the scheme of such eastern bankers, that such eastern bankers have been,
since the eaily stages of the receivership herein and still are conniving and
conspiring to wreck M. & O. and turn its properties over to a competiting
industry, of which such eastern banks are creditors for large amounts; that
the plan and scheme of such bankers has been and is to bear and depreciate
the properties and enterprise involved and that to the consummation of such
scheme, it was essential the defendant Backus should be destroyed and removed,
so far as possible, from the picture, that for the accomplishment of this end,
it was essential that the parties really interested should ostensibly be brought
together through the customary discredited banker's scheme of organizing
creditors' and bondholders' committees; that with their knowledge of the fictation of the securities and the holders thereof, which knowledge was not
possessed by the executive management of either M. & O. or the defendant
STOCK EXCHANGE PRACTICES
7695
Backus-Brooks, the bankers were in a position to' circularize the large number
of widely scattered creditors individually interested and influence the latter in
committing their interests to committees of the banker's selection and designation; that this step was taken with the result that in the course of the
receivership administration such eastern bankers through their chosen committees have assumed to represent the majority of creditors and thus dominate
and dictate the policies of the receivership; that no list or schedule of such
claims has ever been presented to the court or otherwise made a matter of
recore in this cause; that the failure of disclosing such claims) has been accomplished through the medium and device of repeated extensions of the time to
file claims in this cause, which has not as yet expired, that the receivership
herein has been pending since February, 1931, during which period no record
has been made of the creditors individually interested and that notwithstanding
default in the outstanding trust deed or mortgage was made shortly following
the date of the receivership, no steps have been taken by the trustees or the
creditors secured by such mortgage, for the purpose of realizing upon or
enforcing their security
Forty-second* Further answering, these answering defendants allege upon
information and belief, that the steps thus had and taken and the methods followed, as hereinbefore alleged, have been directed and motivated from
the outset, first by the purpose of destroying the defendant Backus, and second
leaving the property and the interests of the creditors therein, to the
tender mercies of the popular pastime or game of a bankers reorganization
in the interests of a certain competing newsprint organization; that
in furtherance of these purposes, shortly following the inauguration of the
receivership, the representatives of the eastern bankers (the aforesaid sotermed "protective committee") demanded the resignation of the defendant
Backus as receiver of the properties herein involved, that such resignation in
the first instance was declined by the defendant Backus but thereafter assented
to upon the understanding that he should be retained as a consultant and
adviser of the receivers of the properties involved and the estate in process
of administration receive the benefit of his knowledge and business experience
m the vanous industries involved, following the matters last stated, complainant Robinson, with absolutely no experience in the newsprint or other allied
industries, with no knowledge of the widely diversified properties involved in
the present receivership, a total stranger to the several locations where the
various properties were located and the various operations of such properties
were being carried on, was selected and designated by the eastern bankers
and their representatives (the aforesaid committees), with full knowledge on
the part of said Robinson of the parties by whom he was designated and the
objective purpose ot his appointment as an incident in carrying out the scheme
above alleged, that at the instigation of such bankers and their respective committees, the court having jurisdiction in this proceeding, was prevailed upon to
appoint said Robinson and to fix his compensation in a sum wholly disproportionate to the value of any services he could render the receivership administration and out of all reasonable proportion to any thing justified by
consideration of the equities of the receivership administration, that in addition to such designation of plaintiff Robinson as last above stated, the same
interest and influences prevailed upon the court to designate the said receiver
as the managing receiver or by characterization of similar import; that as an
ostensible concession and with the intention of concealing and diverting attention from the effect and purposes of the last mentioned appointment, a local
co-receiver was consented to and designated by the court, who has never discovered what the matter is all about; has assumed no independent jurisdiction
and taken little or no appreciable part in the active administration of the
receivership estate
Forty-third: Further answering, these answering defendants allege on information and belief there was no intention or purpose upon the part of such
eastern bankers or their representatives, the so-termed protective committees,
of carrying out the arrangement above indicated for retaining the defendant
Backus in such consulting and advisory capacity of the various enterprises
committed to the active conduct and operation of the receivership, that as the
first step in the accomplishment of this purpose, the authority of the defendant
Backus was gradually taken away and his advice in matters of policy and
expediency either wholly disregarded or not sought, the method last indicated
was continued until the commencement of the present action, when the defendant Backus was removed from all authority and connection with the
175541—34—PT 16
19
7696
STOCK EXCHANGE PEACTICES
receivership administration, his resignation as a director and officer of various
of the subsidiaries of M. & O. required and he, himself, discharged, by the
present receivers.
Forty-fourth • Further answering, these answering defendants allege on information and belief that under the administration of the present receivers, owing
to inexperience, inefficiency and ineptitude, the receivership estate has incurred
heavy losses running into millions of dollars without notice to or knowledge
of the creditors primarily interested therein or opportunity upon the part of
such creditors to protect their several interests, except as such notice or knowledge may have been had by the aforesaid bankers committees, who have ostensibly assumed to be acting in behalf of and in the interest of such creditors,
that pending the administration of the receivership estate by the present
receivers, such estate has been mulcted in excessive costs and expenses far
exceeding anything incurred by M. & O. during the period of its successful operation for administrative and operating expenses; that the objective purpose of
plaintiff Robinson, one of such receivers, is effecting a plan of reorganization,
in which, through the connivance of such Eastern bankers and their respective
committees, said plaintiff will be permanently retained in active control of the
properties involved, that the present suit has been instituted with no regard
to the interests of the creditors or expectation of realization of any recovery
therefrom but solely as a part of the scheme hereinabove alleged, of destroying
the defendant Backus, of dissipating, breaking down and destroying a vast
industry, to the building up and establishment of which, the defendant Backus
has devoted practically his entire life; the throwing out of employment of
hundreds and perhaps thousands of employees, all for the purpose of the selfish
aggrandisement of such eastern bankers and the latter's endeavor to constitute
a monopoly, the profits of which will be derived for themselves and the expense
and loss of which will fall on the innocent investors, and of turning the property over to a competitor on the latter's terms to the great and irreparable loss
of such investors
Wheiefore, These answering defendants demand judgment that a decree be
entered herein, adjudging that they may be hence dismissed and that they may
have and recover their costs and disbursements herein and for any other and
further relief which is consistent with equity and the facts herein alleged.
MORTIMER H BOUTEIXEI,
ADRIAN H DAVID,
Solicitors for Answering Defendants,
1500 Band Tower, Minneapolis, Minn
III
LIBEL SUIT BROUGHT BY E W BACKUS AGAINST RECEIVERS ROBINSON AND
JAWRAY FOR $2,000,000 DAMAGES
State of Minnesota, county of Hennepin, District Court, Fourth Judicial District.
E W Backus, Plaintiff, vs R H M Roomson, and C T. Jaffray, Defendants.
Complaint
Plaintiff complains of defendants, and each of them, and alleges *
I
That all times herein complained of, the defendants were and now are the
duly appointed, qualified and acting Receivers of the Minnesota and Ontario
Paper Company, a Maine corporation, with its principal place of business in
the City of Minneapolis, Hennepin County, Minnesota, and that said defendants
were and now aie administering the afl-airs of said receivership estate under
and by virtue of the power and authority vested in them by order of the United
States District Court for the District of Minnesota.
II
That at all times herein mentioned, plaintiff was and is the President of said
Minnesota and Ontario Paper Company, now in receivership as aforesaid; that
he was, and is, President of Backus Brooks Company of Minneapolis, Minnesota,
and the Kenora Development Company, Ltd, of Kenora, Ontario, which latter
two companies own over ninety per cent (90%) of the voting stock of said
Minnesota and Ontario Paper Company, that plaintiff was the founder and
STOCK EXCHANGE PEACTICES
7697
ljuilder of the vast News Print paper and timber enterprises owned 01 controlled by said Minnesota and Ontario Paper Company, all built through his
energy and devotion over a period embraced m the past forty (40) years, that
at the time of the receivership, said enterprises had a book and actual value in
excess of One Hundred Million Dollars ($100,000,00000); that said enterprises
had a regular and highly rated experience of earnings over a period of many
years, all due to and made possible by the long experience and sound business
judgment used by plaintiff in directing the affairs of these vast enterpnses,
located in the United States, Canada, and Europe
III
That at the time said defendants qualified as receiveis of the aforesaid estate,
there was the agreement and understanding between defendants and plaintiff
that defendants would seek the counsel and advice of this plaintiff with resnect
to management of said estate, because of plaintiff's long experience in directing
said business; that the resignation of prior receiveis and the recommendation
that the present receivers be appointed was based on such understanding, as
herein stated; that very shortly after the defendants qualified as receivers, said
defendant, Kobinson, in particular, ignored and pointedly brushed aside suggestions, advice, inquiries pertinent to the business of said estate, and in all
manner possible, repudiated said formei understanding, and refused to be
guided by counsel or advice of this plaintiff That said repudiations, as aforesaid, were the first step in a conspiracy to wholly displace this plaintiff from
the position of trust and responsibility he had thereby enjoyed in his own business affairs, and through which he became recognized as one of the largest
News Print paper manufacturers on the North American Continent.
IV
That legal proceedings filed by defendants as receivers against plantiff as
hereinafter set forth, set out a pretended cause of action charging plaintiff
with having unlawfully and fraudulently exercised his control over said
Minnesota and Ontano Paper Company, and its siibsidianes, in such a way as
to have unlawfully abstracted from said companies, for plaintiff's and others*
use, large sums of money, that said chaiges are wholly false and untrue, and
not based on fact, that the principal transactions as alleged in said legal
proceedings were concluded a considerable period of time prior to institution
of the receivership of said estate, and were based on bona fide contracts
between coiporation with established separate entities, that defendants' pretended cause of action was brought on the theory of ultra vires and breach of
trust, that it was not essential to defendants' pretended cause of action to
allege "fraud" and "abstraction," which allegations they well knew to be
false and untrue, that such charges of " fraud" and " abstraction" were
inserted by defendants in said pretended cause of action for the sole purpose
of discrediting plaintiff's character, ruining his business standing and lendermg it wholly impossible for this plaintiff to go foiward witb plans oC reorganization of said Minnesota and Ontario Paper Company
That on or about September 30th, 1933, these defendants, in the City of
Minneapolis, Minnesota, did maliciously compose, publish, circulate and deliver
through mail and other channels, a certain written Report, as of said date,
setting out a summary of the business and fiscal condition of said estate, that
there was contained in said printed Report certain false and milicious statements of and concerning plaintiff in words as follows:
SUIT BY RECEIVERS AGAINST FORMER OFFICERS AND STOCKHOLDERS AND COMPANIES
OWNED BY THEM, FORT FRANCIS PULP AND PAPER COMPANY, LIMITED, BEING
JOINED AS A PARTY THFREIN
" On September 18, 1933, the Court, upon application of the Receivers granted
leave to sue Edward Wellington Backus, Mrs Elizabeth H. Backus, Seymour
Wellington Backus, Kenora Development Company, Limited, Backus Brooks
Company, and Fort Francis Pulp and Paper Company, Limited. In pursuance
of such leave, suit was instituted upon that date
7698
STOCK EXCHANGE PRACTICES
"This suit is predicated on the claim that for a period of years preceding
this receivership control over the business and affairs of Minnesota and Ontario Paper Company and of its subsidiaries, was fraudulently and unlawfully
exercised by E W. Backus, S. W Backus, and Backus Brooks Company
through stock ownership and domination of directorates and officers, by means
of which large sums of money were abstracted from Minnesota and Ontario
Paper Company and from certain of its subsidiaries for the use of defendants,
B W Backus, S W. Backus, Backus Brooks Company, and Kenora Development
Company, Limited, resulting in an indebtedness owing by said defendants of
approximately $7,000,000 by the end of the year 1930, and that said defendants fraudulently and unlawfully undertook to discharge said indebtedness by
a series of transactions which included the transfer through Fort Francis Pulp
and Paper Company, Limited, to Minnesota and Ontario Paper Company of
approximately $5,000,000 par value of the preferred stock of Great Lakes Paper
Company, Limited, which stock had little or no value, for a credit of approximately $5,000 000, and the cancellation of approximately $2,000,000 of obligations
owed by Backus Biook- Company and Kenora Development Company, Limited,
by setting up and ^siiu as offsets thereto pretended credits in their favor
"Claimed by them as lawful charges in connection with the construction of plants
and properties of the Minnesota and Ontario Paper Company and certain of its
subsidiaries, both in the United States and in Canada. The Receivers seek to
set ?sule these transactions and to recover from the defendants other than
Fort Fiancis Pulp and Paper Company, Limited, the amount of the aforementioned advances aggregating about $7,000,000, together with lawful interest
thereon "
VI
That the defendants maliciously caused said written Report to be widely
circulated, published and delivered to diverse and sundry persons and corporations throughout the United States and Canada.
VII
That the false and malicious language as hereinabove quoted, was conceived
and planned wholly with a view to destroying confidence in and discrediting
plaintiff, and that the mailing, publishing and circulating of said libelous
matter was done with the intent and knowledge by said defendants and with
the designed purpose that such libelous matter would be republished and recircutated by its recipients and that the same was so republished and recirculated
VIII
That the defendants intended, through said libelous publication, to convey
the thought and to charge that plaintiff had conducted the affairs of said Minnesota and Ontario Paper Company and its subsidiaries in a wholly unlawful
and irregular manner, for his own private gain and benefit; that 1his acts were
fraudulent, and that he had, in fact, so unlawfully abstracted money from
said Minnesota and Ontario Paper Company and its subsidiaries as to constitute
embezzlement; and, that the same was so understood by the recipients thereof.
That said libelous statements were false and known to be false by said defendants , that said words were maliciously intended to so damage plaintiff as to
cause many thousands of bondholders and other creditors of said estate to
lose all confidence in the integrity and business judgment of plaintiff, and so
thereby greatly lessen or make it wholly impossible for plaintiff to obtain the
future necessary consent of said bondholders and other creditors to a plan
designed to rehabilitate the affairs of said Minnesota and Ontario Paper
Company.
IX
That defendants, and each of them, aspire to the future control and management of the properties involved in said receivership and that the pretended
cause of action as alleged in said complaint is, in fact, based on desnes and
schemes of said defendants, and particularly of defendant, Robinson, and big
Eastern Banking interests who wish to obtain control of the vast properties
STOCK EXCHANGE PRACTICES
7699
involved in said estate, on such a basis as to constitute a brazen disregard of
the rights and financial interests of approximately 15,000 bondholders and of
equity owners, and that in order to prosecute such schemes and chicanery,
defendants have launched a comprehensive plan and scheme to place plaintiff in
bad repute and disfavor with said bondholders, and which in fact has resulted,
and as a part of said scheme maliciously caused the publication and circulation
of the statement concerning the plaintiff hereinabove set forth.
That the defendants maliciously connived and obtained the widest publicity
of the libelous statements set forth in paragraph V herein throughout the entire
United States, Canada, and even reaching into Europe, causing great damage
to the good name, fame, reputation and character of plaintiff. That it was
maliciously intended by defendants to have such effect, was intended to and did
impute crime and wrong doing, lack of integrity and character to plaintiff, and
particularly to deprive the plaintiff from participating in the further management and affairs of said Minnesota and Ontario Paper Company, or to receive
consideration of bondholders and creditors in a reorganization plan That
said language and all of the same blackened the name and standing of plaintiff
to his friends and the public generally, and to bankers, bondholders, and to any
and all others having either a claim or slight interest in the affairs and business
of said estate, and held him up to hatred, ignominy, contempt, ndicule and
disgrace, and totally destroyed plaintiff's previous high credit rating, business
integrity and repute, all to plaintiff's special damages in the sum of One Million
Dollars ($1,000,000 00), and to plaintiff's general damages in the sum of One
Million Dollars ($1,000,00000).
Wherefore, Plaintiff prays judgment against defendants, and each of them, in.
the sum of Two Million Dollars ($2,000,00000), together with his costs and
disbursements herein
(Signed)
DAVIS & MICHEL,
Attorneys for Plamttff,
419 Metropolitan Barih Bldg,
Minneapolis, Minnesota
MORTIMER H BOUTEIXE, and HOUGEN and HOLTEN, Of Counsel,
Rand Tower, Minneapolis, Minnesota,
STATE OP MINNESOTA,
County of Sennepin, ss:
E. W. BACKUS, being duly sworn, says that he is the plaintiff in the above
entitled action; that he has read the foregoing complaint and knows the contents thereof, that the same is true to his own knowledge, except as to those
matters therein stated on information and belief, and as to those matters he
believes it to be true.
(Signed)
E W BACKUS
Subscribed and sworn to before me this 5th day of January, 1934
[NOTARIAL SEAL]
(Signed)
HARRIET M BENSHAW,
Notary Public, Hennepm County,
My commission expires March 31, 1936
STOCK-EXCHANGE PEACTICES
TUESDAY, APRIL 3, 1934
UNITED STATES SENATE,
COMMITTEE ON BANKING AND CURRENCY,
WasMngton, D.C.
The committee met at 11:06 a.m. in room 301 of the Senate Office
Building, Senator Duncan U. Fletcher (chairman) presiding.
Present: Senators Fletcher (chairman), Gore, Costigan, Goldsborough, Townsend, Walcott, Couzens, and Kean.
Present also: Ferdinand Pecora, counsel to the committee; Julius
Silver and David Saperstein, associate counsel to the committee;
Frank J. Meehan, chief statistician to the committee.
The CHAIRMAN. The committee will come to order, please. Senator Kean, do you have something that you wish to present?
Senator KEAN. Keferring to my request calling for the record
of sales of the aviation stocks on the New York Stock Exchange,
as outlined in that statement, one of my objects was to show the
thoroughness of the management of the New York Stock Exchange
and their ability to show who bought and sold stocks of any given
security. I think this has been fully demonstrated.
My next object was to give to the press and to the people connected
with the committee who were investigating various financial phases
of operations of banks and other financial institutions the opportunity to show their efficiency.
They have now had 3 weeks in which to examine these accounts,
and they say they will need $100,000 to do this work. The stock
exchange did the work for the committee for nothing. I do not
believe that the value to the public would be sufficient to jus
@FedFRASER