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STOCK EXCHANGE PRACTICES
HEARINGS
BEFORE THE
COMMITTEE ON BANKING AND CURRENCY
UNITED STATES SENATE
SEVENTY-THIRD CONGRESS
FIRST 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 15
NATIONAL SECURITIES EXCHANGE ACT 1934
FEBRUARY 26 TO MARCH 16, 1934
Printed for the use of the Committee on Banking and Gurrency
175641
U N I T E D STATES
GOVERNMENT P R I N T I N G O F F I C E
WASHINGTON 1934
COMMITTEE ON BANKING AND CURRENCY
DUNCAN U. FLETCHER, Florida, Ohatrman
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, Maryland
JOHN G TOWNSEND, J E , Delaware
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, Acting Clerk
SUBCOMMITTEE ON STOCK EXCHANGE PEACTICES
DUNCAN U. FLETCHER, Florida, Chairman
PETER NORBECK, South Dakota*
JOHN G. TOWNSEND, JR , Delaware
JAMES COUZENS, Michigan
CARTER GLASS, Virginia
ALBEN W. BARKLEY, Kentucky *
EDWARD P. COSTIGAN, Colorado
ALVA B. ADAMS, Colorado
1
3
Alternate, Thomas P. Gore, Oklahoma.
Alternate, Phillips Lee Goldsborough, Maryland.
n
CONTENTS
Page*
Adler, Paul, specialist and member of New York Stock Exchange, New
York, N Y . . .
.
6792
Altschul, Frank, chairman committee on stock list, New York Stock
Exchange, New York, N.Y
6677, 6700'
Babbage, Richard G, attorney at law, representing the Real Estate
Board of New York, New York City, N Y
6895*
Bernheim, Alfred L , director of the securities markets survey of the
Twentieth Century Fund, Inc , New York, N Y
6936*
Booker, Y. E , vice president, Washington Stock Exchange, Washington,
DC.
6885*
Butcher, Howard, Jr, vice president, Philadelphia Stock Exchange,
Philadelphia, Pa
696$*
Chinlund, Edwin F , representing the Controllers Institute of America,
New York, N Y
7082
Clarke, Evans, executive director, Twentieth Century Fund, New York,
NYl
1
.
6962'
Clark, Hon William, United States ]udge for the District of New Jersey,
Princeton, N J
692T
Comstock, Louis K , president of the Merchants' Association of New
York, New York, N Y
7051
Corcoran, Thomas Gardiner, in office of counsel for Reconstruction Finance
Corporation, Washington, D C
6463,6506,6543
Filer, Herbert, dealer m puts and calls, 39 Broadway, New York, NY— 7062
Fletcher, R V, general counsel for the Association of Railway Executives,
Washington, D C
7046
Gay, Thomas B , law firm of Hunton, Williams, Anderson, Gay & Moore,
Richmond, V a . . .
658$
Goldenweiser, E A , director, division of research and statistics, Federal
Reserve Board
643fr
Gould, Theodore, member and secretary-treasurer, Baltimore Stock
Exchange, Baltimore, Md
6736
Grubb, E. Burd, president of the New York Curb Exchange, Summit, N J— 7097
Hoblitzelle, Harrison, president of the General Steel Castings Corporation, Eddystone, Pa.
717S
Hope, Frank R , president, Association of Stock Exchange Firms, New
York, N . Y — 1 .
6890
Houston, George H , vice-president, National Association of Manufacturers, Philadelphia, Pa
7241
Johnson, Frederic H , president San Francisco Curb Exchange, San Francisco, Calif
6826>
Johnston, Percy H , chairman of the board and president of the Chemical
Bank & Trust Co, and chairman of the New York Clearing House
Association, Montclair, N J
723$
Kinnicutt, Herman, member, Investment Bankers Association, New
York, N.Y
686G>
Legg, John C , Jr, of the firm of Mackubm, Legg & Co r broker-dealers,
Baltimore, Md., and member of New York, Baltimore, and Washington
Stock Exchanges
6917
Leonard, Franklm, member of the firm of Leonard, Cushman & Suydam,
New York, N Y
7005
Lockwood, William A , counsel for the New York Curb Exchange, East
Hampton, Long Island, N Y
7123
Marsh, Benjamin C , executive secretary Peoples Lobby, Washington,
DC
7144
m
JV
CONTENTS
Page
May, George O , member of Price, Waterhouse & Co, certified public
accountants, New York City, Southport, Conn
7175
Moore, Harry H , partner mfirmof Hallgarten & Co , New York, NY
6797
Newbold, John S , member, firm of W H Newbold's Son & Co , Philadelphia, Pa , Jenkmtown, Pa
6741
Paul, W G, secretary of Los Angeles Stock Exchange, Los Angeles,
Calif
6768
Potter, William C , chairman of the board, Guaranty Trust Co of New
York, Old Westbury, Long Island, NY
7221
Reyburn, Samuel W, president Associated Dry Goods Corporation, New
York, N Y
7023
Rich, George A, secretary and treasurer of the Boston Stock Exchange,
Boston, Mass
7032
Rippel, J S , of J S Rippel & Co , investment securities, Newark, N JL _ 7248
Roosevelt, Archibald B , president of Roosevelt & Weigold, Inc , dealers
in municipal securities, New York, N Y , and George B Gibbons, president George B Gibbons & Co , Inc , municipal bond dealers, New York,
NY
7037
Sewall, Arthur W , Philadelphia, Pa
7165
Shaughnessy, Frank C , president San Francisco Stock Exchange, San
Francisco, Calif
6833
Shaw, A Vere, of A Vere Shaw & Co , investment counsellors, New York,
NY
7252
Sprague, Raymond, speciahst and member of New York Stock Exchange,
New York, N Y
6782, 6801, 6803
Stern, Lewis J , partner of Frank B Cahn & Co , member, New York Stock
Exchange, New York, N Y
6973
Thomas, Woodhef, division of research and statistics, Federal Reserve
Board, Washington, DC
6449,7188
Thompson, Eugene E , president of Associated Stock Exchanges, Washington, D C
6979
Troster, Oliver J , member of firm of Hoit, Rose & Troster, New York,
3Si Y
Weicker, Theodoie, Jr , member, New York Stock Exchange, New York,
7068
NY
6824
Wetsel, A W , Wetsel Advisory Service, Inc , and J J Mitchell, attorney
for Wetsel Advisory Service, Inc , ISl ew York, N Y
7136
Whitney, Richard, president of the New York Stock Exchange, New York,
NY
6582, 6600, 6657, 6709, 6779, 6844, 6870, 7211, 7405
Witter, Dean, member, Dean Witter & Co , San Francisco, Calif
6748
LIST OF STATEMENTS INSEBTED
Beach, Robert B , executive secretary, National Association of Building
Owners and Managers, Chicago, 111
7263
Blumenthal, Sidney, chairman, Sidney Blumenthal & Co , Inc., New York,
N.Y
7264
Gay, Thomas B , counsel, Hunton, Williams, Anderson, Gay & Moore,
Richmond, Va
6647
Knighton, Samuel, president of the New York Produce Exchange, New
York, N Y
7269
Longmire, Rus«ell G, Banker's Building, Chicago, 111
7272
McGann, Gene
7408
May, George O , member of Price, Waterhouse & Co , certified public
accountants, New York City, N Y , Southport, Conn
7183
Merle-Smith, Van S , 30 Pine Street, New York, N Y
6829
Oliver, Fred N , counsel, National Association of Mutual Savings Banks,
New York, N Y
7273
Owens, Robert L , Hon., Washington, D C
7277
Whitney, Richard, President of the New York Stock Exchange
7401-7402
EXHIBITS AND COMMUNICATION'S
Richard Whitney, exhibit no 1, price and earnmgs index
6740
Graph of sales in aviation stocks
6850,6851,6852,6853
Letter to Senator Duncan U Fletcher from the United Fruit Co
6888
CONTENTS
V
Page
Memorandum submitted by Starkweather & Co
6889
Letter of D E Fritz to Senator Duncan U Fletcher, Mai 1, 1934
6890
Clipping from New York Evening Post
6891
Letter from S P Bope to Senator Duncan U Fletcher, Mar 2, 1934
6891
Clipping from St Louis Star Times
6892
Letter from S L Bernstein to Senator Duncan U Fletcher, Feb 27, 1934_ 6892
Michales Haass, letter of
6899
Stock value charts and tables
6957-6962
Chart showing volume of transactions in par value of bonds listed on Exchanges outside of New York City
7003
Letter from the New York Airbrake Co, Feb 27, 1934, to Hon Hamilton
F Kean, United States Senate
7020
Letter to Hon Duncan U Fletcher from Garland S Feiguson, chairman
Federal Tiade Commission, Maich 6,1934
7089
Appendix no 1
7092
Appendix no 2
7093
Communications received by Senate Banking and Cuirencv Committee
tiom the Federal Trade Commission
7089,7090,7091 7092
Letter to Senator Phillips Lee Goldsborough from the Baltimore Chamber
of Commeice, Maich 5. 1934
7135
Pamphlet entitled " German Regulation of Stock Exchanges 1898-1908 "_ 7159
Telegram tiom Leland Lyon, piesident Atlas Powder Co, to Hon John
G Townsend
7203
L'^ttei from J P Moigan & Co to Hon Duncan U Fletchei, March 8,
1934
Letter fioni the Swartwout Co, Cleveland Ohio, to Hon Duncan U
Fletchei Maich 5, 1934
Ciiticisms and recommendations ot the bill submitted by Mr Beinaid
Winfleld
Lettei and memorandum by Juds;e J Harry Covmgton submitted to Committee on Banking and Currency, Maich 8, 1934
Several volumes of original replies submitted, being answers received from
members of the New York Stock Exchange in response to its questionnaire under date of March 3, 1934
Compilation for the United Aircraft & Transport Corporation stock
Report of the committee on publicity of the New Yoik Stock Exchange,
dated April 21, 1931
Minute book of the conference committee ot the New Yoik Stock Exchange from June of 1925 to date
Minute book of the governing committee of the New York Stock Exchange from June 27, 1929, to May 3, 1933
Minute book no 11 of the governing committee of the New Yoik Stock
Exchange
Mmute book of the committee on business conduct of the New York
Stock Exchange fiom December 29, 1930, to Septembei 21, 1931
Minute book of the committee on business conduct of the New Yoik Stock
Exchange for the period from September 22, 1931, to June 3D 1933
Minute book of the committee on business conduct ot the New York Stock
Exchange for the period from Febiuary 2, 1933, to February 21 1934__
Financial report of the New Yoik Stock Exchange for 1931 and 1932
Financial leport of the New Yoik Stock Exchange for the yeai ending
December 31, 1933
Reports of the financial condition of the New York Stock Exchange
Building Co for the years 1931 and 1932
Financial statement of the New York Stock Exchange Building Co foi
the year ended December 31, 1933, together with a balance sheet of
No 39 Broad Street Corporation, a subsidiaiy of the New Yoik Stock
Exchange Building Co
Financial statement ot the Stock Clearing Corpoiation, a subsidiary of the
New York Stock Exchange for the year ended December 31, 1931
Financial statement of the Stock Clearing Corporation, a subsidiaiy of
the New York Stock Exchange, for the year 1982
Financial statement of the Stock Cleaung Coiporation, a subsidiaiy of
the New Yoik Stock Exchange, foi the year ended December 31, 1933—
Financial statement of the New Yoik Quotation Co, and affiliate of the
New York Stock Exchange, for the year ended Decembei 31, 1931
7204
7201
7J!05
7207
7213
7213
7214
7214
7214
7215
7215
7215
7215
7216
7216
7216
7216
7217
7217
7217
7217
VI
CONTENTS
Page
^Financial statement of the New York Quotation Co, and affiliate of the
New York Stock Exchange, for the year ended December 31, 193-2
7217
Financial statement of the New York Quotation Co, an affiliate of the
New York Stock Exchange, for the year ended December 31,1933
7217
Financial statement of the New York Stock Exchange Safe Deposit Co,
an affiliate of the New York Stock Exchange, for the year ended December 31, 1931
7217
Financial statement of the New York Stock Exchange Safe Deposit Co,
an affiliate of the New York Stock Exchange, for the year ended December 31, 1932
7218
Financial statement of the New York Stock Exchange Safe Deposit Co,
an affiliate of the New York Stock Exchange, for the year ended December 31, 1933
7218
Beport of the trustees of the Gratuity Fund of the New York Stock Exchange for the year ended December 31, 1931
7218
Beport of the trustees of the Gratuity Fund of the New York Stock Exchange for the year ended December 31, 1932
7218
Beport of the trustees of the Gratuity Fund of the New York Stock Exchange for the year ended December 31, 1933
7219
Xetter to the New York Stock Exchange from J. P Morgan & Co, March
8, 1934
7259
.Letter1 to Banking and Currency Committee of Senate from Bichard
Whitney
7281
Xetter to the presidents of all listed corporations from Bichard Whitney- 7283
Momorandum in regard to effect or National Securities Exchange Act on
persons or firms not members of an exchange and on corporations whose
securities are not listed on any exchange
7286
Answers submitted by New York Stock Exchange to the questions asked
of it by counsel for the United States Committee on Banking and
Currency
7288
Letter dated November 27, 1983, from Charles E Hudson, president, San
Francisco Mining Exchange to Ferdinand Pecora
7398
Letters from J B Edwards & Co to Senator Duncan U Fletcher
7260-7263
STOCK EXCHANGE PBACTICES
MONDAY, FEBRUARY 26, 1934
UNITED STATES SENATE,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.G.
The committee met at 2: SO p.m., pursuant to call, in room 301 of
the Senate Office Building, Senator Duncan U. Fletcher presiding.
Present: Senators Fletcher (chairman), Wagner, Barkley, Bulkley, Gore, Costigan, Adams, Carey, and Kean.
Present also: Ferdinand Pecora, counsel to the committee; Julius
Silver and David Saperstein, associate counsel to the committee, and
Frank J. Meehan, chief statistician to the committee.
The CHAIRMAN. The committee will come to order. The matter
now coming before the committee for consideration is S. 2693? a bill,
which if enacted into law will be entitled " National Securities Exchange Act of 1934."
These hearings now being begun will continue day after day, except Saturdays and Sundays, until we conclude, and those who wish
to be heard, either for or against the bill, will please signify their
intention to Mr. Sparkman, the acting clerk of the committee, give
their names, and generally if you will, the subject which you wish
to discuss. In other words, there is no need of duplicating and
repeating over and over again the same arguments and the same
views on any particular subject.
We want to speed the hearings as rapidly as we can, but we do not
wish to deny anyone the opportunity to be heard if he signifies a
wish to be heard. Those who are not insistent upon being heard
orally may submit papers and the committee will insert such papers'
in the record as a part of our hearings.
I think it proper to begin the hearings with the printing of the
bill, and then to have some outline of the bill or explanation regarding certain provisions of the bill made so that the committee will
understand fully just what we have before us; and perhaps we
should begin with an appropriate reference to the economic background of the proposed legislation, and for that purpose we will
first hear from Dr. E. A. Goldenweiser, director of the division of
research and statistics, Federal Reserve Board.
Now, Dr. Goldenweiser, you may take a seat where you are, opposite the microphone on the committee table, and we will be glad if
you will give the members of the committee the benefit of your views
regarding the economic background of the bill. I presume you have
familiarized yourself with the bill and understand it, and we will
now be very glad to hear from you.
6421
6422
STOCK EXCHANGE PKACTICES
[S 269o, Seventy third Congresst second session]
A BILL To provide foi the registration of national securities exchanges operating in interstate and foreign commerce and through the mails and to prevent inequitable and
unfair practices on such exchanges, and foi othei puiposes
Be it enacted by the Senate and House of Representatives
States of America in Congress assembled,
of the United
SHORT TITLE
SECTION 1 This Act may be cited as the "National Securities Exchange
Act of 1934 "
REGULATION OF EXCHANGES USING THE CHANNELS OF INTERSTATE COMMERCE AND
THE MAILS NECESSARY IN THE PUBLIC INTEREST
SEC 2 Transactions m securities as commonly conducted upon securities exchanges by means of the mails or instrumentalities of transportation or communication in interstate commerce are affected with a national public interest
Such transactions aie carried on in laige volume by the public generally and by
persons engaged in the business otf dealing in securities in interstate commerce.
The prices established and offered in such tiansactions are geneially quoted
and disseminated throughout the United States and foieign countries as a basis
tor determining and establishing prices at which securities are bought and sold
oy investors in intel state commerce and in the several States and as a basis
xor establishing and determining the value of securities for the purpose of calculating the amount of taxes owing to the United States and the several States
by owners, buyers, and sellers of securities Such transactions involve the use
of credit and affect the financing of trade industry, and transportation in interstate commerce Such transactions give rise at times to a large volume of speculation in securities, a considerable proportion of which originates outside the
States m which the exchanges are located At times the prices of securities on
such exchanges are susceptible to manipulation and control and the dissemination of such prices gives rise to excessive speculation By reason of such
manipulation and contiol and excessive speculation, sudden and unreasonable
fluctuations in the prices of securities on such exchanges occur Such sudden
and unreasonable fluctuations in prices coupled with excessive speculation and
manipulation cause alternately unreasonable expansion and unreasonable contraction of the volume of credit available for trade, transportation, and industry
in interstate commerce and divert credits available from their proper channels
Such unreasonable fluctuations hinder the proper appraisal of the value of
securities by investors m interstate commeice and in the several States and
the fair calculation of taxes owing to the United States and the several States
by owners, buyers, and sellers of securities Such unreasonable fluctuations
constitute obstruction to and a burden upon interstate commerce and upon the
national banking and Federal Reserve System Transactions in securities upon
exchanges create a flow of securities in interstate commerce to and from the
places where such exchanges are located The national credit and the safety
and stability of investment are intimately related to and affected by the prices
for which securities are sold and offered for sale upon exchanges National
emergencies, which pioduce wide-spiead unemployment and the dislocation of
trade, transportation, and industry and which burden interstate commerce and
adversely affect the public welfare are precipitated, intensified, and prolonged
by manipulation and control of puces and excessive speculation on exchanges
Regulation of transactions in secuiities conducted upon exchanges by means or
instrumentalities of transportation and communication in interstate commerce
or of the mails is imperative in the public interest for the protection of interstate commerce, and the national banking and Federal Reserve System
DEFINITIONS
SEC 3 When used in this Act unless the context otherwise requires—
1 The term " exchange " means any board market place, exchange, chamber
of commerce, or association, whether oiganized or unoiganized, however managed or conducted, and whether incorporated or unmcoiporated, where, or by
means of any facility of which, contracts or offers for the purchase or sale of
STOCK EXCHANGE PRACTICES
6423
securities or other transactions in such securities are made, and includes the
members of an exchange
2 The phrase " facility of an exchange " includes its piemises, tangible 01
intangible property, whether on the premises or not, any right to the use of
such premises or pioperty 01 any service theieof, including, among othei things,
any system of communication to 01 trom the exchange, by tickei 01 otheiwise
maintained by or with the consent of the exchange, and any light of the
exchange to the use of any property 01 seivice
3 The term " member " means any peison who is peimitted oi has a light
to use in person any facility of an exchange, for the purpose of making offers
or contracts foi the purchase oi sale of any security theieon, oi anv fiini of
which a member is a partnei
4 The term "broker" means any peison engaged in <i business of effecting
transactions in securities for the account of otheis
5 The teim "dealer" mans any peison engaged in a business ot bujmg
and selling secunties for his own account, through a biokei or otheiwise
6 The term " specialist" means any person who specializes m the execution
of orders in respect of any seeunty oi secuiities on an exchange and who
commonly leceives from other membeis of the exchange oideis foi execution
in respect of such secunty oi secuiities
7 The term " lssuei " means any peison who issues or pioposes to issue any
security or who guaiantees a secunty either as to principal or income, except
that with respect to certificates of deposit voting-trust ceitifuates, oi collateraltiust certificates, or with respect to certificates of interest oi shaies in an unincorporated investment trust not having a board of directois (or peisons peiformmg similar functions) or of the fixed, restucted management, or unit type,
the term " issuer " means the peison oi persons perfoimmg the acts and assuming the duties of depositor or manager pursuant to the piovisions of the trust
or other agreement or instrument undei which such securities aie issued, and
except that with respect to equipment-tiust ceitificates oi like secuiities, the
term " issuer " means the person by whom the equipment oi propeity is or is
to be used
8 The teim " customei " moans anv person foi whose account a broker or
dealer effects any transaction in anj <*ecuiit^, oi from whom a bioker or dealer
solicits such business, oi to whom a bjokei oi dealer extends credit on any
security
9 The term " peison " means an individual, a coiporation, a partnership, an
association, a joint-stock company, a trust, any unmcoi porated organization or
exchange As used in this paragraph the term " t r u s t " shall include only a
trust where the interest or mteiests of the beneficiary or beneficiaries are
evidenced by a security
10 The term " security" means any note, stock, treasury stock, bond, debenture certificate of inteiest or paiticipation in any piofit-sharing agreement,
oil, gas, and other mineial royalties and deeds, collateral-trust certificate, preorganization certificate or subscuption, transferable share, investment contract,
voting-trust certificate, or in general, any instrument commonly known as a
"security", or any certificate of interest oi participation in, temporary or
interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing, but the teim " security " as used in this Act shall
not include any direct obligation guaranteed as to principal or interest by the
United States
11 The teims " buy" and " purchase" each include any contract to buy,
purchase, or otherwise acquire, contract of purchase, attempt or offer to acquire
or solicitation of an offer to sell a security or any interest in a security
12 The terms " sale" and " sell" each include any contract of sale or disposition of, contract to sell or dispose of, attempt or offer to dispose of, or
solicitation of an offer to buy a security or any interest therein
13 The term " communication " means communication of any kind or description, including written, oral, radiographic, radiophonic, telegraphic, or telephonic, or by ticker, television, or cablegram
14 The term " Commission " means the Federal Trade Commission
15 The term " State" means any State of the United States, the District
of Columbia, Alaska, Hawaii, Pueito Rico, the Philippine Islands, Canal Zone,
the Virgin Islands, and the insular possessions of the United States
16 The term "interstate commeice" means tiade oi commerce m secuiities
or any transportation or communication relating thereto among the several
6424
STOCK EXCHANGE PEACTICES
States or between any foreign country and any State, or between any State
and any place or ship outside the United States
For the purpose of this Act (but not in anywise limiting the definition of
interstate commerce) a transaction in respect of any security shall be considered to be in interstate commerce if such transaction is part of that current
of commerce usual in a security transaction whereby an order to purchase or
to sell a security originates from a person in one State with the expectation
that it will or may be consummated by the receipt on an exchange of an
order to sell or purchase the same security originating from another person
in another State, including, in addition to cases within the above general
description, all cases where it is contemplated that a purchase or sale of any
security will be preceded or followed by the shipment of such security from
another State. Any security transaction normally in such current of commerce shall not be considered out of such commerce through resort being had
to any means or device intended to remove the transaction from the provisions
of this Act.
PROHIBITION OF THE USE OP CHANNELS OF INTERSTATE COMMERCE AND THE MAILS
TO UNREGISTERED EXCHANGES
SEO. 4 Unless an exchange is registered as a national securities exchange
under section 5 of this Act, it shall be unlawful for any person, directly or indirectly, to make use of the mails or any means or instrumentality of communication or transportation in interstate commerce for the purpose of using any
facility of such exchange to effect any transaction in a security or to report any
such transaction
REGISTRATION OF NATIONAL SECURITIES EXCHANGES
SEC. 5. (a) Any exchange may be registered with the Commission as a national
securities exchange under terms and conditions hereafter provided by filing a
registration statement in such form as the Commission may prescribe containing
the undertakings, setting forth the information, and accompanied by the
documents here below set forth:
(1) ALn undertaking to comply with, and to enforce so far as is within its
powers compliance by its members and by issuers whose securities are registered thereon with any provision of this Act and any amendment thereto and
any rule or regulation made or to be made by the Commission thereunder
(2) Such data as to its organization, rules of procedure and membership,
and other information as the Commission may by rules and regulations require
as being necessary or appropriate in the public interest or for the protection
of investors
(3) Copies of its constitution, articles of incorporation with all amendments
thereto, and of its existing bylaws or rules or instruments corresponding
thereto, whatever the name, which are hereinafter collectively referred to as
the "rules of the exchange"
(4) An undertaking to furnish to the Commission copies of any amendments to the documents or instruments mentioned in clause (3) of this subsection forthwith upon their adoption
(b) If it appears to the Commission that the exchange applying for registration is so organized as to be able to comply with the provisions of this
Act and the rules and regulations made by the Commission thereunder and
that the rules of the exchange are oust and adequate to ensure fair dealing
and to protect investors, the Commission shall cause such exchange to be
registered as a national securities exchange
(c) The Commission shall enter an order either granting or, after appropriate notice and opportunity for hearing, denying an application for registration as a national securities exchange within thirty days after the filing
of the application, unless the exchange applying for registration shall withdraw
its application or consent to the Commission's deferring action on its applicaton for a stated longer period after the date of its filing The filing with
the Commission of an application for registration by an exchange shall be
deemed to have taken place upon the receipt thereof Amendments to an
application may be made upon such terms as the Commission may prescribe.
(d) No registration shall be granted unless the rules of the exchange provide for the expulsion and suspension of a member for conduct or proceeding
inconsistent with just and equitable principles of trade and declare that the
STOCK EXCHANGE PEACTICES
6425
violation of any provision of this Act or any rule or regulation made by the
Commission thereunder shall be considered conduct or proceeding inconsistent
with just and equitable principles of trade.
(e) Nothing in this Act shall be construed to prevent any exchange from
adopting and enforcing any rule not inconsistent with this Act and the rules
and regulations of the Commission made thereunder and the applicable laws
of the State in which it is located
(f) An exchange may, upon appropriate application in accordance with the
rules and regulations of the Commission and upon such terms as the Commission may fix withdraw its registration.
MARGIN REQUIREMENTS ON LONG ACCOUNTS
SEO 6. (a) It shall be unlawful for any member of a national securities
exchange or any person who transacts a business in securities through the
medium ot any such member, directly or indirectly, to extend or maintain
credit or arrange for the extension or maintenance of credit to or for any
customer on any securities not registered upon a national securities exchange
(b) It shall be unlawful for any member of a national securities exchange
or any person who transacts a business in securities through the medium of
any such member, directly or indirectly, to extend or maintain credit or
arrange for the extension or maintenance of credit to or for any customer
on any securities registered on a national securities exchange in an amount
exceeding at any time whichever is the higher of (1) 80 per centum of the
lowest price at which such security has sold during the preceding three years;
or (2) 40 per centum of the current market price The Commission may by
rules and regulations prescribe lower loan values as may be deemed appropriate in the public interest or for the protection of investors during any
stated period of time or in respect of any specified class
of securities
(c) It shall be unlawful for any person to extend1 or maintain credit or
arrange for the extension or maintenance of credit to any person (other than
to a dealer to aid in the financing of the distribution of securities to customers
not through the medium of an exchange) upon any security registered on a
national securities exchange in an amount exceeding the amount which it is
lawful for a member of a national securities exchange to lend to any customer
on such security, unless the application for the loan is accompanied by a statement by the borrower that such security has been acquired by the borrower and
paid for m full more than thirty days prior to the making of the loan Any
person who for the purpose of obtaining a loan makes such a statement which
is false in any material respect, shall be deemed guilty of a violation of this>
subsection
(d) The Commission shall by rules and regulations prescribe the times at
and the specific methods by which values shall 1be calculated for the purposes
of this section, the time within which initial and subsequent payments shall be
made by the customer, and the notice to be given and the method to be followed in closing out accounts, and no person who shall comply with-such rules
and regulations shall be deemed to have violated any provision of this section.
RESTRICTIONS OF MEMBERS' BORROWING
SEC. 7. 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 Reserve System,
(b) To permit the aggregate indebtedness of such member or person to all
other persons, including customers' deposits, to exceed such percentage of
the net current assets owned by the borrower and employed in the business
not exceeding 1,000 per centum as the Commission may by rules and regulations
prescribe;
(c) To use, if a broker, the capital employed in the business to carry or
finance the carrying of securities for himself or for others than bona fide
customers excluding any partner or employee of such broker,
(d) To hypothecate or arrange for the hypothecation of more of any
securities carried for the account of a customer than is fair and reasonable
in view of the indebtedness of such customer;
6426
STOCK EXCHANGE PRACTICES
(e) To hypothecate or arrange for the hypothecation of any sec unties cairied for the account of a customer under circumstances that will permit the
cominglmg of the securities of one customer with those of any other person,
without the written consent of such customer,
(f) To lend or arrange for the lending of secunties pledged by or carried
for the account of any customer without the consent of such customer and
without crediting the interest received on account of such lending to the
account of the customer
PROHIBITION AGAINST MANIPULATION OF SECURITY PRICES
SEC 8 (a) It shall be unlawful for any person, directly or mdiiectly, by
the use of the mails or any means or instrumentality of interstate commerce,
or of any facility of any national securities exchange—
(1) To effect any fictitious transaction in any security registered on a
national securities exchange, or any transaction which purports to be a sale
of any such /security but involves no change in the beneficial ownership thereof,
(2) To effect, or to authorize another oi others to effect for such person's
account, transactions for the purchase and sale of any security registered on a
national securities exchange at substantially the same time at substantially
the same price, whether such transactions of purchase and sale be with the
same or with different parties, except transactions made on the exchange as
a matter of record only and appropriately recorded and reported as an
•" arranged transaction " ,
(3) To effect, either alone or in concert with one or more other persons,
transactions for the purchase and sale of any security or securities registered
on any national securities exchange for the purpose of raising or depressing
the pi ice of such security or securities or for the purpose of creating or with
the expectation that there will be created a false or misleading appealance
of active trading in such security or securities, or a false or misleading appealance in respect of the market for such security or securities,
(4) If a dealei, broker, or member or a peison m the employ of a dealei,
broker, or membei, to circulate or disseminate in the ordinary couise of business
of business information to the effect that the price of anv security oi securit es
legistered on a national securities exchange will or is likely to use or fall
paitly or wholly because of the market activity of am one oi moie persons, if
the person disseminating' such information has reason to bel eve that the circulation or dissemination of such information on his part may induce the pui chase
or sale of any such security in the expectation of such market activity,
(5) To circulate or disseminate infoimat on legaidmg any security legistered
on a national securities exchange which statement is, in the light of the circumstances under which it was made, false or misleading in respect of anv mattei
sufficiently important to influence the ludgment of an average investor, if the
lerson disseminating such information has leascn to believe that the circulation
or dissemination ot such information on his part may induce the purchase oi
sale of such security, and does not prove that he acted in good fa^th and in the
exercise of reasonable care had no ground to believe that the statement was
false or misleading,
(6) To pay or cause to be paid directly oi mdiiectlv any consideiation or
anything of value to any person to circulate, disseminate, oi finance the cost of
< lrculatmg and disseminating, mformat on to the effect that the price of any
security or securities registered on a national securities exchange will or is
likely to rise or fall partly or wholly because of the market activity ot any one
or more persons,
(7) To engage in any series of transactions or in anv operation foi the
purchase and sale of any security registered on a national-secunties exchange
which has the purpose or effect of pegging, fixing, or stabilizing the price of
such security without having prior thereto leported to the exchange authorities
and to the Commission such information regarding the purpose and nature of
such transactions oi operations, the details thereof, and the person or persons
mteiested therein as the Commission by rules and legulations may prescribe
as appropriate or necessary in the public interest or for the protection of
investors,
(8) To acquire substantial control of the floating supply of any security
registered on a national-securities exchange for the purpose of causing the
price of such secunty to rise on the exchange because of such control of the
floating supply,
STOCK EXCHANGE PRACTICES
6427
(9) To effect by use of the facility of any national secunties exchange—
(i) any transaction in any secunty wheieby any party to such tiansaction
acquires any put, call, straddle, or othei option 01 privilege of buying a security
trom or selling a security to another party to the transaction without being
bound to do so, or
(n) any transaction in any secuiity with relation to which he has, dnectly
or indirectly, any interest in such put, call, straddle, option, or privilege, or
(111) any transaction in any security for account or any peison who, he has
leason to believe, has, directly or indirectly, any interest in an* such put, call,
straddle, option, or privilege with relation to such security,
01 if a member, directly or indirectly, to have oi guarantee anv interest in any
put, call, straddle, option, oi privilege in relation to any security legistered on
a national securities exchange
(b) Any person who participates m any act oi transaction in violation of
subsection (a) of this section shall be liable to any peison who shall purchase
any security, the price of which may have been effected by such act or transaction, and the person so injured may sue in law or equity m any court of
competent jurisdiction to recover the difference between the pi ice he paid for
such security and the lowest price for which such security shall have sold on the
exchange during the ninety days preceding and the ninety days following such
puichase, and such additional damages, if any, as the peison suing may provethat he sustained as a result ot any such tiansaction
(c) Any person who participates in a transaction or transactions in violation
ol subsection (a) of this section shall be liable to any peison who shall have?
sold a security, the price of which may have been effected by such transaction
or transactions, and the persons so mjuied may sue in law oi equity in any
court of competent jurisdiction to recover the difference between the price for
which he sold such security and the highest price for which such secuiity shall
have sold on the exchange dm ing the ninety days preceding and the ninety days
following such sale, and such additional damages, it any, as the peison suing
may prove that he sustained as a result of any such transaction
(d) Every person who becomes liable to make any payment under this section
may recover contribution as m cases of contract from any peison who, if sued
separately, would have been liable to make the same payment, units*, the
person who has become liable was, and the othei was not, guilty of fraudulent
misrepr esentation
(e) No action shall be maintained to enforce any liability created under
this section unless brought within two years after the discovery of the violation
upon which it is based
REGULATION OF THE USE OF MANIPULATIVE DEVICES
SEC 9 It shall be unlawful for any person, dnectly oi mdiiectly, by use of
any means or instrumentality of interstate commerce or ot the mails oi of any
facility of any national securities exchange—
(a) To effect the sale of any security legistered on a national secunties
exchange, which at the time of such sale was not owned by such person oi
his principal except in accordance with such rules and legulations as the Commission may prescribe as appropriate or necessary in the public interest oi for
the protection of mvestois,
(b) To use or employ oi to execute or accept for execution any stop-loss
order in connection with the purchase or sale of any security registered on a
national securities exchange except in accordance with such rules and regulations as the Commission shall prescribe as appropriate or necessary in the
public mteiest or for the protection of investors,
(c) To use or employ in connection with the purchase or sale of any security
legistered on a national securities exchange any device or contrivance which,
or any device or contrivance in a way or manner which the Commission may
by its rules and regulations find detrimental to the public mteiest or to the
pioper protection of investors
SEGREGATION AND LIMITATION OF THE FUNCTIONS OF BROKER, SPECIALIST, AND DEALER
SEC 10 It shall be unlawful for any member of a national securities exchange
or any person who as a broker transacts a business in securities through the
medium ot any such member to act as a dealer in or underwuter ©f securities.
6428
STOCK EXCHANGE PRACTICES
whether or not registered on any national securities exchange It shall be
unlawful for any member of a national securities exchange to act as a specialist
unless registered as such with the exchange, subject to such rules and regulations as the Commission may prescribe, and it shall be unlawful for any
specialist on a national securities exchange (a) to effect on the exchange any
transaction except on fixed price orders or (b) to disclose to any other person
information in regard to orders placed with him which is not available to all
members of the exchange An exchange may provide that officers or employees
of the exchange may perform the functions of specialists subject to such rules
and regulations as the Commission may prescribe
[REGISTRATION REQUIREMENTS FOR SECURITIES
SBO 11. (a) It shall be unlawful for any person to effect any transaction an
any security on a national securities exchange unless a registration is effective
as to such security in accordance with the provisions of this Act and the rules
and regulations made by the Commission thereunder and unless such security
lias been issued.
(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 such undertakings, information, and documents as the Commission may
•by its rules and regulations require in the public interest and for the protection
<of investors together with such additional undertakings, information, and
•documents as the exchange may require If the exchange authorities certify
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: Provided, That if
it appears to the Commission prior to the expiration of such thirty days that
the application for registration does not comply with the provisions of this
Act or the rules and regulations made by the Commission hereunder, it may,
after appropriate notice and opportunity for hearing within such period, enter
an order denying the application for registration unless the issuer shall withdraw its application or consent to the Commission's deferring action on its
application for a stated period longer than such thirty days
(c) The rules and regulations of the Commission in regard to registration
shall require—
{I) An undertaking by the issuer to comply with and so far as is within
its power to enforce compliance by its officers, directors, and stockholders
with the provisions of this Act and any amendments theieto and with the
rules and regulations made or to be made by the Commission thereunder
and, unless the issuer is a member bank of the Federal Reserve System, not
to lend any funds in the money market of any exchange or to any member
thereof or to any person who transacts a business in securities through the
medium of any such member except in accordance with such rules and regulations as the Commission may prescribe,
(II) Such information as to the issuer and affiliates in respect of*
(1) the organization, financial structure, and nature of the business,
(2) particulars regarding the terms, position, rights, and privileges of the
different classes of securities outstanding,
(8) particulars regarding terms on which securities have been or aie to
he offered to the public
(4) particulars regarding the directors, officers, and principal securitvholders and underwriters, their remuneration and their interests in the securities of and material contracts with the issuer and affiliates,
(5) particulars regarding remuneration to others than directors and officers
exceeding $20,000 per annum,
(6) particulars regarding bonus and profit-sharing arrangements,
(7) particulars regarding management and service contracts,
(8) particulars of options in respect of securities existing or to be created;
(9) particulars regarding material contracts not made in the ordinary course
of business, and material patents;
(10) balance sheets for preceding years certified by independent public
accountants;
(11) profit and loss statements for preceding years certified by independent
public accountants; and such other information as the Commission may by
rules and regulations require as necessary and appropriate in the public interest
for the protection of investors.
Digitized fororFRASER
STOCK EXCHANGE PRACTICES
6429
(III) 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 Commission by rules and
regulations may require as necessary in the pubUc interest or for the protection
of investors.
A security registered with a national securities exchange may be withdrawn
or stricken from listing and registration in accordance with the rules of the
exchange and upon such terms as the Commission may fix, upon application by
the issuer or the exchange to the Commission.
ANNUAL, QUARTERLY, AND MONTHLY REPORTS
SEC 12. (a) Every issuer of a security registered on a national securities
exchange shall file with the exchange and with the Commission, in accordance
with rules and regulations to be prescribed by the Commission and in such
form and in such detail as the Commission may by rules and regulations prescribe in the public interest and for the protection of investors—
(1) Such information and documents as the Commision may require to keep
reasonably current the information and documents filed pursuant to section 11;
(2) Annual and quarterly reports, including, among other things, a balance
sheet and profit-and-loss statement certified by an independent public accountant ;
(3) Monthly reports including, among other things, a statement of sales
or gross income;
(4) Such other reports and at such times as the Commission may by rules
and regulations prescribe m the public interest or for the protection of investors
or with a view to ensuring that the security-holders' interests shall not be
prejudiced by the use of information for the advantage of any special group
or interest.
(b) The failure of an issuer to register information, documents, or reports
as required by this section shall be ground for the removal of any of its securities from a national exchange by the exchange or by the Commission
PEOXIES
SEO 13 (a) It shall be unlawful for any person by the use of the mails
or of any means or instrumentality of transportation or communication m
interstate commerce or of any facility of any national securities exchange or
otherwise to solicit or to permit the use of his name to solicit any proxy or
consent or authorization in respeqt of any security registered on any national
securities exchange unless at such time prior to such solicitation as the Commission shall by rule or regulation prescribe the persons named to exercise
such proxy, consent, or authorization shall file with the Commission a statement, which shall be included as a part of every such solicitation, setting
forth the purposes of the proxy, consent, or authorization, the persons to
exercise it, their relations to and interest in the security, the names and addresses of the persons from whom similar proxies, consents, or authorizations
are being solicited, and such further information, and in such form and detail
as the Commission may by rules and regulations prescribe in the public interest
or for the protection of investors.
(b) It shall be unlawful for any member of a national securities exchange
or any person who tiansacts a business in securities through 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 without
a specific written authorization from such customer.
OVER-COUNTER MARKETS
SEC 14. It shall be unlawful for any person singly or in concert with others
to make use of the mails or of any means or instrumentality of communication
or transportation in interstate commerce for the purpose of making or creating,
or enabling another to make or create, a market for any security, whether or
not registered on a national securities exchange, without complying with such
rules and regulations as the Commission may prescribe as appropriate in the
public interest or for the protection of investors
6430
STOCK EXCHANGE PRACTICES
TRANSACTIONS BY DIRECTORS, OFFICERS, AND PRINCIPAL STOCKHOLDERS
SEC 15 (a) Every director, officer, or owner of securities, owning as of
record and/or beneficially more than 5 per centum of any class of securities of
any issuel any security of which is registered on a national securities exchange,
shall file with the exchange and with the Commission at the time of the registration of such security or at the time he becomes such a director officer, or
owner of secunties the amounts of all secunties of such issuel ot which he is
the record and/or beneficial owner, and withm ten days after the close of each
calendar month, it there has been any change in his record or benehcial ownership during such month, shall file with the exchange and the Commission a
statement indicating his ownership at the close of the calendar month and such
changes in his ownership as have occurred duimg such calendar month
(b) It shall be unlawful for any director, officer, or owner of securities,
owning as of record and/or beneficially more than 5 per centum of any class
of stock of any issuer, any security of which is registered on a national securities exchange—
(1) To purchase any such registered security with the intention of expectation of selling the same secunty within six months, and any piofit made by such
person on any transaction in such a registeied security extending over a
penod of less than six months shall mure to and be recoverable by the issuer,
irrespective of any intention or expectation on his part in entering into such
transaction of holding the security purchased for a period exceeding six months
such suit may be instituted in law or in equitv in any court of competent
jurisdiction by the issuer, or by the owner of any security of the issuer in
the name and in behalf of the issuer if the issuer shall fail or refuse to bring
such suit within sixty days after request or shall fail diligently to prosecute
the same thereafter For the purposes of this subsection the profit shall be
calculated on the sale or sales by such person of such security made at the
highest price or prices and on the pui chase of purchases made by such person
of such security at the lowest price or prices during the six months' period,
irrespective of the certificates for such security received or delivered by such
person during such period.
(2) To sell any such registered security, if the peison selling does not own
the secunty sold oi if the person selling owns the security but does not deliver
it against such sale within five days,
(3) To disclose, dnectly or indirectly, any confidential information legardmg or affecting any such registered security not necessary or proper to be
disclosed as a part of his corporate duties Any profit made by any person,
to whom such unlawful disclosure shall have been made, in respect of any
transaction oi transactions in such registered security within a period not
exceeding six months after such disclosure shall mure to and be recoverable
by the issuer unless such person shall have had no reasonable giound to believe
that the disclosure was confidential or was made not in the perfoimance of
corporate duties Such suit may be instituted m law or in equity in any court
of competent jurisdiction by the issuer or by the owner of any security of the
issuer in the name and in behalf of the issuer if the issuer shall fail to bring
such suit within sixty days after request or shall fail diligently to prosecute the
same thereafter For the purposes of this subsection the piofit shall be calculated on the sale or sales by such peison of such security made at the
highest price or prices and on the purchase or purchases made by such person
of such security at the lowest price or prices during the six months' penod
irrespective of the certificates for such security received or delivered to such
peison during such period
ACCOUNTS AND RECORDS, REPORTS
EXAMINATIONS OF EXCHANGES, MEMBERS, AND
OTHERS
SEC 16 Every national secunties exchange, every member thereof, every
person transacting a business in securities through the medium of such member,
every dealer making or creating a market for securities through the mails or
the use of any means or instrumentality of interstate commerce, shall make,
keep, and preserve such accounts, correspondence, memoranda, papers, books,
and othei records and make such reports as the Commission by its rules and
regulations may prescribe The accounts, correspondence, memoranda, papers,
books, and other records of such persons shall be subject at any time or from
STOCK EXCHANGE PRACTICES
6431
time to time to such periodic, special, or other examinations by examiners or
othei representatives of the Commission as the Commission may deem necessary
or appropriate, and the cost of such examinations, including the compensation
of the examiners, shall be fixed by the Commission and paid by the person
examined Any representatives of the Commission designated by it shall have
access to the premises 01 any part thereof of any national securities exchange
and the right to attend any meeting or proceeding of the exchange or any
committee thereot
LIABILITY I OK AlIbLLADING STA1EMENTS
SEC 17 (a) Any person who shall make 01 any peison, including any director, officer, accountant, or othei agent of such person, who shall be responsible
for the making of any statement in any application, report, or document filed
with the Commission, which statement is, in the light of the circumstances
under which it was made, false or misleading in respect of anj matter sufficiently important to influence the judgment of an aveiage investor shall be
liable to any person (not knowing that such statement was false 01 misleading) who shall have purchased 01 sold a security the price ot which may
have been affected by such statement, and the person injured may sue in law
or in equity in any couit of competent jurisdiction for the damages caused by
such statement, unless the person sued shall sustain the burden of proof thai
he acted in good faith and rn the exeicise ot reasonable care had no ground
io believe that such statement was false or misleading
(b) In case the person lDjuied purchased a security the price ot which was
affected by such statement, the damages shall be not less than the difference
between the price for which he purchased the security and the lowest price
foi which it shall have sold vithin ninety days preceding and ninety days
following such pui chase
(c) In case the person mjuied sold a security the price of which was affected
by such statement, the damages shall be not less than the difference between
the price for which he sold such secunty and the highest price for which it
shall have sold within ninety daj s preceding and ninety days following such sale.
(d) Every person who becomes liable to make any payment under this section may recover contribution as in cases of contract from any person who, if
sued separately, would have been liable to make the same payment, unless the
person who has become liable was, and the other was not, guilty of fraudulent
misrepresentation
(e) No action shall be maintained to enforce any liability created under
this section unless brought withim two years after the discovery of the violation upon which it is based.
SPECIAL POWERS OF COMMISSION
SEa 18 (a) The Commission shall have authority from time to time to make,
amend, and rescind such rules and regulations as it may deem necessary or
appropriate to carry out and to implement, administer, and enforce the provisions of this Act, including rules and regulations governrng the form and
content of registration statements and reports for various classes of exchanges,
members, securities, and issuers, and defining accounting, technical, and trade
terms used in this Act
(b») The authority above given the Commission shall include, among other
things, authority to prescribe the form oi foims m which required information
&hall be set forth, the items or details to be shown in the balance sheet and
earning statement, and the methods to be followed in the preparation of
accounts, in the appraisal or valuation of assets and liabilities, m the determination of depreciation and depletion, in the differentiation of recurring
and nonrecurring income, in the differentiation of investment and operating
income, and in the preparation, where the Commission deems it necessary or
desirable, of consolidated balance sheets or income accounts of any person
dnectly or indirectly controlling or controlled by the issuer, or any person under
direct or indirect common control with the issuer, but insofar as they relate
to any common carrier subject to the provisions of section 20 of the Interstate
Commerce Act, as amended, the lules and regulations of the Commission with
respect to accounts shall not be inconsistent with the requirements imposed
by the Interstate Commerce Commission under authority of such section 20.
175541—34—PT 1 5 — 2
6432
STOCK EXCHANGE PEACTICES
(c) The authority above given the Commission shall include, among other
things, authority to prescribe such rules and regulations for national securities
exchanges, their members and persons transacting a business in securities
through such members, in addition to those specifically provided in this Act,
as it may deem necessary or appropriate in the public interest or for the protection of investors, and may by its rules and regulations more specifically
define the form and procedure to be followed in carrying the provisions of
this Act into effect. The Commission, among other things, may prescribe the
time and method of making settlements, payments, and deliveries, the time
and method of calculating margin requirements, and the time and method of
closing out under-margined accounts The Commission, among other things,
may by rules and regulations prescribe rules for the conduct of business on
exchanges, for the classification of members, for the election of officers and
committees to ensure a fair representation of the membership, for the suspension, expulsion, or disciplining of members, for the listing or striking from
listing of any security with right of appeal by the issuer to the Commission,
for the reporting of transactions on the exchanges and upon tickers maintained
by or with the consent of any exchange, including the method of reporting
short sales, sales of securities in default in bankruptcy or receivership, and
sales involving other special circumstances. The Commission may fix or
prescribe the method of fixing uniform rates of commission, interests, and other
charges, may prescribe minimum units of trading, rules limiting the manner,
method, and place of soliciting business, rules for odd-lot purchases and sales,
rules regarding minimum deposits on marginal accounts, and rules limiting or
prohibiting the registration or trading m any security within a specified
period after the issuance or primary distribution thereof, prescribe rules
governing the carrying of accounts and to prohibit fictitious or numbered
accounts and require the disclosure of the real and beneficial owners thereof.
The Commission shall have power to fix the hours of trading, and, if the
public interest in its opinion so requires, summarily to suspend trading in
any registered security or upon any registered exchange for a period not
exceeding ninety days
(d) The rules and regulations of the Commission shall be effective upon
publication in the manner which the Commission shall prescribe
(e) For the purpose of all investigations which, in the opinion of the Commission, are necessary and proper for the enforcement of this Act, any member
of the Commission or any officer or omcers designated by it are empowered to
administer oaths and affirmations, subpena witnesses, compel their attendance,
take evidence, and require the production of any books, papers, correspondence,
memoranda, or other records which the Commission deems relevant or material
to the inquiry. Such attendance of witnesses and the production of such
records may be required from any place in the United States or any State at
any designated place of hearing Such power of subpena and examination shall
not abate or terminate by reason of any action or proceeding brought by the
Commission under this Act. The Commission shall have authority to investigate and in its discretion to publish information concerning any facts, conditions, or practices which it may deem necessary and proper as an aid in the
prescribing of rules and regulations or the recommendation of further legislation concerning exchanges If any person subpenaed to attend any inquiry falls
to obey the command of his subpena without reasonable cause, or if a person
in attendance upon such inquiry shall without reasonable cause refuse to be
sworn or to be examined or to, answer a question or to produce any books,
papers, or correspondence, memoranda, or other records when ordered so
to do by the officer conducting such inquiry, he shall be guilty of a misdemeanor
and punishable accordingly. Any officer participating in such inquiry and any
person examined as a witness upon such inquiry who shall disclose to any
person other than a member or officer of the Commission the name of any
witness examined or any other information obtained upon such inquiry, except
as directed by the Commission or an officer thereof, shall be guilty of a misdemeanor and punishable accordingly.
LIABILITY OF CONTROLLING PERSONS
SEC 19 (a) Every person who, by or through stock ownership, agency, or
otherwise, or who pursuant to or m connection with any agreement or understanding with one or more other persons by or through stock ownership, agency,
or otherwise, controls any person liable under any provision of this Act or of
STOCK EXCHANGE PKACTICES
6433
any rule or regulation made pursuant thereto shall also be liable jointly and
severally with, and to the same extent as such controlled) person to any person
to whom such controlled person is liable
(b) It shall be unlawful for any person, directly or indirectly, to do any act
or thing which it would be unlawful for such person to do under the piovisions
of this Act or any rule 01 legulation thereunder through or by means of any
other person who is controlled by such person by or through stock ownership,
agency, or otherwise! or through or by means of any other person who is controlled by such person and one or more other persons by or through stock
ownership, agency, or otherwise for the purpose of avoiding any provisions of
this Act or any rule or regulation made thereunder
(c) It shall be unlawful, for any director, officer, or security holder of any
issuer of any security registered on a national securities exchange to hinder,
•delay, or obstruct the making or filing of any document oi? report required to
be filed with the Commission under this Act or any rule or regulation thereunder.
(d) If the spouse of a peison subject to any provision of this Act or of
any rule or regulation thereunder, or a child or parent residing with such
person, or a person holding in tiust for such person money or property used
in the transaction m question shall effect any transaction m a security which
would be a violation of any such provision if effected by such person subject
thereto, such person subject thereto shall be deemed to have violated such
provision unless he shall sustain the burden of showing that the transaction
was not effected with his appioval 01 was not for the purpose of evading such
provision
INJUNCTIONS AND PROSECUTION OF OFFENSES
SUSPENSION OB WITHDRAWAL OF
REGISTRATION OF AN EXCHANGE OR OF A SECURITY
SEC 20 (a) Whenever the Commission, either upon complaint or otheiwise,
shall be of the opinion that m the public interest it should make an investigation to determine whether any person has violated or is about to violate
any provision of this Act, or of any rule or regulation thereunder, it may
investigate such facts, and it may, in its discretion, either require or peimit
such person, 01 any peison making such complaint, to file with it a statement
in writing, under oath, or otherwise, as to all the facts and circumstance*
concerning the subject mattei which it believes to be in the public interest to
investigate
(b) Whenevei it shall appeal to the Commission that any person is engaged
or about to engage in any acts 01 practices which constitute or will constitute
a violation of the provisions of this Act, or of any rule or regulation piescubed
cinder authority thereof, it may in its disci etion—
(I) Bring an action in any distuct court of the United States, United States
couit of any Territory, or the Supreme Court of the District of Columbia to
enjoin such acts or practices, and upon a proper showing a permanent or temporary injunction or restraining order shall be granted without bond The
Commission may transmit such evidence as may be available concerning such
acts or practices to the Attorney General, who may, in his discretion, institute the necessary criminal pioceedmgs under this title Any such criminal
proceeding maj be brought m the district wherein the violation complained
of occurred,
(II) After appropriate notice and opportunity for hearing, make an oidev
suspending for a penod not exceeding twelve months or withdrawing altogether the registration of a national securities exchange if the Commission
finds that such exchange has violated any provision of this Act or of the lules
and regulations thereunder or has failed to enforce compliance therewith by
a member or an issuer of a security registered thereon, or withdrawing altogether the registration of a security the issuer of which has failed to comply
with the provisions of this Act or the rules and regulations made thereundei,
(m) After appropriate notice and opportunity for hearing, make an oidei
suspending for a period not exceeding twelve months or ordering the expulsion
altogether from a national securities exchange any member or officei thereof
whom it finds has violated anv provision of this Act or the rules and legulation^
thereunder or lias effected any transaction for any other person who lie has
6434
STOCK EXCHANGE PRACTICES
reason to believe is violating in respect of such transaction any provision of
this Act or the rules or regulations thereunder
(c) Upon application ot the Commission the distuct courts of the United
States, the United States courts of any Temtoiy, and the Supreme Couit of
the District of Columbia shall also have jurisdiction to issue writs of mandamus commanding any person to comply with the piOMsions of this Act 01
any order of the Commission made in piusuanee thereof
HEARINGS BY COMMISSION
SEC 21 All hearings shall be public and may be held before the Commib&ion,
any member or membeis thereof or an officei or ofliceis of the Commission
designated by it, and appiopriate recoids theieof shall be kept
PUBLIC C&ABACTEK OF INFOBMATION
SEC 22 The information contained in or filed with any application, lepoit,
oi document shall be made available to the public under such legulations as
the Commission may prescribe, and copies thereof, photostatic or otherwise,
shall be furnished to eveiy applicant at such leasonable chaige as the Commission may prescribe
COUBT BEVIEW OF OKDEBS
SEC 23 (a) Any person aggrieved by an order of the Commission may obtain,
a leview of such order in the Circuit Court of Appeals of the United States*
withm any circuit wherein such person resides or has his principal place of
business, or in the Court of Appeals ot the District of Columbia, by filing in
such court, within sixty days after the entry ot such order, a written petition
praying that the order of the Commission be modified or be set aside in whole or
m part A copy of such petition shall be foithwith served upon the Commission, and thereupon the Commission shall certify and file m the court a transcript of the record upon which the order complained of was entered No
objection to the order of the Commission shall be considered by the court unle&s
such objection shall have been uiged before the Commission The finding of
the Commission as to the facts, if supported by evidence, shall be conclusive
If either party shall apply to the court for leave to adduce additional evidence,
and shall show to the satisfaction of the court that such additional evidence is
material and that there were reasonable grounds for failuie to adduce such
evidence in the hearing before the Commission, the court may order such additional evidence to be taken before the Commission and to be adduced upon the
hearing in such manner and upon such terms and conditions as to the court
may seem proper The Commission may modify its findings as to the facts, by
leason of the additional evidence so taken, and it shall file such modified or
new findings, which, if supported by evidence, shall be conclusive, and its
recommendation, if any, for the modification or setting aside of the original
order The jurisdiction of the court shall be exclusive and its judgment and
decree, affirming, modifying, or setting aside, in whole or in part, any order of
the Commission, shall be final, subject to review by the Supreme Court of the
United States upon certioran or certification as provided in sections 239 and
240 of the Judicial Code, as amended (U S C , title 28, sees 346 and 347)
(b) The commencement of proceedings under subsection (a) shall not
unle&s specifically ordered by the court, operate as a stay of the Commission's
order
PENALTIES
SEC 24 Any person who willfully violates any provision ot this Act or an>
lule or regulation made theieunder, or any person who shall make, or any
pel son, including a director, officer, accountant, oi agent theieof who willfully is lesponsible for any statement m any application, repoit, or document
filed with the Commission, which statement is, m the light of the circumstances
under which it was made, false or misleading in any matter sufficiently important to influence the judgment of an average investor, shall upon conviction
be fined not more than $25,000 or imprisoned not more than ten years, or both,
except that when such person is an exchange, a fine not exceeding $500,000 may
be imposed
STOCK EXCHANGE PEACTICES
6435
JURISDICTION OF OFFENSES A1SD SUITS
SEC 25 (a) The district courts of the United States, the United States
courts of any Territoiy, and the Supreme Court of the District of Columbia
shall have juiisdiction of offenses and violations under this Act and of all
suits in equity and actions at law bi ought to entorce any liability 01 dut\
created by this Act Any such criminal proceeding may be brought either in
the district wheiem the exchange involved is opeiated, or in the distuct
wherein a tiansaction violating such piovision was consummated, or m the
district wherein an act or agreement to act constituting such violation was
effected An^ such civil suit or action ma] be bi ought m anj such district 01
in the district wheiem the defendant is found or is an inhabitant 01 tiansacts
business and piocess in such cases may be seived in any other district of
which the defendant is an inhabitant or wheievei the defendant may be
found Judgments and deciees so rendeied shall be subiect to review as
piovided in sections 128 and 240 of the Judicial Code, as amended (U S C
title 28, sees 225 and 347) No costs shall be assessed for or against the
Commission m any pioceedmg under this Act brought by or against it in the
Supreme Couit or such other courts
(b) In case of contumacy oi lefusal to obey a subpena issued to any peison,
an\ of the said United States couits, within the -juusdiction oi which said
person guilty of contumacy or refusal to obey is found or resides, upon application by the Commission, may issue to such person an oidei requiting such
pei sons to appear betoie the Commission, oi one of its exammeis designated
by it, there to produce documentary evidence if so oideied, oi there to give
evidence touching the matter in question, and any failuie to obev such oidei
of the court may be punished by said couit as a contempt thereof
(c) No person shall be excused from attending and testifying or fiom producing books papers, contracts, agreements, and other lecoids befoie the Commission, oi m obedience to the subpena of the Commission or any membei|
thereof or any officer designated by it, oi in any cause oi pioceedmg instituted
by the Commission, on the giound that the testimony or evidence, documentalv
or otherwise, lequired of him, may tend to mciiminate him or subject him
to a penalty or forfeituie, but no individual shall be ^prosecuted or subject
to any penalty or foifeituie for or on account ot any transaction, mattei, oi
thing concerning which he is compelled, aftei having claimed his piisiloge
against self-mciimination, to testify or pioduce evidence, documentaly oi
otherwise, except that such individual so testifying shall not be exempt from
prosecution and punishment for perjuiv committed m so testifying
EFFECT OF EXISTING LAW
SEO 26 (a) The lights and lemedies provided by this Act shall be m addition
to any and all othei lights and lemedies that may exist at law oi in equity,
except that this Act shall supersede such laws oi any State as aie inconsistent
with the provisions oi puiposes of this Act and such laws oi any State as
provide foi the supervision or legulation of the administiation oi conduct of
business on anv exchange which is licensed by the Commission
(b) Nothing m this Act shall be construed to modify existing law with
regard to the binding effect on any member of anv exchange of any action
taken b^ the authonties of such exchange to settle disputes between members
or with regard to the binding effect of such action on any person who has
agieed to be bound theieby oi with legard to the binding effect on any member
of any disciplinary action taken by the authorities of the exchange as a result
of violation of any lule of the exchange, insofar as the action taken is not
inconsistent with the provisions of this Act oi the rules and regulations of the
Commission thereunder
VALIDITY OF CONTRACTS
SEO 27 (a) Any condition, stipulation, oi provision binding any person to
waive compliance with any provision of this Act or of any regulation promulgated pursuant theieto, oi of any lule lequired by such regulation shall be void
(b) Every contiact made in violation of, or the peifoimance of which
involves the violation of, any provision of this Act oi of any rule or regulation
thereunder shall be void as regaids any cause of action arising after the
effective date of such provision, regardless of whether the contract was made
before or after such effective date
6436
STOCK EXCHANGE PRACTICES
FOREIGN EXCHANGES
SEC 28 It shall be unlawful for any broker or dealer, directly or izHiirectTy,
to make use of the mails or of any means vor instrumentality of transportation
or communication in interstate commerce for the purpose of effecting on an
exchange situated in a place not subject to the jurisdiction of the United States
any transaction in any security the issuer of which is a resident of, or is
organized under the laws of, or has its principal place of business m, a place
subject to the jurisdiction of the United States except in. accordance with such
rules and regulations as the Commission may prescribe
REGISTRATION FEES
SEC 29 Every national securities exchange shall pay an annual registration
fee for the privilege of doing business as a national securities exchange during
the preceding calendar year or any part thereof Such fee shall be paid to the
Commission on or before March 15 of each calendar year Such fee shall be
an amount equal to one five hundredths of 1 per centum of the aggregate dollar
amount of the sales of securities transacted on such national securities exchange
during the preceding calendar year
EMPLOYEES OF FEDERAL TRADE COMMISSION
SEC 30 For the purposes of this Act and of the Securities Act of 1938,
the Federal Trade Commission may select, emplov, and fix the compensation,
of such employees, attorneys, and agents as shall be necessary for the transaction of the business of the Commission with respect to such Acts without
regard to the provisions of other laws applicable to the employment and
compensation of officers or emplyees of the United States
SEPARABILITY OF PROVISIONS
SEC 31 If any provision of this Act, or the application of such piovision
to any person or circumstance, shall be held invalid, the remainder of this
Act, or the application of such provision to persons or circumstances other
than those as to which it is held invalid, shall not be affected thereby
EFFECTIVE; DATE
SEC 32 This Act shall become effective on October 1, 1934, except that
applications for necessary registrations undei this Act may be made to the
Commission in accordance with its lules and regulations at any time on and
after July 1,1934: Provided, That section 30 shall become effective immediately
upon the enactment of this Act
STATEMENT OF E. A. GOLDENWEISER, ECONOMIST,
WASHINGTON, D.C.
Mr. GoiiDENWEiSER. Mr. Chairman and gentlemen of the committee, I should like to say to begin with that, while I am connected:
with the Federal Reserve Board as director of its research and statistical work, I am not appearing here as a representative of the
Board but as an individual, and that whatever I say presents my
own views and not the view of the Board.
The CHAIRMAN. We understand that.
Mr. GOLDENWEISER. When I was asked to testify on this bill I
was called on particularly for the reason that I am in sympathy
with the objectives which this bill attempts to accomplish. While,
Mr. Chairman, as you have stated, I have read this billy and have*
given it some study, yet I am not familiar with all of the details
of it, and I am not, in my own opinion, competent t© pass upon
STOCK EXCHANGE PKACTIOKS
6437
specific points and specific methods proposed in this bill for the
purpose of accomplishing the broad purposes that the bill is aimed at.
My interest in the bill is from three distinct points of view: I am
interested in a bill for the regulation of stock exchanges because of
the effect that stock exchange speculation has on the general trend
of business, on the rise and fall in business activity, by accentuating
the booms, and making depressions deeper and more disastrous.
I am also interested in this bill from the point of view of the
credit machinery, and of the banking machinery. I should like
later in my testimony to say a few words on the relationship between
stock exchange credit, or the use of credit in the stock exchange, and
the soundness of the banking situation; and, finally, I am interested
in it from the point of view of protecting the public trom the dangers
and the losses caused to them by participation in stock exchange
speculation without being in possession of the necessary means of
information or of finances to put them in position to cope with
situations that are frequently well in hand by people on the inside.
Senator GORE. Dr. Groldenweiser, do you think that can be done?
Mr. GOI/DENWEISER. I do not know, Senator. But I think some
moves in that direction are possible, and I think that any moves that
are effective, that will reduce that evil, deserve the support of those
interested in the public welfare.
The CHAIRMAN. YOU may proceed.
Mr. GOLDENWEISER. Taking the three main lines of discussion upone at a time, it is very clear that the very wide fluctuations in stock
exchange values have an effect upon the development of booms and
of depressions. That has always been the case in nearly every period
of inflationary development, and in every depression. But it has
become much more accentuated in recent years because of the very
great development of communications—the network of telephones,
telegraphs, and radio; the gradual acquaintanceship with the possibilities of the stock exchange that has reached greater and still
greater numbers of the people.
We used to have a relatively few branches of stock exchange
houses. In 1910, there were only 500. In 1929 there were 1,600.
There are very few States now that do not have tickers, and most
of them have a^great many tickers. So that access to the stock exchange has very greatly developed, and this very fact has been a
factor in making tne influence of this speculative development on
the market much greater than it was when the activities of the Stock
Exchange were supported by a much smaller number of people.
As an illustration of the relationship between fluctuations of security values and the business situation, I might mention that the
prices of stocks rose from 60 in 1922, based on the Standard Statistics
average, to 212 in 1929.
During that same period brokers' loans increased from V/2 billion
dollars to 8 ^ billion dollars, and of this very large increase of
brokers' loans, 5 billions of dollars took place in 3 years, and V/2
billion dollars in 3 months.
When the break came in October of 1929, brokers' loans, which had'
reached that very high level, collapsed very rapidly, declined by
3 billions of dollars in 10 days, and by 8 billions of dollars in 3 years,
while stocks declined from an average of 212 to an average of 35.
6438
STOCK EXCHANGE PRACTICES
Now, the very rapid rise m securities values, with the great volume
of brokers' loans supporting them, which preceded 1929, was a very
important contributing factor towardthe over-expansion of business
activity and the stimulation of speculation m many fields.
Senator GORE "What was the first part of that sentence, Dr.
Goldenweiser ? I did not quite understand you
Mr. GOLDENWEISER. I say, this very rapid rise in securities' values
prior to 1929 was a very important factor mt the over-expansion of
business, and the development of the vast speculation going on
during that period.
Senator KEAN. HOW much were brokers' loans m 1929?
Mr. GOLDENWEISER. They were Sy2 billions of dollars.
Senator CAREY. DO you know what portion of the loans of the
country that represented—I mean as compared to the total loans &
Mr. GOLDENWEISER. Well, offhand I should say it was about one
fourth of the loans, from a fifth to a fourth of the total loans.
Senator BARKLEY. A fourth of what loans 2
Mr. GOLDENWEISER. Of all loans extended by banks. Is that what
you meant, Senator 2
Senator CAREY. Yes
Senator BARKLEY. DO you mean long-time and short-term loans ?
Mr. GOLDENWEISER. I mean all loans by banks.
Senator KEAN. The newspapers published that the Standard Oil
Co. had loaned 20 billions of dollars Now, if they had loaned 20
billions of dollars, and the total loans were only Sy2 billions of
dollars, it does not seem to fit into the picture very well. In addition
to that, the Standard Oil Co. testified that they received for their
loans $4,900,000, which would be one quarter of 1 percent interest
on the amount of 20 billions of dollars How about that?
Mr. GOLDENWEISER Well, Senator, I do not know about those
figures, but either that figure is just wrong or else
The CHAIRMAN (interposing). I think it is perfectly well understood that the amount they claimed to have loaned covered amounts
that had been loaned by them temporarily and came back and were
reloaned.
Mr. GOLDENWEISER Yes; no doubt
The CHAIRMAN The total amount of their loans was something
like 70 million dollars, I believe
Mr. PECORA. The daily average of their loans during 1929, that
is to say, their call loans,-was about 69 million dollars
Mr. GOLDENWEISER Yes
Mr. PECORA That was their
daily average of call loans throughout
the year 1929.
Mr. GOLDENWEISER Yes, sir
Mr. PECORA. Which indicates
the real amount of money they had
outstanding in call loans. The figure of 20 billion dollars referred
to by Senator Kean, as having been mentioned by the newspapers,
was probably a totalling of the same money reloaned several times,
instead of the 69 million dollars, which represented the aggregate
at any one time.
Senator KEAN. That was in the newspapers, the figure of 20 billion of dollars Figuring the amount that the Standard Oil Co.
testified they received for these loans, it would make them lending
their money at one quarter of 1 percent
STOCK EXCHANGE PEACTICES
6439
Mr PECORA But it was made clear in the hearings last Friday
with regard to Street loans made by the Standard Oil Co.,
that really what they had outstanding represented a daily average
of 69 million dollars approximately, and that the interest received
of nearly 5 million dollars which they received in the aggregate for
the year on their call loans, represented a rate of about 7 percent*
That is, as an average for that year.
Senator KEAN. All right.
The CHAIRMAN. The interest rate ranged from 5 percent to 15 percent, but the average for the year was about 7 percent You may
now proceed with your statement, Dr. Goldenweiser.
Mr. GOLDENWEISER. What I was going to say in this connection is,
that when there is a prosperous condition of the country and prospects for business success are good, that in itself creates an atmosphere in which a great many people wish to participate m the prosperity by buying stocks, and when they buy stocks they are tempted
by the facilities of the market, to which I shall refer a little later,
to buy not only what their capital or savings will buy, but to buy as
much as they can by borrowing the maximum amount that is permitted to them to borrow.
And what does that result m? These streamlets of speculative
funds coming in from all sections of the country, over all the wires
and in the mails, make the stream of speculation greatly swollen in
size, and contribute to the heights that security prices can be carried
to. In 1929 security prices had reached a level that was not in conformity with any economic appraisal, or even the wildest expectations of future prosperity. Those securities were at a level which
could be reached only in circumstances where no one bought securities except in the hope that he would be able to sell them again in a
few days to someone who was even more optimistic than himself.
It is when people buy securities, not for the purpose of investing
money, nor even for the purpose of profiting by reason of the increased properlty of the industry m which they are buying participation, but are simply buying like they would buy a lottery ticket
or a number in a number game, that the situation becomes entirely
vicious and socially and economically undesirable
The stock exchange is fundamentally an institution which makes
it possible to collect capital for the purpose of launching new enterprises, and also makes it possible for persons who own shares in an
enterprise to sell them to each other through organized machinery
without having to seek for buyers; it furnishes a market place, and
those are the legitimate functions of a stock exchange.
When, however, a stock exchange ceases to be, or in addition to
being that, when it develops into a place where people fiom all
over the country, without any particular knowledge of what they
are doing, are risking their savings and incurring heavy indebtedness on the chance of being able to dispose of their holdings at
higher prices, then such a stock exchange is not serving a useful
social function. On the contrary, it performs a very dangerous part
m our economic machinery, and is destructive and disastrous to
many individuals and also to the prosperity of the country as a
whole.
I t is against these excesses that measures need to be taken, and
the bill under consideration here is actuated, as I understand it,
6440
STOCK EXCHANGE PRACTICES
by the desire to moderate and regulate the activities of stock exchanges in such a way as to prevent a recurrence of the excesses
of appreciation in stocks, of fantastic rises in stocks such as occurred
during the period from 1922 to 1929; and also to prevent the disastrous drops in securities prices, with their repercussions, that have
happened since that time.
A stock exchange is an extremely efficient organization. As a
piece of mechanism I think it is unsurpassed. And it is in its very
•efficiency that lies the danger of wielding its power at a time of
rapid movement, either up or down, of accelerating the movement
to a point where no reasonably conceived brakes can retard its
.action. It is like a 16-cylinder machine fitted with a brake derived
from an antediluvial cart. The very efficiency of the stock exchange
mechanism is one of the reasons why it plays such a dangerous part
in the course of developments.
The borrowing facilities for the purpose of carrying stocks on
speculative margins in this country under the existing system are
xmequaled anywhere. One need to have no credentials; one need to
have no line of credit; one needs no introduction to a broker. All
that one needs is a few dollars that can be put up as a margin, and
the rest of the money required is supplied by the broker, who, in
turn, has very easy, perfect access to the credit reservoir through the
banks.
Often the person who is buying stocks on margin is not even
aware of the fact that he is incurring a liability, or that is so at
least in many cases. He simply thinks that he is giving a broker a
certain amount of money for the purpose of assuring him of his
good will and good intentions, and that if the stocks go up, why, he
wins, and if the stocks go down he loses. The fact that he is really
signing up for a very large loan, and if the broker is not able to
dispose of his securities in time, he has a liability to discharge may
not be known to him, or very frequently it is a fact that is not
known to the person who is engaged in a margin transaction.
It is for that reason that it has occurred to some of us that it
might be a desirable thing to require the customer who borrows on
margin to sign a note and become aware of the fact that he is
incurring a liability as well as buying himself the right to participate in any advance in the stock that he is buying.
In other countries the machinery employed for a similar purpose does not function just in that way. In England a person cannot
borrow any amount or money that he pleases just because he may
happen to have the necessary collateral. There he has to establish
a line of credit, and when he comes to borrow all that he has to
show, so long as it is within his line of credit, is that fact, and
no further questions are asked of him. And in establishing that line
of credit the directors of the institution that established it consi4er
his needs and his financial responsibility. And if he wants to increase that line he has to go before the board of directors, or his
request goes before them, and it must be considered and has to be
approved. In the meantime, in the matter of the collateral he offers,
he cannot borrow as a matter of course an indefinite amount.
I think that is one particular in which our mechanism is entirely
<too easy. It seems to me that an important part of that arrange
STOCK EXCHANGE PRACTICES
6441
ment is the amount that brokers themselves can borrow from banks.
Brokers' loans could not have increased from V/2 billion of dollars
to 8y2 billions of dollars, if the facilities for that purpose had not
teen provided.
Now, brokers' loans are unusually liquid loans. There are very few
Hosses arising out of brokers' loans. Probably their record during
i;he last few years from the point of view of solvency of banks is as
good or better than that of any other class of loans. Yes; I should
say they are probably better than any other class of loans. There
is no money that a bank can lend that is usually as easily repaid as
^brokers' loans. There is no customer relationship, no obligation to
see the customer through and carry him through a difficult situation.
There is no unpleasantness about calling such a loan. Brokers' loans
<can be called by merely pushing a button.
So that it is not a question of the loan itself being a bad loan.
The loan is good. But the aggregate amount of such loans creates
a socially and economically dangerous situation, because when the
turn comes and the loans are being liquidated it results in sales of
securities on a vast scale, and while the person who has made the
loan gets his money out, in the meantime the values of the securities
which he has dumped are declining.
That brings a lot of other loans under water, and those securities
are dumped, and there is a further decline. The result is that there
is an enormous loss of values that affects not only the people in the
market but affects trust companies, savings banks, and insurance
companies, and results also in a vast number of bank failures through
depreciation of their security portfolios. I t is more a matter of
depreciation of their security holdings than it is a matter of losses
on their loans. They may be able to realize on their loans by selling
the collateral, but the sale of the collateral makes the portfolio
decline to a point where the capital is impaired or wiped out, and
that has been one of the important causes of bank failures.
Mr. Chairman, I had not intended to discuss at this point the
^banking part of the situation, because I was not quite through with
-the economic part, with the business situation, but I think that makes
relatively little difference, I mean as to the order in which I take
them up.
One reason why the very rapid rise in securities values accentuates
the height to which a boom may rise, is because it encourages security flotations at a time when every security is snatched up the
minute it is issued. Stories are now current m circulation that there
were some issuing houses that would announce a security without
indicating what it was to be, and that it was oversubscribed before
the issuing house had an opportunity to indicate what it was they
were going to issue. That kind of situation was not an infrequent
occurrence in 1929. Everybody's appetite for securities was, unappeasable, and their optimism was inexhaustible. It was a situation
that, curiously enough, had been paralleled m history. There were
similar situations during the John Law bubble, and the South Sea
bubble. Once a passion for speculation gets fully under way it has
a capacity of resulting in blindness and dumbness on the part of
followers*
In addition to encouraging the flotation of securities, which, of
^course, results in &n enormous amount of funds accumulating in the
6442
STOCK EXCHANGE PRACTICES
hands of business concerns, and overexpansion of plant that later
has serious consequences, a rapid rise of security prices in addition
means profits taken out of the market by those who sell as rises
occur, and results in an enormous demand for a great many kinds of
goods on the part of those profit-takers.
Those demands, however, aie concentrated to a very large extent
in what are generally known as luxury goods, and that results in
an overexpansion m the production of such goods, of plants which
cater to the rich, or more particularly to the newly rich. Those
goods expand very rapidly, and result in a very large overexpansion
of plant for the production of those particular kinds of goods, while
the demands for other goods are likely not to be affected so much, or
not to increase at all, so that there is a dislocation of industry^
When, on the other hand, the boom breaks and depression develops, there is a very rapid decline m these luxury goods, followed
by very great difficulty on the part of those concerns which built
themselves up on such trade; and there is also an absolute drying
up of the capital market, because whereas one year everyone would
buy almost everything blindly, the next year they would not buy
anything whatsoever because of two reasons—for one reasons, because their faith in anything they might buy had been forfeited;
and for another reason, and perhaps the more impelling reason, that
thev do not have the means with which to buy
ISo that the decline m business following upon a collapse of the
stock market is also disastrous, and it accentuates the decline m
business activity, which may be due m the first instance to other
maladjustments m our economic life
It is not my purpose heie to give the impiession that stockexchange speculation is the only thing that causes great changes in
our business activities. I think it is only one of the factors. I
think it is, however, a factor that does contribute to the excessive
uses at the height of a boom and to the excessive declines at the
depth of a depression
It is often said that the stock exchange absorbs a very large
amount of credit Strictly speaking, that phrase is not accurate, because the credit that goes into the stock market does not stay there.
If it is used to buy new securities, the money goes to the corporation.
If it is used in order to pay the profits made by speculation, it is disbursed in the purchase of other securities or of luxury goods.
The stock market does not, strictly speaking, absorb credit in
the sense that is often stated. On the other hand, it does divert
credit from a very large number of small industries throughout the
country. Funds which might go to feed those industries are drawn
out and put into the general big money market and then are concentrated in the larger industries.
So that a rapid rise m brokeis' loans reflects a diversion of credit
from numberless little industries throughout the country into the
larger corporations that can utilize it in security flotations
At the same time it has one other effect on credit, and one that is
as important, perhaps, as the first. It has the effect of making credit
enormously expensive during a period like 1929, when there was a
bidding up of credit going on m the stock market, when paying 15
or 20 percent for money meant nothing That is, paying 15 or 20
STOCK EXCHANGE PKACTICES
6443
percent per annum meant nothing to a speculator, or to a person who
thought he was a speculator, whereas he probably was simply throwing his money away, and yet he thought he was putting his money
into a market where it might increase 15 or 20 percent in a day, and
therefore paying 15 or 20 percent a year for the money he required
was of very little concern to him.
But all this bidding up of the price of money had many consequences in the way of making certain lines of activity, the more
sober and quiet activities throughout the country more difficult, because funds were not available for them inasmuch as people were
able to draw such large rewards m the money market
In addition, this bidding up of the price of credit had the effect
of attracting a very large amount of funds from abroad Foreigners sent money here, both for the purpose of getting the benefit of
the high rates of interest available for short time money in the market, gjnd in the hope of participating in the speculative advances in
securities.
The accumulation of short-time foreign funds at one time reached
the staggering sum of $3,000,000,000, and that was another factor that
accentuated our difficulties, because after England went off the gold
standard in 1931> and again in the spring of 1932 there were enormous withdrawals of those balances m gold, and that created panicky
conditions and contributed to the domestic hoarding movement, and
therefore to the whole cycle of difficulties, including the bank failures
and other consequences.
So that to sum up from the credit point of view, the difficulty in
the first place is that an accumulation of loans, on the scale that it
was accumulated during our boom period, is very dangerous, because
when the turn comes and security values drop very lapidly, they
are being dumped, and that affects a great many institutions that
are anything but speculative; on the contrary, institutions that constitute the backbone of the country's economic life, insurance companies, banks, savings banks, trust companies, and so foith, you can
see what it means.
In the second place, the situation is dangerous because it results
in an over-issue of securities, and m a diversion of credit from a
^reat many small industries, into a few large industries, and particularly into industries manufacturing luxury goods.
In the third place, it is dangerous because it tends to attract funds
from all over the world, which in the conditions that existed then,
became mortgages upon our gold, because they were withdrawable in
gold, and resulted in enormous runs on our gold, runs that shook the
foundations of our economic and financial structure.
It is for all of these reasons, both because of the effect on banking,
which I have outlined in some detail, and because of the effect on
business stability, and because of the social desirability of protecting
the public from stock-exchange manipulation, that this bill appears
to me to be in the right direction and to represent a social advance
toward better-controlled economy
That is all that I wish to say, Mr. Chairman.
The CHAIRMAN Any questions by members of the committee 2
Senator KEAN. I should like to ask a few questions, if everybody
else is through.
The CHAIRMAN. GO ahead, Senator Kean.
6444
STOCK EXCHANGE PRACTICES
Senator KEAN. I should like to ask you, Dr. Goldenweiser, whether
you were familiar with conditions in Germany before the World
War?
Mr. GOLDENWEISER. Not intimately, Senator.
Senator KEAN. Well, during their industrial development just
before the World War, isn't it true that money in Germany wa&
bringing, say, 10 to 12 percent 1
Mr. GOLDENWEISER. During their industrial development?
Senator KEAN. NO. Just before the World War, wasn't money in
Germany for industrial purposes bringing, say, 10 to 12 percent?
Mr. GOLDENWEISER. I am not very certain about that. That sounds
very high to me, but I would have to look it up in order to be sure
about it.
Senator KEAN. If you will look it up you will find that every
exchange house in the United States was sending money to Germany
in order to loan it at those rates.
Mr. GOLDENWEISER. DO you mean before 1914?
Senator KEAN. Along about 1912.
Mr. GOLDENWEISER. Germany was undergoing a very rapid industrial expansion, and presumably the demand for capital was great,
but the height of the interest rate surprises me.
Senator KEAN. I t was something like 10 or 12 percent, I think*
Are you familiar with the Paris Bourse ?
Mr. GOLDENWEISER. Again, not intimately. I do not even know
the New York Exchange intimately.
Senator KEAN. YOU know, do you not, that on the Paris Bourse a
large number of the seats are owned by the Government?
Mr. GOLDENWEISER. Yes.
Senator KEAN. They control the Paris Bourse.
Mr. GOLDENWEISER. Yes.
Senator KEAN. And, owing to their control of
the Paris Bourse r
there is an outside market which is larger than the Bourse market,
is that correct?
Mr. GOLDENWEISER. I think that is correct.
Senator KEAN. But owing to the control of the Government over
the Paris Bourse, the outside market is bigger than the Bourse
market.
Mr. GOLDENWEISER. Yes.
Senator KEAN. I just wanted
to get that into the record. As far
as brokers go, do not nearly all of them require that the customer
shall sign an agreement by which they are allowed to pledge the
securities for the difference between the amount he puts up and the^
amount of the value of the securities?
Mr. GOLDENWEISER. I think there is such a requirement, but it i&
one that has been complied with more universally in recent years
than it was before 1929, and also one that is very frequently in a very
inconspicuous place on the slip that the customer signs.
Senator KEAN. I think it is printed in pretty large letters.
Senator BULKLEY. Does it not go even further than that and permit them to rehypothecate generally?
Senator KEAN. Yes.
Senator BULKLEY. Not merely for the difference.
Senator KEAN. TO rehypothecate for the difference. That is all
they are entitled to borrow.
STOCK EXCHANGE PRACTICES
6445
Mr. GOLDENWEISER. As I say, I am not fully familiar with the
details of the exchange operations.
Senator KEAN. That is notice to the customer, is it not ?
Mr. GOLDENWEISER. It is notice to the customer.
Senator KEAN. He must read that circular, or thing that he signs?
Mr. GOLDENWEISER. Yes.
Senator KEAN. And that
is a notice to him that they are going to»
hold him liable for that whole amount, is it not?
Mr. GOLDENWEISER. I think you are right, Senator. I would agree*
with you in everything except the verb. I think you say he must. X
think he should. I think he very frequently does not.
Senator CAREY. HOW doe$ he sign it when he wires in or tele-phones in to sell a certain stock?
Senator KEAN. He would probably wire it from a correspondent,
and that correspondent has those forms, and he signs it.
Mr. GOLDENWEISER. He signs it at the time he makes his commit-ment, but he does not sign it over again when he increases his commitment, and it is not a vital part of his understanding of the situa-.
tion. Of course, when I say " his " I do not mean everyone, because
there are no doubt a great many people who are wise to the whole
situation. But I think it is a fair statement that a great many do.
not know.
Senator KEAN. Witnesses who have testified here on behalf of
several large corporations have testified that they loaned very large
amounts. They also testified—I think I am correct in the statement—that they did not lo$e a dollar; is that correct?
Mr. PECORA. That is my recollection.
Mjr. GOLDENWEISER. I think that sounds right.
Senator KEAN. SO that I do not believe, as far as I know, that
any bank or trust company lost a dollar on brokers' loans during all
this depression.
Mr. GOLDENWEISER. I think a statement as absolute as that probably could be contradicted, but I think that it is certainly correct
m essence.
Senator KEAN. There is one other question I would like to ask,
and that is this: Many people believe that an important factor was
the income tax allowing people to take profits and losses on their
profits or losses in the stock market. In 1929, when they had large
profits, they refused to sell, which they otherwise would, and a large
part of the floating stock was absorbed by people who were speculating in it, but who refused to sell because their profits were so large
that they would not sell, and that gave other people an opportunity
to put up the prices to the roof. Do vou agree to that ?
Mr. GOLDENWEISER. I agree to the fact that it was a factor. I have
always been told it was a factor. I think it probably was a factor,
but I should say, on the basis of my own opinion, that it was not a
major factor in the situation.
Senator KEAN. Many people that I know regard it as a major
factor.
Mr. GOLDENWEISER. Yes. A great many people have considered it
as a major factor, and they may be right. But m my humble opinion
it is relatively a small number of people who were in that class,
and in the wave of speculation that swept the copntry at that time
6446
STOCK EXCHANGE PEACTICES
this particular factor was not of major importance. It does not
mean that there may not be some defect in the tax machinery that
ought to be corrected. I am not a tax expert, either.
Senator GORE. It works just the other way when the market goes
into reverse. They sell to take their losses.
Mr. GOLDENWEISER It may emphasize sales, and it may emphasize purchases. It certainly has resulted in breaks toward the end
of the year, when people sold to establish losses, but I think, on the
whole, twa things about that, Senator, if you will bear with me One
is that m the situation of the country as a whole, I feel that is relatively minor, an dalso that it hits people mostly of the type who
are much better able to take care of themselves than the rank and
file of the little folks that lose their money m the market.
Senator KEAN. Yes; but the point of the thing is this They refused to sell when the market was going up
Mr
GOLDENWEISER
Yes
Senator KEAN Then, when the market staited to go down, they
weie obliged to sell, and that increased the pressure of sales on
the market.
Mr. GOLDENWEISER Yes.
Senator KEAN And if it
had not been for that income tax, you
would have had them selling all the way up, and blocking the
market from going so high, and, on the other hand, they would
not have had anything to sell when the market dropped.
Mr GOLDEN WEISFR That is right. It was a factor, unquestionably.
Senator WAGNER HOW did the market go down, except that there
must have been a wave of selling 2
Senator KEAN Yes.
Senator WAGNER. YOU said they refused to sell.
Senator KEAN They refused to sell when the market was going
ap, and they were forced to sell when the market went down.
Senator WAGNER. Did not the market go down because there was
less demand for the commodity than there were securities offered for
Senator KEAN. I t carried it very much further.
Mr. GOLDENWEISER. YOU mean, why did it start to go down at all?
I suppose Senator Kean would not claim that that caused it to turn,
but when it turned for other reasons, this accentuated the rapidity
of the decline.
Senator KEAN. That is what I mean exactly.
Mr. DECORA. Dr. Goldenweiser, do you know to what extent new
securities were issued and absorbed by the market in 1929 prior to
October?
Mr. GOLDENWEISER The volume of security issues ^
Mr. PECORA. New issues; yes.
Mr. GOLDENWEISER. Quoting entirely from memory, I think that
year there were 10 billions.
Mr. PECORA. Of new issues ?
Mr. GOLDENWEISER. Yes, sir
Mr. PECORA. Prior to October 1929?
Mr. GOLDENWEISER Yes; 10 billions of new issues.
Senator WAGNER That means that that 10 billions
panding facilities for production, probably.
went into ex-
STOCK EXCHANGE PRACTICES
6447
Mr. GoiiDENWEiSER. Yes. I think that needs to be modified, Senator, because some of it went into brokers' loans. People issued securities and made money, and then used that money to lend on the
stock exchange, because there was a good opportunity to issue securities, and then they had idle funds, and they placed them on the stock
exchange. In the very last lap of that expansion, the securities
issued were those of investment trusts, which were not using it for
any purpose other than to buy other securities. In other words, there
was a pyramiding, and sucking in. I could not say offhand what
proportion, but I do know that the last heights were reached through
securities that were not issued for any productive purpose, but were
issued either for the purpose of benefiting by the easy money, or for
the purpose of forming security companies, investment companies.
Senator WAGNER. And during that period was there not investment of a great deal of excess profits in securities which went into
the expansion of production facilities?
Mr. GOLDENWEISER. Yes, sir. That is right.
Senator WAGNER. That was one of our difficulties, was it not?
Mr. GOLDENWEISER. Oh, yes. I am not minimizing that. I just
wanted to say that that was not all. There were also other factors.
Mr. PECORA. AS I recall, officers of certain of these nonbankmg
corporations who testified before this committee last Friday stated
how much money they loaned out on call loans during 1929, and they
stated that they got a good deal of that money through the sale of
securities which they issued.
Mr. GOLDENWEISER. Yes.
Senator GORE. That was
the inducement at the time, in order to
make call loans. I have been told this, Doctor—and I would like
to get your reaction—that that group was among the first and the
worst to withdraw these brokers' loans when the danger signals appeared.
Mr. GOLDENWEISER. Of course. The so-called " loans for account of
others ", the loans by corporations, were all withdrawn almost overnight when the turn came. I t is different from bank money, in that
it has a complete lack of responsibility toward the market, and has
its entire responsibility toward its stockholders. I t was perfectly
good, straightforward business for a corporation to float securities
and get money while it could get it cheap, because it thought that
some day it might need it, and in the meantime it could get 10 or
12 percent by loaning it on the market. But when the market turned
that corporation quite naturally tried to get all that money out just
as soon as possible, so that almost overnight billions of dollars were
withdrawn, and the New York banks had to step in and carry the
loans in order not to let the market go into an even worse collapse
than it had.
It was a very critical situation, and the banks had to borrow from
the Federal Eeserve, and the Federal Eeserve had to help them,
because when all those billions started out of the market in that
hurry, it had to be supported. I think, with regard to these loans
for account of others—I refer to them by the technical name.
Partly because they are entirely irresponsible money, irresponsible
tfrom the point of view of the money market, they are a very vicious
175541—34—PO? 15
3
6448
STOCK EXCHANGE PEAOTIOES
institution. They are now prohibited both by the rules of the clearing house exchange and by the Banking Act of 1933.
Senator GORE. Then the investment trust was another thing that
accelerated the fall, was it not?"
Mr. GOLDENWEISER. Investment trusts &
Senator GORE. Yes; those that bought secunties at high figures.
Mr. GOLDENWEISER. I think there must have been some investment
trusts that did. I am not very familiar with that.
Senator GORE. It was charged at the time that they were dumping
securities in order to get out of the stock market.
Mr. GOLDENWEISER. The poorer kind of investment trusts, which
themselves borrowed money in order to buy, no doubt had to dump,
but a properly conducted investment trust would not have to dump,
because it would only buy with money that it received from its
investors, and therefore had full equities. It might sell because it
thought it was a good thing to sell, but it would not be forced to
sell by debt.
Senator KEAN. There is one question I would like to ask if I may.
You talked about the development of the stock business from 1922,
or whenever it was, on. Is not the reason there was a large development of the stock business owing to the fact that the Government
went all over this country trying to sell Government bonds, and
organized that activity, and got people trading in bonds, and then
they drifted into trading in other things?
Mr. GOLDENWEISER. I have often heard it said that the liberty
Loan campaigns were the first time that many small folks around
the country got acquainted with investment possibilities, and that
that organization contributed to the ease with which the market
reached out all over the country. I t is one of those things that it
would be very difficult to estimate the extent of, but it has often
been considered a factor, and may have been a factor.
The CHAIRMAN. Nobody made SLILJ very great profits on Liberty
bonds, or fortunes in investment in Liberty bonds.
Mr. GOLDENWEISER. NO, sir.
Senator GORE. Except those
Senator KEAN. In reply to
that bought them at 80 or 84 or 85.
the chairman, I would like to show
him some of the accounts of savings banks in New York that bought
Liberty bonds at 85 and sold them above par, and made a pretty good
profit on them.
Mr. PECORA. Dr. Goldenweiser, I think you made some reference
in the early part of your statement to the committee about the tremendous liquidation of these call loans after the first crash in October 1929. I do not recall whether you told the committee the extent
of that liquidation.
Mr. GOLDENWEISER. I did, but I would be very glad to repeat that.
From 8y2 billions it diminished by 3 billions in the course of 10
days, and it diminished 8 billions in the course of 3 years, so that at
the end of 3 years, from 8y2 billions, it had gone down to 500 million.
Mr. PECORA. And that was all attended by the liquidation of
securities.
Mr. GOLDENWEISER. Yes.
The CHAIRMAN. What do
those loans amount to now, Doctor, do*
you think?
Mr. GOLDENWEISER. They are about 900 million now.
STOCK EXCHANGE PBACTICES
6449
The CHAIRMAN. They have increased somewhat?
Mr. GOLDENWEISER. i es. Since last spring there has been a rise
in securities values, and a rise in broker's loans.
Senator GORE. HOW low did they get—about a quarter of a billion,
or something like that?
Mr. GOLDENWEISER. I think the lowest point was around half a
billion, as near as I recall. [After conferring with an associate.]
As low as between 300 and 400 million.
Senator GORE. Doctor, are there any particular provisions in this
act which you think are especially designed to accomplish the ends
you have in mind, and which you think we ought to seek, that you
care to point out ?
Mr. GOLDENWEISER. I am not intimately familiar with all the provisions. I think the general object of the bill is to do away with
some of those things that I was talking about.
Senator GORE. There is no doubt about that.
Mr. GOLDENWEISER. A S to the details of the provisions, I really
am not sufficiently familiar with the stock-exchange mechanism to
be able to make concrete suggestions.f
Senator GORE. AS I understood you, you think the stock exchange,
as an institution, is desirable as a market place for the public to
buy and sell securities when the public wants to buy and sell ?
Mr. GOLDENWEISER. Oh, yes. There is a very definite place in
the economic organization tor a stock exchange, because without it
it would be very difficult to raise capital, and it would be very difficult for capital to change hands.
Senator GORE. YOU would have to peddle every stock.
Mr. GOLDENWEISER. Yes.
The CHAIRMAN. If you have
nothing further, Doctor, we are very
much obliged to you.
STATEMENT OF W00DLIEF THOMAS, DIVISION OF RESEARCH
AND STATISTICS, FEDERAL RESERVE BOARD
The CHAIRMAN. Please state your name, place of residence, and
occupation.
Mr. THOMAS. Woodlief Thomas; I am connected with the division
of research and statistics of the Federal Reserve Board. For the
past 12 years I have been with the Federal Reserve Board, or the
Federal Reserve bank, of New York, except for a year and a half,
when I was in Germany with the Transfer Committee connected
with the office for reparations payments.
While at the Federal Reserve bank in New York, mostly in the
past 3 years, I have attempted to make a study of brokers' loans
and stock-market credit. A tentative copy of that study, I think,
was filed with Senator Glass' subcommittee when he was working
on the Banking Act of 1933.
In early 1932, I happened to be in Europe for a few weeks, and
I made a very, very casual and more or less superficial inquiry into
methods of financing stock market speculation in some of the European countries. The results of that have never been written up.
Senator GORE. That is just what I wanted to ask about.
Senator KEAN Where was that, Mr. Thomas 2 Where was the
study made 2
6450
STOCK EXCHANGE PRACTICES
Mr. THOMAS. I spent a few days in Berlin, a couple of days in
Amsterdam, 2 or 3 in Paris, and 3 or 4 in London, questioning stock
brokers and bankers, and finding out how stock-market speculation,
or stock-market trading, I might say, was financed.
Senator GORE. DO you know where that information can be had?
Mr. THOMAS. N O ; I do not think it is compiled. I think the
stock exchange authorities themselves, in their library, have a great
deal of information about the operation of foreign stock markets.
Senator GORE. NO doubt.
Mr. THOMAS. I want to limit my statement, more or less, to questions of detail in describing the credit mechanism as it affects the
stock exchange, supplementing the statements that Dr. Goldenweiser
has made. I will limit myself, as I say, more largely to questions
of detail, without taking up questions of general policy.
I should also like not to discuss matters of stock-market manipulation, or listing requirements, or questions of corporation reports, on
which I do not feel that I can say a great deal.
At the beginning I might say that most stock-market speculation
is done on credit. One can go out and buy a stock with the idea of
selling jt, and pay for it outright, but generally that is not done.
Generally they borrow.
I might also say that nowhere else in the world are there such
easy facilities for advancing credit for purposes of stock-market
speculation as there are in the New York money market.
There are three types of credit, you might say, employed in the
stock market.
First. A broker can go to his bank and borrow, giving a signed
note, and purchase the securities in his own name.
Second. A trader can go to a brokerage commission house and
purchase and sell securities through this house on open-book account.
Third. A brokerage house, in order to finance the customer's transactions, borrows from banks and others. These brokers, in doing
that, can sign promissory notes to the lenders and deposit collateral
value in excess of the amount borrowed. These are the brokers'
loans.
Taking the first two types, that is, the trader himself, there are
several important differences between a bank loan and a customer's
margin account with a wire house or a commission house.
In the case of a loan from the bank the trader has to sign a note
for a specified amount, and if his commitments are increased he
has to sign a new note, whereas in the case of a brokerage house,
long commitments are simply entered as a debit in the books of the
broker, and short commitments as a credit. The principal requirement in the case of a brokerage house is that the account be
adequately margined.
Second. In the case of bank loans, the title to the securities
pledged remains with the borrower, whereas the broker generally
takes title to securities held against customers' debit balances.
Third. Banks deal only with their customers who maintain a deposit balance in addition to the collateral, and banks are also likely
to require larger margins than brokers. I am not so sure that that
is always true, but in general it is probably true.
STOCK EXCHANGE PRACTICES
6451
Fourth. In general—although not always—it has not always been
a practice in the past, at any rate, bankers are more particular
than brokers in arranging credit transactions for purposes of stockmarket trading. More recently some brokerage houses are reported
to have been a little stricter in their selection of customers.
Fifth. Brokers keep a close current check on margins and do not
hesitate to sell out accounts that are undermargmed. They may also
encourage customers to increase their commitments when rising
prices increase the margins held. In other words, the very nature
of a brokerage account encourages pyramiding. It makes necessary
rapid sales in case of a declining market, and therefore adds to the
flexibility or the erratic character of the market.
Banks, on the other hand, are not supposed to encourage extensions on speculative loans, and are likely to carry undermargmed
customers longer. The latter they can afford to do, because of the
note held, because of the possession of better information regarding
the customer's credit standing, because of the larger margin, and
because of the additional security obtained from the deposit carried
by the customer.
We have not any particular information regarding the relative
magnitudes of bank loans and brokerage debit balances. At least,
we did not have up until the other day. I think Mr. Whitney gave
a figure of brokers' debit balances of about $1,390,000,000. Bank
loans to customers on securities at the present time are about three
and one half billions, that is, their loans to others than brokers.
Of course, security loans by member banks to other than brokers
are not always for stock-market trading, by any means. Many of
them are simply customer's loans which are collateraled.
Those loans, at the peak in 1929, bank loans to customers on securities, again representing both loans for stock market trading and
loans for other purposes that were collateraled by securities,
amounted to something over 7 billion dollars, whereas, as Mr. Goldenweiser l^tas told you, brokers' loans at the same time amounted to
eight and one half billion dollars. They were only brokers' loans
to the members of the New York Stock Exchange. There were fully
1 billion dollars of brokers' loans to members of other exchanges
made by banks.
In general I have described the re]ationship of the broker to his
customer Brokers' loans do not represent, as a matter of fact, all
the credit that is advanced for stock-market trading. As has been
pointed out in the press in the last few days, brokers are now borrowing some $900,000,000, and their customers' debit balances are
nearly $1,400,000,000 In other words, there is a great deal of
credit that is advanced for stock-market trading that does not come
from the banks It comes through the brokers themselves, through
the commission houses. That may represent brokers' own funds that
the}^ put up It may lepresent customers' credit balances that they
maintain.
Those customers' credit balances can be of two kinds One covers
credit balances against short sales, and the other, free credit balances,
which are pretty much the same as deposits. In other words,
brokerage 1commission houses, in effect, do a banking business
They make loans and they accept deposits. I think after next July
6452
STOCK EXCHANGE PRACTICES
it will be illegal for them to accept deposits under the Banking
Act of 1933. They can, by short selling, however, offset customers'
debit commitments by corresponding credit commitments. In a
system of term settlements, for example, such as prevails abroad,
for a period of 2 weeks
Senator KEAN. NOW you are talking of London?
Mr. THOMAS. Yes; London, Paris, and Berlin. They all have term
settlements. For a period of 2 weeks the short sales exactly balance
the purchases, because everybody who sells is selling short for $
period of 2 weeks. A man does not have to settle for that time. So
during that period no one borrows from a bank or from anyone else.
He simply is, in effect, borrowing from the person to whom he sold.
That is what would take place in this country even under a system
of daily settlements, if you had enough short sales to balance the
long commitments, the brokers would not have to borrow at all.
Of course, that never exists.
Senator BULKLEY. What facilities are there for margin trading in
those European markets ?
Mr THOMAS The facilities for margin trading m London seem to
be exceedingly difficult In fact, I could not find a broker who
would admit that he did a margin business They would all tell me
" Well, you go to the next man. He does it." And I would go to
him, and he would not admit it either. But apparently there are
some houses that do it.
To open an account with a broker in London, as far as I could ascertain, one had to show that he was more or less of a gentleman.
He had to have a credit reference from his bank, and he had to show
that he was a person of high credit standing who was able to undertake such commitments as he might have. Some of the houses, as a
matter of fact, do not require margins of their customers.
On the question of term settlements, one could buy with the idea of
settling after two weeks' time. Generally he did not settle. He
simply sold again before the end of 2 weeks, and the accounts balanced, and he either paid or received the difference. But frequently,
as I was informed, they did not actually require margins. Generally, however, brokers encourage an individual to go to his bank.
If he wants to buy securities on credit and hold them for longer than
2 weeks, he is encouraged to go to his bank and borrow.
Senator BULKLEY. YOU are speaking about London now 2
Mr. THOMAS. Yes, sir.
Senator KEAN. Did you take up the question of carry-over?
Mr. THOMAS. Yes, sir. I could not find many brokers at
that
time who were willing to do a carry-over business.
Senator GORE There is one point on which I am not entirely
clear They have over there what they call fortnightly settlements,
which you refer to as term settlements^
Mr. THOMAS. Yes.
Senator GORE. Suppose
you buy on the 5th of the month. Does
that mean that a fortnight from then you settle, or are these fortnightly settlements for a stated period when everybody has to clear?
Mr. THOMAS. Yes. Everybody has to clear on certain days.
Senator GORE. The same date for everybody?
Mr. THOMAS. The same date for everybody.
STOCK EXCHANGE PEACTICES
6453
Senator KEAN. I S there not a regular fixed rate, just the same
way as the stock exchange makes a rate in the morning for loans?
Mr. THOMAS. Yes.
Senator KEAN. That
is the rate for the day for loans—the renewal
rate.
Mr. THOMAS. I t is the rate for the next period.
Senator KEAN. And you get the same rate to carry-over; is that
right?
Mr. THOMAS. That is right; yes, sir. It is called the " contango "
rate, and in case there happens to be more of a demand for that
particular stock, or in case short sales are very heavy in that stock,
and more people who have sold want to carry over than have bought,
you may have to pay what is called " backwardation." That is, the
short will pay rather than the long trader.
Senator KEAN. That is the same thing as a premium in our
market.
Mr. THOMAS. Exactly the same thing as a premium.
Senator GORE. What was the term you used?
Mr. THOMAS. Backwardation.
Senator GORE. Suppose you spell that.
Mr. THOMAS. B-a-c-k-w-a-r-d-a-t-i-o-n.
There is a certain amount of borrowing. Then, of course, in
London also you have the institution of the jobber, which corresponds, in a sense, to our specialist, but it is not in a very important
sense, in that the jobber is not a broker. He deals only for his own
account, but he stands ready to buy or sell from brokers and from
other jobbers at any time, at certain stated prices. A jobber may find
himself, at the end of a term, having bought or sold more than
he can deliver—not more than he can deliver, but more than he can
carry on his own resources, so that he has to go to a bank and
borrow, but the amount of loans that are made by the five big London joint-stock banks to brokers and jobber, that is, to the stock
exchange, is a very small figure compared with ours. I think the
figures published in the McMillan report ranged from twenty-five to
forty or fifty million pounds, which means something less than 200
million dollars, even at the peak of 1929 or 1928, when they reached
their peak.
Senator GORE. DO you have any idea what all the stocks listed on
the London Exchange were wortn at that time?
Mr. THOMAS. There is no such figure available, Senator, I think.
Senator KEAN. If you wanted to buy 5,000 shares you would go
to the jobber, and the jobber would make a price on 5,000 shares.
Mr. THOMAS. The broker would.
Senator KEAN. But if you should go direct to the jobber
Mr. THOMAS. Not as individual, as I take it.
Senator GORE. They deal with brokers and other jobbers; is that
the idea?
Mr. THOMAS Jobbers deal with brokers and other jobbers. Brokers deal with the public and with jobbers. So that the total amount
of credit that is advanced by London banks to the stock market is,
I believe, if I remember correctly, only about 1 percent of the total
loans advanced by those banks for all purposes, and the important
part about it is that it fluctuates very slightly. An advance to a
6454
STOCK EXCHANGE PBACTICES
broker or a jobber is a customer's loan. I t is not, as in the case
of our market, an open-market loan. I t is a customer's loan. I
will explain how that works.
When a jobber wants to borrow from his bank, as he expresses it,
he puts on his top hat and goes and makes a call. He gets a line
of credit. If he wants to increase that line of credit he makes
another call.
In our market if a broker wants to borrow, he may call his bank
and say, " I want to increase my commitment", and he can do it
over the telephone. That may be a perfectly legitimate customer's
transaction, along perfectly normal lines. The bank may consider
that it has advanced that broker a line of credit. On the other
hand, if the bank does not want to lend to him or increase his line
of credit, he can go to the money desk on the stock exchange, or he
can go to a money broker and borrow practically any amount he
wants, if he is willing to pay the market rate.
Senator GORE That is m New York.
Mr. THOMAS. That is in New York; yes. That system in New
York has grown up because of reasons that I think are more or
less inherent in both our stock exchange practices and our banking
practices. We have to have call loans in the New York market, because we have a system of daily settlements in New York. A broker
likes to be able* to pay off his loans as soon as he gets additional
cash. The banks can call their loans very freely, but the banking
part I will take up later.
The system of daily settlements practically required call loans, although as I understand, in Amsterdam they have a system of daily
settlements and they do not have call loans. They borrow on a
monthly basis, but they manage to arrange their maturities so that
they can always reduce or increase their loans day by day, as the case
may be.
Senator BULKLEY. IS margin trading prevalent m Amsterdam?
Mr. THOMAS. TO a certain extent; yes The Amsterdam market
is very much like our market in many respects
Senator KEAN. Except that they deal m one share instead of 100 ?
Mr. THOMAS Yes.
Senator KEAN. I would
like to ask you a question about this banking situation in London. They do not require collateral from
their customers. They give you an open acount of so much.
Mr. THOMAS. On their loans to the stock market they generally
have collateral, I think.
Senator KEAN. I am talking about others
Mr. THOMAS. Yes. They have both, but in general their advances
on " current account " are not collateraled.
Senator KEAN. In other words, in London you do not sign a note
or anything else. All you do is just draw on your bank
Mr. THOMAS. But you have a line of credit.
Senator KEAN. Up to so much.
Mr. THOMAS. Yes, sir. I t is a definitely limited amount.
Another factor that has made the call money market so important
in New York has been the nature of our banking system, I think.
Before the Federal Reserve System the country banks kept their
reserves mostly in large cities, very largely in New York. Those
STOCK EXCHANGE PEACTICES
6455
Reserves were callable on demand. The New York banks had very
large bankers' balances, which they knew had to be drawn out very
promptly, and they liked to invest them in such a way that they
could get the money promptly. In that way the call money market
provided a very efficient use of these funds, and it has been a very
important part of our monetary and financial mechanism.
Senator CAREY. What do you think the effect of that has been on
the rest of the country ?
Mr. THOMAS. I think Mr. Goldenweiser has answered that question. The call money market is to our money market practically
what the bill market is to the London money market. When banks
have surplus funds they put them in call loans in this country. In
London they put them in bills.
The CHAIRMAN. They send the money from all paits of the
country.
Mr. THOMAS. They take money from all parts of the country.
When that money gets to be usfed, and speculative enthusiasm is
worked up on the basis of cheap money, then the banks decide that
they need the money for their own customers, and generally—I may
say it is quite generally true that banks put their customers first.
They have been quite free in the past about drawing loans out of
the call money market. In 1928 and 1929 banks' loans to brokers
decreased, actually. There was an increase in business activity.
Banks drew their funds out of the call money market, and increased
their loans to their business customers. The increase m brokers'
loans in that period was not due to the banks. It was due to the
loans for others, which were attracted by the high rates, which
were bid up by the speculating and trading community. When they
found they could not get bank funds, they bid up until they got
the others. I t is the first time in our history that that has ever
happened to anything like that extent. Previously when the bank
loans were withdrawn—at least in many of our previous crises—as
bank funds were withdrawn from the stock market, in order to make
loans to customers, the stock market crashed or started down. In
1906 the stock market started down one full year before the crisis
came, before business really began to show signs of difficulty, and
by 1908 the stock market was fully liquidated, funds came back
after business had declined, money was cheap, there was little business demand for funds, and they came back into New York. The
banks outside sent it in to New York, and the stock market was
ready to rise again. That increase in stock market credit probably
did a great deal to bring about business revival.
So far as the banks are concerned, that happened in this crisis, or
in this depression The banks began, after business declined and
customers' loans decreased, to send their money to New York, but
the market was in such condition that it did not have the demand.
It did not offer the demand for the money, so it was unused.
Senator GORE Bank loans, then, ran up during the crisis.
Mr. THOMAS Bank loans to brokers reached the peak in 1930. Of
course, that does not mean that brokers' loans as a whole reached the
peak, because the loans for others were declining.
Senator GORE. The banks stepped in.
Mr. THOMAS. The banks stepped in and increased their loans during that period.
6456
STOCK EXCHANGE PRACTICES
The close relationship between our banking system, the central
money market, and stock market speculation, brings about the results
that Mr. Goldenweiser has already pictured to you. It makes the
most fluid and one of the most important elements in our credit
supply dependent upon the results of stock market speculation. If
speculation is active we can get tremendous expansion in credit. If
speculation is dull we get a contraction of credit. If speculation is
declining we get a contraction of credit. An expansion of credit
temporarily increases purchasing power. A contraction of credit
decreases the volume of purchasing power, and has an effect upon
the business situation.
Of course, all funds loaned on the stock market are not surplus
funds of banks. Banks like to keep a certain amount of funds m
liquid secondary reserves, as they call it. They like to keep them
there always, so that even in 1928 and 1929 you had some brokers'
loans by banks because it was a useful way of keeping money temporarily. Banks have from day to day demands, and they have to
withdraw funds quickly, and that provides a very useful market
for them. Then, also, the New York banks have a certain definite
customer relationship to the brokers, sometimes a perfectly understandable and legitimate one, and they feel some responsibility for
the market. For instance, at the end of the month, the outside
lenders, the outside banks particularly, will draw their funds from
call loans in order to meet certain end-of-the-month requirements.
At that period the New York banks will come in and take the place
of those loans and will, in fact, borrow from the reserve bank for a
few days in order to provide that stability which is essential in any
reasonable market operation.
Senator GORE. Who made the withdrawals in that case?
Mr. THOMAS. Outside banks. Outside banks generally have a lot
of payments to make over the end of the month. They will withdraw
funds from brokers' loans and leave them on deposit for a few days
with New York banks so that brokers' loans with outside b a n k
will decline for a few days at the end of the month, whereas bankers'
balances held by New York City banks will increase. Then, you
might say, the New York City banks* will take those funds deposited
with them and lend them to brokers. It is simply a shift of practically the same funds. Also, they add a few more, because brokers
themselves need a little additional money at the end of the month
to meet perfectly legitimate and temporary end-of-the-month
demands.
Senator GORE. And the banks meet those requirements?
Mr. THOMAS. The banks meet those requirements, and for that
short period of time will borrow from the Federal Reserve bank for
that purpose.
Senator GORE. These loans for the account of others have virtually
vanished, have they not?
Mr. THOMAS. They have virtually vanished; yes. There are a few
still made through some stock-exchange houses—I think about
$100,000,000.
The CHAIRMAN. What are the evils or vices or abuses that this bill
would correct?
Mr. THOMAS. By placing larger margin requirements that would
make the margin business more difficult. The secret of the whole
STOCK EXCHANGE PEACTICES
6457
importance of the stock exchange is the fact that in this country
ftiore than in any other country it is easier to trade on margin
through a brokerage house, and the holding of this large volume
of small margin accounts makes manipulation and pool operations
and short selling and all those things important and successful, because a manipulator can go in and, by bidding up the price of
stocks, will increase the margins that are held by small traders,
a*id will also increase their optimism and enthusiasm for these particular stocks, and it will be possible for them to go in and pyramid
on the basis of those margins, increasing their commitments, and
at the same time on a decline they can go in and, by depressing the
price of stocks, deplete margins, so that it is necessary—it is not
voluntary as in the case of a rise—it is absolutely essential in the
ease of a declining market for these small traders to sell out, because
their margins become depleted, and that intensifies the nature of the
movement.
Senator KEAN. Yes, but if your margin has to be 50 percent, when
the customer gets to 49 percent you are going to sell him out?
Mr. THOMAS. Yes. A fixed margin requirement
Senator KEAN (interposing). I t is just the same whether it is
30 percent or whether it is 50 percent?
Mr. THOMAS If that is followed, that practice, that would be
true.
Senator KEAN. But under the law you have got to follow that
practice.
Mr. THOMAS. Not necessarily.
The CHAIRMAN. We have not heard much complaint about the
requirement here of 60 percent, because the suggestion generally is
that 40 percent would be better, high enough.
Mr. THOMAS. Forty percent margin, you mean ?
The CHAIRMAN. Yes.
Mr. THOMAS. Well, it
makes some difference, because of the amount
of cash that has to be put up. But Senator Kean is correct that a
fixed, inflexible margin requirement would force selling in the
same way. But if this requirement is applied at the time the loan
is made, the commission can no doubt make certain regulations regarding what time the customer should be sold out. I t gives him
a much larger cushion than he had before.
Senator KEAN. Yes, but the point of this business is that today
we have testimony—and I think it is practically true—that all
through this decline there has not been a dollar lost on stock exchange collateral loans.
Mr. THOMAS. Oh, yes.
The CHAIRMAN. Yes.
Mr. THOMAS. There has not been a dollar lost.
Mr. PECORA. Has not been a dollar lost on call loans.
Senator KEAN. That is what I mean.
Mr. THOMAS. There has not been a dollar lost on brokers'
Senator KEAN. Therefore, increasing the margin has been
loans.
ample
as far as protecting the banks.
Mr. THOMAS. Yes; that is exactly true, so far as the protection is
concerned.
6458
STOCK EXCHANGE PEACTICES
Senator BARKLEY. Of course, that comes about in part, if not in
whole, by reason of the fact that before the margin is exhausted a
broker sells a man out and he uses the money to pay the bank.
Senator KEAN. Of course.
Mr PECORA I t protects the bank, but it does not protect the investor.
Mr. THOMAS. There are two points that I can make on that, Senator : One is that the very safety of the brokers' loans is responsible
for the lack of safety of some of the bank loans. Suppose the banks
which had a certain amount of collateral loans to their customers
and also sold out their customers at the same time the brokers did
with the same impunity; the brokers would not have come out so
fortunately.
Senator KEAN. Maybe not
Mr. THOMAS. I t is the very fact that the brokers do build up these
large margin requirements and sell them out so quickly that endangers the whole situation.
And the second point that I would make is that the thing we
would want to safeguard against is the building up of these tremendous margin commitments to the position where they become important A certain amount of margin trading is not unsound. I t is the
lapid expansion and contraction of these margin commitments which
is unsound, and if the customer has a fairly safe cushion of protection, the broker will not be so quick about selling him out, and it
will provide some stability to the market.
Senator KEAN. I am not sure but what the broker under those circumstances would not be liable for the losses
s
Mr. THOMAS. There would not be any losses to the customer.
Senator KEAN. Oh, yes; there would.
Mr. THOMAS. Unless the margin was fully depleted.
Senator KEAN Suppose a man bought a hundred shares of New
York Central and put up 50 percent margin and New York Central
was selling at par, and he put up 50 percent margin, and the requirements were 50 percent margin, and then it went to 49 and he did
not sell him out and it went to 40. Why wouldn't the customer have
a claim there ?
Mr. THOMAS. I should not think so.
Senator KEAN. I should.
Senator BARKLEY. I was ]ust going to ask you this question, which
you partly answered by stating that you think a certain amount of
marginal trading is not unsound: Do you think that any amount of
pyramiding is unsound, or what is your reaction to that? For instance, if a man buys a hundred shares of stock selling at 50 and
he is required to put up 50 percent, which is $2,500, and it goes up,
we will say, to 70, and as it goes up he protects himself by stop-loss
orders. Do you think that in a case like that he ought not to be
permitted to use his profits to buy more stock if he wanted to ?
Mr THOMAS Well, personally I haven't any objection to that practice as a single case. I am not trying to deal with that particular
aspect of the situation But what I am saying is that a general
movement in that direction is unsound, since it rapidly increases
the credit supply of the country in such a way as to give a false
stimulus to business and to such an extent that it must be liquidated
sooner or later.
STOCK EXCHANGE PRACTICES
6459
Senator GORE. Speculative profits are pretty easily used in further
speculation?
Mr. THOMAS. Yes, sir.
Senator BARKLEY. Presumably,
the increase in the market requirements is intended to keep the little fellow out, protect him against
the putting m of a little dab of money and losing it. Of course, if
he has got enough to buy anything at all he can still deal when he
would buy less; instead of buying 200 shares he might buy 100.
Mr. THOMAS. Yes.
Senator BARKLEY.
The only way to keep the small man out of
the market is to require him to pay cash. If he hasn't got the cash
enough to pay for the amount of stock, why, he would not be able
to go in.
Mr. THOMAS. He could borrow from his bank.
Senator BARKLEY. He might borrow from his bank—that is, he
" used to could." [Laughter.] I don't know how long it is going
to be before he will be able to do it again.
Senator GORE. Let me ask you this in connection with< what Senator Barkley has just asked you: What I have in mind is the eighteenth amendment. Suppose we make this margin requirement 60
percent. A man cannot buy on a big or small scale unless he puts
up 60 percent margin. Is there anything m this bill to prevent
some fellow from hovering around in the shadows and operating as
an intermediary between the little fellow who wants to buy on a
10 or 15 percent margin and the big fellow who wants to buy on a
margin according to the law. Would there be bootlegging around
the corner? Can you stop that?
Mr. THOMAS. I am not sure about that, Senator. I have not
looked into the bill carefully enough to see that that could be done.
Senator GORE. I do not see how it could be possible. I t may be.
Mr THOMAS. Well, the thing is that the bootlegger would not
have—should not have—as free access to the banking system as a
reputable brokerage house has now
Senator GORE. That is true. Some men have a good deal of resources of their own, who, with a good margin of surplus, might
operate in that fashion—like these rackets that are organized.
Mr. THOMAS Yes, but probably you could not get it up to anything like as large proportion as it has been.
Senator GORE. I sometimes doubt, Mr. Thomas, whether you can
protect the fool against his folly.
Mr. THOMAS Yes, sir. I have an idea that is true, Senator, and
for that reason
Senator GORE (interposing). He will do it somehow.
Mr. THOMAS. For that reason I would attempt to control the magnitude and the wide fluctuations.
Senator GORE. YOU mean the number of the fools and the extent
to which they are permitted to operate. If you do that, you are
striking at the root of the evil.
Mr. THOMAS. Yes.
Senator BARKLEY.
In normal times my observation has been, by
watching the papers and keeping fairly well informed about the
movement of securities, that there are certain very large number of
stocks, I would say the majority, that do not have wide fluctuations
6460
STOCK EXCHANGE PBACTICES
from day to day but are fairly well stabilized, and my information is
that New York Stock Exchange houses require a smaller margin in
those cases because there is less liability of having to sell out a
customer in order to protect themselves/and they require a larger
margin in case of volatile shares that are liable to go up 10 or down
10 points a day or withm a week. Would you leave any flexibility
in the law so as that the Stock Exchange could continue to fix some
relative margin, depending upon the character of the stock ?
Mr. THOMAS. That, Senator, I think, is the beauty of the particular margin prevision in this bill, that with stocks that are relatively stable or which have not fluctuated very widely, you can
borrow up to 80 percent of which might be up to very close its
present value in the market. On those more volatile stocks they
can borrow only up to 40 percent of the market or 80 percent of the
lowest price, which does provide a larger cushion in the case of the
more volatile stocks. I t is an automatic thing.
Senator BAREXEY. In the case of a stock which had gone down
to $20 a share within the last 3 years, if a man wanted to put up a
margin on' that under this bill, he could buy that stock by putting
up $4 a share, although it is selling now at 40?
Mr. THOMAS. If it has been to $20, yes; he could buy it with $4.
Senator BARKLEY. He could borrow within 80 percent of the
lowest price?
Mr. THOMAS. Yes.
Senator BARTCT«EY.
Which would be $16 a share, although that
stock is now selling at 40 or 50 ?
Mr. THOMAS. Well, if it is selling at 50 he could borrow $20 on
it; if it is selling at 40, he could borrow exactly the same. He could
borrow $16 on it if the lowest price is 20 and its market is 40. If
it goes up above 40, he can borrow an increasing amount on it.
Senator BARKLEY. Of course, that would not necessarily tend to
keep the little fellow out.
Mr. THOMAS. NO.
Senator BARKLEY.
If he could put up $4 a share on a stock that
had been down to as low as 20 and was up at 40 now. He really
would be able to buy it on a smaller margin than he can now, according to the regulations of the stock exchange.
Mr. THOMAS. I t would decrease the amount of credit expansion
that you could get on the basis of a given amount of stocks, and
also decrease the rate of increase in that credit as prices rose. A
man would have to put up more money constantly.
Senator KEAN. What would he have to put up if the stock went to
70? According to Senator Barkley he could buy it for $4 now, on a
$4 margin, if it is selling at 40. Is that right?
Mr. THOMAS. He could buy it by borrowing $16 on it selling at 40.
Selling at 70 he could borrow $28 on it, which would give him a
margin of 42.
Senator KEAN. I am talking about the margin the customer would
have to put up.
Mr. THOMAS. Yes. Giving him a margin of 42 selling at 70.
Senator KEAN. Have to put up 42?
Mr. THOMAS. Have to put up $42.
Senator KEAN. For each share, you mean?
Mr. THOMAS. For each share; yes.
STOCK EXCHANGE PBACTIOES
6461
Senator KEAN. Then if it went up, why, he could not afford to
hold it, could he?
Mr. THOMAS. Well, he would not have to put up any more if it
went up. That gives him more margin, if it went up.
Senator BARKLEY. Of course, if it went up he would not have to
put up any more money.
Mr. THOMAS. He can borrow always 40 percent. He could borrow
money on it. He could draw some out.
The CHAIRMAN. I S there anything else, Mr. Thomas?
Senator GORE. *I wish you would state a case a little more in detail,
carry it through under those operations.
Mr. THOMAS. Exactly how these margin provisions would operate?
Senator GORE. Yes, sir; that you have just been discussing.
Senator BARKLEY. Of the bill.
Senator GORE. Yes; get it in the record in a completed statement.
Mr. THOMAS. Maybe someone who is more familiar with commission-house practice could do it better than I.
Senator GORE. Oh, yes; all right.
Mr. THOMAS. I could give you a general picture of it.
The CHAIRMAN. We are much obliged to you, Mr. Thomas. We
will wait until tomorrow to call Mr. Corcoran. The committee will
now take a recess until 10 o'clock tomorrow morning.
(Accordingly, at 4:25 p.m., the committee adjourned until 10
o'clock on the following morning.)
STOCK EXCHANGE PBACTICES
TUESDAY, FEBRUARY 27, 1934
UNITED STATES SENATE,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.G
The committee met at 10 a.m., pursuant to adjournment on yesterday, in room 301 of the Senate Office Building, Senator Duncan
XT. Fletcher presiding.
Present: Senators Fletcher (chairman), Barkley, Bulkley, Gore,
Reynolds, Byrnes, McAdoo, Goldsborough, Carey, and Kean
Present also: Ferdinand Pecora, counsel to the committee; Julius
Silver and David Saperstein, associate counsel to the committee,
and Frank J. Meehan, chief statistician to the committee; also
Roland L. Redmond, counsel to the New York Stock Exchange.
The CHAIRMAN. The committee will come to order. Now, Mr.
Corcoran, will you please state your name, place of residence, and
occupation.
STATEMENT OF THOMAS GARDINER CORCORAN, IN THE OFFICE
OP COUNSEL FOR THE RECONSTRUCTION FINANCE CORPORATION, WASHINGTON, B.C.
Mr. CORCORAN. My name is Thomas Gardiner Corcoran. I am
in the office of counsel for the Reconstruction Finance Corporation
here in Washington, but I want it fully understood that I do not
speak for the Reconstruction Finance Corporation.
The CHAIRMAN. We understand that. Are you familiar with the
bill the committee has under consideration, S. 2693?
Mr. CORCORAN. Yes; Senator Fletcher. I am one of the persons
whom Mr. Landis called in to help on the drafting of the bill after
you requested of him that, in cooperation with Mr. Pecora and
members of his staff, a bill be prepared for you.
Mr. PECORA. Mr. Chairman, might I interrupt Mr. Corcoran for
just a moment?
The CHAIRMAN. Certainly.
Mr. PECORA. Mr. Redmond, can you have available for us here in
the next day or two the minute books of the committee on business
conduct the conference committee, the governing committee, and the
law committee of the New York Stock Exchange?
Mr. REDMOND. We will produce them here it you wish?
Mr. PECORA. All right, please do so. And the balance sheets and
operating statements of the New York Stock Exchange for the last
3 years.
Mr. REDMOND. For what term?
175541—34—PT 15
4
6463
6464
STOCK EXCHANGE PEACTICES
Mr. PECORA. For the last 3 years, of the New York Stock Exchange
and its affiliated and associated corporations.
Mr. REDMOND. I do not know whether such balance sheets exist,
Mr. PECORA. HOW about the treasurer's reports of such corporations ?
Mr. REDMOND. Yes, they exist.
Mr. PECORA. But there is no consolidated balance sheet for the
associated and affiliated corporations?
Mr. REDMOND. There may be, but only as filed with the Federal
income tax authorities, and that, of course, is a privileged document.
Mr. PECORA. Well, whatever the treasurer's reports are, that those
associated and affiliated corporations made, we should like to have.
Mr. REDMOND. We will produce those, of course, before the committee. We feel that they are confidential papers and should be
produced, if required by the committee, in open hearing.
Mr. PECORA. That is what we want them for, for the committee
in open hearing.
Mr. REDMOND. All right.
Mr. PECORA. And then there is a special report of the secretary of
the committee on publicity of the New York Stock Exchange, which
was acted upon at a meeting of that committee held on April 21,
1931.
Mr. REDMOND. Suppose I make a note of these things?
Mr. PECORA. All right. Please do so.
Mr. REDMOND. April 21, 1981, did you say?
Mr. PECORA. Yes.
Mr. REDMOND. All
right. And now you say you want the minutes
of the business conduct committee, the conference committee, the
governing committee, and what else was it ?
Mr. PECORA. The law committee.
Mr. REDMOND. There are no minutes of the law committee.
Mr. PECORA. Then, of course, they cannot be reproduced.
Mr. REDMOND. I think I now have a memorandum of what you
request.
Mr. PECORA. And the operating statements or balance sheets of
the New York Stock Exchange and its affiliated or associated corporations.
Mr. REDMOND. All right. I have a memorandum.
The CHAIRMAN. Mr. Whitney, do you desire to have Mr. Redmond
appear as counsel for the New York Stock Exchange at these hearings and to take such part as he may see fit to take in the hearings?
Mr. WHITNEY. If you please, Senator Fletcher.
The CHAIRMAN. Without objection, that will be agreed to. So,
Mr. Redmond, you may beiiere at the table.
Mr. REDMOND. I will take a seat down here beyond the person
appearing, if I may.
The CHAIRMAN. Yes; as the representative of the New York
Stock Exchange.
Mr. REDMOND. All right. I thank you.
The CHAIRMAN. NOW, Mr. Corcoran, you may proceed. Please
take up the bill and explain it to us, and let us see if the members
of the committee understand its provisions. It has been published,
STOCK EXCHANGE PRACTICES
6465
but we would like to have it explained, and how we may expect it
to accomplish the results aimed at.
Mr. CORCORAN. I understood, Senator Fletcher, that that was what
you wanted me to do, to explain the bill, the ideas behind the bill,
and to try to illuminate some of the objections that have been made
to the bill.
Senator BARKLEY. May I ask you whether you assisted in the
preparation of the bill?
Mr. CORCORAN. Yes; I did, Senator Barkley. This bill was prepared at Senator Fletcher's request by the cooperation of two groups:
Mr. Pecora's group, who have been carrying on the investigation
before this committee, and Mr. Landis' group. Mr. Landis is one
of the commissioners of the Federal Trade Commission. Senator
Fletcher asked Mr. Landis to prepare a bill in combination with Mr.
Pecora's group, and Mr. Landis asked me, along with some others, to
help him on the bill. One of us is at the House this morning, and
Senator Fletcher has asked that I come over and simply try to
explain what the bill is about.
Senator BARKLEY. I just wanted to get your connection with the
bill, so that I might understand the situation and, so to speak, qualify
you as an expert witness on it.
Mr. CORCORAN. I do not think anyone is an expert on stock exchanges.
Senator BARKIJEY. I know a lot of people who wished they were
or that they had been.
Mr. CORCORAN. Perhaps so.
Mr. PECORA. And there are people who thought they were experts
but who now wish they had not thought so.
Mr. CORCORAN. I once thought so, but I no longer do.
Senator BARKLEY. All right.
Mr. CORCORAN. There are 49 pages of this bill, and there is a great
deal of technical language in it relating to stock-exchange practices
and to corporate practices, as there must be on any subject of this
kind. There is, however, a very definite structure in the bill in
the shape of provisions aimed at four general fields of operation
which you must regulate if you are going to do a thorough job
of regulating stock exchanges.
There are, first of all, provisions relating to the control of the
credit that gets into the stock market, to the field which Dr. Goldenweiser and Mr. Thomas discussed with you yesterday. In this connection there are provisions relating to borrowing by brokers to
finance their own operations and to finance their customers' operations. Then the bill tries to get at the same problem, of borrowed
money in the stock market, by regulating the loans which individuals
may obtain from brokers or from banks to carry securities.
A second group of provisions in the bill relates to the protection
of investors from evils in the stock market machinery as presently
set up, from manipulations, and from what is considered to be the
evil of the combination of the functions of the broker who executes
orders on commission for customers, and of the dealer who is trading
in securities for his own account and has something of his own to sell
to the same man from whom he is taking an order as a broker.
6466
STOCK EXCHANGE PRACTICES
The problem of the specialist comes under that general category,
that is the group of provisions designed to protect investors from
existing evils of the market machinery; and, likewise, under that
heading fall the provisions for control by a Government commission
over the actual practices of stock exchanges.
Then there is a third group of provisions, designed to protect investors in the market from ignorance and from exploitation by corporate insiders. Lack of information on the part of investors and
ignoiance of what they are buying is one of the real factors in connection with that speculation the President talked about in his
message.
And then there is a fourth group of provisions, designed to regulate the over-the-counter market in unlisted securities, to protect
listed securities from having the provisions of this law so burdensome on them that a corporation with unlisted securities will be in
a preferable position.
Now, these provisions have been worked out with the best advice
we have been able to obtain here in Washington. The provisions
with reference to control of credit were worked out m consultation with the best men we could find to work on that matter in.
the Federal Reserve System. The provisions for the protection of investors from evils in market machinery were worked out largely by
Mr. Pecora's staff, who are probably the best-informed men in the
United States on that subject at the present time.
The provisions for the protection of investors in the market from
corporate insiders, particularly insofar as corporate publicity is
concerned, were worked out with the help of the manager of one of
the biggest investment trusts m New York City, a professional investor who invests for 20,000 stockholders, and who testified before
the House committee.
Senator BARKLEY. Who was that?
Mr. CORCORAN. A man named Presley. I have a newspaper release
of his which I will try to read into the record a little later on. The
probley of handling the over-the-counter market is one on which we
consulted many brokers in New York. Likewise the problem of
regulating the stock exchange machinery.
Within the limitations as to the time that could be put on a
bill like this, I really think the field has been fairly well covered.
Of course, in any bill produced to order there will be some errors in
language that need to be corrected. And I, no more than anyone
else who worked on the drafting of the bill, am here to say that this
is something perfect in the last detail.
Now, there has been a great deal of criticism of the bill that
it is too drastic, that it goes surprisingly far; but you must remember that if you are going to tackle the problem of regulating stock
exchanges, and all the implications of stock exchange operations,
and of the flow of credit from the savings of the average investor
into corporate financing, and the problem of handling decent publicity for the investor in connection with all the intricacies of corporation finance, you have a job which is so big that unless you do
it right you might just as well not attempt to do it at all.
The criticism which has been made of the bill, that it gives too
great powers to an administrative commission, does not take into
consideration the fact that the commisison which is given this job
STOCK EXCHANGE PEACTICES
6467
is given a job of regulating the most powerful single institution
in the United States, an institution which with all its connections
cannot be expected tamely to submit to regulation when you pass
this bill or any other bill, that you will have constant pressure on
any organization set up to regulate an institution as powerful as
the Stock Exchange and and the roots of invested interests in which
run as deep as in the case of the Stock Exchange; that you are always
going to have pressure on any administrative commission in such
a case.
Really, to say that the Congress should put a commission without
\ery large powers in charge of the regulation of stock exchanges,
would be like advising that one put a baby into a cage with a tiger
to regulate the tiger. For a commission must have full powers or
the stock exchanges and the forces allied with the stock exchanges,
which are supposedly being regulated, will actually regulate the
regulators.
There is one other matter which I think we ought to discuss
before we get into a detailed report on the bill. This bill is in a
sense the third report on this subject that has come out within
the year. There was an earlier report of a committee
headed by
the Secretary of Commerce, known as the u Dickinson report ,
which the President sent to both Houses of Congress without comment. Then there is another report that was worked out by a
staff of 30 market specialists and investigators, under the auspices
of the Twentieth Century Fund, which, I understand, will be released
in full in the papers tomorrow morning, and which has been released
piecemeal in newspaper reports since about the 9th of February.
The Twentieth Century Fund is governed by a board of trustees
that includes men you certainly would not call radical. Newton D.
Baker is a member of the board, as well as Owen Young of the General Electric Co., Henry Bruere of the Bowery Savings Bank, John
Fahey, chairman of the Home Loan Bank System, Henry Dennison
of the Industrial Advisory Board of the N.R.A., and several others.
The director of the investigation resulting in tnis particular set of
reports is Evans Clark. Some of the ideas of that committee were
used in the preparation of this bill, and you will find that on many
of the very controversial points this supposedly impartial expert
committee, who have made the most thorough investigation made
this year of market operations, agree with this bill, contrary to the
arguments of the stock exchange.
There is one other thing we ought to remember before we go
into a detailed discussion of the bill. Normally when you think
of a stock exchange you think of the New York Stock Exchange.
Just remember that there are many other stock exchanges beside
th^ New York Stock Exchange. I do not know how many there
are, but there is a stock exchange m practically every important city
in the United States. The New York Stock Exchange is so far ahead
of these other stock exchanges, in its rules and regulations, with few
exceptions, that there is almost no comparison, and many of the provisions of this bill that might not seem absolutely necessary if you
were dealing only with the New York Stock Exchange, and if you
were sure that the reform of the New York Stock Exchange would
go on at a sufficiently accelerated pace, become absolutely necessary
6468
STOCK EXCHANGE PRACTICES
when you are dealing with the standards of the smaller stock exchanges in other cities of the country. Now, if we may go on
Senator BARKLEY (interposing). Let me ask you a question right
there. These local stock exchanges that you are speaking of deal
very largely in local stocks, don't they?
Mr. CORCCRAN. Yes.
Senator BARKLEY. And
there is not usually that feverish enthusiasm and impatience and expectation and deferred hope in connection with such local exchanges because of their limitations and the,
limited number of stocks listed, that pertain to the New York Stock
Exchange.
Mr. CORCORAN. That is true. Of course, one difficulty with the
small exchanges is that they were used unfairly as a method of
qualifying securities under blue-sky laws. Blue-sky laws in some
States regulating the distribution of securities were rather onerous.
You really had to do something in order to qualify before the State
blue-sky commission, and under the pressure that was always present in the distribution of a big issue of securities, there was neither
the inclination nor the time to satisfy the blue-sky commissioner of
some of these marketing States on some of these matters. They
really wanted to know something about the securities before they
would permit them to be sold within the State. The favorite device
was, therefore, for some second-rate stock exchange, within the
borders of the State, to go to the legislature of the State and obtain
an exemption from the blue-sky laws of the State for issues listed
on that stock exchange. Then the issue could, by listing the stock
with the second-rate stock exchange, duck the blue-sky law of the
State. Small exchanges were also, unfortunately, used merely as a
place, although there was practically no trading, on which a quotation could be established in order to help the salesmen of securities,
which could not be listed on the big stock exchanges, so that they
could go to their customers and say: " See. This is a listed stock*
There is a quotation."
Senator BARKXEY. TO what extent are the local stock exchanges
regulated by the laws of the States in which they are located, if
at all?
Mr. CORCORAN. Not very much.
Senator BARKLEY. I S there any law in any of them which provides
that no stock shall be listed unless it passes through the blue-sky
process ?
Mr. CORCORAN. NO.
Senator BARKLEY. They
can list any stock, whether it has been
approved by the State authority or not?
Mr. CORCORAN. It is very difficult for the States to regulate stock
exchanges. You cannot very well regulate the home team, you know.
The CHAIRMAN. They claim that they do an mtrastate business
and not an interstate business.
Mr. CORCORAN. Well, sir, even before the Congress acts, of course
any attempt by a State to regulate a stock exchange finds itself subject to a certain degree of political pressure, brought on State legislatures, through local interests. You cannot expect effective legislation of stock exchanges from within the State itself.
STOCK EXCHANGE PBACTICES
6469
The CHAIRMAN. They are almost obliged to do an interstate business, aren't they?
Mr. CORCORAN. Yes, sir.
The CHAIRMAN. And they
cannot succeed in the Conduct of interstate business without the postal regulations being involved.
Mr. CORCORAN. That is true of the very large exchanges, although
it would not be true in the case of the small exchanges, such as
Senator Barkley spoke about a moment ago, because in the case of
the small exchanges they do a great proportion of their business
in local securities.
Senator BARKLEY. TO what extent does the New York Legislature
attempt tp regulate the New York Stock Exchange?
Mr. CORCORAN. Very little; there is regulation which has been
incorporated in this bill and to which Mr. Whitney makes no objection, concerning the hypothecation of stocks of customers. But
there is very little regulation, or at least I think this is right, of the
New York Stock Exchange under the New York law.
Mr. PECORA. There is none at all of the exchange. There are
various? laws in regard to practices.
Senator BARKLEY. Of course, there is a sort of twilight zone,
legally speaking, between the power of a State to regulate an exchange that transacts its business within the borders of the State,
and the power of the Congress to regulate that same exchange insofar as its transactions cross State lines.
Mr. CORCORAN. That is true.
Senator BAREXEY. All right.
Mr. CORCORAN. NOW, if we may go on and discuss, first of all, the
provisions of the bill relating to control of credit. Those provisions
are set forth in section 6 (a) and in section 7 of the bill, beginning
on page 12 and extending over on page 13; and I suggest that
inasmuch as we probably shall not have as much time as would be
necessary to read the bill word for word from the beginning, I be
permitted to work on the sections which are the most important.
As Mr. Goldenweiser and Mr. Thomas stated to you yesterday,
there is a direct relationship between the amount of credit that gets
into the stock market and speculation on the stock market on the
one hand and the fluctuations that result from speculation on the
other hand.
That, first of all, has a very definite effect upon business and,
secondly, a very definite effect upon the pocketbook of the average
small investor who goes in on too small a margin.
This bill tries to hit the problem of control of credit from two
angles. On page 12, section 6 (a) it tries to hit the problem from,
the angle of the amount that a customer can borrow to buy securities in the market; and in section 7 it tries to hit the problem from
the angle of the amount and the manner in which a broker can
borrow to finance those same customers or to finance himself.
If we may just go through this section 6 ( a ) :
It shall be unlawful for any member of a national securities exchange—
That is, for an exchange that will be licensed under the provisions
of this act—
or any person who tiansacts a business in securities through the medium of
any such member, directly or indirectly, to extend or maintain credit or
6470
STOCK EXCHANGE PRACTICES
arrange for the extension or maintenance of credit to 01 for any customer
on any securities not registered upon a national securities exchange
The purpose of that provision is to prevent a broker engaged in
the brokerage business from lending on anything but securities listed
on a national securities exchange, and therefore subject to regulations to be prescribed for national securities exchanges.
Senator CAREY. Does that mean that a customer could not borrow
on a perfectly good security if it did not happen to be so listed ?
Mr. CORCORAN. He could not borrow from a broker on unlisted
securities.
Senator CAREY. Suppose he had some good securities that were
not listed on an exchange, and there are a good many good issues that
are not so listed, does that mean that he could not use tha{ security
to borrow money to buy other securities ?
Mr. CORCORAN. That is true.
Senator CAREY Even though a perfectly good security 2
Mr. CORCORAN. Yes.
The CHAIRMAN But how about banks 2
Mr. CORCORAN. Will you let me come to that,
which is a very im-
portant point?
The CHAIRMAN
Yes.
Mr. CORCORAN. YOU will notice that in paragraph (b) it provides:
It shall be unlawful tor any member of a national secunties exchange oi—
And this is important language, gentlemen of the committee—
any person who transacts a business in securities tlnough the medium of
any such member, dnectly, or indirectly—
That language was not intended to catch banks And I do not
believe it does catch banks It was intended to bring within the
limitation that loans can be made only on listed securities, not
only the broker who is actually a member of an exchange, but a
great class of brokers who are not members of exchanges but who
leceive orders from customers for securities listed on exchanges and
then execute those orders through a broker on the exchange.
Of course under the Glass-Steagall bill a bank can no longer
peddle securities at retail. It can do two things: it can buy securities
xor its own account, for its own investment; and it can act as agent
to transmit to a broker an order to purchase or sell securities, given
to it by one of the bank's customeis.
Certainly we had no conception when we drafted the language
of this bill that it would be said that if a bank bought securities
for its bond account, or merely transmitted, for a service charge,
an order from a customer to a broker (because very often customers
of banks do not know whom to go to for brokerage service), that
operations of that kind on the part of a bank constituted transacting
a business in securities.
And I might say that if there is any difficulty with that language,
or any conception that it does cover a bank, acting as banks may act
under the Glass-Steagall Act, then the language should be changed
so that banks so acting are not within the scope of the language; but
that brokers who aie not members of an exchange but who clear
through or operate through a broker who is a member of an exchange, or a dealer who operates through a broker who is a member
of an exchange, will be within the scope of that language.
STOCK EXCHANGE PBACTICES
6471
Now, objection has been made that it is not fair to deny to holders
of unlisted securities the privilege of putting them up with a broker
and having the broker make a loan on those unlisted securities as a
part of a mixed margin account.
Senator GOLDSBOROUGH. D O I understand that they are ineligible
for credit ? I mean, such securities as municipal bonds, or the stocks
of national banks, insurance companies, and public utilities, that
they will be ineligible under section 6 of this bill?
Mr. CORCORAN. No. They will be eligible for a loan by a bank,
but not for a loan by a broker. If you wanted to carry such securities on margin you would have to carry them at your bank.
Senator GOLDSBOROTJGH. But section 6 of this bill so far as brokers
are concerned would not make eligible even the type of securities I
have asked you about.
Mr. CORCORAN. NO.
Senator CAREY. AS
this reads now, I would think a bank which
made a loan of money on securities that were not listed on an exchange would be violating the law. How about that ?
Mr. CORCORAN . No; I do not think so, because the business that a
bank can do in securities now, as the statutes have been changed,
would not be what you could fairly call business coming within that
language: " Who transacts business in securities."
Senator CAREY. It says :
or any person who transacts a business in securities through the medium of
any such member, directly, or directly—
Let us presume that a bank has securities and was selling them
through such member, that bank would be precluded from lending
on unlisted securities, wouldn't it?
Mr. CORCORAN. Well, Senator, I have just said if that interpretation can be given to that language, you are quite right that the
language should be changed.
Senator CAREY. Then you will agree with me that it should be
changed ?
Mr. CORCORAN. Oh, yes. I do not believe that is the correct interpretation of the language, but no chance should be taken upon it and
the language should be changed if there is any doubt about it.
Now, if I may answer your question, Senator Goldsborough, about
unlisted securities, I think I can better do that a little further along.
Senator GOLDSBOROUGH. All right.
Mr. CORCORAN. Section 6 (b) provides that—
It shall be unlawful for any member of a national securities exchange or
any person who transacts a business in sec antics through the medium of
any such member—
That is the same language and would be subject to the same
change.
directly or indirectly, to extend oi maintain credit or arrange for the
extension or maintenance of ciedit to or for any customer on any securities
registeied on a national securities exchange in an amount exceeding at any
time whichever is the higher of (1) 80 per centum of the lowest price at
which such security has sold during the preceding 3 years, or (2) 40 per
centum of the current market price The Commission may, by rules and
regulations, prescribe lower loan values as may be deemed appropxiate in the
public interest or foi the protection ot investors during any stated period of
time or in respect of any specified class of securities
6472
STOCK EXCHANGE PRACTICES
You will notice that as the language is now written it gives the
commission discretion only to lower the loan value. That is, taking
the correlative of that, to raise the margin requirement. There is
no provision in here, as the bill is now written, permitting the commission to lessen the margin requirement beyond the alternative of
the 80 percent of the lowest price the security has sold for during
the preceding 3 years, or 40 percent of the curient market price,
whichever is the higher.
These margin requirements were worked out, in collaboration with
individuals in the Federal Keserve System, to try to put a premium
for margin purposes on comparatively stable securities, like bonds,
municipals, governments—and governments are exempt from this
bill, anyway—bank stocks, or otner stocks that keep comparatively
stable over a period of time.
Senator GOLDSBOROUGH. And insurance company stocks?
Mr. CORCORAN. And insurance company stocks, and all that sort
of thing.
Senator GOLDSBOROUGH. And public utilities ?
Mr. CORCORAN. Yes, sir; although a lot of them dropped pretty
badly during the period. It would make for a much higher loan
value on a bond that sold very little below par during the last &
years.
Now, if we may go on and finish this section before we discuss
the interrelations of it as a whole.
The CHAIRMAN. May I ask you right there: A great many letters
have come in complaining about that. They claim that it is too
high, that the margin ought to be 40 percent instead of 60 percent.
Mr CORCORAN. Senator Fletcher, I am coming to that. But I
want to take it up in connection with this paper I have distributed
to the members of the committee. And may I just finish this section and then go back to that and discuss the inter-relations as a
whole ^
The CHAIRMAN. The reason I asked the question was that I
thought you were finishing that section right now
Mr. CORCORAN. NO ; I have not finished that section.
The CHAIRMAN. YOU may proceed.
Mr. CORCORAN. I want to go back over this whole section in detail
after reading it entire to get the feel of the inter-relations of the
paragraph.
The CHAIRMAN. All right.
Mr. CORCORAN. I will now read paragraph (c):
It shaU be unlawful tor any person to extend oi maintain credit or arrange
for the extension oi maintenance of credit to any person (other than to a
dealer to aid in the financing of the distubution of securities to customer not
through the medium of an exchange)—
That is, a loan to an underwriter—
upon any secunty registeied on a national beeurities exchange—
I t is limited to listed securities, mind you—
in an amount exceeding the amount which it is lawful for a member of a
national securities exchange to lend to any customer on such security, unless
the application for the loan is accompanied by a statement by the borrower
that such secunty has been acquired by the borrower and paid foi in full
more than 30 days prior to the making of the loan
STOCK EXCHANGE PRACTICES
6473
The exception in there for securities that have been owned outright for 30 days was to provide a convenient way by which it might
be determined that the borrowing on the security was not made for
the purpose of carrying the security so that the limitations here
on securities loans would not apply in cases when a person wanted
to raise some money to pay a bill, to arrange a loan at a bank and
put up securities owned outright as collateral; or when a manufacturer raising a loan for inventory purposes was asked by the bank
to put up, in addition to his note and in addition to his commercial
paper, some collateral security.
Any person who, for the purpose of obtaining a loan, makes such a statement
which is false in any material respect, shall be deemed guilty of a violation ot
this subsection
I will go to section (d)
The Commission shall by rules and regulations prescube the times at and
the specific methods by which values shall be calculated for the purposes of
this section, the time within which initial and subsequent payments shall be
made by the customer, and the notice to be given and the method to be followed
in closing out accounts, and no person who shall comply with such rules and
regulations shall be deemed to have violated any provision of this section
Now, let us discus^ this section as a whole What the section tries
to do is this: I t tries to fix a certain margin requirement on securities
that is very much higher, yes, very inuch higher, than the margin
requirements in vogue at the present time. I t fixes those margin
requirements on listed securities for brokers. It must, or there will
be evasion by brokers, prevent brokers from lending on unlisted
securities where one really never does know what the market value
of the security is.
That comment is not correct for certain categories of unlisted
securities, such as New York bank stocks, and stocks of certain big
insurance companies, of certain big public utility companies; but
you must remember and when you are dealing with unlisted securities that the number of unlisted securities you can think of
as having a well-organized over-the-counter market is very small in
proportion to the number that you have never heard about; and a
broker could, if he were permitted to lend upon unlisted securities,
where the value is indifferently known.* completely evade the margin
requirements for listed securities by taking into an account and putting a value upon unlisted securities which would enable him to balance up for the difference in the margin requirement provided by this
act on listed securities as distinguished from the margin requirements we now have.
There are other reasons for pushing unlisted securities into banks.
One is to give listed securities a frank premium for the purpose of
brokers' loans, as another inducement to keep listed securities on the
exchanges. Another reason is that it is not sound national economics
to have excessive loans made on securities. The value of an unlisted
security for the purpose of a loan is not a market proposition, as is
the case with a listed security. It is essentially a commercial
proposition. Remember, again, that only a few unlisted securities
have the certain market value you can attribute to New York bank
stocks, stocks of large insurance companies, and so on. I t is much
6474
STOCK EXCHANGE PRACTICES
better to put loans on unlisted securities in the banks, which will deal
with them as a commercial proposition, and where you have the
further check of the examinations of bank examiners.
MARGINS
(1) MARGIN RULES
NOTE—All the following lules lelate to mvmmwni maigms, the broker as a
matter of his private relations with his customeis can always lequire mote
on particular securities
(a) Present New York Stock Exchange rules
maintain margin of 50% of debit balance—equivalent of permitting broker to lend 66%% of value of securities, applies to all
accounts where customer " puts up " less than $2,500
(y) On accounts with debit balance of more than $5,000, customer
must maintain margin of 30% of debit balance—equivalent of
permitting broker to lend 77% of value of securities; applies to
all accounts where customer puts " up " $2,500 or more.
(b) Rule proposed by Fleteher-Rayburn bill
The broker may not lend more than whichever is the higher of—
(a) 40% of the current value of securities—equivalent to the
customer's putting up 60% of the market value of securities
purchased or 150% of the debit balance ( l e , the broker's
loan of 40% of the market value) , or
(b) 80% of lowest price within three years—equivalent to customer putting up 20% of the market value of the securities
purchased or 25% of the debit balance ( l e , the broker's loan
of 80% of the market value).
(2) COMPARATIVE TABUS ILLUSTRATING OPERATION OF MARGIN RULES
Maximum
%of
value of
securities
broker may
lend
N Y Stock Exchange—debit of less than $5,000
N Y Stock Exchange—debit of more than $5,000
Fletcher-Rayburn—40% loan value on speculative
securities— _
Fletcher-Rayburn—80%
loan value on
stable
securities _ _
Minimum
%of
value of
seem I ties
customer
must put
up as margin
Maximum Minimum
number of
%of
times his
baldeposit cus- debit
ance customer can tomer
must
buy in mar- put up as
ket value
of securities margin
3
77
23
40
60
m
80
20
5
50
33M
150
25
(3) HOW MUCH STOCK CAN A CUSTOMER BUY WITH A GIVEN DEPOSIT?
With a $2,500 deposit a customer can buy the follow ing values of securities:
(a) $7,500—under piesent New York Stock Exchange rule
(b) $4,100—under Fletcher-Rayburn 40% speculative loan rule
(c) $12,500—under Fletcher-Rayburn 80% stable loan value rule
With a $10,000 deposit
(a) $43,333—under present New York Stock Exchange rule
(b) $16,666—under Fletcher-Rayburn 40% speculative loan rule,
(e) $50,000—Fletcher-Rayburn 80% stable loan value rule
(4) PROTECTION AFFOJRDED MARGIN TRADER BY LARGER MARGIN
(a) Suppose a trader without resources to meet additional margin calls
buys 100 shares X stock at 100 on New York Stock Exchange margin—putting
up $2,300 on $10,000 market value of securities
Account reads Market value long position, $10,000, debit, $7,700.
If stock drops suddenly to 77 where market value equals debit customer's margin is wiped out.
STOCK EXCHANGE PBACTICES
6475
(b) Suppose the trader buys the same 100 shares of X's stock at $100 on the
Fletcher-Ravburn 40-percent loan-value margin. He will have to deposit $6,000
on $10,000 market value of securities and his account will stand:
Market value long position, $10000; debit, $4,000
If the stock drops to 77 the trader can still readjust the account to
the required margin on a smaller number of shares without additional cash By selling 20 shares at 77 for $1,540 and applying the
proceeds to the debit balance, the trader can reestablish his account
on the following basis:
Market value long position, $6,160, debit, $2,460
By the drop in the market the trader will have lost part of his
investment, but not all
(c) Suppose that with the same down payment of $2,300 referred to in the
first case above, the trader buys the maximum number of shares of the same
stock at the same price which the broker will be permitted to carry for him
under the Fletcher-Rayburn 40% loan-value margin rule He will be able to
buy 38 shares of a market value of $3,800 and his account will stand
Market value long position, $3,800, debit, $1,500
If the stock drops to 77, the trader can still readjust the account to the
required margin on a smaller number of shares without additional
cash By selling 8 shares at 77 for $616 and applying the proceeds to
the debit balance, the trader can leestabhsh his account on the
following basis:
Market value long position, $2,310, debit, $884
By the drop in the market the trader will have lost approximately
% of his original investment but he will still have an equity m an
account and may be able to recoup with a rise m the market.
Now, let us go to the matter of the amount of this margin. I
have distributed figures you will want to have so that you will not
have to figure too much with pencil and paper. The computation
that has been distributed to you, shows just what the margins provided for in this bill are in comparison with the margins provided
for by the New York Stock Exchange rules at the present time.
The New York Stock Exchange has margin rules at the present
time. They are not inflexible- Mr. Whitney testified the other day
before the House committee, as I understand, that the New York
Stock Exchange had had percentage margin rules since about 1921
or 1922. But Mr. Pierce testified before the House committee the
other day that those margin rules were very flexible, and that he
was not sure that any objection was raised to trading on much
smaller margins for big operators, of whose ultimate solvency the
broker was sure. That is, the margin rules had been put into effect
for the protection of the broker on his loans to the customer, and
not to dissuade customers from going into the market on too small
a margin. I think he said he was not sure but thought the account
of one big operator must have been carried on something like a
10-percent margin. I do not know whether there are any margin
requirements expressed in percentages, or in any different percentages, on other stock exchanges at the present time.
So I must deal, for the purpose of comparison, with the margin
requirements of this bill and the similar requirements of the New
York Stock Exchange rules. Now, this bill expresses margins m
the way in ^hich the average layman thinks of margins. The layman thinks of a margin in terms of how much he has to put up to
buy 100 shares of such and such stock.
The broker and the banker do not think of a margin in that way.
They think in terms of the amount that the customer owes them
on debit account, and the percentage of security they have up
6476
STOCK EXCHANGE PRACTICES
for that account in terms of the ratio between the value of that
security and the value of the loan outstanding on the security.
The bill has expressed the margin requirements in the way the
average investor thinks of margin. This little table we have here
is a translator's table for turning margins, computed on the basis
which the bill adopts, into margins computed on the basis that the
New York Stock Exchange adopts.
One other thing while we are talking about margins: Mr. Whitney
the other day in his testimony before the House committee intimated
that one of the difficulties arising in connection with an inflexible
margin was that some securities needed more margin than others.
That argument is not applicable to the bill, however, because the
provision, stated in section 6 (b) of the bill, relates to minimum
margins. A broker may, of course, have an arrangement with his
customer to refuse to carry the account unless securities are more
heavily margined. All the matters we will talk about from now on
relate to minimum margins.
Present New York Stock Exchange rules, as we present them on
page 1 of the paper which you have, say that on accounts with a
debit balance of less than $5,000 the customer must maintain a margin of 50 percent of that debit balance. That is equivalent to permitting the broker to lend 66% percent of the value of the securities
as contrasted with the 40 percent which the broker is permitted to
lend under the terms of section 6 (b) of this section 6.
That rule, which is a different rule from that applying to the
bigger traders, applies to all accounts where the customers initial
risk, in the sense of the initial deposit that he puts up, is $2,500 or
For the larger accounts, the accounts with a debit balance of more
than $5,000, the New York Stock Exchange rules require the customer to maintain a margin of 30 percent of the debit balance, which
is the equivalent of permitting the broker to lend 77 percent of the
value of the securities purchased or carried, as compared with 40
percent under section 6 (b) of this bill.
And then the rule proposed by this bill is the alternative of permitting a broker to lend 40 percent of the current value of the
security, or 80 percent of the lowest value to which the security has
fallen within 3 years, whichever is the higher.
Now, on page 2 there is a comparative table illustrating the operation of these margin rules.
Senator GORE. What are you reading from, Mr. Corcoran?
Mr. CORCORAN. I am reading, Senator, from a tabulation which
I have made up for the convenience of the committee on the comparative operation of the margin rules prescribed by the New York
Stock Exchange and those embodied in the bill
Senator GORE. Has it been distributed?
Mr. CORCORAN. I t has been distributed, Senator. I will see that
you get a copy.
You will notice in here, so that we think all around this subject,,
that we have shown in these comparative tables the maximum percentage of the value of the securities the broker may lend under all
four rules; the minimum percentage of the value of the securities
which a customer must put up as margin; the maximum number of
STOCK EXCHANGE PEACTICES
6477
times his deposit a customer can buy in market value of securities,
which is a very important calculation of a customer, particularly as
we stand on the threshold of a bull market.
Senator GORE. State that again.
Mr. CORCORAN. The maximum number of times his deposit a customer can buy in market value of securities.
Senator GORE. YOU mean deposit with the broker?
Mr. CORCORAN. Yes. Suppose a customer has a thousand dollars
and he wants to buy as much as he possibly can with his thousand
dollars, the largest possible market value of securities. He could
buy three times his thousand dollars if he were operating under the
New York Stock Exchange rule relating to accounts with a debit
of $5,000 or less. He could buy four and a third times his thousand
dollars in market value of securities if he were operating under the
New York Stock Exchange rule relating to accounts with a debit
of more than $5,000 He could buy only one and two thirds times
his thousand dollars in market value of securities operating under
the 40 percent rule laid down» in section (b) of this act, or he could
buy five times his thousand dollars in the market value of stable
bonds under the 80-percent rule laid down in section (b) of this act.
Then there is another column, the fourth column to the right,
showing margin percentages computed in the way a broker computes a percentage. Under the New York Stock Exchange rules
on accounts with a debit of less than $5,000 there has to be a margin
of 50 percent of the debit balance. Under the New York Stock Exchange rules on an account with a debit of more than $5,000 there has
to be 33% percent of the debit balance. Under the Fleteher-Rayburn
bill, with a 40 percent loan value on the securities, since the broker
can only lend two thirds as much as the customer puts up, the margin expressed in the way brokers express margins is 150 percent,
and under the Fletcher-Rayburn 80 percent rule, if you are dealing
with securities that come under that rule, the margin is 25 percent
of the amount of loan that the broker puts up. You can buy five
times as much in securities as you put up, and the amount that you
put up is one quarter of the remainder of the price of the securities
which the broker lends you.
At the bottom of this page we can^ see some more tangible illustrations. How much stock can a customer buy with a given deposit
under these margin rules? With a $2,500 deposit—that has been
taken because it is the limit under the New York Stock Exchange
rule—the customer can buy the following amounts of securities.
Under the New York Stock Exchange rule $7,500 market value, you
put up $2,500 and the broker will carry you for a market value of
$7,500 worth of securities. Under the Fletcher-Rayburn 40 percent
rule
Senator GORE (interposing). In that case your deposit is half?
Mr. CORCORAN. Your deposit, sir, is $2,500. You owe $5,000,
and your deposit, therefore, is 50 percent of what you owe. That is
the way a broker computes his margins. You could buy $7,500 worth
of securities under the present New York Stock Exchange rule. You
could buy only $4,100 worth of securities under the Fletcher-Rayburn 40 percent rule. You could buy $12,500 worth of very stable
securities if the Fletcher-Rayburn 80 percent rule were applicable.
6478
STOCK EXCHANGE PRACTICES
Senator BTTLKLEY. That would only be in case you were buying
at the lowest price it sold in 3 years?
Mr. CORCORAN. Yes; your margin is computed at the lowest price.
That is true.
Senator BULKLEY. Then you could only buy this amount if you
were actually buying it at the lowest price within 3 years ?
Mr. CORCORAN. Yes.
Senator BULKLEY. SO that
if you happened to buy it at the lowest
price that it got in 3 years, then you could buy it for this amount?
Mr. CORCORAN. Yes.
Senator BULKLEY. But
if you bought it at a higher price than
that
Mr. CORCORAN. There would be some other scale. You cannot
work it out for the purposes of a comparative tabulation until you
know what price you buy at.
Now, with a $10,000 deposit—and I take a second figure because
the New York Stock Exchange rules are different for small accounts
and for big accounts—with a $10,000 deposit a customer could buy
under the present New York Stock Exchange rules $43,333 worth
of securities. Under the Fletcher-Eayburn 40 percent rule he could
buy $16,666 worth, which you see is less than half, considerably less
than half. And buying at the bottom under the 80 percent rule he
could buy $50,000 worth of securities.
Senator KEAN Why not take a case like this: Suppose Industrial
Alcohol, that we had here the other day: that price was something
like 7. It is now—what is it now ?
Mr. CORCORAN. I t went to 80, and it went down again to under 30.
I don't know where it is now.
Senator KEAN. Well, say, 40.
Mr. PECORA. The last time I looked it was around 49, but that
was only a week ago.
Mr. CORCORAN. YOU want to know how the margins work out?
Senator KEAN. Yes.
Mr. CORCORAN. Well, it all depends. How much do you want to
put up, sir ?
Senator KEAN. $10,000.
Mr. CORCORAN. Well, under the Fletcher-Rayburn rule you get
80 percent of 7 or 40 percent of 40, whichever is the higher. Obviously, you would take the 40 percent of the 40. So that you could
lend on that $1,600; a broker could lend $16 a share. That means that
the customer would have to put up the difference between $16 a
share and $40 a share—$24 a share. Approximately $25 a share.
For $10,000, therefore, you could buy 400 shares.
Senator KEAN. That is all?
Mr. CORCORAN. That is all.
Mr. PECORA. Mr. Corcoran, I think perhaps there is a misconception about the answer you made to Senator Bulkley's question,
and if there is, perhaps it would be clarified if you answer this
question • When does the 80-percent rule apply under the FletcherEayburn bill?
Mr. CORCORAN. When it is the higher, sir; when the computation
on that basis is higher than the 40-percent computation on the
current basis.
STOCK EXCHANGE PRACTICES
6479
Mr. PECORA. And does that mean that the purchase must be made
at the time when the security is selling for its lowest price within
3 years?
Mr. CORCORAN. NO. The computation of margin is made on that
basis.
Senator BULKUBY. Yes; but if the computation of margin is made
at the lowest price, then it would be a different percentage if you
paid any higher price. So unless you buy withiii that lowest price,
you cannot get the benefit of the £0 percent margin.
Mr. CORCORAN. NO. Let us take, for instance, the case of a bond
that has a par of a thousand dollars, sir, and suppose during the
break that bond went down to $80.
Senator KEAN. Suppose it went to 30?
Mr. CORCORAN. I will work out several sets of illustrations. If it
went down to 80, then the rule will not work—it is not that it will
not work, but the computation on current value yields you a greater
loan value. Suppose the bond went down to 800. Suppose the
bond is now selling at par. If we could lend 80 percent on 800, it
would be $640 on the lowest price. You could lend only $400 on the
current price.
Senator BULKLEY. Yes; but you could still lend the 640, but it
would be 64 percent instead of 80 percent.
Mr. CORCORAN. That is true, because you lend 80 percent of whatever
Senator BULKLEY (interposing). You only get the benefit of the
80 percent loan if you happen to buy at the very lowest price in 3
years?
Mr. CORCORAN. Yes; that is true. What you mean is that the
amount that is lent on a security computed on this 80 percent basis
will not be 80 percent of current market value.
Senator BuiiKiiEY. That is it exactly.
Mr. CORCORAN. But it will be 80 percent of the lowest value within
the 3 years and in the case of a stable security the percentage
of current market price which you reach on the 80 percent computation will be higher for a stable security than 40 percent of
current market value.
Senator BULKLEY. Yes, it might be, but it would be very seldom as
high as 80 percent?
Mr. CORCORAN. That is true.
Senator GORE. It could work out in that case. I t looks to me like
it would have to be lower than the lowest in order to function under
that.
Mr. CORCORAN. NO, Senator. Take the thousand dollar par bond
case that we have had just a minute ago. I can illustrate Senator
Bulkley's point by that. You have a bond that has a par of $1,000.
During the deepest of the dark days that bond sold tor $800, and
that is the lowest price within 3 years. The bond is presumably
back to par at $1,000.
Now, if you take 80 percent of the low, it will be 80 percent of
$800, which is $640. That does not represent 80 percent of present
current market value; it really means 64 percent of current market
value.
175541—34—PT 15
5
6480
STOCK EXCHANGE PEACTICES
But the alternative rule based on current market value would
give you only a $400 loan value. So that, although the larger loan
value permitted by the 80 percent rule is not 80 percent of current
market price but is 64 percent, it is nevertheless higher than the
current loan value.
Senator KEAN. Yes, but suppose you take the instance that I
quoted a minute ago, when the bond went down to 35, somewhere
around there ?
Mr. CORCORAN. Which computation gives you the higher margin,
sir, depends upon the particular set of figures that you use. But
there is a very definite premium placed upon the securities that
have had the slightest drop within the last 3 years, which normally
will be the5 securities that you think of as falling into stable categories. Good municipal bonds, good underlying bonds of railroads, stocks of good insurance companies, and that sort of thing.
Senator GORE. In that case the broker could carry the customer
for $640?
Mr. CORCORAN. Yes.
Senator GORE. Instead of $400.
Senator KEAN. NOW, take municipal bonds—why, lots of them
went down to 50-odd.
Mr. CORCORAN. That is true, sir. Lots of municipal bonds deserved to go further than down to $50.
Mr. REDMOND. Mr. Chairman, may I ask a question ?
The CHAIRMAN. Yes.
Mr. REDMOND. Mr. Corcoran, isn't it equally true that this 80
percent provision will apply to a declining security irrespective of
its quality?
Mr. CORCORAN. Once you get, sir, below the lowest price which the
security has reached in 3 years.
Mr. REDMOND. SO that, throughout, let us say, 1930 and 1931
Mr. CORCORAN (interposing). I t would have allowed you much
more liberal margins.
Mr. REDMOND. Even the most speculative securities could have
been carried on a more liberal margin?
l^Er. CORCORAN. That is true, sir, but, of course, the answer to that
is, as we have said before, that this applies only to the minimum
which the broker can exact, and you and I know perfectly well that
in a declining market, although that is a time when you like to have
by law the most liberal computation for margins, a broker would
superimpose upon the minimum margin requirement we required an
additional amount for his own protection. Always trust the broker
to take care of himself on the way down, sir.
Mr. REDMOND. Mr. Corcoran, my point is not that, but you described this 80-percent provision as applying to stable securities.
Mr. CORCORAN. Yes.
Mr. REDMOND. That is actually a misnomer, isn't it, because it
applies to stable or declining securities?
Mr. CORCORAN. It applies to stable securities in its normal application. There is a possibility that in a declining market, after once
in the course of the decline the price gets below the lowest price to
which the security has gone during the preceding 3 years, it will
apply to speculative as well as to stable securities. But that op
STOCK EXCHANGE PBACTICES
6481
eration is insignificant, because, as you and I know, in a situation
like that the broker will take care of himself.
Mr. REDMOND. Might I ask you simply this, As I read this provision the prohibition is not only against the extension but also the
maintenance of credit. Therefore, as securities decline
Mr. CORCORAN. Yes.
Mr. REDMOND (continuing).
This 80 percent provision, which
might have applied, let us say, to a stable security initially
Mr. CORCORAN. Yes.
Mr. REDMOND (continuing).
Goes down with the decline in the
market.
Mr. CORCORAN. Yes.
Mr. REDMOND. Isn't
that going to be a factor which will tend to
force liquidation?
Mr. CORCORAN. NO ; because, sir, again remember it is expressed as
a percentage of loan value, and in this case is a maximum percentage
of loan value, so that it does not put the broker in a position where
he has to liquidate as the stocks go down. That is up to the broker.
This provides for more liberal margins by reason of law when stocks
are going down.
That is why I cannot understand in your own brief, sir, why you
object to this. " In periods of necessity or of decreasing prices it
will permit over-liberal margins." As to that the broker can take
care of himself. The law should be m such shape that in periods of
declining prices if a broker wants to take the chance, he can give
what from a business point of view is a more liberal margin, and
that in periods of rising prices it will fix prohibitively high margins, which is again just exactly the correct result if you want to
keep the market from running away on the upside.
Mr. REDMOND. I am addressing myself now, Mr. Corcoran, to a
different point, if I may, and that is that it seems to me that this
requirement governs not only the extension but also the maintenance
of credit.
Mr. CORCORAN. Yes.
Mr. REDMOND. And
that it is going to mean that in a loan, let us
say, made on stable securities, where your 80 percent clause applied,
and the loan was made on that basis, a perfectly conservative loan,
let us say on municipal bonds.
Mr. CORCORAN. Yes.
Mr. REDMOND. If you
should get a decline in the market from par
to 80, as you used yourself
Mr. CORCORAN. Yes.
Mr. REDMOND (continuing).
Automatically the loan value of those
so-called " stable securities^' gets fixed at 64 for at least 3 years to
come.
Mr. CORCORAN Are you talking about an immediately undesirable
effect in driving the market down 2
Mr. REDMOND. True, because it is going to force loans which are
otherwise well margined to be liquidated, because you go over from
your 80 percent to your 40 percent category.
Mr. CORCORAN. NO. What you are saying to me, Mr. Redmond,
is this, that a broker may lend 80 percent on the value of securities.
If the security'is at 1,000 the broker may lend $800. If the security
6482
STOCK EXCHANGE PRACTICES
falls from a thousand to 800 the broker can lend only $640. Well,
of course, the broker lends a less aggregate amount as the security
goes down.
As far as the drop in the particular market is concerned, you will
agree with me that of course if you are lending 80 percent you are
lending up to about the limit anyway, and if the value of the
security goes down of course the aggregate amount that may be lent
against it on an 80 percent basis also goes down.
Is this what you are worried about: We will say it goes down to
640 and then comes back to 1000. The benefit that is given to stable
securities through this 80 percent loan value will always be fixed
until you get another year rolling by at 64 percent rather than at
80 percent after the market comes back.
Mr. REDMOND. NO, I was not concerned with that. But remember
that as soon as you reach the limit of the loans that can be made
Mr. CORCORAN. Yes.
Mr. REDMOND. Because
this bill imposes criminal penalties, the
loan will have to be liquidated.
Mr. CORCORAN. Well, you mean when the loan gets below 80 percent loan value?
Mr. REDMOND. Yes.
Mr. CORCORAN. Certainly. That is true.
Mr. REDMOND. In the slightest degree?
Mr. CORCORAN. Yes; that is true, except
that the commission is
given power in here to determine the time at which you can close out
the account. But it is absolutely true that when a security drops
in value that is what happens. You cannot have a loan higher than
80 percent loan value, no matter what value the security has.
Mr. REDMOND. That is true.
Mr. CORCORAN. Well, I did not understand that a broker objected
to marking down the margins as the securities went down, sir.
Mr. REDMOND. They do not, Mr. Corcoran, but I think you are
increasing the complexity of the problem. Very few brokerage accounts consist, or even bank loans, of a single security.
Mr. CORCORAN. NO. On some you would loan 80 and some you
would loan 40.
Mr. REDMOND. And there, when you once get a decline which carries you down below, then on that security, taking the example that
you yourself used a minute ago, that bond is then marked at 64 for
all purposes, even if it recovers, while other securities m the loan may
decline.
Mr. CORCORAN. That is true.
Mr. REDMOND. SO that you permanently write down the so-called
" stable security."
Mr. CORCORAN. YOU write down the security, sir, for 3 years;
that is true.
Mr. REDMOND. For 3 years ?
Mr. CORCORAN. And that is an inevitability of this way of working out a more flexible margin.
Mr. REDMOND. I agree.
Mr. CORCORAN. Of course, you realize that this 80-percent rule
is lagniappe as far as the general margin provisions of this bill are
concerned.
STOCK EXCHANGE PRACTICES
6483
Senator GORE. DO I understand that that fixes that value for a
period of 3 years?
Mr. CORCORAN. I t fixes the low. Of course, the 80-percent calculation is based upon the lowest price ^ithin 3 years. Mr. Whitney
says you should not talk too much about the advantage that is given
stable securities by the 80-percent margin rule, because the 80 percent
is based of course upon the lowest price within 3 years, and you may
have a situation in a catastrophic market where the value of" a stable
security will drop very, very low and then that very, very low price
is the basis on which your 80-percent calculation is made for the
next 3 years. That is very true.
The CHAIRMAN. Mr. Corcoran, what effect will this have on the
volume of business ?
Mr. CORCORAN. That is what I wanted to come to next. If you
look at paragraph three in this computation and see how much stock
the customer can buy with a given deposit—and you realize that
brokers collect a commission on the market value of securities purchased, irrespective of the margin requirements—you can readily
see from those figures why brokers are howling about the bill.
This bill will cut the margin business at least in half, and the
brokers will lose that half of the commissions they would collect
under the present margins. It is easy to understand for that reason why the brokers do not like the bill.
Senator GOLDSBOROUGH. That is the " flight of commissions " ?
Mr. CORCORAN. That is the flight of commissions, sir.
Senator KEAN. It would cut it more than half.
Mr. CORCORAN. I don't know, sir. I t all depends on how much of
your accounts are big accounts and how much are small accounts.
You see, the comparative figures are $7,500 and $4,100 that may be
bought with a $2,500 deposit for small accounts. There the proportion is about 7y2 to 4 So, that it does not quite cut it in half.
But when you get into the bigger accounts you more than cut it in
half. The proportions are 43 to 16. So, that you really appreciably cut into the margin business.
Senator BuiiKiiEY. What do you conceive to be the advantages of
having margin trading?
Mr. CORCORAN. Sir, you heard yesterday—I don't remember
whether you were present, but I think you were
Senator BuiiKXiEY. Not all day. No; I was on the floor.
Mr. CORCORAN. YOU heard yesterday the argument of Dr. Goldenweiser and of Mr. Woodlief Thomas about margin trading. From
the social point of view there are two justifications for margin trading. I do not think they are very good myself, but I will give them
to you, state them fairly for what I think they are worth.
The first is that you should permit a man when a stock is down,
as stocks now are down, and when there is a prospect that those
stocks are going to get out of sight, to buy on a down payment
and then pay in as he goes along. You buy a stock now at 50. If
you wait 2 months for it, it might be 100. The market on many
stocks is already, sir, 100 percent of what it was last March, when
we were in the depths. The argument is that a man who is acquiring for investment may very well want to buy at 50 more stock
than he can presently pay for, and then, just as he buys an automo
6484
STOCK EXCHANGE PRACTICES
bile on the installment plan, he will pay for it out of future earnings
until he owns the stock outright.
The difficulty with that situation is that in a rising market
human nature is such that the man never pays for the stock as it
goes up. He just pyramids his margin and buys some more.
The second justification is one that is of a piece with the arguments
of the economists of the stock exchange in favor of speculation
generally; that if you are going to have a liquid market you must
have a very active market. To have a very active market you must
have a speculative market, because a market of investors is not
active enough. To have a speculative market you must have a market into which borrowed money can enter, and to have a borrowed
money market you must have a margin market.
Now, the nub of that argument goes back to the purely pragmatic
question of how valuable speculation is in the market. You have
seen the report on that of the Twentieth Century Fund, the group
of experts I have just been talking about. There is no question
as to the position Mr. Meekei and all the rest of the slock exchange
people take on the value of a speculative market. It is very significant that the Twentieth Century Fund, which has been looking into
this proposition and examining on a completely independent basis
the premises of that argument in favor of a speculative market
reported the other day—I have to read from a report in the Herald
Tribune.
All the conclusions we have leached on the basis of our factual studies
converge at one point Speculation, especially when accompanied by manipulation, should be drastically curbed, not only because it actively interferes with
the proper evaluating functions of the market, but also because it does not
exert the beneficial effects which it has been commonly supposed to produce
Senator BUCKLEY. Would it not be a good idea to confine speculation to a man speculating with his own funds instead of being
encouraged to borrow?
Mr. CORCORAN. Well, sir, I think so, because I am not so- sure that
the prospective value of having a liquid market is worth what it
has cost society to have the debacle we have had in the last few
years. There is not any way, however, of finally determining it. I
mean it is a matter of judgment.
When we sat down to draw this bill there was a very strong
element that believed in cutting out margin trading altogether.
This bill is a compromise between those who believe that you should
eliminate margin trading altogether and those who are willing to go
along with the stock exchange for a time in its thesis that a liquid
market made liquid with borrowed funds is worth enough so that
some margin money should be left in it, though not much. The
particularly drastic cut in margins that has been made in this
bill is based on a theory that if any bill is going to have any effect
by cutting down the amount of borrowed money in the market it
has got to go a long way; that cutting margins 5 percent won't make
any difference at all.
Senator BTJLKLEY. Of course, my criticism of your theory is that
you do not really go the whole way and take the broker out of the
banking business.
Mr. CORCORAN. The difficulty with that, sir, is the necessity of
compromising. You will find a great many people who think there
STOCK EXCHANGE PEACTIOES
6485
should be no margin business at all; but at least, although you do
not go the whole way, if you moderate the amount of borrowed
money in the market you may help the situation considerably, providing you moderate enough. If you cut these margins 5 percent,
you may just as well not legislate on margins. If you cut the
amount of borrowed money that gets in the market by a half,
you may have done something toward attaining the social benefits
that are urged by those that think there should be no margin
tradingat all.
Mr. ITECORA. In other words, Mr. Corcoran, it is not deemed that
we should go to either one extreme or the other ?
Mr. CORCORAN. That is true, sir.
Mr. PECORA. We wanted a middle ground that was sought to be
found in the provision that is now in the bill.
Mr. CORCORAN. That is true, sir.
Mr. REDMOND. Mr. Corcoran, is that based upon your conclusion
that there is too much borrowed money in the market today?
Mr. CORCORAN. Well, of course, today—you provided some figures
the other day about the amount of brokers' loans in the market.
Mr. REDMOND. The borrowed money has been published right
straight along for years, Mr. Corcoran.
Mr. CORCORAN, xes; that is true.
Mr. REDMOND. What we provided the other day were the figures
of the brokers' debit balances.
Mr. CORCORAN. The brokers' debit balances showed how much
of the borrowed money in the market was represented by borrowed
money in brokerage accounts as distinguished from borrowed money
in bank accounts.
To answer the question somebody asked me just a minute ago,
whether I thought there was too much borrowed money in the
market, I do not pretend to be an economist, sir; but Dr. Goldenweiser of the Federal Reserve told you yesterday that he felt there
was entirely too much money in the market.
Mr. REDMOND. I do not remember his making that statement as
of the present time
Mr. CORCORAN. That was the aggregate. And of course what we
are doing is sitting down at the bottom of the market, even with
prices at a hundred percent above last March, and legislating with
respect to what we all expect is going to be a rise in the stock
market. If vou take hold of the situation now you may prevent
the market from running away, with the inevitable repercussions
on business you get from a run-away market, and with the repercussions you had in the business situation last year.
Senator BioiiKLEY. Are you giving us a reliable tip that the market
is going to rise?
Mr. CORCORAN. NO, sir.
Mr. REDMOND. Mr. Corcoran,
on that very point, though, I suppose you appreciate that the adoption of these margin requirements
means necessarily an immediate liquidation of part of the brokers'
debit balances held today?
Mr. CORCORAN. Let us talk about that right now. When this section was drawn, perhaps in a little overexpectancy of how fast the
market was going to move, it was thought that by putting the date
6486
STOCK EXCHANGE PEACTICES
at which these margin provisions would become applicable over to
October 1, after the expected spring and expected fall rise in the market, and by confining these margin requirements to listed securities,
which in the case of the best securities are well above the lows of
last fall, at which level present brokerage accounts are being held,
there would be plenty of time for the market to rise to a point by that
date where most brokerage accounts that could get out of the red
would be out of the red on the standards of these particular margins.
There has been a great deal of factual criticism to the effect that
that judgment is wrong, and that by next October 1 there will still be
many brokerage accounts and many bank accounts carrying securities that will be under water on the present margin requirements.
Therefore, the other day before the House, talking for those who
drafted the bill, and very humbly as such, we suggested that this
section should be modified so that the new margin requirements
would not apply to accounts that were presently existent; that they
could be carried indefinitely if in the judgment of Congress it were
wise to carry them indefinitely; but that the new margin requirements, to prevent evasion, should apply if any substitutions were
made in those accounts after the 1st of October.
Senator KEAN. What do you mean by " substitutions "?
Mr. CORCORAN. Suppose, sir, you have an account now that is
under water; but suppose you have an account with stock X in
it that has a market value of $1,000. The account is under water
on October 1. You think that the X stock won't go up as fast as
Y stock now selling at a thousand dollars. You say to the broker
" Sell out the thousand dollars worth of X stock and buy me a
thousand dollars worth of Y stock." So long as you carry the X
stock which you have held in that account prior to the time when
the new margins went into effect, it will be carried for you at whatever margin rate the bank is carrying it. But the minute you transfer to a new stock, then the new margin requirements apply.
Clamping down on substitutions is an absolute necessity. If you
are going to permit the leniency of carrying present accounts indefinitely, then you must prevent the certain evasion that would come
about by customers rushing into the market now to buy lots of
stock at the present low margins, and then want to carry their
accounts through after October 1 indefinitely.
Senator GORE. If he substituted in the case you supposed there, it
would require a larger margin to carry Y stock than X?
Mr. CORCORAN. Yes, that is true.
Senator GORE. I S that on the general assumption that it is not
wise to shift from a more sluggish stock to a stock that is presumed
to be more active?
Mr. CORCORAN. NO. It is a rule of necessity to prevent evasion
of the new margin rules by the device of carrying through securities under the old margin rules and then being allowed to switch
indefinitely within the accounts. Otherwise, you could rush into
the market right now, anticipating a change in margin rules by
October 1, and load up on a 10-percent margin, if the stock exchange
would permit you to do so. Then after October 1 you could trade
indiscriminately on the theory that you were substituting so long
as you provided the fiction that you were dealing with the same
account.
STOCK EXCHANGE PRACTICES
6487
Senator BARKLEY. I S there any real difference between the man
who in the last year or two or during this crisis was either sold
out or had to sell out voluntarily, so as to put him under water,
although his account may not be under water he is very much under
water, and the man who has been able to hang on all this time with
his stock, though it is under water, and would run into the 1st of
October and be able to carry that stock on indefinitely, as against
the man I referred to first who might now get hold of some money
and buy a little stock and want to carry it in the hope that he might
recoup the losses that he sustained in his former transactions?
Mr. CORCORAN. Sir, what you are really talking about is the difference between the fellow who carried his margin account with a
broker who sold him out and the fellow who carried his margin
account with his home-town bank, which, because of its customer
relationship to him, carried him through.
Senator BARKLEY. That is by and large.
Mr. CORCORAN. Yes; that is a rough classification. I am not passing on the morals involved in it, sir. I just don't know. I am
simply concerned that because of its deflationary effect there should
not be any forced liquidation of present underwater accounts between now and October 1.
Senator BARKLEY. YOU mean by present accounts stocks held at
this time?
Mr. CORCORAN. Stocks held at this time in banks.
Senator BARKLEY. YOU do not mean accounts that fluctuate from
day to day, that you can buy today and sell next week?
Mr. CORCORAN. They can fluctuate from day to day, sir, up to
October 1. I t would be impractical to work a idle that said that
all accounts had to be frozen with their present long commitments
until October 1.
Senator BARKLEY. I S it your theory that anybody who tuys stock
now and carries it up? till October should then be subject to the new
margin requirements
Mr. CORCORAN. In any changes made after October.
Senator BARKLEY. If he bought stocks now and carried the same
stocks on the books up till the first of October he would not thereafter be required to put up more margin?
Mr. CORCORAN. That is true, sir. If there is any seeming inequity
in that situation, it is because you just cannot put the law into
effect right away, anyway. You have to give a date somewhere
in the future to which the market can be adjusted and before which
machinery can be set up for the enforcement of the act.
Senator BARKLEY. AS to all such accounts the status quo would
be maintained?
Mr. CORCORAN. Right, sir.
Senator BULKLEY. If you are going to allow existing accounts
to be carried through, would it not be ? better to make the effective
date a good deal earlier than October 1
Mr. CORCORAN. We all—all who are interested in the recovery effort—do not want to put any damper on the beginnings of an upturn, and we wanted to put the date ahead as far as we could consistently with the act getting into operation.
Senator BARKLEY. If that is your viewpoint about it, is October
late enough ? The fall has just begun in October.
6488
STOCK EXCHANGE PEACTICES
Mr. CORCORAN. Sir, you have to stop somewhere. You can jiggle
this date, October 1, to any date that your good judgment dictates,
but sometime there comes a time in the history of every book when
it has to be written, and there comes a time in the history of every
statute when it goes into effect.
Senator GORE. Senator Barkley wants to be sure the recovery
has started.
Mr. PECORA. Mr. Corcoran, you are not using the term " jiggle "
in street parlance, are you ?
Mr. CORCORAN. Oh, no, sir; I am careful.
Mr. REDMOND. YOU have talked about this thing as affecting only
brokerage accounts in stocks, but of course it would also affect,
would it not, loans in banks ?
Mr. CORCORAN. Yes.
Mr. REDMOND. SO as to
Mr. CORCORAN. On the
prevent substitutions?
same basis. You could not substitute except pursuant to the new margin requirements after the 1st of
October.
Mr. REDMOND. SO that if a person who had borrowed money
against good bonds thought that it would be advisable, because of
developments in a particular industry, to sell some of those bonds
and buy other equally good bonds, he would find that that would
be impossible unless he put up additional margin?
Mr. CORCORAN. He could not buy as much.
Mr. REDMOND. He would have to pay his loan off?
Mr. CORCORAN. He would have to pay his loan off.
Mr. REDMOND. It would be impossible unless he put up more
margin?
Mr. CORCORAN. I t would be impossible with the same market value.
Mr. REDMOND. That means payment of part of the loan?
Mr. CORCORAN. Yes, sir; that means payment of part of the loan.
Senator GORE. YOU apply these same requirements to the banks as
well as to the brokers?
Mr. CORCORAN. Yes; you have to apply them to the banks, Senator,
for the reason that a great, great part of the margin accounts, that
is, the securities carried on borrowed money, are carried through
the banks, a much larger proportion right now than are carried
through the brokers, and if you are trying to reach the general evil
of too much borrowed money in the market, both from the effect
upon the general economy and the effect upon individuals you have
to reach those accounts in the banks as well as in the brokerage
houses.
Another reason why you must reach the banks is that if you did
not regulate the amount of margins required on securities accounts
in banks, brokers who wanted to evade the requirements that you
put upon them would simply arrange for their customers, and you
would never be able to catch the practice, loans from the banks on
small margin requirements.
Senator GORE. 1 was asking the question yesterday and the gentleman said somebody else knew more about it. That was on that very
point2 as to whether or not, if you impose this regulation of higher
margin requirements—now I am speaking in the light of our experience under the eighteenth amendment—would there not be some
STOCK EXCHANGE PRACTICES
6489
bootleg broker around the corner who would sell it and buy it,
dealing with Tom, Dick, and Harry on a low margin?
Mr. CORCORAN. Well, sir, you always hear the possibility of the
bootlegger. But, by and large, the bulk of the business will not
be done by the bootlegger. You will not be able to stop all bootlegging. You will be able to stop enough of it so that tne purpose
that you are trying to reach by cutting down the aggregate amount
of borrowed money will be achieved. You will always have some
bootleggers, sir.
Senator GORE. What I have in mind, though, is the people that
I assume you are trying to protect, Tom, Dick, and Harry, that
do not know anything about stocks, do not know anything about the
earning capacity or the capital investment or the character of the
management of anything else. They buy because stocks have been
going up, and they guess they will continue to go up.
Mr. CORCORAN. Sir, you can stop the bootlegger just as much as
you stopped the bucket shop. The stock exchange will say you
are pushing us back into the era of the bucket shop, which is the
form that bootlegging would normally take.
Senator GORE. Yes.
Mr. CORCORAN. That depends upon the extent to which you can
enforce the law. The problem of breaking up the bucket shop is
no more difficult under this statute than it has ever been under any
other statute. You have successfully handled the bucket shop You
have not completely eliminated it, but you have to a great degree
reduced the bucket-shop problem. Mr. Pecora himself chased the
bucket shops out of New York. You can keep the bucket shops
down by effective prosecution under this law, just as you kept
them down by effective prosecution under the existing law.
Senator BARKL»EY. What effect would this margin requirement
have upon people of small means who are not speculators, but who
desire to accumulate stocks and pay for them outright upon the
installment plan?
Mr. CORCORAN. It would make the amount of stocks which persons
of small means could accumulate in that way very much smaller.
But the trouble is, Senator BarkLey, even if it sounds, as the fixed
investment trusts would say, like "permitting the small man to
buy an interest in America should be discouraged ", that very few
of the people who started in buying on margin as a method of
buying stocks on the installment plan ever completed the installment. As the stock went up they pyramided or they bought more.
The very optimism that led them to think that it was a good time
to accumulate stocks because they were cheap led them to try to
accumulate more and more and more on margin as the price went
up; and the man who started out with the best intentions in the
world of paying a quarter down while stocks were low—the man
who started out with that very good intention found himself playing
a speculative account within 2 or 3 months afterward.
The CHAIRMAN. And about 7 out of 10 lost?
Mr. CORCORAN. More than that I think lost.
Senator BAREXEY. I am speaking more particularly of those who
intended to accumulate for investment.
Senator GORE. I have seen the figures that 97 percent lose, 2 percent win, and 1 percent come out even.
6490
STOCK EXCHANGE PEACTICES
Senator BARKJLET. I am speaking of those who deal with banks,
who in good faith go to a bank and say, " I would like to have a
hundred shares of Steel or American Telephone or L. & N. Railroad,
anything, to lay aside ", without any education and who never do
get into the speculative fever.
Mr. CORCORAN. Very few of those people, sir, really exist. A lot of
good intentions start out, but the good intention gets completely
wrapped up in the speculative fever as the rise in the stock in anticipation of which the installment movement was made comes about.
Mr. REDMOND. Might I ask Mr. Corcoran: Those last statements
of yours are very sweeping in their nature. Might I ask on what
authority they are made ?
Mr. CORCORAN. YOU mean that most people lose?
Mr. REDMOND. N O ; you stated that they practically all lost; that
they practically all when they once bought on margin ended up by
having nothing but a speculative account in which they never completed their purchase.
Mr. CORCORAN. Mr. Redmond, I haven't the statistics to prove
that the majority of people who go into a rising market buying
securities on installments end up by running a speculative account
on margin. I do not think there are any statistics on that.
Mr. REDMOND. I think there are some, Mr. Corcoran.
Mr. CORCORAN. I simply know that everybody I know who started
that way ended up just as I have stated.
Senator GORE. I was looking at an analysis of 500 accounts in
the Board of Trade, I believe at Chicago, and 414, I believe, lost,
72 won, and 16 came out even. Now, if that works out, it is approximately that. That was based on an actual analysis, and there were
500 stock accounts dealt with in the same statement. I didn't go
through that. Someone told me Henry Clews said—and he was in
the market 50 years—he never knew of anybody who dealt on margin
and stuck to it but what came out broke, and I think he was pretty
conservative.
At the same time, I do not think you can stand between the fool
and his folly. I tnink he is intelligent enough to beat you to it.
If you do that, I am for you.
Mr. CORCORAN. YOU can stand part of the way, Senator.
Senator GORE. Yes.
Mr. CORCORAN. There is one more provision
The CHAIRMAN (interposing). Before you pass from that, what
specific provision and what change would be made in the bill so as
to prevent this forced liquidation?
Mr. CORCORAN. Something would have to be added to the bill.
The CHAIRMAN. Section 6?
Mr. CORCORAN. There would have to be a new section. I t is the
cleanest way to draft the change.
Mr. PECORA. Or a subdivision of 6?
Mr. CORCORAN. Or a subdivision of 6. I t might be done by inserting
a few words, but it is probably a matter of considerable redrafting.
The CHAIRMAN. Very well. Now, passing on, Mr. Corcoran, to
page 14—
To borrow on any security registered on a national securities exchange
from any person other than a member bank of the Federal Reserve System
STOCK EXCHANGE PRACTICES
Mr. CORCORAN. Could I come to that
The CHAIRMAN. Yes.
Mr. CORCORAN. I am going to come to
6491
in just a minute, sir?
that. I would rather handle
that together with the other.
The CHAIRMAN. Very well.
Mr. CORCORAN. There are two other things we ought to talk
about before we leave this section on margins. One is the answer
to a question which Senator Kean asked yesterday: What difference
does it make whether a fellow puts up 60 percent margin or 20 percent margin ? In any case, when the margin is reached he has lost
his money.
The answer is attempted to be given on pages 3 and 4 of this
analysis. I t is true that as soon as the debit balance—what a trader
owes the broker—corresponds with the value of the securities the
trader is wiped out; but the deeper the margin the longer it takes
for the trader to reach that unfortunate stage, and on the way
down he has time to readjust the account by selling a certain number of shares without putting up additional cash, so that he can
maintain the margin much further down.
This computation on page 3 shows three cases: One where a trader
buys 100 shares of stock at $100 under the New York Stock Exchange
rules and the stock drops to 77 and wipes him out. That is, we are
taking the New York Stock Exchange case as the normal.
Then we show two other situations: One wheie the trader buys
the same amount of stock on the Fletcher-Rayburn margin; and
one where he buys not the same amount of stock but puts up the
same amount of money as margin, and in each case his 60 percent
margin gives him time to readjust his account on the way down
without putting up more money. So that if the stock drops to the
same 77 he is not wiped out. He has lost part of his money, but
he still has an account; he still has a chance to come back if there
is any come-back, and he still has an equity.
I will not go through that in detail.
Senator KEAN. I would like to point out to you thefe that if the
market goes down so that his margin is impaired by 1, 2, 3 percent
at once, why, the broker must notify him either to put up more
margin or else he will be wiped out.
Mr. CORCORAN. That is true; but, sir, after that notification comes
he has a chance to readjust the account if his margin is wide enough.
I am supposing the case of a man who has put up all he has and
has no cash left in his pocket when a margin call comes. When the
margin call comes if his margin is wide enough he still has a chance
by selling a part of the securities to readjust the account without
putting up more money.
Senator KEAN. If his margin is 30 percent or 35 percent he still
has the same opportunity ?
Mr. CORCORAN. N O ; because, sir, a smaller drop in the market
will wipe him out.
Senator KEAN. A smaller drop in the market, of course, will wipe
him out.
Mr. CORCORAN. That is what we are talking about.
Senator KEAN. But he still has to liquidate a large part of his
stock in order to make his margin good; is that right?
6492
STOCK EXCHANGE PRACTICES
Mr. CORCORAN. Yes.
Senator KEAN. He does not have to liquidate quite so much?
Mr. CORCORAN. That is true.
Senator KEAN. That is true?
Mr. CORCORAN. That is true.
Senator KEAN. And it would be less if he had 75 percent margin?
Mr. CORCORAN. That is true.
Senator KEAN. Or if he had a hundred percent margin?
Mr. CORCORAN. Yes, sir.
Senator KEAN. He would not have to liquidate at all?
Mr. CORCORAN. That is right.
Senator KEAN. But as soon as his margin goes below the point
that you are allowed by law to carry you are going to make him
either sell out or else put up more margin?
Mr. CORCORAN. That is right. But the point I am trying to make,
Senator, is that there is a real protection to the investor in requiring
him to put up a bigger margin.
Senator KEAN. I t would be better to make it 75 ?
Mr. CORCORAN. That is true.
Senator KEAN. I t would be better at a hundred. Then he would
not have to put up any margin.
Mr. CORCORAN. And if you are interested in not having men
cleaned out, as a social problem, the deeper margin you make them
take the less chance there is they will get cleaned out.
Senator GORE. Have you considered undertaking to fix it so that
small purchases, $1,000 or less, could not be made on margin.?
Mr. CORCORAN. I think there is a rule of the New York Stock
Exchange now—I do not know; Mr. Redmond can tell you—by which
brokers refuse to take accounts under a certain amount, and most
brokers as a matter of fact would not handle a small account.
Mr. EEDMOND. I t is a question of individual decision.
The CHAIRMAN. HOW is that, Mr. Redmond?
Mr. REDMOND. I t is a decision made by each member or firm to
either take the account or refuse it, Mr. Chairman. There is no
fixed minimum.
Mr. CORCORAN. I t might be wise, Senator Gore, to put such a provision in. It would be something additional to the present protection of the bill.
Senator GORE. I have wondered about it a good deal, what the
reactions would be and whether it would really prevent people who
want to become small investors from buying at an.
Mr. CORCORAN. Most reputable brokers, the people who do the
big business, will not take an account of that size. A bank, of
course, will take an account for its customer of almost any size.
Senator GORE. I was wondering if it would not be better to force
them to go to the bank, where they could at least get the banker's
advice—not that it is good advice always.
Mr. CORCORAN. That might be added to the bill, sir. It is a
question whether, under the present practices, brokers who are acting
as if such a statute were in effect would know where they would get
their commissions.
Senator GORE. AS it is, he g;ets his commission whatever happens
to the unfortunate trader, but if you eliminate that so far as brokers
STOCK EXCHANGE PEAOTIOES
6493
are concerned and turn those people to the banks, it might be a sort
of a protection, I don't know.
Mr. CORCORAN. There is one more point, and one very serious
point, about these provisions for margin. Why should there be any
rigid roof beyond which no commission is given discretion to raise
the permissible loan value on securities?
A great many people have said—
We agree with the social policy of cutting down the amount of borrowed
money in the market, but you should not say 40 percent; you should give
some commission power to fix that rate in its discretion.
The answer to that involves a pure problem of practical statesmanship. If you believe that there is a public interest to be served
in having the amount of borrowed money and the amount of margin
operations in the market curbed—and we drew the bill on the supposition that there was such a public policy—you will have to make
a drastic cut in margin trading or you will not have influenced
the market sufficiently to have achieved your purpose at all. Secondly, there is one immutable law of political physics, as of all other
physics, and that is, when an irresistible body meets a movable
object the movable object goes just as far as the irresistible force
wants to push it.
Behind low margin requirements is all the vested interest of the
brokerage fraternity. Perfectly legitimate—it is bread and butter to
them. Any Government commission that is put down here with
complete discretion to fix margins at any point that seems desirable
is going to be under terriffic pressure all the time to push those
margins to the limit.
The placing of a bright line beyond which discretion cannot go
assures you that you do achieve tne maximum of the social policy
you are trying to effect. If you are afraid that these margins are
too high, it would be far better to move the bright line to a higher
loan value, say 60 percent, and stop there, than to take away the
bright line and put a commission down here under the terrific pressure that will always be on them to extend their discretion to the
limit.
There is one possible exception to that rule. I t may be that for
normal purposes you will want a bright line at 40% or at 60%. We
think 40, because unless you really cut into this margin business,
you may just as well not play with it at all. I t may be, however,
that thie line you would want as a norm u n d ^ usual circumstances majr need a little flexing in cases of national emergency.
The theory of this bill is that if you catch the market now you
will not have another 1929, because you will never get another runaway market. There will not be enough borrowed money to make
a run-away market possible.
But if you are thinking of the possibility of a 1929 you might
provide something like this: The bright line is 40 percent, but it
might be possible to lessen those margin requirements, upon a
finding of national emergency and for a definite length of time,
not of just one commission in Washington, but of the Federal
Reserve Board and the Federal Trade Commission and possibly
the Secretary of the Treasury. Then you make discretion something
that can be exercised only in really unusual emergencies, and you
make it a mighty hard thing to exercise.
6494
STOCK EXCHANGE PRACTICES
Senator GORE. Mr. Corcoran, have you been able to figure out in
that connection any way to protect the lambs who want to buy real
estate on margin?
Mr. CORCORAN. NO. There is no way to protect the lambs.
Senator GORE. That is the worst situation. The stock market
buries its dead, and these farmers and home owners who bought on
margin; their ghosts are stalking. They are what is giving us
trouble. These fellows who lost in the market are dead and" buried.
Mr. CORCORAN. I am trying to take care of one species of lamb at
a time, Senator. After we take care of the stock-market lamb, as
far as we can take care of him, perhaps we can try to take care of
the others.
Senator BAREXEY. We are feeding the other lambs out of the Public Treasury in the form of bonds.
Senator GORE. I think suicide is the hardest thing to prevent in
the world.
Mr. CORCORAN. Of course, you have two purposes to serve when
you are dealing with margins: One is to protect the lamb; another,
and probably the more important of the two, although it does not
appeal to one's human instincts as completely, is the protection of
the national business system from the fluctuations that are induced
by fluctuations in the market, which in turn stem back to this very
exquisite liquidity you get when you have a lot of borrowed money
in the market. That is the point which Dr. Goldenweiser made
yesterday. From the sheer unmoral standpoint of public policy it is
probably more important to protect the business system from the
effects on the market of too much borrowed money than it is to
protect the lamb.
Senator GORE. Mr. Corcoran, that is the point which always discourages me. If you can prevent men from buying on a rising market and selling on a falling market, if you can repeal that law of
human nature, you can stop this business.
Mr. CORCORAN. YOU cannot repeal it, sir. You can help it a little
by seeing that they do not buy as much and do not sell as much.
But that is all.
Senator GORE. I hope you are rigfrt.
Senator BARKLEY. There are some stocks that are very volatile,
go up and down very rapidly. There are others that are more or
less stable over a period of years.
Mr. CORCORAN. Yes.
Senator BARKLEY. Even
in depression the fluctuation in value of
certain stocks is not very great. Would you give the Stock Exchange or anybody else any discretion to fix margin requirement,
depending upon the volatility of the stock?
Mr. CORCORAN. There was an attempt to do that, sir; in this
section 6(b), the 80-percent alternative about which we have been
doing so much talking. That was an attempt to do that. It does
not work out perfectly, as Mr. Eedmond showed. It has a general
tendency to favor the staple stuff for margin accounts over speculative accounts
Senator BARKLEY. I was attending another committee and did not
hear that testimony.
STOCK EXCHANGE PEACTICES
6495
Senator GORE. Did you consider this point? I assume you did,
because you seem to have carefully considered the matter. That is
the advisability of placing some sort of limit upon daily fluctuations,
like they undertook to do in the Grain Exchange in Chicago, so that
it could not fluctuate more than 10 percent of the open price, up or
down. My point is that that might help to stop a stampede, just a
frenzy of selling or buying.
Mr. CORCORAN. Senator, I am not enough of an economist to know
whether such an interference with a free market is a wise thing or
not. Those artificial limitations of that kind on the fluctuations of
securities tie up with the real problem of the wisdom of permitting
short selling and all other activities of a free market. I honestly
do not know enough about the economics involved to be able to give
you an opinion on that subject, sir.
Senator GORE. Of course, I believe in a free and open market,
subject to reasonable limitations.
Mr. CORCORAN. I know that Mr. Eedmond would have apoplexy
if that sort of thing were put into the bill.
Mr. REDMOND. NO ; I would not. I think the market would take
care of itself very rapidly.
Mr. CORCORAN. In other words, there would not be any market?
Mr. REDMOND. Precisely.
Senator GORE. The grain exchange functions under that limitation.
Mr. CORCORAN. It functioned last summer under it.
Mr. REDMOND. But if you remember, for a number of days, Senator, the grain market went along with very small transactions,
immediately dropping down to the permissible limit, so that although
there was no volume of activity, grain prices were carried very, very
low indeed; and then it turned around and rebounded.
Senator GORE. I watched those stocks drop like a plummet, 30
or 40 points in an hour. I t ought to be a reasonable market, so far
as can be, where some sort of reason prevails. But you have seen
times when reason just took flight and people were seized with
frenzy. Sometimes you put an individual in a straight-jacket and
in a padded cell to prevent him from doing violence to himself. I
want a market place where people can buy and sell, and I only want
to guard against those things that are preventable. We do not want
to undertake to prevent things that we cannot prevent. Then we
would do more harm than good. We would be attacking impossibilities.
Senator REAN. We have in New York the Bank of Montreal, the
Bank of Nova Scotia, and lots of individuals. There is no difficulty
in any of them selling their 60-day bills in the open market and then
selling their demand and thereby receiving large sums of money to
loan on the market. If the market in London is 2 ^ percent and it
is 5 percent in New York, that is a very profitable business.
Mr. CORCORAN. Yes.
Senator KEAN. Why can they not lend on any margin?
Mr. CORCORAN. AS long as they do not lend on these securities.
Senator KEAN. I have letters from people who say that they now
have their stocks listed on the stock exchange, and if this bill goes
175541—34—PT 15
6
6496
STOCK EXCHANGE PRACTICES
into effect they are going to withdraw their stock from the stock
exchange and have it traded in on the curb, in the open market.
Mr. CORCORAN. Of course if it is traded in on the curb, it would
still be subject to this bill. That is a problem which I wanted to
come to later, but which we might just as well face now. That is the
statement that if we put restrictions upon trading in listed stocks,
and if we require companies, as a condition of such trading, to furnish
adequate information to its stockholders, all of the companies will
withdraw their listings and get off the stock exchanges. There is a
provision in this bill which empowers the Federal Trade Commission
to regulate the over-the-counter market. Just exactly how you are
going to regulate that market, no one has yet worked out. Undoubtedly it can be done; so long as you have control over mails
and over interstate commerce you can work out a way to handle
the over-the-counter market.
There are two other factors in this threat of the flight of securities
from the exchanges. Number one is that stockholders for whose benefit all these supposedly onerous requirements of reporting are made,
are not going to let their directors pull off the stock exchanges.
You remember, about two years ago, the fight that the Stock Exchange had, and it was a very creditable fight with reference to
Allied Chemical & Dye Corporation. I t was carrying in its accounts
a large number of shares of its own stock. I t was required to report
more fully to the stockholders. The management threatened to get *
off the exchange. There were other fights going on for other reasons
in that situation; but the stockholders prevented the directors from
pulling off the exchange. The requirement of supposedly onerous
bulletins and reports and publicity put upon listed stocks will not
cause the stockholders to permit tne directors to pull a corporation
off the exchange.
Senator KEAN I think that is quite right; but I am takling about
the onerous part of trade in these stocks.
Mr. CORCORAN. NOW, sir; as far as the onerous part of trading
in the stocks is concerned, in the first place, you have given listed
securities an advantage over unlisted securities in permitting brokers
to carry them in accounts while you do not permit unlisted securities
to be carried in their accounts. What onerous provisions are there
in this bill as to listed companies that are not for the benefit of the
stockholders? After all, sir, the stockholders determine whether
companies keep their shares listed, not the directors.
Senator KEAN. That is right, and I hope they always will; but
there are many provisions in this bill which makes it onerous on
the boards of directors and also on the margin accounts
Mr CORCORAN. NOW, let us take them one by one, sir. Insofar as
the onerous requirements on the board of directors are concerned,
they are all for the benefit of the stockholder. A stockholder is not
going to say, " Pull the stock off the board because my directors cannot deal in that stock and make profits on their inside information
and because they don't want to tell me what is going on in the company." So far as any requirement on the director is concerned, it is
all for the benefit or the stockholder; and no stockholder is going
to force his company to pull off the board because it is doing the
right thing by him.
STOCK EXCHANGE PRACTICES
6497
Insofar as restrictions on trading are concerned, you have given
listed stocks a premium over unlisted stocks for the purpose of margin accounts.
Senator KEAN. Yes; you have given it to a certain extent; but do
you take it that no curb stock can be dealt in by a broker here?
Mr. CORCORAN. Sir, any curb stock that is listed can be dealt in.
Senator KEAN. Listed where?
Mr. CORCORAN. Listed on the curb. There is a problem in connection with the New York Curb, if that is what you are thinking
about, as to which you will undoubtedly hear from counsel for the
curb exchange. The fact is that a great many stocks that you
normally think are listed on stock exchanges are not listed at all.
If you have a New York paper here this morning and you look at
the report of transactions on the New York Curb Exchange, you will
notice that a certain number of stocks quoted have a little star
opposite them, which means fully listed on the curb exchange. That
is, the issuing company has listed the stock on the exchange, giving
the information required for listing on the exchange, and has entered
into certain covenants with respect to its activities.
Stock exchanges throughout the country, however, have made a
practice of attempting to hold out for trade on the exchange securities that are not listed at all. A broker for instance vouches for a
security, not the company. He gives the listing committee a certain
amount of information with respect to the security. The issuing
company has never listed nor has ever entered into any covenant to
observe the requirements upon listing companies. Nevertheless that
stock can be traded in. I think Electric Bond & Share is in the
category of an unlisted stock right now. The problem of the effect
of this legislation on the New York Curb and whether the Curb
can force presently unlisted stocks into full listing depends Gompletely on the degree to which you can make listing desirable under
the terms of this bill and how you can control the over-the-counter
market to which the unlisted securities would run.
That is my opinion, and there is nothing but opinion in this
matter. I t is my opinion that no shareholder is going to have the
liquidity of his shares jeopardized by having his company run off
the exchange simply because of rules under which listings can
hereafter be had requiring directors to shoot straight with the
stockholders and tell the stockholders something about the management of the company.
Senator KEAN. I agree with that; but at the same time, where a
man controls the company, or his family controls it, he may object
to some of those rules or may not.
Mr. CORCORAN. What you are saying, sir, is that a majority
stockholder or a majority of the stockholders may want to take their
shares off the exchange. In a case like that, that is a possibility.
But most of the cases we are dealing with are cases where we do not
have the majority of the stock held so closely.
Senator GORE. When England went off the gold standard, did
not the stock exchange close for a day or place certain limitations
on short transactions ?
Mr. CORCORAN. That is true, sir.
Senator GORE. Did the stock exchange survive ?
6498
STOCK EXCHANGE PEACTICES
Mr. CORCORAN. I t survived, sir.
Senator GORE. We will have to corroborate that by Mr. Redmond.
Mr. CORCORAN. I t is a very live corpse, sir, if it did not.
Senator KEAN. Yesterday we had a discussion on the subject of
the London Stock Exchange. Is it not true that in their fortnightly
settlements, at one time, about 1926 or somewhere around there, the
cash settlement was postponed for 3 or 4 years because they were
unable to settle their accounts?
Mr. CORCORAN. I do not know much about the London Stock
Exchange, sir.
Senator KEAN. It was brought up here yesterday. As I remember
it, when there was a large drop m London—I think it was in 1926
or somewhere thereabouts—London was unable to settle on their
regular settlement, and I think it was a year or two before they could
complete the settlement.
The CHAIRMAN. That was before our day.
Senator KEAN. NO ; it was not before your day.
Mr. CORCORAN. Shall we go on, sir, to the next section?
The CHAIRMAN. Yes.
Mr. CORCORAN. AS a summary
of this margin section, there is no
argument of social policy against cutting down margins except what
I think is the weak argument that borrowed money is necessary to a
liquid market, which we have discussed. On the other hand
Senator KEAN. Pardon me. Let me interrupt you right there. Is
not borrowed money in speculation necessary to make a broad market
in close quotations ? I mean, that if you take a bond that is dealt in
once a month, or something like that, the bid price is 4 or 5 percent or
3 percent different from the offered price, and that is not a satisfactory market, because if you want to buy you have got to sacrifice
half a year's interest.
Mr. CORCORAN. That is the problem which I was discussing with
Senator Bulkley—whether the much vaunted advantages of liquidity
of the market were worth the cost to society of the abuses resulting
from the margins believed necessary to make such liquidity possible.
Senator KEAN. One of the reasons is that there has been testimony here as to billions of dollars or hundreds of millions of dollars
loaned on the stock exchange, and that they did not lose 1 cent.
Mr. CORCORAN. That is, the broker didn't lose, nor the bank that
loaned didn't lose. But how about the fellow that bought stocks
on margin? He did lose.
Senator KEAN. Yes.
Mr. CORCORAN. I do not think we need legislation particularly to
protect the broker all the time. They normally won't lose.
Senator KEAN. I do not know. If you get a narrow market, they
might lose. The liquidity of the market is what they loaned money
on.
Mr. CORCORAN What you are talking about, Senator, is the social
desirability of accepting all the perils that have been perfectly evident to us over the last 5 years of excess of borrowed money in the
market. You are balancing those perils against the advisability of
having quotations that will run an eighth or a quarter of a point
instead of 2 or 3 points
Senator KEAN. What I am saying is this, that the money market
in New York has been of continuous benefit to protect banks and
STOCK EXCHANGE PBACTICES
6499
trust companies all over the country so they might have a liquid
form of loan which they knew they could give back to their customers and to their depositors at any moment. To illustrate: As
I understand it, a bank in New York has so much commercial paper,
so much permanent loans, time loans and so much demand loans
on the market. They have a debit balance in the clearing house
at 9 o'clock in the morning of $1,000,000, and they want so many
brokers' loans. If, on the other hand, they have a credit balance of
so much money, they loan so much money in the market and that
gives them the opportunity of using the floating money in their
bank that may be called out tomorrow. It gives them an opportunity.
Mr. CORCORAN. What the ultimate simplicities of that argument
come down to, Senator, are ]ust this, that society should take on
all the burdens we have had with margin speculation m the market
so that the New York banks will have a place where they can
lend liquid funds. That is what it ultimately comes down to.
Senator KEAN. I think you are right in that the margins ought to
be sufficient. If you create a margin of 35 or 40 percent, I think
that you are doing all you can in this matter to protect the individual. I think if we insist upon that kind of a margin and that
becomes; the law, that margin will be so great that it will protect
the public from losing their money the way they have on many
occasions.
Mr. CORCORAN. TO summarize, we have on the one hand the argument of social policy against margin money in the market, both from
the point of view of its effect upon business and upon the social fabric which was described to you yesterday, and from the point of view
of loss to the individual investor.
Against that we balance the advantages of liquidity in the market
from the standpoint of having a place where banks can lend
liquid funds and where investors can realize on securities. I am not
trying to make that balance. For me there would be no choice. If I
had to sacrifice liquidity of the market in the sense that sales had to
be within a quarter of a point rather than within two points to prevent 1929 from occurmg again, the decision would be easy for me;
but that is a question of policy. If you do, as a matter of policy,
decide that you want to limit margins, then you are up against the
propositions that to effect that policy you must limit margins in banks
as well as in brokers' loans and that you must make a real limitation
of margins, if you are going to have any effect upon the market big
enough to carry out the purposes of your social policy. And to be
able to make the margin limitation effective, you must have a bright,
rigid line with any discretion removed or made as difficult of application as possible.
Mr. REDMOND. DO I then understand that this bill really carries
out the social principles of the persons who drafted it?
Mr. CORCORAN. N O ; not the social principles of the persons who
drafted it, any more, than the social principles of Mr. Goldenweiser
who talked here yesterday. I t embodies the philosophy that too
much borrowed money in the market is a dangerous thing for the
economic structure of the country as well as for the people who go
into the market on borrowed money. To the extent that it embodies
6500
STOCK EXCHANGE PRACTICES
that philosophy, it does embody not only the philosophy of most of
the people who drafted it, but of a lot of other people as well.
Senator GORE. YOU stated earlier m your statement who did draft
the bill. I was not here.
Mr. CORCORAN. I t was drafted as the result of cooperation between
two groups. Senator Fletcher asked Mr. Landis of the Federal
Trade Commission to cooperate with Mr. Pecora, who is counsel
for the investigating committee and counsel for this committee,
now. He asked Mr. Landis and Mr. Pecora to cooperate in the
drafting of a bill. Mr. Landis asked several persons to help him.
I was one of those. Mr1. Pecora had several members of his investigating staff helping him; and the two groups cooperated in the
drafting of the bill.
Senator GORE. DO you know who Mr. Pecora's assistants were?
Mr. CORCORAN. Mr. Pecora is here himself, sir; he can tell you.
Senator GORE. I thought maybe you knew. He is not a witness.
I would be glad to have it in the record, however.
The CHAIRMAN. I do not see that it makes any difference at all. Is
not the conception really that the purpose of reducing these loans
and reducing the amount of money flowing into speculation is to
leave some mnds for agriculture, commerce, and industry throughout the country ?
Mr. CORCORAN. That is true to a certain degree, sir. To be perfectly fair, as Dr. Goldenweiser pointed out yesterday, the stock
market does not really divert funds from industry; it merely redistributes funds as between agriculture and industry. But the fact is
that it did take money from agricultural communities and put it into
securities of large corporations, and it took money that normally
would have gone to the financing and developing of small corporations and routed it into the coffers of large corporations.
Senator GORE. DO you not think it acted as sort of a suction drawing funds from all parts of the country into New York?
Mr. CORCORAN. That is true, sir; but to be perfectly fair, that
money, it went into the purchase of securities and hence into the
coffers of the corporations offering those securities or it went out in
the expenditures of persons who made profits on the securities and
eventually got back into the channels of trade somewhere.
Senator GORE. But in consequence of that, the concerns floating
the stock took advantage of the opportunity to get this money which
might otherwise have remained m the interior parts of the country
devoted to carrying on legitimate business; so that the crash, when
it came, might have found a real cushion instead of a more or less
artificial one 2
Mr. CORCORAN. That is true, sir.
Senator GORE. I t not only withdrew money from my part of the
country, but from Europe as well. Europe sent immense funds over
here.
The CHAIRMAN. Proceed.
Mr. CORCORAN. Section 7. We have talked about margins in the
sense of getting credit into the market through the borrowings of
persons operating in the market. Section 7 deals with an attempt to
control the amount of credit that goes into the market by restricting
borrowings of brokers. You will notice in section 7 that it provides
[reading]:
STOCK EXCHANGE PEACTICES
6501
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
That language should be amended to make it certain that it does
not cover banks. [Continuing reading:]
(a) To borrow on any security registered on a national securities exchange
from any person other than a member bank of the Federal Reserve System.
New legislation puts in the Federal Reserve Board the power to
limit the loans which a member bank makes upon securities. The
purpose of canalization through the Federal Reserve bank of
borrowings going into the market through banks to brokers is to
make it practicable to exercise the control over money going into
securities which the Glass-Steagall bill attempts to give to the
Federal Keserve Board.
There is another provision which should go in at this point. It
comes in from page 23. You will notice on page 23 that any issuing
company, as a condition of registration, must agree, if it is not a
Federal Reserve member bank, not to lend to carry securities. On
page 23 it is provided [reading] :
The rules and regulations of the Commission in regard to registration shall
require—
(I) An undertaking by the issuer to comply with and so far as is within
its power to enforce compliance by its officers, directors, and stockholders
with the provisions of this act and any amendments thereto and with the
rules and regulations made or to be made by the Commission theieunder and,
unless the issuer is a member bank of the Federal Reserve System, not to
lend any funds in the money market of any exchange or to any member
thereof or to any person who transacts a business in securities through the
medium of any such member except in accordance with such rules and
regulations as the Commission may prescribe
That is to control these outside corporation loans which you were
discussing yesterday.
Section 7, then so far as we have gone in connection with this other
provision, limits the borrowings of brokers, first, from Federal Reserve member banks; secondly, from outside lenders under such rules
and regulations as the administrative commission may prescribe.
Senator EJBAN*. I do not think that would interfere in any way
with a company lending to its directors and officers money to purchase their own stock; do you?
Mr. CORCORAN. NO, sir. The internal corporation laws ougfit to
require that. A New York corporation cannot lend to its shareholders.
Senator KEAN. Most of the companies give to their employees
an option to acquire so much stock a year.
Mr. CORCORAN. YOU see the lending is simply made subject to any
rules and regulations of the Commission; and if there were any
question of that kind, undoubtedly the rule would except such a
situation. [Continuing reading:]
(&) To permit the aggregate indebtedness of such member or person to all
other persons, including customers' deposits, to exceed such percentage of the
net current assets owned by the borrower and employed in the business not
exceeding 1,000 per centum as the Commission may by rules and regulations
prescribe
Roughly, what that says is that a broker cannot borrow more than
10 times his capital to lend to his customers. I understand from
6502
STOCK EXCHANGE PBACTICES
Mr. Whitney's statement that that does not constitute a burden on
New York Stock Exchange members at the present time. I understand that there has been some objection from smaller exchanges that
their members simply cannot carry on their accustomed volume of
business if they can only borrow from the banks 10 times the amount
they have invested as capital.
This is a provision to make certain that brokers do not operate on
a shoestring and that there is a capital cushion for their customers.
I understand that some brokers during the crash—Mr. Redmond can
check me on this—were permitted to borrow up to 50 times their
capital.
Mr. REDMOND. Not that I know of. I t may have happened in a
particular case where a firm was being reorganized, or something like
that.
But what is the definition of the term " net current assets owned
by the borrower and employed in the business " ?
Mr. CORCORAN. I t is substantially as you put it in your brief.
Mr. REDMOND. I S not that a very vague term?
Mr. CORCORAN. NO.
Mr. REDMOND. " Net
Mr. CORCORAN. NO.
current assets " ?
It is his current assets after you deduct his
liabilities. You know what we are after. If you can suggest a
better way to phrase it I should be very glad to accept your language.
I do not care how you define it.
Mr. REDMOND. That term " net current assets " would normally
be the difference between your current assets and your current liabilities. That is quite different from capital.
Mr. CORCORAN. NO, but it does represent the cushion of protection
immediately available for the protection of your customers.
Mr. REDMOND. I think not.
Mr. CORCORAN. Mr. Redmond, as long as you and I know what
we are after, I will be perfectly willing to accept any suggestions
you have for the redefinition of that term.
Mr. REDMOND. I am simply raising the question that the term
at present is not accurately defined; and being a point on which
criminal liability would turn, I think it should be very definitely
defined.
Mr. CORCORAN. I agree.
Mr. REDMOND. I S there going to be any provision made for those
cases that are bound to arise where a man, no matter what good
faith he may have exercised, would fall below the fixed ratio ?
Mr. CORCORAN. N O ; because there, again, Mr Redmond, you are
up against what I call the irresistible force and the movable object.
You have got to fix a limit somewhere. This provision fixes 1,000
percent as the top. The Commission can require that brokers actually
borrow on a smaller ratio of borrowing. Somewhere there has to be
a top. Below that the commission can adjust. But you must not
have an administrative commission in the position where it is certain
to be under pressure all the time.
Mr. REDMOND. I have greater faith than you have, apparently^
in the ability of the commission to resist pressure.
Mr. CORCORAN. I have been trying to resist it for 2 years. It is
much harder than you think.
Mr. REDMOND. The last 2 years may have been exceptional.
STOCK EXCHANGE PBACTICES
6503
Mr. CORCORAN. All pressure always finds exceptional circumstances, sir.
Mr. KEDMOND. The Reconstruction Finance Corporation was
rather inviting pressure, was it not?
Mr. CORCORAN. I am not going to talk about that
The CHAIRMAN. YOU say, it is 10 times the capital?
Mr. CORCORAN. Yes, sir. That is the ratio on which a bank normally takes deposits.
The CHAIRMAN. Would it improve it any to specify 10 times the
capital, inasmuch as this is 1,000 percent?'
Mr. CORCORAN. Mr. Eedmond thinks that the term " net current
assets " is ambiguous and should be redefined. I think we agree
generally on the figure we are trying to reach as a basis, and that
can be straightened out as a matter of language.
Mr. REDMOND. DO not take anything I say as an agreement. I am
raising points to clarify the situation.
Mr. PECORA. In other words, he wants to find out how far you will
agree, and then he will not agree.
Mr. CORCORAN (reading from the bill):
(o) To use, if a broker, the capital employed in the business to carry or
finance the carrying of securities for himself or for others than bona fide
customers excluding any partner or employee of such broker
That proceeds on the proposition that a broker should have a fund
or capital as a cushion against losses and that he should not employ
that cushion in trading for his own account
The two biggest failures we had during the 1929 debacle, and
one in 1930, arose noty because the brokers' loans were unsafe, because as a matter of fact brokers' accounts for their customers are
usually very safe. They arose rather because the capital of the house
became involved in positions for its own account.
(Reading further from the bill:)
(d) To hypothecate or arrange for the hypothecation of more of any securities carried for the account of a customer than is fair and reasonable in view
of the indebtedness of such customer
And (e) should be considered with it [reading] :
(e) To hypothecate or arrange for the hypothecation of any securities carried
for the account of a customer under circumstances that wiU permit the commingling of the securities of one customer with those of any other person, without
the written consent of such customer
A broker, to lend you money, must borrow money on the same
securities on which you borrow from him.
Senator KEAN. DO you mean you have to separate each customer ?
Mr. CORCORAN. Unless you get the customer's consent.
Senator KEAN. YOU always do get the customer's consent?
Mr. CORCORAN. YOU normally do in operations on the New York
Stock Exchange or in operations under the statutes of the State of
New York, from which these subsections are practically excerpts.
You always do get the customer's consent. But that is not always the
case in other States nor under the rules of other exchanges than the
New York Exchange. So we simply put it in here to make very sure
that the rule becomes general throughout the country.
Mr. EEDMOND. May we for one moment go back to (c) % The
definition of the term " to carry or finance the carrying of securi
6504
STOCK EXCHANGE PRACTICES
ties "—would that go so far as to exclude a man who had a business
capitalized by, let us say, Liberty bonds ?
Mr. CORCORAN. YOU mean, it is the old problem of whether you
have to have cash capital?
Mr. REDMOND. Precisely.
Mr. CORCORAN I should say you would, under this, have to have
cash capital.
Mr. EEDMOND. That would mean that not only would the man
engaged in that business have cash capital employed in that business,
but could not carry any securities for his own account.
Mr. CORCORAN. 2fa>; he would have to segregate a certain amount
of his capital for that business. I am perfectly willing to agree with
you that possibly there should be investment in Government bonds or
anything else that is comparatively safe for the capital of the broker.
As the section now reads, it requires cash capital.
Mr. REDMOND. YOU would not draw any distinction between the
man who was borrowing money so as to acquire securities and the
man who owns the securities and contributed them as capital?
Mr. CORCORAN. NO, sir. There has to be a certain capital cushion
in the business.
Mr. REDMOND. There would be a capital cushion. If I have
securities and put them in as capital, the capital is there.
Mr. CORCORAN. Not unless they are perfectly safe securities. The
customer takes a risk on the value of them. Again, it is a question
of degree. I t is a sheer question of degree as to the safety of the
security. I say that, as the section now reads, the broker has to
have cash capital which is a cushion for his customers. You say,
" Why should he not be allowed to have Government bonds * They
are just as safe as cash." Then, when I say, "All right," you push
me one more and say, " Why should he not be able to invest it in
Atcheson bonds *" And I say, "All right," and you push me one
more. Pretty soon you will have me assenting to investment in
securities on the Produce Exchange. I t was intended that there
should be a safe cushion of capital in the business.
Mr. REDMOND. The reason I asked it was that I did not understand the principle of it. I should think it would have said simply
that the capital to be employed in the business of a broker shall
be contributed and maintained in cash. That is the thought, then?
Mr. CORCORAN. A S the language now reads, that is the thought.
I have no objection to a concession as to Government bonds. But
the difficulty with going any further is that you reach a degree when
you start on the toboggan chute and never know when you are going
to land at the bottom.
(Reading further from the bill:)
(f) To lend or arrange for the lending of securities pledged by or carried
for the account of any customer without the consent of such customer and
without crediting the interest received on account of such lending to the
account of the customer
That deals with a broker's lending his customer's security in
connection with request made upon him by other brokers for the
loan of securities to cover their short accounts. The stock exchange
has criticised that language with respect to the interest provision,
and it is absolutely right. The language is badly drafted. When
STOCK EXCHANGE PRACTICES
6505
a broker lends stock to another broker he normally gets back as a
deposit the market value of that stock in cash. No interest is usually paid on this deposit.
The theory of the section is this: After all, there is no reason why
a broker should have the privilege of lending his customer's stock to
cover the short accounts of other brokers, unless he pays for that
privilege; and even if he does not receive any interest on the deposit
himself, he must, during the time that the stock is loaned out to
another broker, credit his customer with an amount of interest at
some given rate on the market value of the securities while they are
out.
I understand perfectly that there is difficulty in allocating such
interest as between customers; but it is something that can be worked
out, and certainly as a matter of fairness between the broker and his
customer there is no reason why the broker should use the customer's
securities to lend to another broker who has to cover a short sale, and
not pay something for the privilege. And if you do not believe in
encouraging short selling, and believe in putting at least some discouraging minor obstacles in the way of it, this would be one of those
obstacles.
Mr. REDMOND. IS it not true, if you have looked into the question,
that attempting accurately to credit interest on this theoretical basis
which you have described, to the customers of a large firm, would
be so impossible that no len^ding could in fact take place ?
Mr. CORCORAN. Not impossible; rather difficult. But again, as I
say perfectly frankly, this is intended to put a minor obstacle in the
way of short selling.
Mr. REDMOND. And if it should develop to be a major obstacle and
simply prohibit the lending of securities, that would be deemed to
be socially good, too, I take it?
Mr. CORCORAN. If, and I am not one of the persons who goes along
with that idea, you think short selling is bad.
Mr. REDMOND. What would you do in the case, which is very common, of a man who orders securities sold when he is out of town?
Let us say a broker in Texas orders securities sold. For the days during which those securities would be in transit from Texas to New
York for delivery, securities have got to be borrowed to be delivered
on the New York contract.
Mr. CORCORAN. That is not a short sale for profit. That is a short
sale by reason of the physical unavailability of the securities.
Mr. REDMOND. But what I am pointing out is that that would
require the borrowing of securities and the out-of-town seller would
therefore have to pay this extra premium.
Mr. CORCORAN. That is quite true, and perhaps that particular provision for interest, the accounting difficulties of which I perfectly
well realize, ought to be changed to make some allowance for that
kind of a situation. But as I say, whether you will eliminate it
entirely depends upon your attitude toward the advisability of short
selling.
Senator GORE. That, however, involves, as a rule, a long sale.
Mr. REDMOND. Yes; but you nevertheless have to borrow.
Mr. CORCORAN. It is a sale against the box.
Mr. REDMOND. A sale against securities m transit.
6506
STOCK EXCHANGE PBACTICES
Mr. CORCORAN. Yes.
Senator KEAN. There
are a great many women that order you
to sell some bonds, and then they do not come down for 2 or S
days, but you are forced to deliver them.
Mr. CORCORAN. Sir, I cannot pretend in this statute to govern the
vagaries of women customers.
The CHAIRMAN. The committee will take a recess at this time
until 2:15.
(Whereupon, at 1 p.m., a recess was taken until 2:15 p.m. of the
same day.)
AFTERNOON SESSION
The committee resumed at 2:15 p.m. on the expiration of the
recess.
The CHAIRMAN. The committee will resume, please.
STATEMENT OF THOMAS GARDINEK CORCORAN—Eesumed
The CHAIRMAN. Mr. Corcoran, you may resume where you left off,
which I believe was section 7.
Mr. PECORA. Mr. Chairman, we had just finished with section 7
of the bill.
The CHAIRMAN. All right. You may proceed, Mr. Corcoran.
Mr. CORCORAN. We are through, then, with the provisions relating
to the control of the amount of borrowed money that gets into the
stock market.
We can now begin with section 8, the provisions to protect the
investor from evils in the present set-up of the market machinery.
The CHAIRMAN. All right.
Mr. CORCORAN. If we may now begin with section 8, Senator
Fletcher, those provisions have been drafted from suggestions of
your counsel m charge of the work of investigating stock-exchange
practices. In other words, most of them have been evolved as a
result of the investigation that has been carried on before your
committee for the last year and a half.
I will begin now by reading section 8:
SEC 8 (a) It shall be unlawful for any person, directly or indirectly, by the
use of the mails or any means or instrumentality of interstate commerce, or of
any facility of any national securities exchange—
(1) To effect any fictitious transaction in any security registered on a
national securities exchange, or any transaction which purports to be a sale of
any such security but involves no change in the beneficial ownership thereof
That was intended to prohibit wash sales. A wash sale is a transaction designed to create the illusion of activity in a stock. A trader
orders one broker to sell a security at a certain price, and orders
another broker to buy the same security at the same price. The
stock exchange (^uite agrees that wash sales should be prohibited,
but raises the point that possibly subsection (1)—no, it is on the next
point that the stock exchange makes objection
Mr. REDMOND (interposing). Mr. Corcoran, might I ask you a
question right there?
Mr. CORCORAN. Yes.
STOCK EXCHANGE PEACTICES
-
6507
Mr. REDMOND. Would there be any reason why that provision
should not be extended to any security, whether registered on an
exchange or not?
Mr. CORCORAN. That immediately raises a constitutional point.
Mr. REDMOND. Does it? I thought it was limited to transactions
through the mails or by means of interstate transportation.
Mr. CORCORAN. Yes. But it raises the same point of constitutionality that has been raised as to the over-the-counter market
provision.
Mr. REDMOND. Precisely.
Mr. CORCORAN. I do not see why it could not be done if, in the
committee's judgment, it thinks it desirable that it should be done.
Mr. REDMOND. Of course it is the law of the State of New
York, and the rule of the New York Stock Exchange as well, that
fictitious transactions should not take place. But it just struck
me that the constitutional question exists as to many other provisions of the bill, and that at least you might go as far as striking
out the words " registered on any securities exchange."
Mr. CORCORAN. I t might seem proper to the committee to go that
far.
Now we go to subparagraph (2):
(2) To effect, or to authorize another or others to effect for such person's
account, transactions for the purchase and sale of any security registered on
a national securities exchange at substantially the same time at substantially
the same price, whether such transactions of purchase and sale be with the same
or with different parties, except transactions made on the exchange as a
matter of record only and appropriately recorded and reported as an " arranged
transaction "
That provision is intended to catch match orders, where by prearrangement a buy order and a sell order at a given price go into
the exchange together to create the illusion that there is activity in
the stock, or to create a quotation on the stock for the purpose of
helping salesmen distribute the stock.
The CHAIRMAN. Mr. Eedmond, would you suggest that the words
*' registered on a national securities exchange" be stricken out
there?
Mr. REDMOND. I think it might be well to strike that out. Of
course, Mr. Chairman, the possibility of matched orders except upon
an organized exchange is very remote. But I think it might be just
as well to strike those words out there if they are going to be stricken
out in the first instance.
The CHAIRMAN. The committee will consider that.
Mr. REDMOND. Mr. Corcoran, isn't the language of subsection (2)
capable of a much broader meaning than just a prohibition of
matched orders
Mr. CORCORAN. I do not think so. But I have noted the objection
you have made to it, on page 14 of your brief, and if the committee
ivill permit me, I would suggest to Senator Fletcher that possibly
some clarification of it, to prevent the section being given an interpretation which will prevent a man, in the course of a single day,
buying and selling the same security, might be considered.
Mr. REDMOND. The essence of the difference being what you yourself stated a minute ago, and that is, that by prearrangement orders
are sent in to buy and to sell at the same time.
6508
STOCK EXCHANGE PRACTICES
Mr. CORCORAN. And the exception would just be restricted to bona
fide buying and selling on the same day, without any intention to
create the illusion of activity or to make a quotation on the stock.
The CHAIRMAN. YOU may proceed, Mr. Corcoran.
Mr. CORCORAN. We now take up subparagraph (3):
(3) To effect, either alone oi m concert with one or more other persons, transactions for the purchase and sale of any security or securities registered on any
national securities exchange for the purpose of raising or depressing the price
of such security or securities or for the purpose of creating or with the expectation that there will be created a false or misleading appearance of active
trading in such security or securities, or a false or misleading appearance in
respect of the market for such security or securities
The stock exchange would prefer that this prohibition should be
confined to cases where there is an intentional effort to unfairly
influence the price of securities for the purpose of making a profit.
The difficulty with such a restriction is that once you accept a word
that leaves so much leeway as " intentional" and is susceptible of
so many difficulties of proof, or a word like " unfairly " that has the
same difficulties about it, you really have emasculated your provision. To prove that a man intentionally operated a pool to unfairly
influence the j>rice of a security is a refinement that is impossible of
practical administration.
Mr. REDMOND. Well, don't we then fall on the other horn of the
dilemma. Nobody buys a security with the idea that his purchase
is going to leave the market price entirely unaffected, and, therefore, under this bill if it is given the broadest possible interpretation every purchase or sale of securities would be for the purpose
of raising or depressing the price, and hence every buyer and seller
would be a criminal.
Mr. CORCORAN. N O ; I do not think so. I do not think language
relating to transactions which take place for the purpose of raising
or depressing the price of securities brings within the normal meaning of that language the inevitable effect upon the market of any
transaction m securities. What you are saying is that since any
transaction in securities must in some way influence the price of the
security, even by reason of the very existence of the transaction,
therefore if a statute says that you must not carry out a purposeful
transaction for the purpose of raising or depressing the price of
securities, the mere fact of buying and selling securities without
any ulterior purpose except the buying or selling of the security is
within that language.
Mr. REDMOND. Exactly.
Mr. CORCORAN. Oh, no. I respectfully disagree.
Mr. REDMOND. What, then, is going to be the norm by which
people might guide themselves ?
Mr. CORCORAN. There cannot be any norm, Mr. Redmond, in the
interpretation of language like that, any more than there can be in
any case where you are working with standards and questions of
degree.
Mr. REDMOND. But we are dealing with a criminal statute here.
Mr. CORCORAN. We are, that is true.
Mr. REDMOND. And isn't it generally true that crime requires intent, and it is the criminal intent that distinguishes a crime from
many acts which otherwise would not be punishable in any form?
STOCK EXCHANGE PRACTICES
6509
Mr. COKCOBAN. No. I do not believe that is any longer a norm
of the criminal law. I think it was a norm of the old criminal law,
and I still think that so far as more serious offenses are concerned
the criminal law requires intent to be proved, but in modern
society there are many things you have to make crimes which are
sheer matters of negligence. As you know, there are many statutory
crimes, such as those in connection with driving an automobile, where
intent is not required.
Mr. REDMOND. DO you mean as to the speed statute ?
Mr. CORCORAN. NO. If you drive an automobile when drunk,
it is not necessary to prove an intention to become drunk, or to
drive an automobile when drunk. You can still be put in jail for
it, whether intent is proved or not.
Mr. PECORA. That is, mala prohibita.
Mr. REDMOND. But even so, Mr. Corcoran, in your automobile
case if by reason of speed while intoxicated you run down a man
normally you can be tried for manslaughter but not for murder.
Mr. CORCORAN. But manslaughter is a crime. And this is not
murder.
Mr. PECORA. That is because of the statutory definition of that
crime.
Mr. CORCORAN. What you are saying to me, Mr. Redmond, is that
you have to have intent in order to hold a man for crime. I say
that no matter whether you are tried for manslaughter or for murder
under the automobile case manslaughter is a crime, just as murder
is a crime. So for the purpose of settling the point as to whether
the modern criminal law requires intent, you must concede that
manslaughter, without any requirement of specific intent, is a crime
just the same as murder.
Mr. REDMOND. Not necessarily, because manslaughter ties in with
the requirement that the man must be conscious of what he is doing.
Mr. CORCORAN. Not necessarily.
N
Mr. REDMOND. Let me finish my sentence. Here, ordinarily, a man
is engaged in the ordinary process of buying or selling securities, or
of buying or selling property, and suddenly you say to him: If you
do this for the purpose of raising or depressing prices—and we give
here no indication beyond that as to what distinguishes a legitimate
commercial transaction from a criminal act—you are doing a criminal act ? How are people going to know how to guide themselves ?
Mr. CORCORAN. Mr. Redmond, I may agree with you that if you
are trying to skin corners as closely as you can, you cannot tell at
exactly what stage a kitten becomes a cat in determining whether
a man bought or sold on the market for the purpose of raising or
depressing the price of securities. But for practical purposes, the
language is adequate. You cannot be able to decide ahead of time
just where the line falls. That is the question present in every problem that a law court has to decide.
Mr. REDMOND. I should just like you to give me some instance
in the criminal law in which a man may become a criminal when doing ordinary commercial work, doing a perfectly ordinary commercial transaction.
Mr. CORCORAN. Mr. Redmond, you do not need any precedents
in the commercial law for that. Once you establish the principle
6510
STOCK EXCHANGE PEACTICES
of law that intent is not necessary for every crime, we can establish a new crime here within that principle without the necessity of
having other precedents in the commercial law. Now, Mr. Redmond,
are you arguing with me on the question of policy?
Mr. REDMOND. NO.
Mr, CORCORAN. Or
are you arguing with me on the question of
law?
Mr. REDMOND. I am arguing with you on the question, that
this provision gives no means by which the average citizen can tell
when he is going to fall within the scope of the criminal provision
or not.
The CHAIRMAN. Well, it says it must be done for the purpose of
raising or depressing the price.
Mr. REDMOND. But every purchase might be so termed.
Mr. CORCORAN. That is not a fair interpretation of the language
at all.
Mr. PECORA. Oh, no. Perchance it might be in fact as an incident to the act, but where the act is doixe for the specific purpose
set forth in the statute, then the statute is violated.
Mr. REDMOND. But that specific purpose may be assumed the
case of a large insurance company which holds half a million dollars
of a certain issue of bonds, and they go and buy $50,000 more, and
this purchase actually increases the price of that security.
Mr. PECORA. But they purchase not for the purpose of increasing
the price.
Mr. REDMOND. Yes; but even then.
Mr. PEOORA. This has to do with avowed market operations, where
a specific purpose is sought to be effectuated by the operation.
Mr. REDMOND. Well, then, shouldrf't we have the clause in the
bill clearly describe that, if that is to be the intention of the statute?
Mr. PECORA. I think it does insofar as it specifies what the purpose shall be in the case of an unlawful act. Under that purpose
the act done may be unlawful, or is to be declared unlawful.
Mr. REDMOND. Mr. Pecora, you yourself a minute ago said this
section had to do with an avoweu market transaction. Couldn't
we find some language which would show clearly what this clause
is intended to cover ? Otherwise I fear people will not know whether
they are on the verge or on the edge of the criminal law or not.
Mr. PECORA. I think the language of the section as it now stands
is clear enough.
Mr. REDMOND. Well, I have raised my point.
Mr. PECORA. Excluding from its scope an act that is not done with
any ulterior motives or purposes, as set forth in the act.
Mr. REDMOND. Aren't you then treating " purposes " the same as
" intent", which Mr. Corcoran objected to ?
Mr. CORCORAN. I did not object to it.
Mr. PECORA. YOU might regard them as synonymous terms.
The CHAIRMAN. But you have to prove the purpose, which is
practically the same thing as proving the intent.
Mr. PECORA. Yes. You may treat them as synonymous terms,
Mr. Redmond.
Mr. REDMOND. All right
The CHAIRMAN. YOU may proceed, Mr. Corcoran.
STOCK EXCHANGE PRACTICES
6511
Mr. CORCORAN. Subparagraph (4) provides:
(4) If a dealer, broker, or member or a person in the employ of a dealer,
broker, or member, to circulate or disseminate in the ordinary course of business information to the effect that the price of any security or securities registered on a national securities exchange will or is likely to rise or fall partly or
wholly because of the market activity of any one or more persons, if the person
disseminating such information has reason to believe that the circulation or
dissemination of such information on his part may induce the purchase or
sale of any such security in the expectation of such market activity;
That section deals with dissemination of rumors of pools. As Mr.
Redmond points out in his brief, such acts are already prohibited
by the rules of the New York1 Stock Exchange.
Mr. EEDMOND. Simply for the purpose of the record, Mr. Corcoran, that is Mr. Whitney's brief.
Mr. CORCORAN. All right. And it is not your brief?
Mr. EEDMOND. I was merely setting you right on that.
Mr. CORCORAN. NOW WO will take up subparagraph (5):
(5) To circulate or disseminate information regarding any security registered
on a national securities exchange which statement is, in the light of the circumstances under which it was made, false or misleading in respect of any
matter sufficiently important to influence the judgment of an average investor,
if the person disseminating such information has reason to believe that the
circulation or dissemination of such information on his part may induce the
purchase or sale of such security, and does not prove that he acted in good
faith and in the exercise of reasonable care had no ground to believe that the
statement was false or misleading
I would suggest, Mr. Chairman, if I may be permitted, that the
language of that subparagraph should be amended a little to make
it clear that the statement must be made for the purpose of inducing
the purchase or sale of the security. Not because I do not think the
subparagraph is perfectly clear now, but there has been some apprehension on the part of perfectly legitimate houses dealing in investment information, liket the publishers of standard manuals, and
investment counsel, and trustees administering estates, that they
might be unwittinglj caught by that provision even though they
acted with the best intentions in the world. I would suggest that
the amendment proposed in Mr. Whitney's brief, on page 15 thereof,
be considered.
Mr. REDMOND. Might I say one word right there, because I think
there again it might be wise to strike out the limitation as to securities registered on national securities exchanges, so as to prevent
a false statement in regard to unlisted securities.
Mr. CORCORAN. I will next take up subparagraph (6):
(6) To pay or cause to be paid directly or indirectly any consideration or anything of value to any person to circulate, disseminate, or finance the cost
of circulating and disseminating, information to the effect that the price of
any security or securities registered on a national securities exchange will or
is likely to rise or fall partly or wholly because of the market activity of
any one or more persons;
That relates to the financing of tips of pools. I do not think there
is any substantial objection to a provision of that kind, is there, Mr.
Redmond?
Mr. EEDMOND. None. And I think we would like to see it go
further so as to prevent the activities of tipster sheets, which, as I
175541—34
6512
STOCK EXCHANGE PRACTICES
read subparagraph (6), does not do, because it is limited to the
statement in regard to the market activity of one or more persons.
Mr. PECORA. Tipster sheets might be covered by subdivision (5).
Mr. CORCORAN. With respect to new securities at least they are
covered by the present provisions of the Securities Act.
Mr. REDMOND. Yes; in regard to new issues of securities.
Mr. PECORA. Tipster sheets certainly ought to be brought within
the provisions of this bill, and if the language of the bill in its
present form is not certain to do that, it ought to be clarified and
strengthened accordingly.
Mr. REDMOND. I think certainly within the scope of one of these
two sections that result could be accomplished.
Mr. PECORA. Yes.
Mr. CORCORAN. I will now take up subparagraph (7), and from
now on the entente cordiale disappears. [Laughter:]
(7) To engage m any series of transactions or in any operation for the purchase and sale of any security registered on a national securities exchange which
has the purpose or effect of pegging, fixing, oi stabilizing the price of such security without having prior thereto reported to the exchange authorities and 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
With this section we enter upon the whole problem of the advisability of artificial price operations in the market* The theory of this
subparagraph is simply this: There is so much discussion of good
pools and bad pools to stabilize and to fix prices that the safe thing
to do is to say: " Let us not absolutely prohibit them, but let them
be carried on only under such rules and regulations as the Commission may devise and after they have first been reported to the
Commission."
Mr. REDMOND. Of course, we all recognize that there are perfectly
proper transactions in the matter of stabilizing prices. Our own
Government, in fact, has used that method very largely in the flotation of its own issues of securities. I personally very much question
the wisdom of putting in a criminal provision and requiring every
such transaction to be reported to the commission, because I think
you are going to flood the regulatory commission with a whole set
of details which it might well exclude by general regulation. I
think it has been the experience already of the Federal Trade Commission under the Securities Act that there are certain types of
transactions that they would like very much to exempt from the
provisions of that act, because they recognize that they are small
in amount or of a nature which does not require registration. Now,
if you should vest this power in the regulatory commission rather
than make it mandatory and a crime, unless the commission is notified in advance, you will have accomplished all of the same possibilities of regulation without in any way hampering ordinary and
legitimate business transactions.
Mr. CORCORAN. Well, doesn't that objection, Mr. Redmond, go to
the amount of information which would be piled in upon the commission, and couldn't the commission by its own rules and regulations prescribe, if necessary or if thought advisable, limits to the
amount of such information—Perhaps it would only be necessary
STOCK EXCHANGE PRACTICES
6513
to state the fact that a pool was to operate in a certain stock with
the purpose of stabilizing it within certain limits—and then there
wouldn't be any administrative burden upon the commission? Even
the mere fact of the prior filing of information would warn tha
commission that such an operation was to take place, so that if i t
wanted to make an investigation to see whether it desired further
information, it would have at least a warning that something was
up of which it should possibly take cognizance.
Mr. REDMOND. That is true, but remember that there is another
aspect of this problem. The records of the commission are public
documents, and, therefore, if you should form a group to stabilize
the price of a security, and announce it to the public, you open,
a new door to fraud that might be more vicious even than what
you are striking at,
Mr, CORCORAN. Why shouldn't the public know that an artificial
operation is being carried on in a stock? And in that connection
should be considered the broad question of the social advisability,
the wisdom from an economic standpoint, of having secret operations m a stock taking place while the public in complete ignorance
of the situation is buying and selling in the market on the faith of
the quotation going out on the ticker.
Mr. REDMOND. But you cannot make these things binding. For
instance, let me give you an example that I have in mind. Suppose
a group of people announce to the Federal Trade Commission that
they are going to stabilize the price of a certain security at a point
between 45 and 50, and that they had formed a group for that purpose with resources of a million dollars or of 5 million dollars. That
might lead many people to believe that that security would remam
within the range at which the group was stabilizing the price, and
that group might refuse to buy or sell a single share, and the price
might go down to 30 or up to 60.
Mr. CORCORAN. Well, the commission at the time it makes the
details of the intended operation public might clearly warn the public.
This subsection requires merely a filing of a statement of intention*
The process is just like the taking out of a marriage license. We
warn you that nobody knows whether the pool operators are going
through with the operation or not.
Mr. REDMOND. Isn't the answer to that, that the information given
to the public is of no value?
Mr. PECORA. In other words, it defeats the purpose.
Mr. REDMOND. Yes; completely.
Mr. CORCORAN. The public knows that there is an intention to
carry on pool operations.
Mr. REDMOND. And the public will rely on that published intention and may be^ misled.
Mr. CORCORAN. But if the public is warned at the time that possibly the pool operators will not carry out their filed intention, the
public does not need to be misled. It is only a question of how
accurate is the information given to the public.
Mr. REDMOND. I think, Mr. Chairman, I have expressed the doubt
that exists in my mind as to the value of this provision as a mandatorv provision, and that really is the point that I was trying to
make. Whether it might not be better to treat it as a permissive
one.
6514
STOCK EXCHANGE PBACTICES
Mr. CORCORAN. There is one other point raised by the Exchange in
connection with this subparagraph (7), and that relates to arbitrage.
An arbitrage transaction, of course, is one intended to keep in line
on different exchanges, the respective quotations for some security,
or to maintain the relative prices of securities within a given relation to each other. With your permission I should like to say I do
not believe that arbitrage transactions, which merely adjust prices
of securities one to another, come within the provisions of subsection
(7). If they do, then possibly the committee would like to consider
whether it wants to exclude or include arbitrage transactions, or,
if they are not in there, whether the committee wants to include them.
Now we come to subparagraph (8):
(8) To acquire substantial control of the floating supply of any security registered on a national securities exchange for the purpose of causing the price
<of such security to rise on the exchange because of such control of the floating
supply;
That relates to cornering a security. I do not believe there is any
substantial objection to that.
Mr. REDMOND. None except the vagueness of the definition of
floating supply, which I think should be, as this seems to be a criminal statute, made definite and certain.
Mr. CORCORAN. I will now take up subparagraph (9). I t shall
be unlawful—
To effect by use of the facility of any national securities exchange
The CHAIRMAN (interposing). Befdre you pass from that,
Mr,
Corcoran, what do you mean by floating supply?
Mr. CORCORAN. The supply that is in the market. That again is
a market term. Of the outstanding shares of stock a certain amount
is always held by more or less permanent investors, while a certain
other amount of the stock is sold back and forth on the exchanges,
usually represented by substantially the same certificates. That
floating supply is the stock which figures on the market and in the
quotations, and it is that floating supply which, if cornered, puts
anybody else who comes into the market at tremendous disadvantage
as against the person who has cornered that floating supply of stock.
Mr. PECORA. Mr. Bedmond, do you seriously think that the term
"floating supply" is one that needs elaboration in the bill?
Mr. REDMOND. I do, and I think that under the definition which
is given by Mr. Corcoran, it would be impossible, under this provision, to proceed against those who actually cornered the market,
because even when there is a corner there is always a residual amount
of stock that is in the hands of brokers that could be said to be
floating supply. A corner is, of course, a perfectly definite thing.
Mr. PECORA. YOU easily see the principle underlying this particular provision, do you not?
Mr. REDMOND. Yes; and we have it in our constitution.
Mr. PECORA. But you mean the effectuation of that principle by a
suitable provision in the bill.
Mr. REDMOND. Yes. And we go one step farther and suggest
that it be not a criminal provision out effective control by giving the
regulatory body power to fix the settlement price. I will say that
the exchange adopted that rule in 1925, in its constitution, and there
has been no approximation of a corner since then.
STOCK EXCHANGE PRACTICES
6515
Mr. PECORA. If you do that you might put the culprit into the
position of holding on to a part of his loot if he is detected.
Mr. KEDMOND. Wouldn't he be permitted to do this under that
provision
Mr. PECORA (interposing). He might take the chance, but the
penal arrangement would cause him not to take the chance. For
instance, a pickkpocket might not be deterred if he gave up half of
his loot in event of detection, but if the penalty is a penal arrangement it might deter him.
Mr. REDMOND. Suppose you were to make it so the pickpocket
could not profit at all ?
Mr. PECORA. That is just the plan, to set up a more effective
deterrent.
Mr. REDMOND. I t is a question of method, then.
Mr. PECORA. We are agreed that the principle should be inserted
in the bill, are we not?
Mr. REDMOND. Entirely, and I think the New York Stock Exchange was the first institution that adopted such a plan.
Mr. PECORA. All right.
Mr. CORCORAN. Next we have subparagraph (9) that it shall be
unlawful:
To effect by use of tl?e facility of any national securities exchange-^
,(i) Any transaction in any security whereby any party to such transaction
acquires any put, call, straddle, or other option or privilege of buying a security
from or selling a security to another party to the transaction without being
bound to do so; or
(11) Any transaction in any security with relation to which he has, directly
or indirectly, any interest m such put, call, straddle, option, or privilege, or
(m) Any transaction in any security for account of any person who, he has
reason to believe, has, directly or indirectly, any interest in any such put, call,
straddle, option, or privilege with relation to such security; or if a member,
directly or indirectly, to have or guarantee any interest in any put, call,
straddle, option, or privilege in relation to any security registered on a national
securities exchange
The puts, calls, straddles, mentioned specifically in this subparagraph are particular kinds of options. A put is a right to sell
to a given person at a given price within a definite time. A call is
the right to buy from a given person at a given price within a given
time. And a straddle is a combination of the two.
This subparagraph raises the whole problem of what Congress
thinks should be the policy of regulation in respect of options. The
exchange argues in its brief that there are good option transactions
as well as bad option transactions. The theory upon which this
subparagraph was drafted is that there is no satisfactory way
of distinguishing good options from bad options, or of knowing
when an option originally taken for a good purpose turns into a bad
option, and therefore, faced with the inability to distinguish between
kittens and cats, it is better on the balance of convenience to prohibit
options altogether.
Now, shall I go on, Mr. Chairman 1
The CHAIRMAN. Yes.
Mr. KEDMOND. I think Mr. Whitney's brief states the fundamental
objection, and that is that you are destroying completely a perfectly
legitimate form of contract, purely because it is capable of abuse.
But that, of course, is true of every single form of business in the
6516
STOCK EXCHANGE PRACTICES
whole world. Abuses can exist. But thalt does not mean that
business should stop.
Mr. PECORA. I have not seen the exchange's brief yet, Mr.
Redmond.
Mr. REDMOND. I t was Mr. Whitney's statement made before the
House committee that Mr. Corcoran is referring to, I think.
The CHAIRMAN. Does the exchange approve of puts and calls ?
Mr. REDMOND. The exchange does not permit trading in puts and
calls on ihe floor, and it does not recognize them as exchange contracts until notice of their exercise has been served. Foreign exchanges, particularly the London market, not only recognizes option
contraete but permits dealing in them exactly as ii they were dealing
in securities. That is also true of the Paris Bourse and the Berlin
Boerse. That is practically true the world over
Mr. PECORA. Give us an illustration of that.
Mr. REDMOND. We will assume a corporation has a large block
of securities to distribute. It may give an option to a dealer so
that that dealer may go out and distribute them in a perfectly proper
way.
Mr. PECORA. It also dangles before the dealer the temptation to
resort to market operations.
Mr. REDMOND. Well, temptations exist in everything.
Mr. PECORA. All of the evidence before this committee in regard
to options that has been presented up to the present time consist
of instances where options have been prostituted to ulterior uses
and purposes.
Mr. REDMOND. Well, isn't it true that your investigators have had
access to the files of the committee on business conduct of the New
York Stock Exchange, where all options have been reported since, I
think, the first of August 1933?
Mr. PECORA We haven't had the time nor the facilities for investigating all of those options or the activities of the persons
holding those options
Mr. REDMOND. It does not necessarily follow just because the evidence which has been presented to this committee, a very limited
number of cases, did involve operations in the market in connection
with options, that all options must be connected with market
operations.
Mr. PECORA. Well, I think a generalization to that effect may be
said to have been made by members of the exchange who have operated under options. They have frankly said what their purpose was.
Mr. REDMOND. In some instances that is true, but I think
Mr. PECORA (interposing). I think m some instances members of
the exchange who have been examined here have testified that that
was the general purpose for obtaining such options.
Mr. REDMOND. But they were members of the exchange, if I remember correctly, who were primarily floor men I think you are
referring to the testimony of Mr. Wright.
Mr. PECORA And he was not the only one.
Mr. REDMOND. And that of Mr. Mason Day ?
Mr. PECORA Those two, and this committee has heard testimony
of dealers and investment bankers generally along similar lines.
Mr. REDMOND. But I do not want, of course, to go into an argument on the basis of the evidence, because I am not here to give
STOCK EXCHANGE PRACTICES
6517
evidence. But it is I think true, and I think the committee should
consider the possibility that option contracts in large quantity
entirely for legitimate purposes, do exist.
The CHAIRMAN. Very well, Mr. Corcoran, you may proceed.
Mr. CORCORAN. I next take up subsection (b) of paragraph (9),
and I mi^ht explain that the next three sections which I shall read
give a civil right to an individual
Mr. PECORA (interposing). May I interrupt you for just a
moment?
Mr. CORCORAN. Certainly.
Mr. PECORA. This bill insofar as it prohibits options prohibits
the use of them through the facilities of exchanges, don't they, Mr.
Redmond?
Mr. REDMOND. That is true. But the facilities of an exchange
Mr. PECORA (continuing). And therefore would not cover an
option given by a corporation to distribute a part of ite stock
through means other than the facilities afforded by an exchange.
Mr. REDMOND. But the facilities of an exchange are defined in
such broad language that it might easily sweep in the entire securities business of the country. For instance, section 3, subsection (2),
provides:
The phrase "facility of an exchange" includes its premises, tangible or
intangible property, whether on the premises or not, any right to the use
of such premises or property or any seivice thereof, including, among other
things, any system of communication to or from the exchange, by ticker or
otherwise, maintained by or with the consent of the exchange, and any right
of the exchange to the use of any property or service
Therefore if a person used a ticker to see what the quotations
were in connection with a dealer's operation me might be said to
be using a facility of the exchange.
Mr CORCORAN. If I may be permitted to suggest, Senator Fletcher,
it may be possible to except from the provisions of this section,
warrants or options that are registered on an exchange, except that
that raises again the whole problem of whether warrants or options
should be registered.
Mr. REDMOND. What would you do with rights to subscribe?
Mr. CORCORAN. On a great many exchanges they are listed, aren't
they ?
Mr
REDMOND. Yes.
Mr. CORCORAN. I would say in a case like that that you might make
an exception for those warrants and options that it is advisable to
have listed on an exchange.
Mr. REDMOND. I think the section deserves, and this is the only
point I wish to 'make, further consideration before a useful and normal commercial practice is made criminal.
The CHAIRMAN. We will consider that, Mr. Redmond.
Mr. REDMOND. All right.
Mr. CORCORAN. NOW, going on with the next three paragraphs,
(&), (<?), and (d), these give to any individual injured by reason
of having been induced, by reason of any practices forbidden by the
preceding sections, to buy or to sell securities at the price at which he
did buy or sell them, the right of civil action for damages for the
amount of the injury done him.
6518
STOCK EXCHANGE PEACTICES
The criticism the Exchange made of these sections is that they
do not confine the measure of recovery to the actual damage suffered
by a person who has actually sold or bought securities after the first
transaction which he was induced to make by these manipulative
practices. That is, the bill as now drafted does not limit civil
liability to actual damage which can be proved to have resulted from
a violation of the preceding paragraphs of this section, as it can be
proved, in the case of the man who buys on the faith of a pool tip
and actually sells out, or of the man who sells short on a pool tip
and then actually buys in and covers, so that you know what the
exact damage is.
I would suggest that possibly the section should be amended to
make certain where you can prove actual damage, that that be the
limit of the damage. The sections as they are now drafted—but
perhaps I had better read them:
(6) Any person who participates in any act or transaction in violation of
subsection (a) of this section shall be Uable to any person who shall purchase
any security, the price of which may have been effected by such act or transaction, and the person so injured may sue in law or equity in any court of
competent jurisdiction to recover the difference between the price he paid
for such security and the lowest price for which such security shall have
sold on the exchange during the 90 days preceding and the 90 days following
such purchase, and such additional damages, if any, as the person suing may
prove that he sustained as a result of any such transaction
The theory of the section is that if a pool is operating, or if a tip is
circulated that a pool is operating, a person might buy a security at a
price at which he might not otherwise have bought it. Then if you
cannot prove actual damage to him by reason of reliance upon the
pool tip, you will give him the difference between the very high
price at which he did buy and the low price during the 90 days before
and after the transaction, which in a very, very rough way measures
the price at which he might have bought if it had not been for the
pool tip that induced him to buy at the particular time that he did.
The principle of civil liability for the damage, with which I do
not think the exchange agrees, is moreover not only a matter of justice
to the person injured but is also the surest way of guaranteeing that
there will be some compliance with the section. In other words,
there is no policeman so effective as the one whose pocketbook is
affected by the degree to which he enforces the law.
Now, the Exchange will reply to that, that it opens the law up
to a great many strike suits. That is the objection you hear in
connection with other sections of this bill, and it has to be looked
in the eye right now. I t is the same objection made to the liabilities
under the Securities Act. It is the bugaboo that there will be a
great many unjustified strike suits by which unscrupulous lawyers
will hunt up clients with whom they may make up cases to shake
down defendants.
I might say that the strike-suit bugaboo has been talked about so
much in connection with the Securities Act that, so far as purely
informational purposes go, there is hardly need to talk about it
here. Some lawyers, whose judgment is probably as good as that
of others, will tell you that ordinarily a strike-suit lawyer won't
take on a case unless there really is a pretty good case, for other
STOCK EXCHANGE PEACTICES
6519
Wise he won't be paid. And that, as a mater of fact, about the
only effective weapon there is for keeping certain big financial operators m line and within some semblance of the law is the fear that
the strike suiter might be just around the corner. Futhermore, there
are a great many people who think that the strike suit is a weapon
of social utility not to be discouraged rather than something to be
shouted about as a species of unfortunate blackmail.
As a matter of fact, I think I have a strike suit right here that
was approved by the Supreme Court of the United States the other
day in the National Radiator Co. reorganization.
Mr. REDMOND. Was it a strike suit? I didn't know it.
Mr. CORCORAN. Why, you know, Mr. Redmond, that the three
plaintiffs in that case must have been called the name that you and
I are familiar with all over the street for months and months.
Mr. REDMOND. Well, Mr. Corcoran, I do not think it is profitable
to discuss a particular case, but I would like to point out what I
understand to be the result of that decision and see whether its
social utility is so great. I believe some 95 percent of the bondholders agreed on a plan of reorganization. Five percent did not agree.
Th company having been in a bad way, the reorganization was a
drastic one. The company has had further reverses, and I understand that as a result the 5 percent who recover under that decision
will take the entire property which belongs to the 95 percent. I
question very much whether the strike stut which has a result like
that is to the benefit of the public as a whole.
Mr, CORCORAN Well, Mr. Redmond, here is the decision of the
Supreme Court of the United States.
Mr. PECORA. Mr. Corcoran, that was a unanimous decision.
Mr. CORCORAN. It was a 9-judge decision, and the nine judges
seemed to think that the reorganization had been pretty bad, not
only for the 5 percent who did not consent to it but also for the 95
percent, probably 60 percent of whom did not know what they were
doing when they consented to it
Mr. REDMOND. I do not know anything about what they had in
their minds when they consented to it, nor do I question the soundness of the decision, because the decision was predicated upon a very
technical point, and that was that an equity receivership was used in
a case which ought to have fallen withm the provisions of the bankruptcy law. I think I am stating the legal principle correctly.
Mr. CORCORAN. I am afraid the court, whether by way of dicta or
otherwise, certainly went much further than that in the language it
used in the case.
Mr. REDMOND. It may have; but I think probably we are consuming the time of the committee with a technical legal discussion.
Mr. CORCORAN. I am just, sir, trying to find an accolade of justification for a strike suit, and I cannot think of anything better than a
decision of the Supreme Court of the United States on the matter.
All strike suits are not bad.
The CHAIRMAN. What case was that?
Mr. CORCORAN. First National Bank of Cincinnati against Flershem & Co., handed down by the Supreme Court on January 8 of
this year.
6520
STOCK EXCHANGE PRACTICES
We come now to section 9, on the regulation of manipulative
devices.
It shall be unlawful for any person, directly or indirectly, by use of any
means or instrumentality of interstate commerce or of the mails or of any
facility of any national securities exchange—
(a) To effect the sale of any security registered on a national securities
exchange, which at the time of such sale was not owned by such person or his
principal except in accordance with such rules and regulations as the Commission may prescribe as appropriate or necessary in the public interest or
for the protection of investors,
(6) To use or employ or to execute or accept for execution any stop-loss
order in connection with the purchase or sale of any security registered on a
national securities exchange except m accordance with such rules and regulations as tjie Commission shall prescribe as appropriate or necessary in the
public interest oi for the protection of investors
What that comes down to is this, that it shall be unlawful to sell
short or to use stop-loss orders except under such rules and regulations as the Commission may prescribe. That avoids a decision as
to the utility and advisability of short selling and stop-loss orders by
putting it up to the administrative commission to permit their use
under such regulations as it shall deem advisable.
In connection with the short selling it is interesting to notice that
m this morning's Herald Tribune—no, it is the Tribune of the
21st—there is a quotation from another report of the Twentieth
Century Fund on short selling, which to a slight degree disagrees
with the position of the Exchange that short selling is a very valuable
factor in cushioning a falling market. This is from the report of
Mr. Evans Clark*
Whatever influence short selling does have on general price movements is
to accelerate the downward trend of prices duimg the early and middle phases
of a decline, and either to check the price trend m the lower phase or accelerate the recovery after prices have turned upward
Then outside the quotation from the Herald Tribune:
According to figures gathered by the Fund, short selling does not have any
appreciable effect on limiting the extremes to which prices may rise
I am simply calling the attention of the committee to that report,
because in considering what the policy should be m respect of short
sales that report may be very useful to the committee.
The CHAIRMAN. DO you understand the provisions of the bill now
prohibit or prevent stop orders?
Mr. CORCORAN. It prohibits stop-loss orders except in accordance
with such rules and regulations as the commission shall prescribe.
The CHAIRMAN. What line and page is that ?
Mr. CORCORAN. It is on page 20, sir.
The CHAIRMAN. I have had some criticism to that effect, that they
ought not to be absolutely prohibited.
Mr. CORCORAN. They are not, sir, as the bill is now drawn.
The CHAIRMAN. Yes. I did not think it was, myself.
Mr. CORCORAN. NOW, if we may go on to the next section, on the
segregation and limitation of the functions of broker, specialist,
and dealer. Possibly we would better first read the section (reading):
It shall be unlawful for any member of a national securities exchange or
any peison who as a broker transacts a business in secunties through the
medium of any such member to act as a dealer in ojr underwriter of securities,
whether or not registered on any national securities exchange It shall be
STOCK EXCHANGE PRACTICES
6521
unlawful for any member of a national securities exchange to act as a specialist unless registered as such with the exchange, subject to such rules and regulations as the Commission may prescribe, and it shall be unlawful for any
specialist on a national securities exchange (a) to effect on the exchange any
transaction except on fixed-price orders or (b) to disclose to any other
person information in regard to orders placed! with him which is not available
to all members ot the exchange An exchange may provide that officers or
employees of the exchange may perform the functions of specialist subject
to such rules and regulations as the Commission may prescribe
I shall not attempt to go into that section too much m detail,
because, sir, you will probably hear more about that section from
other witnesses before this committee than about any other section of
the bill.
The situation which that section meets in a certain way—and
there may be other proposals for ways to meet it—is simply this:
At the present time there are operating as part of the machinery
through which the public buys securities underwriters who underwrite and distribute a security, and for the sake of their own reputation, as well as out of a sense of duty to their customers, attempt
to maintain a good market in that security after it has been distributed.
There are on the other hand brokers who act theoretically as
agents for customers who send m to them orders to buy or sell securities on exchanges.
As I told you before, a good deal of the business done on exchanges,
although all actual orders on an exchange are executed by brokers
who are members of such exchange, originates with brokers who are
not members of the exchange but who clear their transactions
through an exchange broker.
Intermediate between the underwriter, who has a very special
interest in sponsoring and maintaining the market for a particular
stock or security, and the broker who acts only as a commission
agent to execute an order to buy or sell for a commission, there is
a group of dealers who, as merchants, buy and sell securities for their
own account and resell them to the public.
Very often a stock exchange house will be a broker, it will also
be an underwriter, and it will also have a dealer's department in
which it peddles out stocks or bonds that are bought on the exchange. And you have two evils that arise out of that duality or
tripality of function.
First of all, if a broker is also an underwriter, or to a less extent
if he is a dealer, and a customer comes to him, he acts as a practical
matter not only as the commission agent to execute the transaction
on the exchange but also as the customer's investment lawyer and
gives the usually bewildered customer advice as to what to buy. The
broker thus may be in a very tempting position—a little too much for
ordinary humankind. A customer comes to him and says: " I want
to buy some stock. What shall I buy ? " And thus, in connection
with every broker's office there is an informal investment service
going on. If the broker unconsciously has real faith in a security
because, as an underwriter he promoted it, or if he is not quite thai
honest and wants to get as many orders as possible into the market
to hold up the price of the security that he has floated, he is in a
very tempting position to advise the customer to put in an order to
buy that security m which he is personally interested.
6522
STOCK EXCHANGE PBACTICES
The other difficulty is that the capital in the brokerage business
becomes involved in the operations of the broker in his capacity as
dealer or underwriter.
As we said this morning, the four biggest failures in the Street,
Prince & Whitely, Pynchon & Co., West & Co., and Bauer, Payne,
Pond & Vivian, were cases where insofar as their brokerage accounts
were concerned the houses were perfectly solvent. But their assets
were involved in positions in securities which they had sponsored or
in which they were interested, and when they were wiped out in
their positions in such securities the bankruptcy pulled the brokerage
clients down with them.
On the other side of the picture you have the fact that at the
present time both in New York City and throughout the country
there is a great deal of actual combining of all these functions.
You will hear argument before you from other witnesses that if you
drive a person to choose, as this bill would do, between being a broker
on a stock exchange and a dealer or an underwriter or a broker off
the stock exchange, you will make it very, very difficult for many
houses to continue in business at all
You must remember that one of the advantages to a dealer in
being a member of the stock exchange is that he does not have to pay
regular stock-exchange commissions, and that a good many dealers
operate on a spread which at the present time would not permit them
to stay in business if they are to pay a full broker's commission..
You have another complication in the situation arising out of the
position of the so-called "odd-lot dealer." The New York Stock
Exchange does not deal in lots of less than 100 shares. If a small
investor wants to buy less than 100 shares the order he gives to his
broker is not met by the offer of another broker on a stock exchange
as a brokerage transaction. The broker really buys 10 shares from
an odd-lot dealer who has purchased those shares and taken a position under an arrangement with the exchange whereby he agrees that
he will sell odd lots at any time within a given fraction of a point,
one quarter or three eights, or a half, of the last transaction in the
security.
Mr. REDMOND. Mr. Corcoran, for the sake of the record, that differential is one eighth.
Mr. CORCOCAN. That is on the New York Stock Exchange ?
Mr. REDMOND. Yes.
Mr. CORCORAN. HOW about the odd-lot dealers in securities on
other exchanges? The Curb is higher than that.
Mir REDMOND. There is no organized odd-lot dealer, as I remember
it, on the curb. The specialists do the odd-lott business. But on the
New York Stock Exchange the differential is one eighth on the active
stocks.
Mr. CORCORAN. The problem before you is, how are you going to
handle the situation where it is undoubtedly very much to the
advantage of an investor that he should ba dealing with a broker
who has nothing to sell him but is willing to act as a completely unbiased agent, and with a broker who is not going to imperil the
customers position by investing his capital in positions of his own
as a dealer or an underwriter ? How are you going to reconcile that
with the fact that the brokerage, investment, and dealing business
is in many cases today organized as a unit ?
STOCK EXCHANGE PBACTICES
6523
The underwriting business is not profitable today. The underwriting business is a feast and famine business. The backlog of
many of the houses that in better times carried on the bulk of
the underwriting business is brokerage commissions at the present
time.
I t is very clear that one exception should be made to the provisions of the section as now drawn, and if I might suggest,,
Senator, I would like to reccxmsjend that in the case of the odd-lot
dealer who really has to clip his spread very close to serve the
public which wants to buy odd-lot securities, some exception should
be made to the rule expressed in this section, which demands that
nobody can be a member of the exchange except a broker.
I should like to suggest, if 1^ might, that the provisions of this
section that only brokers can be members of exchanges might be
modified to permit odd-lot dealers also to be members of the
exchange and to have the advantage of not having to pay full
brokerage commissions, under such rules and regulations as the
Commission may prescribe.
Now, as for the treatment of the rest of them: As this section is
drawn it says the exchange has no justification in the economic
system except as a market place in which the orders of the investing public can be executed. Therefore, no one can be a member
of the exchange except a broker.
A suggestion has been made that if, as a matter of fact, the
hardship that will be worked on houses doing a combination business at the present time is too great, if because they choose to do
a dealer or an underwriting business, they would under this rule
have to withdraw from the exchange as brokers, some arrangement
might be worked out to enable them to operate for a limited period,
say 1 or 2 years, off the exchange, but with the privilege of splitting
commissions under very careful rules and regulations with members
of the exchange. That is, a house that had been a member of the
exchange but wanted to concentrate in a dealer or underwriting
business would withdraw from the exchange but would be permitted to have an arrangement under which it could split commissions for a time on the brokerage business that came into it with a
broker on the exchange, so that it would not have to pay full
brokerage commissions during the period of transition.
That would, you see, permit a house to do a brokerage business
off the exchange as well as act as a dealer or underwriter, but it
would not have a broker's privilege of going on the floor of the
exchange, nor would it, except for this transition period, be able to
do business at ordinary stock exchange member rates or without
incurring any commission at all. I t would only be able to do business through another broker on the exchange but at a very much
reduced rate.
The further suggestion has been made that if that sort of a compromise is worked out some arrangement should be made to insure
that the capital of such a house which continues to stay off the
exchange in the brokerage business, and in the dealer business, the
underwriting business should be divided and segregated so that a
certain portion of it would be definitely allocated to the brokerage
business and a certain portion of it definitely to the dealing and
6524
STOCK EXCHANGE PEACTICES
underwriting business. The result would be that if there should be a
crash in the house, for reasons connected with its dealer business or
its underwriter business, that crash would not involve the safety
of the customers who were trading with it as a broker. [Addressing
JMr. Redmond.] Do you want to step in here?
Mr. EEDMOND. NO ; unless you are through.
Mr. CORCORAN. NOW, the next point relates to the specialists. You
will undoubtedly hear a great deal about specialists from the witnesses who will follow. Your committee has, of course, heard a
great deal about specialists in the investigations that have been held
before you. We may read section 10 again with respect to specialists.
I t provides [reading] :
It shall be unlawful for any member of a national securities exchange to
act as a specialist unless registered as such with the exchange, subject to
such rules and regulations as the Commission may prescribe.
There is no objection to the language so far.
It shall be unlawful for any specialist on a national securities exchange
(a) to effect on the exchange any transaction except on fixed price orders or
(&) to disclose to any other person information m regard to orders placed
with him which is not available to all members of the exchange. An exchange may provide that officers or employees of the exchange may perform
the functions of specialists subject to such rules and regulations as the Commission may prescribe.
The specialist—and as an amateur I hesitate to talk about such
an intricate subject—the specialist is a combination of a clerk who
keeps the books for orders, and also a kind of dealer who trades for
his account to make a market in a security between the extremes of
the orders that are on his books. If there are orders to buy at 90
and to sell at 93, the theory of the function of the specialist is to
keep the. buying orders on his books until they meet selling orders,
or himself to buy and sell at some point in between the difference
between the bids and offers, so that a market may be maintained at
the time when no natural juxtaposition of the buy and sell orders
occurs and there is no natural market for the security.
Now, the abuses that have arisen out of the specialist system:
The specialist, of course, always knows what is on the books and
has, so long as he is trading for his own account, an inside look at the
<eards of a poker game. The difficulties of the specialist system have
been completely brought out in investigations before your committee.
There is in the brief of the stock exchange a long argument for the
specialist system as it is at present set up. Without attempting to decide between them, I think it might be a good thing if I should read
to you a slightly different attitude toward the specialist, which was
reported this morning by the Twentieth Century Fund, the report
of the 30 experts who, acting completely independently of any pros
and cons toward this stock exchange bill and under the auspices of a
very trustworthy board of directors, have reported on several phases
of market regulation. There is a report given this morning on
collusion of specialists with pools. May I be permitted to read it for
the record?
The CHAIRMAN. Yes.
Mr. CORCORAN (reading):
STOCK EXCHANGE PEAOTIOES
6525
The testimony of members of the New York Stock Exchange given before
the Senate Committee on Banking and Currency tends to confirm the common
knowledge of "the Street" that collusion with specialists has been a method
of price manipulation used by pools This practice is almost impossible to
jrove, but enough evidence has been cited in the survey to establish a reasonable presumption that it exists
The key position of the specialist in the operation of the market is clearly
revealed in a special statistical study of original source material included in
this survey This covers a detailed examination of the actual books of 69
floor members in 151 typical active, semiactive, and inactive issues made
available for this purpose by those concerned for 4 periods of 1 week each
in 1933, representing periods of slow and rapid advances and declines of
prices The records show that about one half of all the transactions in the
New York Stock Exchange go through the specialist's hands While the
specialist is prohibited by the Stock Exchange rules from divulging the orders
on his "book", he himself has at all times a clear picture of the buying and
selling orders which would become effective at various price levels The
specialist acts not only as a broker, but also can trade on his own account—
except that he is forbidden to act as broker and dealer m the same transaction
The specialist is expected to "make the market" in his stock To enable
him to carry out this duty he is permitted to buy or sell for his own account
shares of the stock in which he is the specialist When he acts as a commission broker he is an agent, but when he buys or sells for his own account
he acts as principal It is through his personal transactions that he may
influence market prices
It appears that the influence of the purchase and sales of the specialist will
vary because of certain conditions prevailing at the time. In a dull market a
comparatively small percentage of trades, if made on one side of the market,
will probably produce as definite a reaction as a larger proportion in a more
active market The condition of his "book" will materially affect the influence of his transactions and alter the percentage of total sales required to
produce a specific result. That the specialist, by the very nature of his relationship to the market, is in a position whereby his influence may be readily
converted into a price factor of major importance, and may even become the
price determinant, is scarcely open to question.
The records included in this survey show that the personal trading of
specialists for their own account bulks large in the day-to-day operations of the
New York Stock Exchange About 15 percent of all transactions are of this
nature While this personal trading of the specialist is justified by defenders of the practice as making a continuous market, the facts show that
this trading constitutes a larger proportion of total transactions
in the active
stocks which would have a continuous market without his7 personal trading
than in the less active stocks.
Furthermore, there is serious doubt as to whether the specialists' personal
activities exert a stabilizing effect on the market. The records ot their trading jEor their own account does not disclose any pronounced tendency to trade
either with or against the trend of the market, but they show that the
specialists' activities are of the in-and-out variety and that their profits and
losses are based largely on price changes within each trading session.
That is the report of about as expert a group as you could have.
I t is very interesting—I think I have the report here—in connection with this subject to see what the Twentieth Century Fund did
recommend as to the segregation of brokers and other operators on
the exchanges. This is section 6 of the filing committee's report
read on February 9. I am reading from the New York Times
report:
No individual or firm doing a commission business in securities should be
permitted to act as a dealer in securities or to trade in securities, either on
margin or otherwise, for his or its own account
6526
STOCK EXCHANGE PRACTICES
The difference between the provisions of this bill and the Twentieth Century report is that this bill refuses to allow a dealer to be
on the floor at all.
And with respect to specialists:
Specialists, as well as other exchange members, should be permitted to function either as traders or as brokers but not as both.
There is one other operator on the exchanges who operates solely
for his own account whom the bill would prohibit being a member of
the stock exchange, and that is the so-called " floor trader." I understand that of the 1,300-and-odd members of the New York Stock
Exchange there are at the present time approximately 100 members
who, though entitled as members of the exchange to carry on any of
the operations on the floor of the exchange, including brokerage,
simply trade on the floor for their own account. Those are the
so-called " floor traders."
Under the terms of this bill a floor trader could not be a member
of the exchange. Only brokers could be members of the exchange.
I t has been argued for the floor trader that his constant operations in and out of the market make for a more even and constant
market. The argument is because of the floor traders as well as the
specialist, who is a species of floor trader, in not quite so concentrated a form, the differences between sales are a quarter or an eighth
of a point instead of being two or three points.
That, again, is one of those arguments for liquidity in the market,
in which the advantages of liquidity may be well weighed against the
disadvantages of having on the floor of the exchange a body of men
who have no function with relation to the public but whose activities
on their own behalf are supposed, without any intention on their
part, to operate to the benefit of the public.
Floor traders may cut down the spread between sales from
sale to sale, but they do not in any way cushion the market over the
day, because the floor trader, who knows and senses the trend of the
market better than any individual broker, knows where it is going
much better than the people on the outside who have to buy from the
ticker, naturally follows the trend.
Most floor traders actually unload in the course of a day. This
bill would drive the floor trader from the floor.
Just before we finish on this segregation section and I turn it over
to Mr. Redmond, there is one argument being made in connection
with permitting brokers, dealers, and underwriters to continue in a
unified business that really from the side of the economic structure
deserves some of your attention.
I t is argued; the underwriting business at the present time is unprofitable; if you do not allow the present underwriting houses to
have a bread and butter commission business they will have to go out
of business, and then what will happen to the necessary national
machinery for distributing securities ?
In all fairness, and I mink I have fairly stated and recognized
the practical problem of immediacy in divorcing these three-in-one
businesses, it might not be such a bad thing if a lot of the underwriting outlets did have to go out of business. One of the difficulties
with the market of 1928 and 1929 and with the kind of security that
was put out in that underwriting market of 1928 and 1929 was that
STOCK EXCHANGE PBACTIOES
6527
the securities-distribution machinery had been built up to the point
where there were so many outlets, so many men, and such an investment in the business that securities had to be found at any cost to
keep that machine going. Matters had reached a point where the
maintenance of the mechanism had become more important than the
quality of the merchandise that the mechanism had to sell. Dr.
Goldenweiser told you yesterday that we reached a point where
issues advertised by underwriting syndicates were sold and snapped
up before anyone really knew what the issue was about.
We had a very much overbuilt underwriting and distributing
mechanism in 1928 and 1929. In the opinion of many well-informed
people, it was not a good thing for the country to have such an
overbuilt mechanism. And it might be well in considering the validity of the argument that these three-in-one businesses must be left so
that there will be an outlet for the underwriting of securities when
underwriting again becomes possible, to consider that it might not
be such a bad thing if we did not have quite so much underwriting
machinery, with a temptation which the size of that machinery
entails to sacrifice the quality of securities.
The CHAIRMAN. Was that responsible to some extent for the overissue of securities?
Mr. CORCORAN. Yes; very definitely so, Senator.
Mr. REDMOND. Mr. Chairman, you undoubtedly will have many
witnesses more qualified than I to discuss the complicated questions that are touched on by this section. The only thing I would
like to point out is that this section carries out certain theories, which
have been based upon certain conclusions drawn from the evidence
before this committee or upon the study made by the twentieth century fund, and makes mandatory these separations.
Senator GOLDSBOROUGH. May I ask you what section you are dealing with?
Mr. REDMOND. Section 10, page 21.
Mr. Whitney, in his statement to the House committee, merely
had this to say in describing the powers which might be vested in
the stock-exchange authority:
That this authority should also have power to study and, if necessary, to
adopt rules in regard to those cases where the exercise of the function of
broker and dealer by the same person is not compatible with fair deaUng.
That I take it is the position of the exchange; that instead of a
mandatory provision this question of the segregation of the functions of broker and dealer should be studied and only those prohibited that are incompatible with fair dealing.
The CHAIRMAN. I S your membership now, Mr. Redmond, limited
to brokers ?
Mr. REDMOND. I did not get the question.
The CHAIRMAN. I S your membership limited to brokers ?
Mr. REDMOND. NO, Mr. Chairman. A member of the exchange
can act, as Mr. Corcoran said, as a broker or as a dealer or as a
floor trader.
The CHAIRMAN. Yes; but is anybody eligible for membership in
the exchange except the brokers ?
175541—34—PT 15
8
6528
STOCK EXCHANGE PEACTICES
Mr. REDMOND. Yes; any person who is a citizen of the United
States, more than 21 years of age, as I remember the constitutional
provision.
The CHAIRMAN. SO you would not like to have the membership
limited to brokers as this bill provides?
Mr. REDMOND. AS this bill provides, Mr. Chairman, that would
prevent entirely many of the dealing functions which are now and
have been for many years a normal part of the market.
Mr. PECORA. That is, you would prohibit those functions being
exercised by persons who also exercise the functions of a broker?
Mr. REDMOND. Insofar as that, after study, was found to be
incompatible with fair dealing.
The CHAIRMAN. YOU agree, though, that no man ought to be in
position to serve two masters at one time?
Mr. REDMOND. I would not quite make that generalization, Mr.
Chairman. I think in many things that we do, we serve two masters.
Mr. PEOORA. Well, if two masters include self, do you think that
principle should be followed?
Mr. REDMOND. I think it is perfectly possible. It is done in all
lines of business, isn't it, Mr. Pecora?
Mr. PECORA. I think it has come under the ban of our courts quite
extensively.
Mr. REDMOND. I think the court of appeals in a case not long ago
took the position that, while dealing as a broker and as a principal
raised a question that required investigation, there was nothing
in that relationship which in and of itself was unlawful.
Mr. PECORA. Apart from the question of legality, how do you
deal with it on the basis of morals? Do you think a man should
be put in a position where he may have to make a decision that
would involve consideration on the one hand of his own interests and
on the other hand the interest of his customer or client?
Mr. REDMOND. I think that we are faced in life every day by
questions of just that kind, and that that is why we have ethical
standards. Some people cannot stand the temptation, but the vast
majority of honest people can. I t goes without saying as Senator
Gore said this morning, that you cannot legislate temptation out of
the way.
Mr. PECORA. YOU may not legislate it entirely out of the way, but
when you legislate against a situation which creates the temptation
or accentuates it, it might be a good thing to do.
Mr. REDMOND. That is what we did m the prohibition law, isn't
it, Mr. Pecora?
Mr. PECORA. This is not a sumptuary law like the prohibition law.
You are not using a fair analogy, in mjr opinion.
Mr. CORCORAN. Section 11, registration requirements for securities : This is the section on which you have heard perhaps the loudest
thunder from the exchanges, and this is the section which the
exchange has advised all corporations in the United States puts
them completely under the domination of the Federal Trade Commission. I think it might be a good thing, at the expense of boring
you a little, to read the section through before we start to talk
about it.
SEC 11 (a) It shall be unlawful for any person to effect any transaction in
any security on a national securities exchange unless a registration is effective
STOCK EXCHANGE PBACTICES
6529
as to such security in accordance with the provisions of this act and the rules
and regulations made hy the Commission thereunder and unless such security
lias been issued.
The rest of this section in effect permits the Federal Trade Commission more or less to dictate within certain limitations the listing
requirements for securities on stock exchanges. When a security is
fully listed for trading on a stock exchange it is required to meet
certain requirements before it is admitted to listing. To be listed
on the New York Stock Exchange security has to be seasoned 2 or 3
years to make certain that it is well distributed; and, furthermore,
to make certain that it has a certain quality. Otherwise, the New
York Stock Exchange will not deal with it. To a lesser degree
similar requirements are made of securities listed on all exchanges.
This section in effect says the Federal Trade Commission will
have something to say about the listing requirements in the event that
the listing requirements imposed by the exchanges are not stiff
enough to meet what the Federal Trade Commission thinks is decent
protection of the public in buying that security.
Now, the very fact that the stock exchanges universally require
the filing of certain information, the making of certain reports to the
stockholders and the observance of certain covenants as to practices by listed companies, shows that listing requirements for the
securities and the enforcing of compliance with certain decent standards of operation is a normal part of the function of a securities
exchange or of any other securities market.
With that background, let us go on and read section (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
such undertakings, information, and documents as the Commission may by its
rules and regulations require in the public interest and for the protection of
investors, together with such additional undertakings, information, and documents as the exchange may require
Now, it is upon an interpretation of the breadth of that language
that the exchange, outside of reliance upon the power of the Commission to enforce uniform accounts, depends for its charge that
this bill puts all American business under the heel of the Federal
Trade Commission: The specific language is that a security may
be registered, that is, it may be listed, only upon the " filing with the
exchange and with the Commission of such undertakings, information and documents as the Commission may by its rules and regulations require in the public interest for the protection of investors."
The language is " such undertakings as the Commission may by
its rules and regulations require " but notice the qualifying phrase
that comes afterwards—" in the public interest and for the protection of investors." The exchange has put an interpretation upon
that language that says there is no limit to the kind of undertaking
which the Commission may demand as a condition of listing; that
the Commission will be in a position where, if it just does not like a
further investment in a particular industry during a year, it may
say, " No more capital goes into that industry. We just arbitrarily
refuse to let you list, because in our judgment industry does not
need this particular issue."
Now, I am facing this thing squarely and hammering on the
language because I think that when you read the rest of the section
6530
STOCK EXCHANGE PBAOTIOES
in the light of which that allegedly too loose language has to be
interpreted, you will see by the kind of things asked for in the
specific parts of the section that it is an unfair interpretation of the
language to say that there is any intent to set up a capital issues,
committee in the Federal Trade Commission, seeking under the guise
of prescribing listing
Mr. KEDMOND. Might I interrupt you there, simply because you
have said that it is an unfair interpretation, and I take full responsibility for interpreting the legal aspects of this bill to the
exchange. You are aware, are you not, Mr. Corcoran, that in another and later provision the findings of the Federal Trade Commission as to the facts are made conclusive?
Mr. CORCORAN. That is a provision that is a prerogative of every
administrative commission. I t is one of the first principles of
administrative law that an administrative body, when appeal is
taken from its decision to a court, is in the position that its findings
as to facts, unless absolutely unsupported by the evidence, are conclusive.
Mr. KEDMOND. But you will admit, will you not, that that power
given in this provision—that these regulations be such as the Commission will require in the public interest and for the protection
of investors—allows the Federal Trade Commission, whenever it
thinks that a thing is in the public interest and for the protection
of investors, to demand it?
Mr. CORCORAN. Yes; but I say, however, that the general language
at the beginning of this section has to be read in connection with
the specifio illustrations of the kind of things the Commission is
expected to require in the succeeding pages of the section.
Mr. REDMOND. Then, I will wait for further discussion.
Mr. CORCORAN. Let us jump (b), which sets forth the mechanical
provisions of registration, and go to subsection (c) on page 23.
Mr. REDMOND. DO you want to discuss the 30-day provision, which
I think is provided for in the balance of (b) ?
Mr. CORCORAN. I will let vou pick! it up. I have not much time.
Under subsection (c)—and this is an illustration of the specific
thing that the Commission is entitled to require—it is provided
(c) The rules and regulations of the Commission m regard to registration
shall require—
(I) An undertaking by the issuer to comply with and so far as is within
its power to enforce compliance by its officers, directors, and stockholders with
the provisions of this act and any amendments thereto and with the rules
and regulations made or to be made by the Commission thereunder and, unless
the issuer is a member bank of the Federal Reserve System, not to lend any
funds in the money market of any exchange or to any member thereof or to
any person who transacts a business in securities through the medium of
any such member except in accordance with such rules and regulations as
the Commission may prescribe.
Certainly so far innocent enough.
(II) Such information as to the issuer and affiliates in respect of—
As we enumerate these things, let us see if there is anything which
you could not fairly say a corporation should disclose in its registration statement and in its listing application to a stock exchange for
STOCK EXCHANGE PBACTICES
6531
the information of its stockholders and those who are expected to
buy that stock in the open market [reading] :
(1) The organization, financial structure, and nature of the business
(2) Particulars regarding the terms, position, rights, and privileges of the
different classes of securities outstanding.
(3) Particulars regarding terms on which securities have been or are to
be offered to the public
(4) Particulars regarding the directors, officers, and principal securityholders and underwriters, their remuneration and their interests in the
securities of and material contracts with the issuer and affiliates.
(5) Particulars regarding remuneration to others than directors and officers
exceeding $20,000 per annum.
(6) Particulars regarding bonus and profit-sharing arrangements.
(7) Particulars regarding management and service contracts.
(8) Particulars of options in respect of securities existing or to be created.
(9) Particulars regarding material contracts not made in the ordinary
course of business, and material patents.
(10) Balance sheets for preceding years certified by independent public
accountants.
(11) Profit and loss statements for preceding years certified by independent
public accountants; and such other information as the Commission may by
rules and legulations require as necessary and appropriate in the public
interest or foi the protection of investors
(III) Copies of aitides of incorporation, bylaws, trust indentures, or corresponding documents, whatever the names, underwriting arrangements, and
other documents of the issuer and affiliates which the commission by rules and
regulations may require as necessary in the public interest or for the protection of investors
Now, Mr. Chairman, if I may, to make sure that there can be no
charge that this earlier language goes so far as to set up a capital
issues committee dominating American industry, I should like to
suggest that, in the light of the specific provisions in this long section, the general language, which, of course, takes its color from the
.kind of thing specifically asked for, no fair construction such as that
which is put upon it as a bugaboo by the Stock Exchange. But to
make absolutely sure that there cannot be any charge of any such
intent on which industry can be rallied against this bill, I would
suggest that you do change the language m section (&) where it says:
such undertakings, mfoimation, and documents as the Commission may by its
rules and regulations lequire m the public interests
The CHAIRMAN. What line?
Mr. CORCORAN. I t is line 12, page 22. Change it to read in such a
way that there will be no question that the rules and regulations
which the Commission may make are only those to insure fair protection to investors and honest dealing in the securities. Then I
think the bugaboo vanishes.
Another indication of the way in which that general language
should be interpreted is obtained after you read section 12, which
indicates the kinds of documents which the Commission should resquire. Let us read section 12. It relates to the reports which the
Commission can require every listed company to file with it and with
the exchange for the information of its stockholders. And while
we are on this, just remember again that as part of stock exchange
practice in relation to the corporations whose securities are listed with
them, the stock exchanges, as Mr. Whitney's brief says, have always
sought for more publicity on the part of the companies whose securities are listed with them and have considered that every advance they
6532
STOCK EXCHANGE PRACTICES
could make in that direction was something very much to their credit
as exchanges and something very much in the line of their duty to
the public as an exchange [reading] :
SEO 12 (a) Every issuer of a security registered on a national securities
exchange shall file with the exchange and with the Commission, in accordance
with the rules and regulations to be pi escribed by the Commission and in such
form and in such detail as the Commission may by rules and regulations prescribe in the public interest and for the protection of investors—
(1) Such information and documents as the Commission may require to
keep reasonably current the information and documents filed pursuant to
section 11,
That is the section that we have just read.
from the bill:]
[Eeading further
(2) Annual and quarterly reports, including, among other things, a balance
sheet and profit-and-loss statement certified by an independent public
accountant
Senator KEAN. DO you not think that to require quarterly reports is putting a pretty big task on them?
Mr. CORCORAN. I will discuss that m just a second, sir [reading] :
(3) Monthly reports-
worse than quarterly ones—
including, among other things, a statement of sales oi gro&s income
Now, there are two objections made to those reports. One of
them is in connection with other provisions, that you are requiring
the corporations to report too frequently. The second one is that
even if you are not requiring them to report too frequently, you are
making it too expensive because of the cost of certified public
accountants.
A further objection is made that you are putting the Federal Trade
Commission in a position where it can prescribe uniform accounting
rules for particular industries. The problem about uniform accounting arose before the House committee the other day, and as
Chairman Rayburn pointed out, if accounts are going to mean anything they have to be compiled in accordance with some uniform
accounting principles; and the awful situation that the Exchange
points out of some Government commission being in a position to
prescribe uniform accounting rules for particular kinds of businesses
has been a fact for many years with the railroads through the Interstate Commerce Commission apparently to the benefit of all concerned, and nobody has died yet.
Senator KEAN. Except the railroads.
Mr. CORCORAN. N O ; they have not died either. They are probably
in a little better shape than they were before, sir.
The second point, with reference! to the cost of auditing accounts.
Mr. Whitney stated before the House committee that a corporation
with a capitalization of $5,000,000 would probably have to pay—
and check me if my figures are incorrect—from $500,000 to $1,000,000
a year to have its accounts audited monthly and quarterly. My
humble judgment, and the judgment of a great many other people
is that if that ,is so, accounting is a great business to get into. I
just don't believe that is so. Furthermore, I don't believe that if
you had business accustomed to keep accounts on the basis of uni
STOCK EXCHANGE PRACTICES
6533
form rules prescribed by the Commission, the accountant's job would
be anywhere near so hard as it is now or justify any such fees.
Then we get to the last --point—whether you are asking too
much of industry to give these annual and quarterly reports and
these interim monthly reports that show at least gross sales and
gross income.
If I might I would like to read into the record at this point*
a statement which appeared in the New York Times on the eighteenth
and which is in substance a paraphrase of testimony before the
House committee of a Mr. Fred Y. Presley who is the manager
of a very large investment trust in New York, a professional investor m the securities market who makes it his business, as
I understand, since the information offered him in published reports
is so inadequate, to go around himself and see what he can learn
by consultation with the managers of companies. If I might just
read this at the present time [reading] :
" It has been stated in connection with the bill that the quarterly reporting
of pertinent facts would cause companies to divulge trade secrets that would
lay domestic companies open to foreign competition", Mr Presley said. " I
know of no * trade secrets', or other significant facts concerning the operation of leading companies that are not alieady in the possession of concerns,
domestic or foreign, that are worthy of being regarded as competitors Therefore, Quarterly leportmg would not place such secrets in the hands of
competitors "
Parenthetically, every one who has ever dealt with industrial
engineers knows that the system of commercial espionage that exists
at the present time in the United States is so perfect that normally the directors of a corporation know much more about their
competitors' business than they do even about their own; that any
competent engineer for a manufacturing concern, for example, who
knows the location of that plant, the prevailing rates of wages for
labor, the cost of raw materials, railroad rates to the nearest market
and other costs of transportation, all now on almost a uniform basis,
can, according to one of the best engineers I know who sat with me
the other night, compute the cost of production
and the cost of selling
of any competitor's product down to l1/^ percent.
But to go on with Mr. Presley [reading] :
If by the termsi " trade secrets ", opponents of this measure mean excessive
margins of profit, which would be revealed only by the publication of earnings
against sales, then these critics have cited the best reason for publication of
the figures
If margins of piofit are too wide and prices are too high, the consuming
public should be afforded the protection of open competition and investors
should be apprised that the margins are so wide as to become untenable
through competition
Some directors and executives of corporations have failed to keep pace with
the progressive transfer of control from pnvate gioups to the public The
directors today are merely employees working in the mteiest of the investing
public The latter never intended to place the directors in a preferential
position with regard to information concerning the company's earnings, but
this situation exists in hundreds of companies today
Pool operations in lecent years have been concentrated largely in stocks of
companies which report annually and which thus preserve secrecy and mystery
concerning their earnings for months at a time
A study of hundreds of companies in the last 7 years has convinced me that
the units which do not leport adequately on their operations and financial
status have either been losing ground competitively, have been pursuing policies which they do not care to have exposed, have been operating on margins
6534
STOCK EXCHANGE PRACTICES
of profit which are clearly excessive, or have been influenced in their public
relations by private groups, which have not yet recognized the shifting of
ownership of great corporations to the public and are not sensitive to the
fiduciary responsibilities of directors and officers.
The reporting of large corporations has improved in recent years, partly as
a result of the leadership of the New York Stock Exchange and because of the
increasing recognition of the rights of the smaller investor, which has been
produced by the recent depression.
If the corporate form of organization is to endure, millions of investors must
be protected by legislation
that will ensure that the small stockholder and the
large one will be treated1 on a basis of equality.
The major problem of investors and investment trusts is the appraising of
values Whenever the financial community has gotten too far away from
values and loses its perspective, as in 1929 and the summer of 1933, there has
been trouble
The problem of appraising values depends on three factors General business
•conditions, on which Government agencies, such as the Federal Reserve Board
and the Department of Commerce, present full information; the condition of the
industry in which one is seeking to invest funds; and the financial record of the
individual companies The success of the investor in ascertaining facts regarding industries and individual companies is dependent largely on the policy
of companies as to issuing adequate and frequent reports
All that the investing public wants is a quarterly statement, audited by
public accountants, showing what has actually transpired in the way of earnings and sales and containing the financial position of the company. It does
not seek to learn future plans, disclosure of which might prejudice the company's competitive position
I do not believe that any company would have the effrontery to seek to evade
the reporting requirements of this bill by withdrawing its shares from listing
on any exchange in this country.
The CHAIRMAN. I think there is some ground for a complaint
he has made. I have numerous letters from people who say that
under this bill they would have to have auditors and accountants
in their establishments practically continuously, at enormous expense. That is one thing. Then, take a corporation engaged in
manufacturing products, say, only 3 months in the year. The rest
of the time they are doing nothing. Their plant is practically idle.
What is the use of requiring that sort of a concern to make monthly
reports or even quarterly reports?
Mr. CORCORAN. Senator, insofar as the first problem is concerned,
as soon as you do work out uniform accounting principles on which
companies can keep their books (and if you want to know what the
importance of that means in corporate reporting, there is an article
on the subject in Harper's for this month just come out which is well
worth studying)—after you get uniform accounting principles set
up, it will not be so hard for auditors to make reports on companies
nor for companies to keep their own books in such shape that they
know what is going on. Until that point is reached, what you are
weighing is the cost to the company of keeping its books in such
shape that an auditor can go over the books pretty easily, against the
cost to the stockholders of not knowing what is going on and against
the cost to the stock exchange of having pools operated on mysteries
when no one really knows what the position of the corporation is.
As to your second point, that business is cyclical with a great
many corporations, that is true. But the annual reports or quarterly
reports would not necessarily fall on January 1 or April 1. Different
businesses have their cvchcal quarters at different times, and there
would be no objection if the quarterly reports for different businesses
should come out at different times. As for the objection that many
STOCK EXCHANGE PEACTICES
6535
businesses do all the work they do during 3 months of the year, the
answer is that the auditing job would be a snap for the rest of the
year.
Senator KEAN. Yes; but they would have to pay for it just the
same.
Mr. CORCORAN. They do not have to pay very much for it, sir.
The CHAIRMAN. I quite agree that there ought to be reports, but
I do not know about monthly reports.
Mr. CORCORAN. The monthly report does not have to be audited by
a certified public accountant. That is required only for the annual
and quarterly statements.
Senator KEAN. If it was every 6 months that would be all right.
Mr. CORCORAN. That leaves 6 months of mystery in there in which
a pool can operate. I do not pretend to be an expert on corporate
reporting, but I have read into the record the testimony in reference
to whether a quarterly or semiannual statement is adequate of a
man who is.
Senator KEAN. I believe they should make monthly reports; I
believe they should make quarterly reports, but I do not think you
ought to ask them to have expert accountants do it.
Mr. CORCORAN. The Twentieth Century Fund report suggested
since this sort of thing was done for the protection of stockholders,
that just as in English practice the stockholders pay one director who
acts as their inspector for their particular and separate benefit, the
stockholders might pay for the report. But I do not see why the expense should not be on the company. I do not see why, in the first
place, the cost of auditing reports cannot be brought down with
a universal practice like this, with the prescription of a uniform accounting method; and I do not see why it is not the duty of proper
management to let the investor know what he is buying.
Senator KEAN. I think you ought to have a uniform system; I
agree with that.
Mr. CORCORAN. But you object to the cost of the report.
Senator KEAN. The cost of the report.
Mr. CORCORAN. There is one more point which I would like to
talk about before I finish this section.
Senator WALCOTT. Let me ask you a question. What do you
mean by a quarterly report that has to- be audited ? Do you mean
a physical inventory or a book inventory?
Mr. CORCORAN. I should say a book inventory, sir.
Senator WALCOTT. Suppose the Federal Trade Commission requires, as it may—it has the authority to require such a thing—a
physical inventory quarterly, and suppose you are running a gross
of, say, 30 or 40 or 50 million dollars. Have you ever been connected
with a large business yourself ?
Mr. CORCORAN. Yes; I know what the problem of physical inventory is.
Senator WALCOTT. Have you been associated with a large business?
Mr. CORCORAN. Only as a lawyer.
Senator WALCOTT. YOU have never been through that, then.
Mr. CORCORAN. YOU will have to depend to some degree, and I
think you can reasonably depend, upon the Commission's being a
little reasonable in that respect.
^536
STOCK EXCHANGE PRACTICES
Senator WALCOTT. I don't know about that.
Mr. CORCORAN. YOU are not setting up any God-given group of
men completely removed from public criticism when you give this
Commission that power.
Senator WALCOTT. I t is too great a power, because they could
easily require a physical inventory which would be almost a physical
impossibility. They would barely take one physical inventory when
they would be starting on the next one.
Mr. CORCORAN. That is true. I completely agree with you on
that.
Senator WALCOTT. I think it ought to be hedged about in some
way to show exactly what is meant.
Mr. CORCORAN. Possibly, sir, that should be done.
There is one more idea that should be ventilated before we finish
with this section, and that is the suggestion of the New York Stock
Exchange that all this publicity required of corporations, together
with the standard of fidelity to the corporation required of officers
and directors is the matter of a Federal corporation law. Such matters do not belong in any stock-exchange bill, they say.
There are two answers to that: First of all, if you were to have a
Federal incorporation law, the same provisions that we have here
would have to go into it.
The second thing is that, looking matters right square in the face,
talking about a Federal incorporation law is just a dilatory plea,
as a lawyer would put it. I t is a red herring to put action off. The
legislative course of a Federal corporation law is going to be a lot
longer than anybody thinks now. There are a great many people
who believe in this bill and in the principles of stock-exchange regulation who think there are serious objections to a Federal corporation
law. Furthermore, to say that decent accounting of corporations to
their stockholders should be put off until there happens to be put
through Congress a law which deprives all States of their present
powers over their corporations is to put off until the millennium. A
Federal incorporation law, granting that it is desirable, is something
so far in the future that to avoid putting provisions in a stockexchange bill because it would be much more artistic in a Federal
incorporation law, looked at candidly, means a 4- or 5-year
postponement.
Mr. REDMOND. I do not want to take time to discuss the particulars
that you have taken up, because I am sure witnesses will be heie
before this committee who are much more competent that I to
give information—based on actual facts and experience and not
purely upon hearsay—as to the expense of these audits, if not as to
the actual impossibility of corporations complying with these requirements of the bill. I would like, however, to say just two things,
first of all, because you originally said that my interpretation of this
act was an unfair interpretation, and that there might be some
amendment. I think an amendment along the lines that you suggested, if it was clear, would go a long way toward removing my
objection. My opinion was based upon this bill as it was drawn; and
I pointed out to you that the powers given to the Commission were
unlimited when read in relation to the other provision of the law
which makes the findings of the Commission as to facts conclusive.
STOCK EXCHANGE PRACTICES
6537
I also want to point out that these broad powers run right straight
through the bill.
Mr. CORCORAN. Yes.
Mr. REDMOND. It was not just in subdivision (6) of section 11
that I found unlimited powers given to the Commission. You read
a list of the specific things which had to be filed as a condition of
registration; but if you will notice the final part of subparagraph 11,
it reads [reading]—
and such other information as the Commission may by rules and regulations
require as necessary and appropriate in the public interest or for the protection
of investors
Again a repetition of the language which I pointed out to you was
the equivalent of unlimited power.
Mr. CORCORAN. And again to be read in the light of the specific
language contained in the same section
Mr. REDMOND. Let me continue. If you will turn to subdivision
(4) of section 12, you will find this language [reading! :
Such other lepoits and at such time as the Commission may by rules and
iegulations piesaibe in the public interest or for the protection of investors
«i with a view to msuung that the security holders' interests shall not be
prejudiced by the use ot information for the advantage of any special group
<or mteiest
Again unlimited power.
Mr. CORCORAN. And again in a section in which you have some
indication of what specific things are expected.
Mr. REDMOND. Well, let us not rely too much on that, because when
you turn to subdivision (b) of section 18, where specifically it is
provided [reading] :
The authority above given the Commission shall include, among other things
authority to prescribe the form or forms in which required information shall be
set forth
Mr. CORCORAN. That is the uniform accounting.
Mr. REDMOND (continuing reading) :
The items or details to be shown m the balance sheet and earniugs statement
and the methods to be followed in the preparation of accounts, in the appraisal
or valuation of assets and liabilities, in the determination of depieciation and
depletion, in the differentiation of recurring and nonrecurring income, in the
differentiation of investment and operating income, and in the preparation,
where the Commission deems it necessary or desirable, of consolidated balance
sheets or income accounts of any person dnectly or indirectly controlling or
controlled by the lbsuei, or any peison under direct or indirect common control
with the issuer
Mr. CORCORAN. But that again comes down to uniform accounting
methods, which we have just discussed, and nothing more.
Mr. REDMOND. That, as I see it, deprives management of the right
to determine
Mr. CORCORAN. NO more than railroad managements are now deprived of their right to determine how they want to carry depreciation and depletion, and differentiate recurring and nonrecurring income.
Mr. REDMOND Remember that our railroads have been under regulation for many years, and those accounting rules have been developed from many years of practice and experience.
6538
STOCK EXCHANGE PRACTICES
Mr. CORCORAN. A S these will have to be developed, because no one
expects them to come full fledged from the head of Jove on October 1Mr. REDMOND. Let me finish my statement about the railroads.
The railroads are all engaged in one particular type of business,,
where the Interstate Commerce Commission has power to regulate
their rates, and likewise largely to regulate their expenditures.
Mr. CORCORAN. Yes.
Mr. EEDMOND. We all
feel that the railroads are under the domination of the Interstate Commerce Commission, and I do not think it
is too much to say, reading these provisions, that all commerce and
industry registering on these national exchanges would likewise be
under the domination of the Federal Trade Commission. That is my
opinion, and I am prepared to stand by it.
Mr. CORCORAN. Will you go along, now, if we make the kind of a
suggestion we have suggested for the first paragraph ?
Mr. EEDMOND. If it be clarified to carry out what you say, and
it runs right through the bill, not only will we go along, but I say
it is the New York Stock Exchange which is responsible for the
fact that American corporations do give current information.
Mr. CORCORAN. That is absolutely correct.
Mr. REDMOND. The New York Stock Exchange established the*
idea of quarterly reports.
Mr. CORCORAN. And this is just along the line you have been
working for yourself for many years, and we are helping you get
what you have wanted for a long time.
Mr. REDMOND. There is the old expression, Mr. Corcoran, " God
save us from our friends." Sometimes it is more than true. This
time our friends have pushed it beyond the limit of common sense.
Might I say one final thing ? You used the expression " a red herring " in regard to the suggestion that these corporate provisions*
properly belong in a national incorporation law. That is not a
red herring. That has been the position of the exchange for years.
I t is not put forward at this time to delay or otherwise prevent any
act regulating the exchanges.
Mr. CORCORAN. But, frankly, you do not expect the passage of a
Federal corporation law for a long time, do you ?
Mr. REDMOND. We do not know whether it can or cannot be done,,
but we do say that it is the sound way, the right way, and the only
way in which corporate practice in this country can be regulatedWe should not regulate simply the corporations that are listed upon
an exchange.
Mr. PECORA. Mr. Redmond, is there any legal authority now which
would restrain the governing authorities of the New York Stock
Exchange from imposing any requirements that, in their judgment,
they saw fit to impose as a condition to listing a stock 2
Mr. REDMOND. Legally, no; but practically
Mr. PECORA. Then they exercise their judgment, which is untrammeled or unrestricted by law.
Mr. REDMOND. But practically there is a limit which is stronger
than any legal control.
Mr. PECORA. That is common sense.
Mr. REDMOND. If we put on false or undue listing requirements,
corporations simply would not list.
Mr. PECORA. That is based upon the principle of common sense.
STOCK EXCHANGE PBACTICES
6539
Mr. REDMOND. And freedom of contract.
Mr. PECORA. And it is just as fair to assume that the Federal
Trade Commission would exercise that same degree of common sense
AS the governing authorities of the New York Stock Exchange may
be expected to exercise.
Mr. REDMOND. NO, Mr. Pecora. The issue is different. I t is not a
question of common sfense. I t is a question of freedom of contract.
There is no action the New York Stock Exchange can take to compel
a corporation to list, whereas under this bill penalities are put uj>on
unlisted securities. Atte-mpts are going to be made to drive
them into these national securities exchanges, and then to submit
themselves to such regulations as the Federal Trade Commission
may see fit to adopt.
Mr. PECORA. DO they not now submit themselves to regulation by
the Stock Exchange, within its requirements?
Mr. REDMOND. Only when they are willing to do so. That is
freedom of contract, and there is no freedom of contract, as we see
it, in this bill.
The CHAIRMAN. The Stock Exchange has to keep in mind the
thought of competition, does it not?
Mr. REDMOND. Competition? Barely, Mr. Chairman. The corporations that want listing on the Stoct Exchange want it because
they feel that they have the size or the number of stockholders to
warrant it. They could get listing on easier terms on other exchanges, but still they come to theTSew York Stock Exchange, because they are willing to give their investors the degree of information that the exchange requires.
Senator KEAN. They also receive a larger market.
Mr. REDMOND. A larger market, naturally.
Mr. CORCORAN. And that advantage of the larger market is such
an advantage that it will compensate for a great deal stiffer requirements for giving information before a company will actually withdraw from listing.
Senator KEAN. In that connection I would like to show you that
letter [handing a paper to Mr. Corcoran].
Mr. CORCORAN (after examining paper). That is typical.
Senator KEAN. I would like to have it go into the record. You
have read the letter?
Mr. CORCORAN. Yes.
Senator KEAN. I offer
for the record a letter from a man who
says he would withdraw his securities from the New York Stock
Exchange if this bill went through.
The CHAIRMAN. YOU want to offer the letter?
Senator KEAN. I have offered the letter. May it be received?
The CHAIRMAN. Yes.
Mr. PECORA. May the
letter be read?
(Senator Kean hands paper to Mr. Pecora.)
Senator KEAN. I do notlmow the man. He is a stranger to me.
The CHAIRMAN. We have filled up a good many pages of this record with letters. I got a letter from a man the other day who said
that his children were without shoes, and he did not have any money.
Senator KEAN. I have lots of those.
The CHAIRMAN. He wants us to bring suit against the three concerns for $15,000, which he has lost through buying worthless stock.
6540
STOCK EXCHANGE PRACTICES
and still he protests against this bill and says he wants to be free
to buy some more.
(The letter referred to is as follows:)
MONSANTO CHEMICAL CO ,
GENERAL OFFICES,
8t Louis, February 21, 1984
Hon
HAMILTON F. KEAN,
Umted States Senate, Washington D C
My father devoted his lifetime to building up this company I have spent my entire career since the war in it and have been its
piesident since 1928 Our common stock is listed on the New York Stock
Exchange Neither my father nor myself has ever speculated in the stock
of this company There have been no pools and neither* of us has ever sold
a share short Although I cannot speak for the other officers and directors,
I am confident m my own heart the same applies to them
The Metcher-Rayburn Bill now pending before Congress to regulate the
Stock Exchanges of the country would have a most disastrous effect on the
community at large and upon our stockholders I say without hestitation that
should this bill become law we would remove our stock from listing on the
New York Stock Exchange, thereby denying the benefit which our several
thousand stockholders, the great majority of whom are small investors, now
have in a ready market for the sale of their securities and a definite loaning
value at the banks
Although I have never issued and never will issue any misleading statements
or accounts regarding our corporate affairs, this company cannot afford to pay
me and other officers' salaries which would be commensurate with the risks
we would take under the liability provisions of the act The provisions of the
act would place our company at a decided disadvantage with those of our
competitors, whose securities are not listed, to have our monthly sales and
profits, and any other information which the Federal Trade Commission demand of us a matter of public information and available to our domestic and
foreign competitors
There are many other provisions of the bill which are extremely impracticable and objectionable both to corporations and the Exchanges
I believe it would not accomplish its lofty purpose It would result in bootlegging of securities, the loss of an orderly market in which investors can go to
buy or sell, and deprive corporations of the means of securing necessary working capital from time to time
It would be a severe blow to the recovery which is now being evidenced and
shatter the confidence of corporation executives throughout the country, wljo,
after all, must be relied upon by the United States Government to maintain
employment in their own and heavy construction industries, as the Government
cannot do so indefinitely Not only would their confidence be shattered, but
their wherewithal to make the necessary investments would be denied to them.
I am very sincerely in hopes you will oppose the passage of this bill in its
present form, or that it be so materially amended that it would have practically no resemblance to the present measure
Sincerely yours,
(Signed) EDGAR M. QUEBNY, President
Senator WALCOTT. What is the alternative, Mr. Corcoran, if a
concern is not satisfied with the operation of this bill and the excessive powers given to the Federal Trade Commission, and wants,
therefore, to withdraw from the exchange ? What can a man do to
still operate his company?
Mr. CORCORAN. In a very few cases possibly there would be withdrawals from the stock exchange, except that there always hangs
over the head of those companies that are withdrawing from the
stock exchange they will still be subject to the possibility of working
out a control over the over-the-counter market, such as is provided for
in here. You were not here when I was discussing with Senator
Kean this morning the suggestion that since practically all these
requirements are for the purpose of making information available
MY DEAR SENATOR .
STOCK EXCHANGE PRACTICES
6541
to stockholders, insofar as there is an interest in the stockholders m
having the shares listed on the stock exchange, the shareholders just
simply will not permit the companies to be withdrawn from the stock
exchange because of these requirements.
Senator WAiiCOTT. Of course, there are thousands of companies,
many of them of large size, that prefer not to have their securities
listed on any exchange.
Mr. CORCORAN, Yes, sir.
Senator WALCOTT. Would
you deny them the right to operate
those corporations?
Mr. CORCORAN. NO.
Senator WALCOTT. They
are not interested, necessarily, in the public buying any securities, or selling securities.
Mr. CORCORAN. NO.
Senator WALCOTT.
There is nothing m this bill to curtail their
operations ?
Mr. CORCORAN. NO. There i$ a provision in here, on page 27, section 14, with regard to over-the-counter markets, which would put
the Commission in a position where it might prescribe rules and
regulations for companies, the securities of which are sold through
the mails or in interstate commerce. Just how that will be worked
out, nobody knows. Neither the Dickinson report, nor the Twentieth Century Fund, nor this bill has any specific ideas as to how
you would reach the over-the-counter market, but certainly there is
some way it can be reached.
Senator KEAN. Suppose the company is not offering any securities ?
Mr. CORCORAN. YOU are talking about new securities now?
Senator KEAN. Yes.
Mr. CORCORAN. This deals only with securities that are listed on
an exchange. New securities do not normally reach an exchange
until a year or so after they are issued and have been distributed.
Senator KEAN. Suppose you have a company that has, say, $5,000,000 capital or $10,000,000 capital, and they do not offer their securities. Their securities are out. They have no interest in whether
there is any market for them or not.
^ Mr. CORCORAN. I S there an over-the-counter market for the securities ?
Senator KEAN. Yes.
Mr. CORCORAN. The regulations which the Commission would try to
impose in that case, where there was very little of a public investor,
interest would, I should think, be very, very slight, if any at all.
Senator KEAN. They can say, " Here, it is of no interest to us.
We do not care whether anybody buys these securities or not. We
have got the money. We are doing the business. We do not want
anybody to buy our securities."
Mr. CORCORAN. I t might be difficult to reach them.
Senator WALCOTT. Why would you want to reach them?
Mr. CORCORAN. YOU would not want to reach them, unless there
were a real public interest in the seucnties, and some public turning
over of the securities.
The CHAIRMAN. The committee will now take a recess until 10
o'clock tomorrow morning.
(Whereupon, at 4:45 p.m, Tuesday, Feb. 27, 1934, an adjournment was taken until tomorrow, Wednesday, Feb. 28,1934, at 10 a.m.)
STOCK EXCHANGE PEACTICES
WEDNESDAY, FEBBTJARY 28, 1934
UNITED STATES SENATE,
COMMITTEE ON BANKING AND CURRENCY,
Washingtony D.C.
The committee met at 10 a.m., pursuant to adjournment on yesterday, in room 301 of the Senate Office Building, Senator Duncan U.
Fletcher presiding.
Present: Senators Fletcher (chairman), Barkley, Bulkley, Gore,
Reynolds, Byrnes, Bankhead, McAdoo, Adams, Carey, and Kean. >'
Present also: Ferdinand Pecora, counsel to the committee; Julius
Silver and David Saperstein, associate counsel to the1 committee; and
Frank J. Meehan, chief statistician to the committee ; also Roland L.
Redmond, counsel to the New York Stock Exchange.
The CHAIRMAN. The committee will come to order. We will
further hear Mr. Corcoran.
STATEMENT OF THOMAS GAEDINEE C0BC0RAN, IN THE OFFICE
OF COUNSEL FOE THE EECONSTEUCTION FINANCE C0EP0EATION, WASHINGTON, B.C.—Resumed
The CHAIRMAN. NOW, Mr. Corcoran, I believe you were dealing
with section 11 when the committee adjourned yesterday afternoon.
Will you please take up the subject where you left off, and continue 2
Mr. CORCORAN. Mr. Chairman, we had finished section 12, as I
remember it, sir.
The CHAIRMAN. All right.
Mr. CORCORAN. NOW, Mr. Chairman, I shall go along as fast as
possible so I won't cut into Mr. Whitney's time any more than I can
possibly help.
The CHAIRMAN. All right.
Senator CAREY. Did you say you had finished with section 12 of
the bill?
Mr. CORCORAN. We had finished with section 12, and I am now
going to section 13 (a). This section relates to proxies. The purpose of the provisions is to require that when a management solicits
stockholders for proxies, or when any committee solicits stockholders
for proxies, the management or the committee so soliciting proxies
shall reveal the purpose of such solicitation of proxies (which under
the laws of even the most advanced States at the present time is not
required to be made too definite) and just how much ownership
interest they have in the corporation.
May I now read the section—
Sec 13 (a) It shall be unlawful for any person by the use of the mails or of
any means or instrumentality of transportation or communication in interstate
175541—34—PT 15
9
6543
6544
STOCK EXCHANGE PEACTICES
commerce or of any facility of any 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 registered on any national securities
exchange unless at such time prior to such solicitation as the Commission shall,
by rule or regulation, prescribe the peisons named to exercise such proxy,
consent, or authorization shall file with the Commission a statement, wl^ich
shall be included as a part of eveiy such solicitation, setting forth the purposes
of the proxy, consent, or authorization, the persons to exercise it—
And then this is important:
their relations to and interest in the security, the names and addresses of the
persons from whom similar proxies, consents, or authorizations are being
solicited, and such further information, and in such form and detail as the
Commission may by rules and regulations prescribe in the public interest or
foi the protection of investors
^r, the New York Stock Exchange is completely correct in its
criticism of the present drafting of that section insofar as the section
as now drafted would require the names and addresses of the persons from whom similar proxies are being solicited, to be sent out
with each request for a proxy. The section, Mr. Chairman, according to the suggestion made, is in that respect imperfect. The request
for the proxy should contain everything except the names and
addresses of all other persons solicited, and those names and addresses should be required to be filed only with the regulatory
commission.
The CHAIRMAN. What page and line do you now refer to, Mr.
Corcoran?
Mr. CORCORAN. Line 2 on page 27. I might say that the purpose
of requiring the filing of the names and addresses of other persons
solicited is perfectly obvious. I t is almost impossible for stockholders who are herded together like sheep under present proxy
practices to get together or to get up courage enough to assert their
rights unless they have some opportunity of knowing who their
fellows in interest are. Although under the laws of a gre^t many
States at the present time stockholders' lists are open to the inspection of stockholders, there are some States in which that is not true;
and, besides, there are many States where the management might be
able as a practical matter to obstruct the obtaining of the
information.
Now I will take up subsection (b):
(b) It shall be unlawful for any member of a national securities exchange or
any person who transacts a business in secunties through such member to give
a proxy, consent, or authorization in lespect of any security legisteied on a
national securities exchange and carried for the account of a customer without
a specific written authorization from such customer
The evil which that section is intended to reach is that brokers
very often hold large amounts of customers' securities. In all cases
where securities are carried on margin the stock is of record in the
name of the broker or in a u Street" name, so that the stockholder
actually entitled as a matter of record to vote at the meeting or give
a proxy, is the broker, and sometimes unscrupulous proxy committees
as a result of this situation have been able to pick up huge batches of
votes through such brokers, although the beneficial owner of the
stock does not give his consent to the proxy at all.
STOCK EXCHANGE PEACTICES
6545
Now I will take up section 14 of the bill
Senator KEAN (interposing). Mr. Corcoran, in regard to the section you are leaving, don't you think that the section as is practically
perpetuates every management? In other words, do you thmk it
goes far enough, or that it gives a fair chance to the outsider ?
Mr. CORCORAN It gives a fairer chance than the outsider now has.
Senator KEAN. Well, at the present time I do not think there are
many brokers who would give a proxy without the consent of the
owner of the stock, but
Mr. CORCORAN (interposing). That is quite true.
Senator KEAN (continuing). I think nearly all people having
stock in their names, say: " Oh, yes. I will ask the principal, and
if he consents, why, then I will give the proxy." But otherwise they
do not give the proxy.
Mr. CORCORAN. Yes. Subsection (b) as now written says if the
broker gets such authorization, then all right.
Senator KEAN. Yes; that is all right. But as to the other part of
it, why, it seems to me it might be drawn a little more in favor of
the stockholder who wishes to protest against the management of the
company, rather than the way it is now drawn.
Mr. CORCORAN. Well, Senator Kean, you will notice that there is
a flexible clause at the end of the first subsection, on lines, 4, 5 and
6, page 27, which requires that the proxy and the solicitation shall be
in the form and contain such details as the Commission may by rules
and regulations prescribe in the public interest or for the protection
of investors.
Senator KEAN. That puts it all back again, to the matter of
simply blanket authority to the commission.
Mr. CORCORAN. Senator Kean, I am very certain, and I respectfully
suggest that nobody in the committee would object, that if it is
possible to work out a more thorough-going protection for the stockholder in the use of proxies, every one would be very grateful for a
more effective means of protecting him.
Senator CAREY. I S this done now enough to warrant legislation at
the hands of Congress?
Mr. CORCORAN. Yes.
Senator GORE. This
means, I take it, that stockholders' meetings
at the present time are more or less perfunctory. Somebody simply
gets proxies and holds the meeting, and that gives rise to this proposed legislation.
Mr. CORCORAN. Yes; that is true.
Senator MCADOO. There is no doubt that there has been great
abuse of the use of proxies.
Mr. CORCORAN. Yes, sir.
Senator MCADOO. And more
adequate provision for the protection
of stockholders should be made.
Mr. CORCORAN. Yes, sir.
Senator MCADOO. And I
think this section pretty well meets that
situation.
Mr. CORCORAN. I think so too.
Senator KEAN. The question in my mind is whether it gives
sufficient protection.
Mr. CORCORAN. Well, that might very well be considered.
6546
STOCK EXCHANGE PRACTICES
Senator GORE. This would seem to me to contemplate what ought
to be done. I am not certain that it contemplates what will be done,
that is, whether this will energize stockholders enough to get any
practical results. I doubt that, Mr. Corcoran.
Mr. CORCORAN. Well, Senator Gore, I do not know of anything
that can be done to stir stockholders from their inertia.
Senator MCADOO. NO ; you cannot energize them, I fear.
Senator GORE. Certainly a lot of things go on that ought not to
go on, but can you enact a law that will properly meet that situation?
Mr CORCORAN. We fully realize that stockholders will not give
the time for, nor incur the expense of acting alone. But if you let a
stockholder know who are the other stockholders of similar interest
who might go along with him, by letting him look at a list filed with
the Commission, then, having the information by which he can get in
touch with them and possibly persuade them to go along with him,
and share the expense, he may act, whereas he would not act blindly
and alone.
Senator GORE I think, perhaps, the vice of the situation is the
inertia of the stockholder, and if we could overcome that inertia we
might accomplish something. I t seems to me one of the worst evils
in the situation is due to the divorcement between the management of
corporations and the owners of corporations.
Mr CORCORAN. That always happens when things get too big.
Senator GORE. Yes; and I suppose this proposed legislation is
directed more or less to that. Take, for instance, this bonus matter,
the paying of a million dollars to the president of a concern—and
in that connection we have just had a report from the Federal Trade
Commission which I think shows the abuse, and I do not think that
thing would happen if you could get stockholders themselves to act,
if you could get the stockholders themselves to act to protect themselves against such an imposition.
Senator MCADOO. All that we can do, I think, is to provide a means
by which stockholders can protect themselves if they want to do it,
or if they have the enterprise or the energy to do it. If they have
not the required enterprise or energy, then of course you cannot
enact any law that will cover the situation.
Senator GORE. Yes; that is true, but
Senator CAREY (interposing). Why wouldn't it be proper for the
corporation to furnish each stockholder with a list of its stockholders ?
Senator KEAN. They are obliged to do it now under the laws of
most States.
Mr. CORCORAN. That is only a matter of local corporation law.
Senator CAREY I mean if the shares are being traded in in interstate commerce, couldn't that requirement be put into this law?
Mr CORCORAN. We have reached it m another way, by saying that
no one can use the mails or any other means of interstate communication through the facilities of a stock exchange, which is a little more
artistic way of saying it for the purpose of this bill.
Senator KEAN Well, I think this clause ought to be studied a little bit, and rewritten.
Mr. CORCORAN. Oh, I am quite willing to agree with you on that.
Senator KEAN. I have no objection to subsection (b).
STOCK EXCHANGE PEACTICES
6547
The CHAIRMAN. YOU may proceed with your statement, Mr. Corcoran.
Mr. CORCORAN. Section 14 relates to over-the-counter markets. An
over-the-counter market is an irregular market, although in some
cases fairly well orgamzed, for securities not listed on regular exchanges. There must be some potentiality of control of the overthe-counter market in the Federal Trade Commission or the regulatory body to whom you entrust the working out of your law or the
securities listed on exchanges will be subjected to unfair competition
from the over-the-counter market.
You will appreciate that there has been some talk of the possibility that corporations would withdraw their securities from exchanges, and from listing, because the provisions of this bill are
too onerous. As we have tried to point out, the only provisions of
the bill that are in any way onerous on present management are for
the benefit of stockholders by giving them information and protecting them from inside trading by officials and directors. So that it is
hardly likely stockholders will permit their corporations to withdraw
shares from listing simply because the bill makes it necessary for
directors, while the shares are listed, to give adequate information
to stockholders.
Undoubtedly the regulatory commission will have to have some
potentiality 01 control over the over-the-counter markets, and this
provision was drawn as broadly as possible to enable the Commission
to take whatever action to regulate over-the-counter markets a study
might show feasible.
May I read that section:
OVER-COUNTER MARKETS
SBO 14 It shall be unlawful for any person, singly or m concert with others,
to make use of the mails or of any means or mstiumentaLty ot communication
or transportation in interstate commerce for the purpose of making or creating,
or enabling another to make or create, a market ioi any secunty, whether or
not registered on a national securities exchange, without complying with such
rules and regulations as the Commission may piescube as appropnate in the
public interest or for the protection of investors
I t is almost impossible at the present time to draw any section
more specific on the regulation of the over-the-counter securities.
Senator KEAN. Mr. Witness, if you will take the bond market, let
us say that 10 bonds are traded in on the exchange and 500,000 bonds
are traded in outside. I mean to say that the exchange business in
bonds as compared with the outside market in bonds, does not amount
to anything.
Mr. CORCORAN. NO.
Senator KEAN. SO that
all trading in bonds, or at least a large
part of the trading m bonds, is done entirely outside of any exchange.
Mr. CORCORAN. But there is no reason why it could not be done on
an exchange, is there, Senator Kean?
Senator KEAN. Yes; there are a good many reasons.
Senator GORE. Are there any abuses connected with that matter
under the present scheme of things that this would correct?
Senator KEAN. I do not think so.
Senator GORE. Then why include it?
6548
STOCK EXCHANGE PEACTICES
Senator KEAN. That is what I want to know.
Senator CAREY Mr. Corcoran, let us presume that a man has a
small corporation whose stock is not listed on any stock exchange; if
he should desire to write to a number of his friends and say that
h& had that stock and would like to have them take a certain amount
of it, would he be precluded under this section from so doing unless
the Commission first passed upon it?
Mr. CORCORAN. Yes; unless the Commission had worked out general rules and regulations covering it. But the way the bill will
be handled administratively, of course, will be that within the 6 or
7 months before the act goes into effect the Commisison will give
general permission to carry on the business of selling in the usual
way pending such a time as the matter can be worked out.
Senator KEAN. And it may not work the matter out to cover
Senator Carey's objection.
Senator CAREY. Let us say that there is a small corporation with
a capital of $10,000, a more or less private affair; would that mean
that the man who was interested in the corporation—I mean a corporation of that kind—could not do business with anyone without
having it registered here in Washington?
Mr. CORCORAN. He could not do business buying and selling its
securities through the mails or through interstate commerce except
under the regulations of the Commission.
Senator CAREY. DO you mean that he could not even write to a
friend in another State about it?
Mr. CORCORAN. Well, that sort of transaction would be at least
subject to such rules and regulations as the Commission would prescribe, and an intelligent commission would not prescribe any rules
and regulations that would cover such a case But the law has to
stretch that far because it is impossible to draw logical differentiations between classes, to fit this case and the next bigger case, and
then the next bigger case. The administrative commission has to be
intelligent and not interfere in a small case like that.
Senator GORE. Well, we seem to have had such good luck under
the eighteenth amendment in the matter of discriminations that we
now want to prohibit ordinary transactions in stocks.
Senator CAREY. Well, Mr. Corcoran, how are you going to get
such a matter straightened out?
Mr. CORCORAN. This matter would be covered by general rules and
regulations as soon as the commission began to organize to administer the act.
Senator BARKLEY. In view of the requirements of the Securities
Act providing that all stock shall be registered with the Federal
Trade Commission, is there really any need for any further supervision over the sale of stock by new corporations that might be
created ?
Mr. CORCORAN. This applies to securities that have already been
issued. The Securities Act applies only to new issues of securities.
Senator BARKLEY. Well, this would apply to stock that may be
issued from time to time.
STOCK EXCHANGE PRACTICES
6549
Mr. CORCORAN. This applies to stock that may be issued from time
to time; yes. In other words, this applies in the first place to stock
that has been issued without having had to comply with the Securities Act, because it was issued before the Securities Act came into
existence; and then it applies, of course, to trading in that stock
after it has been registered with the Federal Trade Commission
under the Securities Act.
Senator BARKLEY. Yes; and it would apply to all future issues.
Mr. CORCORAN. YOU see, Senator Barkley, the Securities Act as
now drawn does not provide any continuous supervision over sales.
It relates only to the original public offering
Senator BARKLEY. Well, they have pretty broad powers to follow
up the transaction.
Mr. CORCORAN. Not very much, sir. That is unfortunate.
Senator BARKLEY. I am wondering whether there is a sufficient
amount of abuse in over-the-counter transactions to make it necessary
to apply to the ordinary processes of organization of a small company
in the sale of its stock, where, we will say, some man wants to write
to a relative that he is going to organize a little real-estate company,
or a litle oil company, or a little coal company, and prevent him
from writing a letter and getting any of his friends or relatives to
take stock in such a company without first coming up here to Washington and gettingthe permission of the Federal Trade Commission.
Mr. CORCORAN. >¥ell, you see, Senator Barkley, you are putting
a case up to me which is way down at the small end of the scale. On
the other hand, there are very big transactions on the over-thecounter markets which it is very essential the Commission should be
able to reach, particularly for the protection of the markets of the
exchanges. Now, the matter of differentiating between these big
over-the-counter transactions, which must be reached in order to
prevent unfair competition with the exchanges, and the small transactions, which, as you say, are so small that there is really no public
interest in regulating them, can be dealt with by means of differentiation between cases in the rules and regulations of the Commission.
Senator KEAN. Well, it seems to me they ought to be dealt with in
the law.
Mr. CORCORAN. All right, if you can find any logical place to draw
a line in the law.
Senator CAREY. AS I read this bill this seems to me to be the situation : If I had a block of stock in a corporation and that stock was
not listed on a stock exchange, and if I had to sell that stock and I
knew some man in another State whom I thought might purchase
it, and I wrote a letter to him and asked him if he would buy that
stock, then I would be violating this law.
Mr. CORCORAN. Not in the case of a single transaction like that.
Senator CAREY. Why not?
Mr. CORCORAN. Because this says:
For the purpose of making or creating, or enabling another to make or create,
a market for any security
Senator CAREY. Well, in such a case wouldn't that man be creating
a market for the security?
6550
STOCK EXCHANGE PRACTICES
Mr. CORCORAN. Hardly in the case of that one transaction, or
hardly in the case even of 10 or 12 transactions. But if you are
maintaining a regular mechanism through yhich bids and asks are
matched, as maintained by the over-the-counter market dealer, then
such mechanism would be within the scope of this bill. But I hardly
think that the mere solicitation of four or five friends to buy stock
in a small company would be considered an attempt to create a
market for that stock within the meaning of this section.
Senator CAREY. AS I read that section, it seems to me to mean
that, if a stock is not listed on an exchange, a man is precluded from
selling such stock through the mails.
Mr. CORCORAN. The purpose of the section was to catch what is
called in the market over-the-counter transactions.
Senator CAREY. I understand that perfectly, but I also want to
know where this little man will find himself.
Mr. CORCORAN. If you are afraid that the language- is too broad,
that it will prevent any solicitation, even without an attempt to set
up a market for the stock, I would suggest that amendments to that
section are in order.
Senator BARKLEY. HOW would it do instead of saying—
It shall be unlawful for any person, singly or in concert with others, to make
use of the mails or of any means or instrumentality of communication or transportation in interstate commerce for the purpose of making or creating, or
enabling another to make or create, a market for any security
to so clarify the language as to distinguish these transactions. I do
not see how you can distinguish, under this bill, between making a
market for 100 shares and making a market for 100,000 shares. An
effort to sell the shares is an effort to create a market for them.
Why wouldn't it do to simply authorize the Commission, in general
terms, to fix rules and regulations under which transactions of that
sort might be carried on without starting out to make it unlawful
for anybody to do that unless he complies with rules and regulations
providing that it must be done. The Commission cannot make separate regulations, I imagine, for each class of transaction unless they
can fix some line of demarcation dependent upon the amount of
stock or the value of it or something of that kind. If they attempt
to make general rules and regulations which will cover large transactions in the over-the-counter market, they are bound to include the
smaller transactions.
Mr. CORCORAN. YOU see, Senator Barkley, the purpose of the section is to reach the situation where a dealer sits at a telephone or
writes letters and says, " I am maintaining a market in this unlisted
stock. I solicit bids and offers." And he does that as a business.
Now, as a matter of degree it is very difficult to draw a line separating different kinds of solicitations, to find one point where you will
not permit solicitation and another where you do not want to interfere with it. If it is possible to make any such differentiation in the
section, however, and if it is possible to cut off the application of
the section at the point where the Congress does not think there is
any public policy in following the thing up, so much the better.
Senator BuiiKiiEY. Is it your conception that the Commission will
make such differentiation by regulation?
Mr. CORCORAN. I should certainly think so.
STOCK EXCHANGE PRACTICES
6551
Senator BULKLEY. Well, if we do not happen to get on the Commission smarter men than, any of us it would just be too bad.
Mr. CORCORAN. Senator Bulkley, as to the matter of smarter men
than any of you, I would hardly dare comment.
Senator BULKLEY. Well, I am really serious in my statement.
Senator GORE. Yes; or if you could get somebody on the Commission who would attend to the matter himself and not leave it to somebody else, then there would be a different situation.
Senator BULKLEY. And if the Commission can make such differentiation, Mr. Corcoran, why not write it into the law.
Mr. CORCORAN. Because when you are dealing with a provision
that, as you yourselves know, is to cover the situation all the way
from the market in New York bank stocks m New York City, and
the over-the-counter market in insurance stocks and bonds, down
to a case where you have a trader on his own with a one-room office
in a small town making a market in a local stock, you have so many
differentiations all the way down that you would need a 500-page
law in order to cover them ^11.
Senator BULKLEY. Well, do you think they will be able to cover
it by regulations?
Mr. CORCORAN. That is what this bill proposes they do.
Senator BULKLEY. Why don't you think they will meet the same
difficulties?
Mr CORCORAN. Because they will have a chance to study the problem and change their rules and regulations as they go along if they
find their rules and regulations do not work out.
Senator BULKLEY. Yes, but they are subject to very direct pressure
while in our case the pressure is more remote.
Mr. CORCORAN. That is true; but at the same time the Commissioners will have a professional job to study and know all the
varieties of conditions. I t is the same problem you always run up
against when you have to give an administrative commission the
power to meet a number of situations as they arise, especially when
you face a problem on which no one is completely sure of the details.
You will notice that in the Dickinson report and in the Twentieth
Century report, as well as in this bill, the general conclusion is that
something must be done about this problem, but at exactly what
point or degree control should cease no one yet knows. And since
it can only be decided after a great deal of study and a great deal
of experimentation, any statutory provision should be as flexible as
possible.
Senator GORE. On that point let me remind you that liquor has
always been regarded as outlaw commerce. Our effort to prevent
the sale of contrabands of that sort has not been a very pleasant
success, and it is now being abandoned with a great deal of parade
and flourish of trumpets. On the other hand, here we are going to
the extent of almost universal prohibition, not in the matter of contrabands of commerce, but in the matter of stocks and bonds, legitimate subjects of commerce. Do you think the policies are at all
inconsistent 8 I think it was Fortescue who said, " Excessive good
laws produce excessive mischief ", and I think that is true if you
attempt to tell people when to go to bed and when to get up. They
are liable to disregard your advice. I think we should have a
minimum instead of a maximum.
6552
STOCK EXCHANGE PEACTICES
Mr. CORCORAN. And that is the attitude any intelligent commission
will take. But, Senator Gore, the difference between the prohibition
law and this regulatory law is that in the one case you were trying to
prohibit something on possibly moral grounds, which raised a great
deal of resentment among many people, while here
Senator GORE (interposing). But at least it had a great deal of
moral sentiment behind it, and there were the religious organizations strongly backing it.
Mr. CORCORAN. That is true, but the difference between the two
situations is this: In the one case you were prohibiting absolutely
the use of liquor, and m this case you are merely regulating means
and methods of trading in securities.
Senator BTJLKLEY. But if we had left it to the discretion of a commission as to who would have been allowed to buy liquor, it would
have been all right, would it ?
Mr. CORCORAN. I t might have been. [Laughter.]
Senator GORE. Don't you think that here we have a case of meddling with people's daily concerns, and that you should leave something to the individual to do for himself?
Mr. CORCORAN. This is true. And this bill leaves a great deal for
the individual to do for himself. As a matter of fact, this leaves1
the stock-trading business fundamentally in the position of going
on as it has always gone on, subject to certain requirements and
control. In other words, the business will be fundamentally free to
go along, subject only to certain rules and regulations covering certain well-known abuses. There is no social philosophy behind this
bill as Mr. Eedmond tried to make me say the other day. TJiis is
not at all a moral proposal for abolishing stock trading. This is
the result of the economic judgment of the community.
Senator GORE. If you limit it to preventable abuses that would be
one philosophy, but when you go on and on, that is another thing.
The CHAIRMAN. I cannot see any difficulty in that section. The
purpose is to prevent the creating and establishing of a market in
one instance, and in the case Senator Carey mentioned here it is
simply a fellow trying to sell his stock and to realize on it, not for
the purpose of making a market or of creating a market.
Senator GORE. Well, one of your little agricultural corporations
that he was talking about this morning would have to run down to
Washington and ask somebody's permission.
Senator CAREY. Well, if you intend to have a $10,000 livestock corporation man come down here to Washington and take the matter
up with the Federal Trade Commission, it would cost more money
perhaps than the corporation is worth.
Senator GORE. Oh, well, he could come down here and borrow
money from the Government for that. So that would not matter
so much.
Senator BANKHEAD. HOW comprehensive is the matter of making
and creating a market?
Mr. CORCORAN. I told you a while ago of the typical case it was
intended to catch.
Senator BANKHEAD. Would the matter of a newspaper advertisement mean the making of a market?
STOCK EXCHANGE PRACTICES
6553
Mr. CORCORAN. If it were in connection with the general course of
conduct of soliciting bids and offers that could be matched by the
dealer; yes.
Senator BARKLEY. It might depend upon what the courts would
decide, might it not?
Mr. CORCORAN. I t could also be worked out by the rules and regulations of the Commission which are finally to give form to the
language m the bill.
Senator BANKHEAD. AS I get the meaning of this section, it is to
create what one might call a Federal blue-sky law for all stock transactions that move in interstate commerce in any way.
Mr. CORCORAN. Not a Federal blue-sky law in the sense that the
Commission will in any way pass upon the merit of a security.
Senator BANKHEAD. I did not use the term "Federal blue-sky
law " as being objectionable at all, but you know what is generally
mentioned in that connection.
Mr. CORCORAN. There are three or four kinds of blue-^ky laws. I
wanted to be sure that you understood it was not the kind m which
a commission passes upon the matter of the merit of a security and
practically blesses it for sale in the State. As I say, the typical
situation this bill is intended to catch is the situation of the dealer
in securities who uses the mails or the interstate telephone to make
a market. He tries to find people who want to sell to him and tries to
find people who will buy from him, and he tries to pay a little less
for what he buys than he sells for, with the idea of making a profit
in between the two prices. In other words, he makes it his business
to trade in securities. Now, that is the typical case.
Senator BANKHEAD. Let me ask you right there: Is that the sort
of trading that means the making of a market ?
Mr. CORCORAN. Yes; that is making a market.
Senator BARKLEY Let us suppose that I have 2,000 shares of
stock in some small corporation, and that stock is not listed on a
stock exchange, and I have in mmd 20 friends who inight buy 100
shares apiece, and I call them up on the telephone, or write letters
to them—which of course have to go through the mails—soliciting
the purchase of that stock. Of course I am trying to make a market
for my stock because I want to sell it. Now, what is the difference
between doing that and my calling up one man who might be able
to buy all of the 2,000 shares?
Mr. CORCORAN. I am not absolutely sure that even your first case
would be making a market for the stock, in the sense that you were
carrying on, or trying to carry on, a continuous series of buying and
selling transactions. You are trying to distribute stock, in which
operation you do all the selling and the other people do all the
buying. You are not soliciting buyers and sellers to trade through
you. I will not say that could not be within the provisions of this
section, because I do not know. The difference, certainly, between
your 20-buyer case and 1-buyer case is a question of degree.
Senator BARKUEY. AS I indicated a while ago, the meaning of this
language here, " to create a market" ultimately depends upon what
the courts are going to say it means.
Mr. CORCORAN. That is true.
6554
STOCK EXCHANGE PEACTICES
Senator BARKLEY. If they should say it means any sort of effort
to create a market for any quantity of stock, then the transaction I
mentioned would be covered.
Mr. CORCORAN. Yes; except, sir, that the rules and regulations of
the Commission could exempt that transaction at the very beginning
of the administration of the law.
Senator KEAN. I t could, but probably would not.
Mr. CORCORAN N O ; I think it probably would, because if there is
anything that is going to get the Commission into trouble, it is this
over-the-counter market section, and the first thing the Commission
would do would be to see that while it was working out other sections
in the law, it did not get itself snarled up with this one.
Senator KEAN. Under this bill, suppose you have a bank with
$100,000 capital in a town, and some man owns 100 shares, and he
dies. Then his executors have to create a market by soliciting the
other directors and the other people in the town, and selling that
stock, and they would have to come under this law.
Mr. CORCORAN. NO ; I do not believe they would be under the law
just for 100 shares of stock
Senator CAREY. They would, the way that reads
Mr. CORCORAN. NO I t is a matter of degree.
Senator CAREY. YOU have not any degree in this.
Mr. CORCORAN. If I sell you 100 shares of stock out in the corridor,
have I created a market within the meaning of this bill ?
Senator KEAN I think so.
Mr. CORCORAN I just do not think so, Senator, but that is a matter
of judgment.
Senator BARKLEY. That might depend upon how many others you
had asked to buy it beforehand.
Senator KEAN. There is nobody that can buy 100 shares, and it
has to be split up into 10-share lots How are the executors of that
estate going to part with that stock and get the cash to pay the
Government taxes(*
Mr. CORCORAN. They will have to sell the stock. Let us sum the
thing up in three steps. First of all, I am quite sure that the phrase
" creating a market" does not relate to a single isolated transaction,
even though that sale is made in installments, as in your 100-share
case, or as m the case of Senator BarHey's 20 purchases. If I am
wrong on that, then the Commission is given discretionary power to
exempt those transactions by rules and regulations. If I am wrong
in supposing that the Commission will be intelligent in so doing,
then, Senator, I certainly will agree with you that if better language
can be worked out to cover the kind of transaction we all agree should
be subject to regulation, at the same time excluding the type of situation you have been describing, it would be a desirable thing to do.
Senator BANKHEAD. DO you not think the public would be protected if that were limited to dealers in stock?
Mr. CORCORAN. Then, you get into the problem of the definition of
a dealer. All bodies which nave studied this problem, sir, feel that
there has to be some regulation of the over-the-counter market The
Commission established by Mr. Roper, which reported in the Dickinson report, and the Twentieth Century Fund, feel that there must be
some regulation of the over-the-counter market. The over-the
STOCK EXCHANGE PBACTICES
6555
counter market is not concentrated on one or more kinds of technique.
Therefore, it is a subject on which you will have to leave complete
discretion to some commission to study and work out reasonable
rules.
Senator BANKHEAD. AS I gather, the people you are trying to
protect the public from are these professional dealers.
Mr. CORCORAN. That is true—who scalp.
Senator BANKHEAD. If you limit it to deelers, you would exclude
all this controversy about the individual having a right to find a
buyer for his own stock. You are just after people who are engaged
professionally in skinning the public, so to speak.
Mr. CORCORAN. Not always skinning, sir; unconsciously skinning,
perhaps.
Senator BANKHEAD. Otherwise that would not be injurious.
Mr. CORCORAN. But even though you know that the problem of the
dealer is the present problem which concretely suggests itself to your
mind, you are just simply not sure enough that there may not be
others than dealers whom you would like to reach, that you would
like to close the door at this time.
I think you will find, sir, that the representatives of the exchanges
will say that if the exchanges are to be regulated, they would prefer
that the Commission be given pretty complete discretion to control
the over-the-counter market, without too rigid limitations on that
discretion by the statute.
Senator BANKHEAD. I am not considering the exchanges at all.
Senator KEAN. We are not trymg to speak for the exchanges. We
are trying to speak for the little fellow at home.
Mr CORCORAN. The issue is this: Whether you would limit control
of the over-the-counter market to that portion of trading in unlisted
securities which you can definitely trace to somebody you can call a
dealer, or whether you will leave control more flexible, with the
possibility that some other persons might come into the net.
The CHAIRMAN. Let us go on to section 15.
Mr. CORCORAN Section 15, " Transactions by directors, officers, and
principal stockholders." This is one of the most important provisions m the act in that it provides foi the protection of the stockholder from the so-called " corporate insider." Someone has called
it the anti-Wiggm provision of the bill. There is a mistake in the
drafting. I would suggest that the language of the first lines of
section 15 (a) seem to confine the application of the section only to
those directors and officers who own more than 5 percent of any class
of securities. I would suggest, Mr. Chairman, if I might, that the
language should be corrected so that the section applied to every
director and every officer, irrespective of how much stock he owns;
and also to every owner of more than 5 percent of any class of
securities—that is, to every director, to every officer, and to every
influential stockholder, who by reason of his office, and to every influential stockholder, who by reason of his position—and 5 percent
is a lot of stock m a modern corporation—is on the inside of the
circle Section 15 (a) reads as follows [reading] :
SEC 15 (a) Every director, officer, or owner of securities, owning as ot
lecord and/or beneficially more than five per centum of any class of securities
of any issuer any security of which is registered on a national securities
exchange, shall file with the exchange and with the Commission at the time
6556
STOCK EXCHANGE PRACTICES
of the registration of such security or at the time he becomes such a director,
offlcei, or owner of securities the amounts of all securities of such issuer
of which he is the record aad/or beneficial owner, and within ten days after
the close of each calendai month, if there has been an change in his record or
beneficial ownership during such month, shall file with the exchange and
the Commission a statement indicating his ownership at the close of the calendar month a ad such changes in his ownership as have occurred during such
calendar month
That is, stockholders shall know whether the directors are selling
or buying the stock of the company. There has been very little
criticism of that provision. Essentially the same provisions are contained in the Twentieth Century Fund report, and, as I remember,
something to the same effect is m the Dickinson report.
Senator KEAN. Suppose a man is not a director at all and does
not want to be a director, and he happens to own 5 percent or buy
5 percent. Do you think you are going to get him to file with the
exchange all the time just the number of shares he has?
Mr. CORCORAN. I think so, sir.
Senator KEAN. I think then he is not going to take it in his own
name.
Mr. CORCORAN. It says: "As of record and/or beneficially ", so that
if he does not take it m his own name, you catch him just the same.
Senator KEAN. I do not think you will catch him.
Mr. CORCORAN. That is a problem always.
Senator CAREY. IS " beneficial owner " the proper term there ?
Mr. CORCORAN. It is the broadest term you can have.
Senator KEAN. I think it is all right to apply it to a director or
officer, but I think to require the ordinary investor
Mr. CORCORAN. Five percent is a lot in a modern corporation.
Many corporations are controlled by 5 percent or 10 percent.
Senator KEAN. They may own it or they may sell it. This applies to all corporations, and you are getting down to the point where
you are interfering with the individual a good deal there. I agree
with you, with respect to the officers and directors.
Mr. CORCORAN. A stockholder owning 5 percent is as much an
insider as an officer or director. Whether he is a titular director or
not, he normally is, as a practical matter of fact, a director.
Senator KEAN. He might not be.
The CHAIRMAN. If you do not have this provision, you will have
the directors putting in dummies. We have had cases where dummies were used.
Senator KEAN. They are all going to be dummies in the future.
Mr. CbRCORAN. There is a provision in the bill to catch that, if they
use dummies. I will come to that later.
Senator KEAN. I mean to say that if a man owns 5 percent, and
then simply refuses to become a director, they do not elect a dummy.
They elect some other fellow.
Senator BARKI^EY. We tried to prevent dummies in the securities
act.
Mr. CORCORAN. The same provision is in this act.
Senator BARKLEY. They are stirring up a lot of trouble about it.
Mr. CORCORAN. Subsection (b) reads as follows [reading] :
(b) It shall be unlawful for any director, officer, or owner of securities,
owning as of record and/or beneficially more than five per centum of any class
of stock of any issuer, any security of which is registered on a national securiexchange—
Digitized for ties
FRASER
STOCK EXCHANGE PEACTICES
6557
(1) To purchase any such registered security with the intention or expectation of selling the same security within 6 months, and any profit made by
such person on any transaction in such a registeied security extending over
a period of less than 6 months shall mure to and be recoverable by the issuer,
irrespective of any intention or expectation on his part in entering into such
transaction of holding the secunty purchased for a period exceeding 6 months
That is to prevent directors receiving the benefits of short-term
speculative swings on the securities of their own companies, because
of inside information. The profit on such transaction under the
bill would go to the corporation. You hold the director, irrespective
of any intention or expectation to sell the security within & months
after, because it will be absolutely impossible to prove the existence
of such intention or expectation, and you have to have this crude
rule of thumb, because you cannot undertake the burden of having
to prove that the director intended, at the time he bought, to get out
on a short swing.
Senator GORE. YOU infer the intent from the fact.
Mr. CORCORAN. From the fact.
Senator KEAN. Suppose he got stuck in something else, and he
had to sell?
Senator BARKLEY. All he would get would be what he put into it.
He would get his original investment.
Mr. CORCORAN. He would get his money out, but the profit goes to
the corporation.
Senator KEAN. Suppose he had to sell.
Mr. CORCORAN. Let him get out what he put in, but give the corporation the profit. [Continuing reading:]
Such suit may be instituted in law or in equity in any court of competent
jurisdiction by the issuer or by the owner of any security of the issuer in the
name and in behalf of the issuer if the issuer shall fail or refuse to bring such
suit within 60 days after request, or shall fail diligently to prosecute the same
thereafter For the purposes of this subsection, the profit shall be calculated
on the sale or sales by such person of such security made at the highest price
or prices and on the purchase or purchases made by such person of such
security at the lowest price or prices during the 6 months' period, irrespective
of the certificates for such security received or delivered by such person during
such period.
That is in case he said, "Well, I sold within 6 months after 1
bought some stock, but the stock I sold was not the stock I bought
within a 6 months' period. It was stock I bought a year before."
Senator BUCKLEY. DO you provide for the converse of that, where
a man might sell for a short term with the intention of repurchasing?
Mr. CORCORAN. NO ; it should have been provided for. No; I do
not think you need to, sir, because the next section prevents selling
short.
Senator BULKLEY. It would not be selling short. He might be a
large stockholder, and sell his own stock with the intention of repurchasing.
Mr. CORCORAN. The bill does not cover that case. I do not know
whether it should or not.
Senator BULKLEY. I S that not just as reprehensible as to take a
short turn on the up side?
Mr. CORCORAN. YOU see, the next provision prevents either short
selling, or selling against the box.
Senator BULKLEY. It would not be a short sale.
6558
STOCK EXCHANGE PBACTICES
Mr. CORCORAN. Or selling against the box.
Senator BULKLEY. I t would not be against the box. I t would be
his own stock.
Mr. CORCORAN. YOU mean a case where he sold the stock, and
within 6 months bought it back at a lower price?
Senator BTJLKLEY. Yes. A man having a large amount of stock
might know that his company was going to pass a dividend, and then
sell it with the intention of purchasing after the news was out.
Mr. CORCORAN. Possibly a provision to catch that should go into
the statute. That does not happen as often as the other case.
Senator CAREY. If something happened so that he had to raise
some money, he would be penalized by the difference between his high
and his low price.
Mr. CORCORAN. Yes. You have to have a general rule. In particular transactions it nought work a hardship, but those transactions
that are a hardship represent the sacrifice to the necessity of having
a general rule.
Senator CAREY. Suppose this stock passed to an estate, and the
estate had to raise money?
Mr. CORCORAN. I do not think, in that case, sir, the statute would
apply.
Senator KEAN. Why not?
Senator CAREY. The estate is the beneficiary.
Mr. COCORAN. I do not believe it would. Certainly the intention
was that it should not apply to that sort of a situation.
Senator GORE. Would this prevent him from confederating with
someone else, if he were willing to forfeit the profit? His mends
on the outside would take the profit resulting from the influence he
exercised on the market, and then split the pot with him.
Mr. CORCORAN. There is an attempt m the next section to catch
that.
Senator CAREY. Would it be possible for a man to have several
people purchase this stock for him?
Mr. CORCORAN. There are provisions later to catch his wife and
children, as well as trustees ior him. There is also a provision in
the next section to catch those whom he tips off, and who probably
buy for his account, and split the profit, insofar as they can be
caught. Usually men are not as ready to sell a stock with the expectation of picking it up on the down grade as they are to buy a
stock on what they think is going to be a rise in the market.
Senator BULKLEY. A director would be in a position to know bad
things about the company in advance of the public, the same as he
would know good things.
Mr. CORCORAN. That is absolutely true.
Senator GORE Does this rule apply to insiders as well as to the
layman on the outside?
Mr CORCORAN. This is all about insiders.
Senator GORE. Your rule might apply to laymen, but I do not
think it would apply to insiders. They know what is going to
happen.
Senator BARKLEY. Suppose a man buys 100 shares at $10, and
100 shares at $12, and 100 shares at $15. The lowest price, of course,
is 10. Suppose he sells it for 20, 22, and 25. The highest price is 25.
STOCK EXCHANGE PRACTICES
6559
As I understand this language, the profit on the total amount of
stock is the difference between 10 and 25.
Mr. CORCORAN. Oh, no. He buys 10 shares at three different priees.
If he sold 10 shares, the profit would be the biggest spread between
the lowest price at which he bought 10 shares and the highest price at
which he sold 10 shares. But if he sold 30 shares, you would take,
for the first 10 shares, the biggest spread of profit, for the next 10
shares the next biggest spread of profit, and for the third 10 shares,
the next biggest spread of profit. But you would not establish a
given spread of profit for all three sales on the widest spread between
the lowest price and the highest sale.
Senator BARKLEY. All these transactions are a matter of record.
It seems to me the simple way would be to charge him with the actual
profit.
Mr. CORCORAN. YOU are talking now about the sentence that begins
at line 11 on page 29. That is intended to apply only to the situation where a director who has a large block of stock, or a stockholder
who owns 5 percent of the stock, which he has accumulated over a
period, says when he is charged with selling within 6 months, " Oh,
this is not a 6 months' swing, because the particular shares I sold
within this 6 months I picked up 2 years ago."
It is the same provision you have in the income-tax law. Unless
you can prove the actual relationship between certificates, you take
the highest price sold and the lowest price bought.
The Stock Exchange comment on this section is very interesting.
You will notice it says [reading] :
The New York Stock Exchange has long been aware of these evils, and
despairing of effective prosecutions undei the laws of all States, we have urged
that this situation be cured by the passage of a Federal law governing the
mcoiporation of companies
The only objection the Stock Exchange has to these provisions is
that they put a heavier burden on listed companies, because the directors of such companies cannot cheat their stockholders, than it does
on unlisted companies, which will still be m the position where their
directors can cheat their stockholders.
I hardly think that is a reason why we should not protect what
stockholders the law can protect.
Senator BARKLEY. I am not concerned as much about the stockexchange reaction to this section as I am about the effect on the
average man.
Senator GORE. This is aimed at the general evil of officers and
directors rigging their stock up and down, and squeezing out their
own stockholders.
Mr. CORCORAN. Yes.
Senator GORE. I think
Mr. CORCORAN. Before
the objective is desirable.
we discuss it in general, may we go on to
the next paragraph of the same section, subsection (2) [reading] :
(2) To sell any such registered security, if the person selling does not own
the security sold or if the person selling owns the security but does not deliver
it against such sale within 5 days
That is to prevent the same director, officer, or principal stockholder from selling short or from selling against the box.
175541—34—PT 15
10
6560
STOCK EXCHANGE PRACTICES
Senator GORE. That is absolute, is it?
Mr. CORCORAN. Yes; it is absolute.
Senator GORE. An officer or director cannot sell the stock of his own
concern ?
Mr. CORCORAN. He cannot sell short, nor can he sell stock which
he holds in his own box for delivery against the eventual short
covering.
Senator KEAN. In other words, if he happens to be in Europe, he
cannot sell his stock.
Mr. CORCORAN. Within 5 days, sir. There is no difficulty about
delivery within 5 days. If you were in Europe and sold your stock,
the stock would probably be in a strong box in New York, and you
would certainly leave the key with someone who was conducting
your affairs. Normally you do not go to Europe and put the key
to your safe-deposit box m your trousers' pocket.
Senator KEAN. NO ; but you hide it away.
Mr. CORCORAN. And leave nobody in charge of your affairs?
Senator KEAN. And leave nobody in charge of that box.
Mr. CORCORAN. Probably, sir, the statute should make an exception
for such untrustmg people who go away with their strong-box key.
It might provide for duplicate keys.
Senator BAK&LEY. YOU might require him to take his securities
with him.
Senator GORE. Or turn all the keys over to some key commission.
[Laughter.]
Mr. CORCORAN. Subparagraph (3) affects the friends to whom
these corporation directors and officers and big stockholders pass on
a tip that the stock is going up for a short swing, and through whom
they may conceal their own operations, since the friend may be
simply acting as an agent through whom the director, officer, or
principal stockholder effects the transaction for his own benefit.
The paragraph reads as follows [reading] :
(3) To disclose, directly or indirectly, any confidential information regarding or affecting any such registered security not necessary or proper to be disclosed as a part of his coiporate duties Any profit made by any person, to
whom such unlawful disclosure shall have been made, in respect of any transaction or transactions in such registered security within a period not exceeding 6 months after such disclosure shall mure to and be recoverable by the
issuer unless such person shall have had no reasonable ground to believe that
the disclosure was confidential or was made not in the performance of corporate duties.
The other provisions are the same. That provision will make the
stock market a lot less fun, but it is probably necessary.
Senator CAREY. That would mean that if an oil company expected
to bring in a well, and an officer knew of it and imparted that information to a stockholder, it would be contrary to this law.
Mr. CORCORAN. If that were confidential, and if the stockholder to
whom the tip was imparted knew it was confidential and should not
have been disclosed. You will notice the provision, sir, in lines 5 to
7 on page 30. Then, if there were any profit in the 6 months' swing
in the stock, the company would get the profit.
Senator CAREY. Suppose he did not say it was confidential, but
said they had a good well coming in tomorrow, and this fellow went
out and bought some stock?
STOCK EXCHANGE PRACTICES
6561
Mr. CORCORAN. The person who is being sued by the company, if
he can show that he had no reasonable ground to believe that the
disclosure was confidential or was made not in the performance of
corporate duties, would not be liable.
Senator BARKLEY. HOW can the digging of an oil well be confidential? Anybody who passes along would see it.
Mr. CORCORAN. I do not know anything about the oil business.
Senator CAREY. The information is not always given out.
Senator GORE. They can tell whether they are going to produce,
or whether it is a dry well.
Senator BARKLEY. They cannot tell until they finish.
Senator CAREY. I do not see how you can determine when the information is confidential and when it is not.
Mr. CORCORAN. That would depend, sir, upon the nature of the
business of the company and the nature of the information.
Senator CAREY. Suppose he said, " I have a letter here today from
our man out in the field, and I am certain from what he says that we
are going to have a good well." The man goes out into the market
and buys.
Mr. CORCORAN. Whether that is a revelation of confidential information depends upon all the circumstances surrounding the case.
Senator CAREY. I think you are breeding a lot of lawsuits here.
Senator GORE. If he says, " strictly between us two ", that would
be confidential.
Mr. CORCORAN. May we go on, sir?
The CHAIRMAN. Yes.
Mr. CORCORAN. Section
16 relates to the accounts and records,
reports, examinations of exchanges, members, and others [reading] :
SBO 16 Every national securities exchange, every member thereof, every
person transacting a business in securities through the medium of such member, every dealer making or creating a market for securities through the mails
or the use of any means or instrumentality of interstate commerce, shall make,
keep, and preserve such accounts, correspondence, memoranda, papers, books,
and other records and make such reports as the Commission by its rules and
regulations may prescribe The accounts, correspondence, memoranda, papers,
books, and other records of such persons shall be subject at any time or from
time to time to such periodic, special, or other examinations by examiners or
other representatives of the Commission as the Commission may deem necessary
or appropriate, and the cost of such examinations, including the compensation
of the examiners, shall be fixed by the Commission and paid by the person
examined
Senator KEAN. Why paid by the person examined ? If they want
to examine anything, let them go and examine it, but let them pay
for it.
Mr. CORCORAN. This is one of the costs of administration of the
act.
Senator KEAN. I t may be one of the costs of administration of
the act, but it is a great burden and a special tax on the individual.
Mr. CORCORAN. This, of course, applies only to brokers and dealers
on exchanges. I t does not apply to the companies listed on the
exchanges.
Senator CAREY [reading]:
Every person transacting a business in securities.
And so forth.
6562
STOCK EXCHANGE PRACTICES
Mr. CORCORAN. That is a broker who is not a member of the
exchange.
Senator CAREY. It does not say a " broker." I t says " person."
Mr. CORCORAN. Transacting business in securities.
Senator CAREY. A person who sells securities is transacting business.
Mr. CORCORAN. N O ; he is not. We had some talk about that the
other day when you were not in here, and we are going to clarify
that language. I am quite sure that a man who merely bought and
sold a security would not be said to be transacting a business in
securities.
Senator BARKLEY. Any more than a man who is in the habit of
buying a new suit of clothes now and then would be in the business
of buying clothes.
Senator KEAN. If he. sold it to another fellow, he would come
under this act.
Senator GORE. If he sold it to a second-hand man he would be in
trouble.
Mr. CORCORAN. Just one suit?
Senator GORE. Yes.
Mr. CORCORAN. Then we should be careful about that.
Senator KEAN. I do not see why, if the commission wants to get
any information, they shoulH not employ their own people to get it.
Mr. CORCORAN. Senator, it comes down to this. If you are willing
to make an appropriation large enough to cover the costs of examinations, and pay it out of the Treasury, all right.
Senator BULKLEY. HOW much would that be?
Mr. CORCORAN. I do not know, Senator.
Senator KEAN. The tax is enough at the present time on all these
businesses.
Mr. CORCORAN. I think you will find in practically every State law
a provision for the examination of persons whose examination has
been thought to be in the public interest, and that the person examined pays the cost of the examination.
Senator KEAN. In banks that is true, but not in other businesses.
Mr. CORCORAN. I know; but certainly, sir, the securities business
has been important enough in our national economy so that if you
are justified in asking banks to pay the cost of their examination, you
are justified in asking exchanges and brokers and dealers to pay for
theirs.
Senator BULKXEY. W^th respect to banks, it is usual to have a
statutory number of times a year when they are to be examined, and
it is not merely held, over them as a club, with the threat " if you
don't do so and so, we will examine you, and it will cost you so
much."
Mr. CORCORAN. I t is merely a question of where you want the burden to fall.
Senator BULKLEY. I t is more than that. I t is a club held over
them. In the case of an arbitrary examination at the discretion of
the commission, and at the expense of the party to be examined, it
is a club held over them.
Senator KEAN. And they can employ a great many men to e_xamine
them.
STOCK EXCHANGE PBACTICES
6563
Mr. CORCORAN. In speaking of the periodic examinations that
•are required of banks, the policy or wisdom of which has been questioned, since we have learned how statements are dressed for the
bank examiner these days, you want to remember that the banking
business is a more steady and regular business than is the business of
the broker, the dealer, or the exchange. Certainly you would not
want to cut down the Commission to a periodic examination. The
problem, then, arises: If you feel, as a matter of public policy, that
you want the Commission in a position where it is not held down
to periodic examinations but m a position where it can make examinations whenever it chooses, the problem arises as to where the cost
of such examinations should fall. If the Congress is willing to appropriate enough money so that the Commission may feel that it can
make examinations when it is in the public interest to do so, that is
perfectly all right. We are merely talking now of where the money
comes from.
Senator BULKLEY. I do not think that is all that is involved in
it at all.
Senator KEAN. NO. There is a great deal more than that.
Mr. PECORA. In the case of banks the law authorizes or directs the
Comptroller of the Currency to make a minimum number of examinations a year.
Senator BULKLEY. Exactly, and everybody that goes into the banking business knows what he is up against m that respect.
Mr. PECORA. But there is nothing in the law which prevents the
Comptroller of the Currency from making more than the minimum
number of examinations of the bank.
Senator KEAN. But it is a custom.
Mr. PECORA. There is no record of the Comptroller of the Currency having abused that authority to the prejudice of a bank.
Senator KEAN. The other side is this, that m the income-tax administration they go around and examine your books. In my office
I have one pretty nearly all the time, I think.
Senator BARKLEY. YOU ought not to have so much business.
Mr. PECORA. From some of the evidence this committee has heard,
there have not been enough examinations by income-tax agents.
Senator KEAN. I do not pay for that, and I do not expect to pay
for that.
Senator BARKLEY. YOU do if they find anything wrong.
Senator KEAN. Yes.
Mr. CORCORAN. Section 17
Mr. REDMOND (interposing). Mr. Corcoran, is there not a final
sentence to that last section of some importance ?
Mr CORCORAN. I t is something that has worried you? I t has never
worried me. Perhaps you would like to make the argument before
the committee.
Mr. REDMOND. I do not think you read it to the committee.
Mr. CORCORAN (reading):
Any representative of the Commission designated by it shall have access to
the premises or any part thereof of any national-securities exchange and the
right to attend any meeting or proceeding of the exchange or any committee
thereof
After all, under the theory of this bill, exchanges and exchange
committees are no longer private clubs but are instrumentalities of
6564
STOCK EXCHANGE PEACTICES
the public. Certainly there is no reason I can see why a representative of the Commission should not be permitted, if it is thought
desirable, to attend meetings of an exchange.
Mr. EEDMOND. It raises simply the question as to whether the
exchanges are going to be operated by the Federal Trade Commission, or whether the exchanges are going to be left as independent
bodies subject to regulation.
Mr. CORCORAN. Not operated, sir—merely an observer setting at
the meeting. This does not say he shall run the meeting.
Mr. REDMOND. NO ; but every bit of confidential information would
be immediately available to that representative, and might be used
by him, apparently, for any purpose.
Mr. CORCORAN. Sir, under the circumstances and in view of the
need for public regulation of the stock exchanges, is there any strictly
stock exchange business that is confidential any more ?
Mr. REDMOND. I think there is, Mr. Corcoran.
Mr. CORCORAN. YOU mean you would like to have it so.
Mr. REDMOND. NO. I think it exists, but that is just a different
point of view.
Mr. CORCORAN. May we go on to section 17?
The CHAIRMAN. Yes.
Mr. CORCORAN. " Liability for misleading statements." [Reading:]
Sec 17 (a) Any person who shall make or any person, including any director, officer, accountant, or other agent of such person, who shall be responsible for the making of any statement in any application, report, or document
filed with the commission, which statement is, in the light of the circumstances
under whch it was made, false or msleadmg m respect of any matter sufficently
important to influence the judgment of an average investor shall be liable to
any person (not knowing that such statement was false or misleading) who
shall have purchased or sold a security the price of which may have been
affected by such statement, and the person mjuied may sue in law or in equity
in any court of competent jurisdiction for the damages caused by such statement, unless the person sued shall sustain the burden of proof that he acted
in good faith and in the exeicise of reasonable care had no ground to believe
that such statement was false or misleading.
That is the provision of the Securities Act toned down a little.
Senator KEAN. I think that is all right.
Senator GORE. Who is an " average investor " ?
Mr. CORCORAN. I think that is as close as you can come to it. I
have heard the criticism that no one knows who the average investor is, but I do not know how otherwise you are going to describe
the standard you are trying to uphold.
Subparagraphs (b) and (c) establish a rough rule of damages in
the event that the person cannot prove his actual damage. Subparagraphs (b) and (c) need to be redrafted to make certain that if
actual damage is provable, the injured person can collect no more
than the actual damage. This rule of thumb is substantially that
which we have discussed earlier in connection with manipulations
and pools.
Mr. REDMOND. TO be limited to the actual damage ?
Mr. CORCORAN. Yes; if there is any actual damage provable.
Mr. REDMOND. YOU would not allow them to recover unless there
was actual damage, would you, Mr. Corcoran?
Mr. CORCORAN. What we are talking about is a situation where,
for instance, an investor has purchased on the basis of a false report
STOCK EXCHANGE PBACTICES
6565
whereas he might not otherwise have purchased and has not sold out.
In that case I do not know what the actual damage is.
Senator COSTIGAN. YOU might allow nominal damages.
Mr. CORCORAN. NO ; not nominal damages.
Mr. REDMOND. Suppose the stock is selling higher than he purchased it.
Mr. CORCORAN. Then there is no damage.
Mr. REDMOND. There is nothing which would prevent his recovering under the theory you just advanced.
Mr. CORCORAN. A S I have just said, we have discussed reworking
these sections concerning damages for civil liability, for manipulations.
Section 18
Senator KEAN. I want to talk about subparagraph (c) of section
17. That I regard as nothing but blackmail.
Mr. CORCORAN. Then subparagraph (b) is blackmail, too.
Senator KEAN. N O ; because you say " 2 years after the discovery."
Two years after filing the papers would be all right, but 2 years after
discovery means nothing but blackmail.
Mr. CORCORAN. YOU are talking about subparagraph (e). I
thought you said (c). I am very sorry.
Senator KEAN. YOU are right. I have made a mistake. Subparagiaph (e) is nothing but blackmail. I think that the suit should be
brought withm 2 years after filing the papers.
Mr. CORCORAN. But very often you do not discover
Senator KEAN. They discover it after the market has gone down,
and after something has happened, and they are looking for mistakes, and years afterwards there is a liability that carries to your
grandchildren and great-grandchildren.
Mr. CORCORAN. YOU mean that there should be a cut-off—say 10
years after the basis of suit actually happened ?
Senator KEAN. I think it should be 6 years after the thing happened, at most. That is, the legal liability.
Mr. CORCORAN. What you mean to say is that there should be a
provision, or statute of limitations, in here to the effect that the
action may be maintained at any time within 2 years after the discovery of the violation, but in no event more than 6 years after the
actual filing of the false report ?
Senator KEAN. I am ready to take that.
Senator CAREY. DO you not think it will be discovered within 2
Senator KEAN. It ought to be. I think it ought to be within 2
years.
Senator CAREY. This says he has to sue within 2 years.
Senator KEAN. After discovery.
Senator CAREY. Would he not have discovered it, if he had bought
stock? Would he have to wait 2 years?
Senator KEAN. Suppose he waited 10 years, and some fellow found
out that there was a mistake in a paper 10 years afterward.
Senator CAREY. YOU mean he discovered a fraud was perpetrated?
Senator KEAN. Ten years afterward, or 20 years afterward.
Mr. CORCORAN. There is a provision in the Securities Act which requires you to bring suit within a certain time after the discovery, but
there is a cut-off at 10 years. You wish something analogous to that?
6566
STOCK EXCHANGE PBACTICES
Senator KEAN. I think the suit should be brought within 2 years
of the filing of the paper.
Mr. CORCORAN. That is pretty short.
Senator KEAN. I do not think so.
The CHAIRMAN. The other suggestion is better.
Mr. PECORA. Within 2 years after discovery, but in any event not
more than 6 years after the violation.
Senator KEAN. That is the legal limit, but this only leads to
blackmail.
The CHAIRMAN. We will consider that.
Senator BARKLEY. I do not quite understand that blackmail
reference.
Senator KEAN. YOU would if you were in the business.
Senator BARKLEY. If I were in the blackmail business; yes.
Senator KEAN. If you were in the blackmail business you would
understand it very well.
Mr. CORCORAN. Section 18 Some of this we discussed yesterday,
down to, I should say, paragraph (c). Is it satisfactory to you,
Mr. Redmond, if I start at (c) ?
Mr. REDMOND. Oh, yes.
Mr. CORCORAN. Jumping
over to page 34 of the bill [reading] :
The authority above given the Commission shall include, among other things,
authority to prescribe such rules and regulations for national securities exchanges, their members and persons transacting a business in securities through
such members, in addition to those specifically provided in this act, as it may
deem necessary or appropriate in the public interest or for the protection of
investors, and may by its rules and regulations more specifically define the
foim and procedure to be followed in carrying the provisions of this act mto
effect The Commission, among other things, may prescribe the time and
method of making settlements, payments, and deliveries—
Which amounts to this, that if an exchange is not doing its job
in respect of the rules for operating the exchange, the Commission
can step in and prescribe the rules under which the exchange shall
operate m practically all particulars affecting the investing public.
Senator KEAN. In other words, it can run the exchange.
Mr. CORCORAN. In a very extreme case, yes; it can run the exchange as an alternative to rescinding its license and putting it out
of business altogether, which practically every other proposal for
regulating the exchanges provides for. [Reading further:]
The Commission, among other things, may prescribe the time and method
of making settlements, payments, and deliveries—
That is with relation to transactions in stocks and bonds—
the time and method of calculating margin requirements, and the time and
method of closing out undermargmed accounts
Senator KEAN. I think that is very bad. If a fellow is undermargined and will not pay up his margin, I want to sell him out;
I want my money.
Mr. CORCORAN. Of course, you represent the broker's attitude, sir;
you are a broker. But there may be a certain public desirability that
there be a locus pemtentiae for the fellow to whom you have given
notice at 2 o'clock in the afternoon to " pony up " by 5 in the afternoon.
STOCK EXCHANGE PRACTICES
6567
Senator KEAN. I might get wiped out in the meantime.
Mr. CORCORAN. Very seldom, sir. I think it is pretty well established that brokers very seldom get wiped out through their relationships with their customers.
Senator KEAN. A lot of them have lost a lot of money in the last
few years.
Senator BARKIJEY. That was not because they did not wipe out
their customers in plenty of time.
Senator KEAN. A lot of them have lost a lot of money themselves.
Senator GORE. In dealing on their own account, you mean ?
Senator KEAN. NO ; I did not mean that.
Senator GORE. Maybe they operated on insufficient margin 2
Senator KEAN. NO ; they had plenty of margin to start with, but
they were carried too long; the market was not broad enough. This
is a question of allowing a political body to tell you when you can
sell out and when you can't. The point is that if that political
body does not want you to sell out, they can say you cannot sell;
and how are you going to protect yourself ?
The CHAIRMAN. Where is that, Senator?
Senator KEAN. The first two lines at the top of page 35.
Senator BARKLEY. What are you driving at, near the top of page
35, where you say:
The commission, among other things, may by rules and regulations prescribe
rules for the conduct of business on exchanges, for the classification of members—
What do you mean by that?
Mr. CORCORAN. Sometimes on some exchanges you have variations
in memberships. On the New York Exchange all members have
equal privileges. That is not true of all exchanges. [Heading further :]
The commission, among other things, may by rules and regulations prescribe
rules for the conduct of business on exchanges, for the classification of members, for the election of officers and committees to insure a fair representation
of the membership, for the suspension, expulsion, or disciplining of members,
for the listing or striking from listing of any security with right of appeal
by the issuer to the commission, for the- reporting of transactions on the
exchanges and upon tickers maintained by or with the consent of any exchange, including the method of reporting short sales, sales of securities in
default in bankruptcy or receivership, and sales involving other special circumstances The commission may fix or prescribe the method of fixing uniform
rates of commission, interests and other charges, may prescribe minimum units
of trading, rules limiting the manner, method, and place of soliciting business,
rules for odd-lot purchases and sales, rules regarding minimum deposits on
marginal accounts, and rules limiting or prohibiting the registration or trading
in any security within a specified period after the issuance or primary distribution thereof—
That is to prevent listing securities on an exchange before they
have been sufficiently broadly distributed.
Senator GORE. Are these the general powers of the Commission?
Mr. CORCORAN. Yes, sir.
The CHAIRMAN. Does the
bill give the Commission power to fix
interest rates on call loans?
Mr. CORCORAN. The word " interest" here relates to charges made
to customers for carrying an account. When you buy on margin,
6568
STOCK EXCHANGE PBACTICES
of course you borrow from a broker. He charges you interest on
the debit balance.
The CHAIRMAN. I understand that; but is there any provision in
the bill reaching that question of interest on call loans?
Mr. CORCORAN. NO, sir; but since all call loan borrowing will have
to be done through members of the Federal Keserve System, they
will have a certain control over that
The Commission has power to—
Prescribe mles governing the carrying of accounts and to prohibit fictitious
or numbered accounts and require the disclosure of the real and beneficial
owners thereof The Commission shall have power to fix the hours of trading,
and, if the public interest in its opinion so requires, summarily to suspend
trading in any registered security upon any registered exchange for a period
not exceeding 90 days
(d) The rules and legulations of the'Commission shall be effective upon
publication in the manner which the Commission shall prescribe
Senator GORE. Eight there you suspend trading Would you not
limit the rights
Mr. CORCORAN. I t is suspending a stock from trading because you
think there is something wrong in the trading. I think even the
Exchange does that It suspends operations m a stock when it finds
there is something wrong going on.
Taking the criticisms of those two sections, let us first deal with
a minor criticism of section (d). That section was taken verbatim out of the securities act. Mr. Whitney points out that the
rules and regulations go into effect overnight without adequate
notice. I would suggest, Mr. Chairman, that, if there is any feeling
about that, there is no objection to a provision for adequate and reasonable notice prior to the time the rules and regulations go into
effect.
Section (c) raises a frank problem of policy, whether to put the
regulatory commission in the position, wherever an exchange does
not promulgate adequate rules and regulations for the handling
of the public's money on the exchange, to step in and compel the
exchange to change its rules and regulations. Understand that
at the present time the public's money is subject to rules and regulations drawn up at the absolutely untrammeled discretion of an
exchange operated like a private club, and that you are giving the
regulatory commission here no more power than the stock exchange
itself possesses over the operations of the public's money in the
market without any law.
I think Mr. Eedmond wants to say something about that.
Mr. REDMOND. NO. I think you have summed up the situation.
It is the power to operate which is being vested in a Federal administrative body.
Mr. CORCORAN. I t is a power to step in in the event the Commission finds the method of operation being undertaken by the exchange
unsatisfactory to it
Mr. EEDMOND. There is no such limitation to the provision.
Mr. CORCORAN. I admit it comes down to the same thing, but I am
just putting it from the other point of view.
Mr. EEDMOND. I should, I think, point out that some of these
powers go beyond the powers of the governing committee of the
Exchange and involve matters that can only be changed by an amendment to the constitution of the exchange.
STOCK EXCHANGE PBACTICES
6569
Mr. CORCORAN. But still completely within the power of the
exchange as an exchange.
Mr. REDMOND. If you assume that all the members would vote in a
particular way, yes; but if they should vote differently, not even the
governing committee nor any other group of members of the exchange
could possibly make the change.
Mr. CORCORAN. But the Exchange as a whole could make the
change. It is completely within its power
Mr. REDMOND. Yes
Senator KEAN. But
you do not think that, given this power, a
commission is not going to step in right away, do you?
Mr. CORCORAN. N O ; I should think that a commission in selfprotection
Senator KEAN. I t would step in under any circumstances and
exercise the full powers conferred by the law.
Mr. CORCORAN. I do not think that the Commission would. I
think a commission with any intelligence would be discreet enough not
to try to run the Stock Exchange. But if the Commission is to be in
position to revoke the license of and completely suspend an exchange,
it certainly should be in a position to do something less than that and
change the rules of the exchange or any particular rule of the exchange. Otherwise, you put the Commission in a position where it
cannot correct an abuse on an exchange short of suspending the
exchange and completely ruining the market for its securities.
Senator GORE. YOU do not think that would be desirable ?
Mr. CORCORAN. I think in some cases it may be necessary, but it
certainly is not desirable, sir, to empower the Commission to change
bad conditions on an exchange only by abolishing the exchange.
Senator GORE. Let me ask you this, Mr. Corcoran. I suppose you
have considered this, but do you think it an impossibility by this act,
if those powers were exercised, that it might drive the exchanges to
Montreal ?
Mr. CORCORAN. We are ready for Montreal, sir; that comes in in
section 28.
Senator GORE. YOU are going to regulate Canadian exchanges?
I think that is a good idea. But what I had really m mind was this
heavy typewriter or teletype machine. I can sit in this room and
write on such a typewriter and it will also operate one in Montreal.
Does not the matter involve an element that is hard to reach, appreciating the persistence of the bootlegger in his determination to
survive?
Mr. CORCORAN. We have done our best with Montreal.
Senator GORE. If there are some people here who really would like
to be excused from your regulation and who want to transact business
in Montreal, do you think you ought to pursue them up there?
Mr. CORCORAN. Yes; I think so. I think so, particularly because
one of the arguments made against regulation is the threat ihat if
you try to regulate the business of American securities in the United
States it will all run over to London or Montreal or Amsterdam.
Senator KEAN. Are they not entitled to?
Mr. CORCORAN. Yes; except that if you are going to regulate the
American public's dealing in their own securities you should not let
that dealing get out of your jurisdiction.
6570
STOCK EXCHANGE PRACTICES
Senator GORE. YOU want to pen them up and then regulaate them ?
Mr. CORCORAN. We will give the Commission power to prescribe
rules and regulations for such cases as seem in the public interest.
Senator KEAN. I would like to state here that when I was a boy I
was with a house that was not a member of the exchange. They
succeeded in making more money than almost anybody in Wall Street
at that time.
Mr. PECORA. That is probably still true of some individuals.
Senator KEAN. They made a great deal of money. They would
prepare the mail to go abroad, and I would take that mail to the
steamer, putting English stamps on it, and it was delivered to the
steamer by hand, which was not interstate commerce, because when
I gave it to the purser of the steamer they said it was in the custody
of the Queen and it was all right. The law would not cover that.
Senator GORE. Oh, yes.
Senator KEAN. NO.
Senator GORE. We have got to take the Queen into this scheme.
Senator KEAN. All foreign mail was delivered by hand to the
purser of the steamer.
The CHAIRMAN. A foreign ship?
Senator KEAN. Yes. The mail had English stamps on it.
The CHAIRMAN. Proceed, Mr. Corcoran.
Mr. CORCORAN. We are running short on time, sir. May I just
simply say that subsection (e) provides for the power of the Commission to subpena witnesses in connection with investigations under
this bill. The stock exchange objects to the provision in subsection (e). I think that is a little bit unusual, because, as a matter of
fact, these are practically the provisions of the Martin act of New
York, of which the stock exchange urged the passage so that the
attorney general could deal with people whom it did not like. This
is just simply turning around the very act which the stock exchange
pushed through the Legislature of New York so it may apply to the
stock exchange as well.
Mr. REDMOND. I do not know whether it is your youth or not, but
the history of the passage of the Martin Act which you have just
given is slightly inaccurate.
Mr. CORCORAN. I had my information, sir, from an assistant to the
Attorney General of the State of New York, who is in this room.
Mr. REDMOND. I realize that there has been a great deal of information given you and that you have testified from information
quite freely; but aside from that, there is a difference, as I understand the language of the two acts. This purports to prevent a
witness who is examined from giving any information in regard
to the examination to anybody except with the permission of the
Commission.
Mr. CORCORAN. That is to protect the market from leakage as to
what i^ going on in the witness room. In the event that an examination is being made which eventually does not end up in the pillorying
of the stock, there should not be leakage from the examination room
that may affect the market or hurt the stock.
Mr. REDMOND. Then you want to prevent him, as I see it, from
giving information of the examination. Surely he ought to be allowed to consult his own counsel as to what transpired m the exam
STOCK EXCHANGE PBACTICES
6571
inations before the representatives of the Commission. Otherwise
we have come to a star-chamber proceeding of a most unique kind.
Mr. PECORA. DO you not recognize the language here as being
almost verbatim from the Martin Act 2
Mr. REDMOND. I do not, quite frankly; I am not as familiar with
it as Mr. Corcoran seems to think I am.
Mr. PECORA. This language was taken verbatim from the Martin
Act, and that has been in operation, now, in New York State for
fully 10 or 12 years and it has been upheld by the court there.
Mr. REDMOND This provision?
Mr. PECORA. Yes; it is frequently invoked by the attorney general
of the State of New York, practically every week of the year; and
I never have heard any criticism of it from the stock exchange. I
have heard nothing but encomiums of praise from the stock exchange
with respect to the Martin Act.
Senator BTJLEXEY. What language are you referring to?
Mr. PECORA. The concluding sentence of subdivision (e) on page
37.
Mr. REDMOND. I will be delighted to compare it with the Martin
Act and see whether the context is the same, Mr. Pecora.
Mr. PECORA. If you will take the trouble to do that, you will verify
my statement.
Mr. REDMOND. But there must be some further limiting language.
Certainly it has not been enforced m New York, to my knowledge,
to prevent a man from consulting his own counsel.
Mr. PECORA. I am telling you that this is a provision of the Martin
Act which has been practically lifted bodily out of the Martin Act
and put in this subsection; and it is invoked, I venture to say, practically every business day of the year by the attorney general's office
in the State of New York.
Senator CAREY. Does this deny an attorney to a man summoned
as a witness ?
Mr. PECORA. That construction has never been placed upon it in
any court that I know of. The obvious purpose of the section is
clear to everybody, I think, and it is just as Mr. Corcoran has indicated. There may be an abuse of power under any kind of statute,
regulatory or otherwise; but that is no reason for not enacting laws
designed for the public interest.
Senator GORE. This does not give the Commission power to prescribe what a witness shall testify to, does it?
Senator KEAN. Not quite; almost.
Mr. CORCORAN. Section 19, "Liability of controlling persons."
Without reading those paragraphs, the first is taken verbatim from
the Securities Act. The purpose is to prevent evasion of the provisions of the section by organizing dummies who will undertake the
actual things forbidden by the section.
Subsection (d) has come in for some criticism. That says, in
effect, that if the wife of a director sells short the stock of her husband's company, or if his child or parent residing with him sells it
short, or if a trustee for him sells it short, he has the burden of proof
that the transaction was not done with his approval, nor for the
purpose of enabling him to evade the prohibition against his selling
the stock short.
6572
STOCK EXCHANGE PEACTICES
Senator KEAN. DO you think that this would prevent a banking
house or brokerage house from organizing a separate corporation
to buy and deal in securities?
Mr. CORCORAN. If it controlled that separate corporation house
that bought and dealt in securities, it would be responsible for the
acts of that separate corporation under this bill.
Senator KEAN. YOU are going to prevent a broker from buying
securities for his own account?
Mr. CORCORAN. Under the provisions as they are now drawn, you
have to be a broker only; yes.
Senator KEAN. YOU cannot take customers' accounts?
Mr. CORCORAN. NO.
Senator KEAN. The
only other way you can do it is by organizing
a separate firm, such as some people have done, or organizing a
corporation and have the same people own the stock of that corporation.
Mr. CORCORAN Of course, as the bill is now drawn you cannot do
that; but if the bill were amended to provide for that, then the dealing of that separate corporation would not be a violation of the act.
The controlling originating house, the house that set up the separate
corporation, would not therefore be subject to any liability under
the act for doing both kinds of business.
Senator KEAN. Don't you think that ought to be allowed?
Mr. CORCORAN. We went over that ground yesterday, sir. That is
away back in section 10.
Senator KEAN. It seems to me, for instance, that a firm that I
happen to know something about, which is a large dealer in municipal bonds—they are not listed on the exchange, but do a very large
business—suppose we wish to continue to do that business; under
this bill, they would have to either get out of the exchange or else
give up that business?
Mr. CORCORAN. That is true, sir. That ground we went over, you
will remember, Senator, for nearly an hour yesterday.
Section 20 This section gives power to the Commission to enforce the act by injunction, by order. I am jumping to page 40,
subsection (ii). Under this paragraph the Commission has power,
after appropriate notice and opportunity for hearing, to make an
order suspending for a period not exceeding 12 months, or withdrawing altogether, the registration of a national securities exchange if
the Commission finds that such exchange has violated any provision
of this act or of the rules and regulations promulgated thereunder or
has failed to enforce compliance therewith by a member or an issuer
of a security registered thereon, or withdrawing altogether the registration of a security the issuer of which has failed to comply with
the provisions of this act or the rules and regulations promulgated
thereunder.
Senator KEAN. t would like to go back to (d) for a moment on
page 38. Would that not prevent a son from being a broker if his
father were an underwriter or dealer?
Mr. CORCORAN. Unless he could sustain the burden of showing—
of course the son would have to live with the father—unless he could
sustain the burden of showing that his brokerage transactions were
not carried out with the father's approval nor for the purpose of
enabling the father to evade this provision.
STOCK EXCHANGE PEACTICES
6573
Senator BTJLKLEY. The easiest way would be to acquire separate
residence.
Senator CAREY. Why did you not put the mother in there ?
Mr. CORCORAN. They are both in.
Senator CAREY. A man might be dealing for his son.
Mr. CORCORAN. The bill says, a child or a parent.
Senator CAREY. The family is not all in.
Mr. CORCORAN. Yes; the whole family is in, sir.
Senator KEAN. That would prevent a son becoming a member of
the exchange if his father dealt in securities.
Mr. CORCORAN. Only, sir, if it could be shown that the son was
acting as a dummy for the father.
Senator KEAN. I do not know whether it would require a dummy
or not.
Mr. CORCORAN. May I go on, Mr. Chairman ?
The CHAIRMAN. Yes.
Mr. CORCORAN. We were on subparagraph (ii), on page 40, providing that after appropriate notice and opportunity for hearing the
Commission may suspend the registration of a securities exchange;
that is, withdraw its license to do business, or it may withdraw the
registration of a particular security the issuer of which has failed
to comply with the provisions of the act or the rules and regulations
made thereunder. That is an enforcing provision to the effect that if
an exchange will not comply with the act the Commission may shut up
the exchange, or if the issuer of a particular security on the exchange
will not comply with the act, the Commission may force the exchange to strike the security from the list, just as the exchange now,
for reasons, strikes a security from the list when the issuer will not
comply with the regulations of the exchange.
Senator GORE. It is your theory, at least, that most of the evils that
proceed from dealing in stocks, and so forth, result from machinations and sinister activities on the part of the stock exchange as such,
or from brokers and outsiders and officers and directors who are
manipulating their own stock? Who is the chief sinner in this
scheme?
Mr. CORCORAN. I t is hard to tell who is the chief sinner, sir; there
are so many sinners.
Senator GORE. I had figured that the stock exchange itself had
not been so guilty.
Mr. CORCORAN. Not the New York Stock Exchange; but there are
many others, sir.
Senator GORE. I know there are about 18 that operate more or less,
and there are more than that that are inconsequential. Of course, the
New York Stock Exchange is the head and front of the whole business A great many abuses have been perpetrated by officers and
directors and brokers and others.
Mr. CORCORAN. Your investigating committee can tell you more of
that than I can.
Senator GORE. I am more or less familiar with that. I hesitate to
strike with paralysis the exchange itself.
Mr. CORCORAN. Of course, this is the extreme remedy if everything
else fails.
6574
STOCK EXCHANGE PRACTICES
Senator GORE. Yes; capital punishment is the extreme limit; that
is true.
Mr. CORCORAN. Somewhere abuses have to stop, sir.
Senator CAREY. There is no appeal from any ruling of the Commission, is there ?
Mr. CORCORAN. Oh, yes; there is an appeal to the courts. But
the findings of fact of the Commission, just as the findings of facts
of a jury when you appeal to the upper court, are final.
Senator GORE. Which would be the worse—to "fly to evils that
we know not of "—which would have more serious consequences, to
allow the stock exchange to continue to function and limit your
regulations largely to those who on the outside abuse the privilege
afforded by the exchange, or just to close the exchange entirely and
say, " We are going to cut this business out; you cannot operate this
business; you cannot function at all" ?
Mr. CORCORAN. I am one of those who just believe the stock exchanges have a function in the economic system; so you should not
kill them.
Senator GORE. DO you underscore the word " just"—that you just
believe?
Mr. CORCORAN. I withdraw that word, sir.
Senator GORE. I think it is further proof of your very keen
intelligence.
Mr. CORCORAN. NO ; I believe in stock exchanges. I do not believe
you should kill them. I do believe you should regulate them—not
because I have any social philosophy in regard to the subject—
but because as a sheer matter of economic wisdom they should be
regulated. That is the only test of statesmanship. They have cost
many millions of dollars; they have cost 12,000,000 men their jobs
Senator GORE. Oh, yes; but you cannot center that on the stock
exchange. The point is, would conditions be worse without any stock
exchange at all than they are with it ?
Mr. CORCORAN. Are you proposing to eliminate the stock exchanges
completely ?
Senator GORE. NO. I was wondering if you were not; if it came
to that.
Mr. CORCORAN. NO, sir.
Senator KEAN. Are you not coming pretty near it under this bill?
Mr. CORCORAN. NO.
The CHAIRMAN. Proceed, Mr. Corcoran.
Mr. CORCORAN. The next subsection is {in) which permits the
Commission to suspend any member or officer of an exchange whQ it
finds is violating any provision of this act or the rules and regulations made thereunder, or has effected any transaction for any other
person whom he has reason to believe is violating in respect of such
transaction any provision of this act or the rules or regulations made
thereunder. That is giving the Commission as a last resort the power
to suspend a member.
Section 21 provides that all hearings by the Commission shall be
public. There has been an objection made to that—that possibly
trade secrets will be made public to the advantage of foreign competitors. I think we went over some of that ground yesterday—that
there were very, very few of those secrets, anyway, and that there
STOCK EXCHANGE PEACTICES
6575
is no reason why anything m a hearing before the Commission should
involve such trade secrets; and that even if it did, it is more important to establish the principle of publicity on these things than
to have the same sort of star-chamber proceeding which the stock
exchange is worried about under the provisions of the Martin Act.
The same comment relates to section 22 with regard to the public
character of all information filed with the Commission.
Section 23 has to do with court review of orders. I t provides that
there may be a review of orders of the Commission by a Federal
<3ourt, with the proviso which is common in connection with the review of all proceedings of administrative bodies, that the findings of
the Commission as to the facts, if supported by evidence, shall be
conclusive. That is, the case is not retried over and over again in
every appellate court, a provision which is the very essence of the
right of appeal in any court system.
Mr. REDMOND. Might I just ask you one question—because a moment ago you made the statement that findings of fact are conclusive
here just the same as the findings of a jury are conclusive. That is
hardly true, is it? The findings of a jury are conclusive if supported
by the weight of the evidence.
Mr. CORCORAN. This says, " I f supported by evidence."
Mr. REDMOND. Shall be conclusive?
Mr. CORCORAN. Yes.
Mr. REDMOND. SO that
means any evidence whatsoever. I t is not
a question of the weight of the evidence as would be involved in an
appeal from a jury.
Mr. CORCORAN. I do not know the difference between weight of
evidence and evidence. This says that if the findings of facts are
supported by evidence, they shall be conclusive. I do not see what
you gain, sir, by putting some more words in.
Mr. REDMOND. Except that we might get the right that court in
review could set aside a finding of the commission as being contrary
to the evidence; whereas, the way I read it, if the commission has a
finding of fact and if there is any evidence of any kind to support it,
no court can set aside that finding.
Mr. CORCORAN. I must say I do not really understand the difference.
If the finding is supported by evidence, you want to require it further to be supported by the preponderance of the evidence ?
Mr. REDMOND. NO ; it is the same question as you get in an appellate court, setting aside the verdict of a jury.
Mr. CORCORAN. I do not really see what the difficulty is. If there
is any worry about it, Mr. Chairman, I would see no objection to
making the same provision
The CHAIRMAN. It is in accordance with the Supreme Court deci5 ions on cases coming up from the Interstate Commerce Commission.
Mr. REDMOND. That is true, Mr. Chairman, because the Interstate
Commerce Commission is an administrative commission charged
with the administration of a very complicated act, where the evidence in regard to findings might be very difficult of submission to a
court of appeal, and, therefore, to facilitate administration, such a
provision was included in the Interstate Commerce Act and has been
175541—34—PT 15
11
6576
STOCK EXCHANGE PEACTICES
supported by the Supreme Court of the United States. But here
we would be dealing with facts that are very simple, and yet of a
very vital nature on which the business life of a member of the exchange would depend, because if the man had violated, or even intended to violate, one of the numerous provisions of this bill, the
Commission could expel him or compel his expulsion from the exchange. I see a vast difference between the administrative necessity
that makes a provision like that wise in the case of the interstate
commerce law, and the present bill.
Mr. CORCORAN. Mr. Redmond, is it not true that just as complicated factual situations can arise under this act as under the Interstate Commerce Act?
Mr. REDMOND. I do not think so.
Mr. CORCORAN. D O you want to try the evidence all over again in
the courts? Otherwise
Mr. REDMOND. Have you ever been in a rate case before the Interstate Commerce Commission? Because I know of nothing more complicated.
Mr. CORCORAN. NO.
Mr. REDMOND. And
it was proceedings of that character that the
courts were not felt competent to pass upon and review the evidence.
Mr. CORCORAN. Suppose you had a very complicated case here and
were trying to prove an indirect participation m a pool; is that
not almost as complicated?
Mr. REDMOND. There may be complications; but then, the court,
from the evidence, can determine whether the findings are justified
or not.
Mr. CORCORAN. But we are talking now, if I get the distinction,
about the difference between being supported by evidence and being
supported by the weight of evidence. Is that it?
Mr. REDMOND. I t is a question as to whether a court can set aside
a determination of a jury as contrary to the weight of the evidence*
The CHAIRMAN. We will consider that and take the matter up in
detail. I t is a question of whether we want the court to try the
whole case over again on the facts and the laV, or let the facts stand
as found.
Mr. CORCORAN. I S there anything further you want to take up r
Mr. Redmond?
Mr. REDMOND. NO.
Mr. CORCORAN. Section
24 relates to penalties.
[Reading:]
Any person who wilfully violates any provision of this act or any rule or
regulation made thereunder, or any person who shall make, or any person,
including a director, officer, accountant, or agent thereof who wilfully is
responsible for any statement in any application, report, or document filed with
the Commission, which statement is, m the light of the circumstances under
which it was made, false or misleading in any matter sufficiently important
to influence the judgment of an average investor, shall upon conviction be fined
not more than $25,000 or imprisoned not more than ten years, or both except
that when that such person is an exchange, a fine not exceeding $500,000 may
be imposed
I think that section speaks for itself.
Senator GORE. The courts require penal sections to be pretty
explicit m defining what constitutes a crime. I am wondering
whether " to influence the judgment of an average investor 5<l would
be sufficiently definite.
STOCK EXCHANGE PRACTICES
6577
Mr. CORCORAN. I t is as definite, sir, as you can make the proposition.
Senator GORE. That may be true. But courts sometimes hold that
when you do your best you have not done enough; and I was wondering whether, m your judgment, that defines anything at all of a penal
nature.
Mr. CORCORAN. That, sir, is for final determination by the court.
To say whether you can make this a crime or not—I should certainly
think that the evil you are trying to reach, and the practical limitations of language m such circumstances are factors which have to
be taken into consideration in applying a philosophy of what can
be put in a criminal statute.
Senator GORE. That is the point. You would have to prove what
an average investor was, and the facts proven would have to be in
addition to that what were calculated to influence the average investor's mind. Of course there is no such thing as an average man.
I remember that the clerk of the parish in which the University of
Oxford is located reported that for 20 years the crop was below the
average. I t is pretty hard to picture averages.
Mr. CORCORAN. Section 25 relates to the jurisdiction of offenses
and suits. These provisions have been taken practically verbatim
out of the Securities Act and are merely provisions for the jurisdiction of the courts for violation of the act.
Section 26 covers the effect on existing law and provides
[reading]:
The rights and remedies provided by this act shall be in addition to any
and all other rights and remedies that may exist at law or in equity, except
that this act shall supersede such laws of any state as are inconsistent with
the provisions or purposes of this act and such laws of any state as provide
for the supervision or regulation of the administration or conduct of business
on any exchange which is licensed by the Commission
An objection has been made to that, that the superseding of State
law by a national law in this case is unconstitutional. I understand, Senator, that the committee is permitting a brief to be submitted on the constitutionality of the act, rather than endure the
rather doubtfully valuable process of arguing it out orally. Of
course, this problem will be taken up with all the other constitutional questions.
Senator CAREY. Has there been any law that has been passed with
that provision m it?
Mr. CORCORAN. That effect is true of any Federal statute in which
the national power invades a field which, prior to the time the national power was exercised, was permitted to
Senator CAREY. Does that mean that any law of New York State
affecting the New York Stock Exchange would become inoperative
after this law became effective?
Mr. CORCORAN. Insofar as it was inconsistent with this law.
Senator GORE. The bankruptcy law, for instance ?
Mr. CORCORAN. Like the Federal bankruptcy laws superseding
State insolvency laws, the national law drives out all systems in
so far as they are inconsistent. That is a situation you always have.
A State can legislate additionally to the Federal law, but it cannot
legislate inconsistently with it.
6578
STOCK EXCHANGE PRACTICES
There is, therefore, a flexible discretion left to the Commission in
this provision to take care of American securities already listed on
foreign exchanges, or to permit the Commission to take care of the
problem of foreign arbitrage mentioned in Mr. Whitney's brief.
Subsection (b) of section 26 provides that [reading]—
Nothing in this act shall be construed to modify existing law with regard to
the binding effect on any member of any exchange of any action taken by
the authorities of such exchange to settle disputes between members or with
regard to the binding effect of such action on any person who has agreed
to be bound thereby or with regard to the binding effect on any member of any
disciplinary action taken by the authorities of the Exchange as a result of
violation of any rule of the Exchange, insofar as the action taken is not
inconsistent with the provisions of this act or the rules and regulations of the
Commission thereunder
That leaves the jurisdiction of the exchanges over their members
intact except insofar as it is exercised m a ^ a y inconsistent with
the act or the rules and regulations of the Commission under the act.
Section 27 covers the validity of contracts [reading] :
Any condition, stipulation, or provision binding any person to waive compliance with any provision of this act or of any regulation promulgated pursuant thereto, or of any rule requned by such regulation shall be void
That is taken verbatim out of the Securities Act.
Subsection (b) provides as follows [reading]:
Every contract made in violation of, or the performance of which involves
the violation of, any provision of this act or of any rule or regulation thereunder shall be void as regards any cause of action arising after the effective
date of such provision, regardless of whether the contract is made before or
after such effective date
There again, the Federal power simply steps in. There is no
contract clause binding the Federal Government.
Now, Montreal—this is to prevent the flight of American securities from American exchanges to foreign exchanges. [Reading:]
It shall be unlawful for any broker or dealer, directly or indirectly, to make
use of the mails or of any means or instrumentality of transportation or communication in interstate commerce for the purpose of effecting on an exchange
situated in a place not subject to the jurisdiction of the United States any
transaction in any security the issuer of which is a resident of, or is organized
under the laws of, or has its principal place of business in, a place subject
to the jurisdiction of the United States except in accordance with such rules
and legulations as the Commission may prescribe
There is, therefore, a flexible discretion left to the Commission in
this provision to take care of American securities already listed on
foreign exchanges, or to permit the Commission to take care of the
problem of foreign Arbitrage mentioned in Mr. Whitney's brief.
SEO 29 Registration Fees Every national securities exchange
Senator GORE (interposing). Pardon me just a moment. That
would embrace, you think, these typewriters ?
Mr. CORCORAN. Teletype? Certainly, sir. That is an instrumentality of communication in interstate commerce.
Senator CAREY. Could a broker established in Montreal do business
in this country?
Mr. CORCORAN. AS long as he did not keep communication with
this country in connection with the business through the mails.
Senator CAREY. He could not have customers in this country deal
on that exchange ?
STOCK EXCHANGE PEACTICES
6579
Mr. CORCORAN. Not if he had to use the mails or instrumentalities
of interstate commerce to keep contact with their business on that
exchange.
Senator CAREY. HOW could you prosecute a broker in Montreal
who did establish ? You could bar him from the mails. You could
not prosecute him.
Mr. CORCORAN. NO ; you could not You could bar him from the
mails, but you could not prosecute him unless you could catch him.
Senator GORE. Let me ask you this: There is a little town up there
on the border about 35 miles from Montreal. He could concentrate these orders and messages and so on and run over to Montreal
and get them. Would that be embraced in this ?
Mr. CORCORAN If he operated completely withm Montreal ?
Senator GORE. HOW IS that?
Mr CORCORAN. If he operated completely in Montreal ^
Senator GORE I mean if on this side of the line he concentrated
his messages and ordered and got them, say, by 7 or 8 o'clock in the
morning, then motored up to Montreal by the time the exchange
opened. Would he be included ?
Mr. CORCORAN. I do not know, sir. He certainly used the mails.
It is true that the mails stop short at the Canadian border, but I
certainly would say that in that case he ^ as using the mails for the
purpose of carrying on a business m American securities in Montreal.
SEC 29 Registration fees
Senator KEAN. Excuse
me, but if he went to the steamer and deposited his letters on British ground, then he would not be, because
it would not be the American mails ?
Mr. CORCORAN. That is true—and put the Queen's stamps on the
letters.
Senator KEAN. Yes.
Senator GORE. They could get out to sea a mile or two and radio
it across. Suppose they addressed somebody on the ships, and when
they got out 3 miles they radioed it across ?
Mr. CORCORAN. That is an instrumentality of communication in
foreign commerce which you can reach just as easily, which you do
reach under the definition.
Senator GORE Would it reach it under the circumstances described ?
Mr. CORCORAN. That is, the radio?
Senator GORE. N O ; leaving it on the ship, which is the soil of
England, mailed on the boat to John Doe, who is a sort of generalissimo on the boat in a transaction of this sort. He could open up the
mail as soon as he got out 3 miles. These are inspired by the fertility
of the bootleggers that we had under this other prohibition act.
Senator CAREY. HOW about delivering orders by plane ?
Mr CORCORAN. YOU could have a British ship come into this
country to get orders and go beyond a 3-mile limit and maintain a
st^ck exchange upon it, if you want to think of fantastic possibilities.
Senator GORE. YOU know, these bootleggers get pretty fantastic
The CHAIRMAN. Proceed, Mr. Corcoran.
Mr. CORCORAN. Section 29 provides that an exchange shall pay a
registration fee for the privilege of doing business as a securities
exchange during each calendar year. That is a very common and
6580
STOCK EXCHANGE PEACTICES
normal provision. A dealer registering under the blue-sky laws of
a State pays a registration fee for a license to act as a dealer. Even
his salesmen pay a registration fee.
Senator GORE. There would not be any point about that.
Senator KEAN. Yes; but here is a pretty big tax, and ought not
that to cover all examinations and everything else, when you put on
that tax ?
Mr. CORCORAN. If it is enough, sir.
Senator KEAN. It is surely enough.
The CHAIRMAN. It is not a very heavy^tax, one five-hundredth of
1 percent.
Senator KEAN. Yes; but that is pretty big. That runs into a lot
of money.
Mr. CORCORAN. The fee is one five-hundredth of 1 percent of the
aggregate dollar amount of transactions. I understand in the case
of the New York Stock Exchange it might run between $500,000 and
$1,000,000 for a year.
Senator KEAN. Ought that not to pay for the examination ?
Mr. CORCORAN. I do not know, sir. I t is a sheer matter of arithmetic—how much the examinations are going to cost, whether the
Federal Government wants to pay for them by appropriation or
whether it thinks this fee is enough to swing the load, or whether
there should be an additional assessment of the cost of examination
to the persons examined.
The CHAIRMAN. We can work that out after a little experience,
Mr. CORCORAN (reading):
SEC 30 Employees of Federal Trade Commission
For the purposes of this act and of the Securities Act of 1933, the Federal
Trade Commission may select, employ, and-fix the compensation of such employees, attorneys, and agents as shall be necessary for the transaction of the
business of the Commission with lespect to such acts without regard to the
provisions of other laws applicable to the employment and compensation of
officers or employees of the United States
That simply says that within the appropriation made available
the Federal Trade Commission for the execution of these two acts
during any given year the Trade Commission may use that money
to hire expert employees without regard to the civil-service
classifications.
Senator CAREY. All employees ?
Mr. CORCORAN. Yes. That provision has been taken practically
verbatim out of the Reconstruction Finance Corporation Act.
The CHAIRMAN. It has been suggested there ought to be some provision m this act to prevent employees of the Federal Trade Commission from participating in the sale and purchase of securities.
Mr. CORCORAN. Possibly that should be done, sir.
Section 31 is the common separability provision, and section 32
provides that the act shall become effective on October 1, 1934,
except that applications for necessary registrations may be made to
the Commission at any time on or after July 1, 1934, and that
section 30, which permits the Commission to build up its organs
ization, shall become effective immediately upon the enactment of
this act. So that immediately after the act was enacted the Federal
Trade Commission could go about organizing its force. From July
STOCK EXCHANGE PRACTICES
6581
1 on it could begin to register securities in anticipation of the effective
date, and on October 1 the act would go completely into effect.
That finishes the act, sir.
The CHAIRMAN Are there questions by any member of the committee, now 2
Senator KEAN. I have one that I would just like to add to the
definition. On page 5, section 5, the term " dealer "—do you think
that is a sufficient definition?
Mr. CORCORAN. In what way, sir ?
Senator KEAN. Suppose that a man buys or sells stocks for his
own account.
Mr. CORCORAN. Engages in a business of buying and selling stock
for his own account ?
Senator KEAN. Yes; but I mean, do you think that is sufficient?
Mr. CORCORAN. I should think so, sir; but if there is any question
whether that brings within the term " dealer" a man who invests
his own money
Senator KEAN (interposing). Suppose a customer, for instance,
comes in and buys stocks, and the next day he comes in and buys
some more; the next dav he sells some, and back and forth. Under
that term would he not oe a dealer ?
Mr. CORCORAN. I do not think so. I think " engaged in a business
of buying and selling securities for his own account"
Senator KEAN. That is what he is doing.
Mr. CORCORAN. NO.
Senator KEAN. Yes;
he is buying and selling securities for his
own account.
Mr. CORCORAN. He is buying and selling securities for his own
account, but within the normal interpretation of that language he is
not engaged in the business of buying and selling securities for his
own account.
Senator KEAN. Suppose that is the only business he has? Suppose he is a retired man?
Mr. CORCORAN. If, Senator, that language worries you, I should
quite agree with you that it should be amended to a point where it
does not cover a man who is simply investing his own money.
Senator KEAN. Yes.
Mr. CORCORAN. And not engaging in a business of buying and
selling securities to payy them on to others.
Senator KEAN. I just wanted to bring that out.
The CHAIRMAN. Are there any other questions ? That is all then,
Mr. Corcoran. We are much obliged to you. I t has been a very
interesting statement.
Now, Mr. Whitney, would you like to go on now or wait 'till 2
o'clock?
Mr. WHITNEY. I would prefer, if it is the same to you and the
committee, sir, to wait 'till 2.
The CHAIRMAN. Very well; we will take a recess.now until 2
o'clock.
Mr. WHITNEY. Thank you.
(Accordingly, at 12:45 p.m., a recess was taken until 2 p.m., of
the same day.)
6582
STOCK EXCHANGE PRACTICES
AFTERNOON SESSION
The committee resumed at 2 p.m., on the expiration of the recess.
The CHAIRMAN. The committee will come to order, please. Mr*
Whitney, we will be glad to hear you on the bill. Please state your
name, place of residence, and business.
STATEMENT OF RICHARD WHITNEY, PRESIDENT OP THE NEW
YORK STOCK EXCHANGE
The CHAIRMAN. Mr. Whitney, are you familiar with the bill the
committee has under consideration, S. 2693, and, if so, we will be
very glad to have you discuss the bill.
Mr. WHITNEY. Mr. Chairman, with your permission I should like
to make a brief statement with regard tp the general purposes of this
bill and thereafter at your pleasure go on with any questions or remarks in more particular and minute detail as may be desired.
The CHAIRMAN. All right. Proceed in your own way, Mr.
Whitney.
Mr. WHITNEY. Thank you, sir.
Now, Mr. Chairman and gentlemen of the committee: I appear
before you in opposition to Senate Bill No 2693 entitled "A bill to
provide for the registration of national securities exchanges operating m interstate and foreign commerce and through the mails and
to prevent inequitable and unfair practices on such exchanges, and
for other purposes."
On the occasion of my appearance before the Committee on Interstate and Foreign Commerce of the House of Representatives I took
up m detail the sections of the identical bill pending before that
committee. This discussion is now in print and I shall make copies
of it available to you for the record.
I t is not my desire at this time to discuss the bill in detail but to
make clear beyond any possibility of misunderstanding the position
of the New York Stock Exchange with regard to Federal regulation.
The pending bill, as I read it, has three main purposes. First, it
establishes rigid laws to govern exchanges and vests in the Federal
Trade Commission the power not only to regulate but actually to
administer their business. Second, it seeks to restrict and control
the credit system. Third, it seeks to vest in the Federal Trade Commission the control of corporations regardless of whether or not they
are engaged in interstate commerce. If the stock of a corporation
is listed, the corporation is subject to the regulations of the bill and
the potential control of the Federal Trade Commission. If a corporation's stock is not listed, its value is impaired by its meligibility
as collateral in any loan by a member of an exchange or by; any
institution which transacts a business in securities through a member
of an exchange.
Any attempt to regulate by statute and in minute detail the operation of security markets is impossible of accomplishment. Rules
of law effective today would be worse than useless tomorrow and
the harm that would be done before the Congress could assemble
and amend them would be beyond repair. The purpose of Federal
regulation should be to establish supervisory powers with authority
to prevent abuses as time and circumstances require.
STOCK EXCHANGE PRACTICES
6583
The power given to tjie Federal Trade Commission over stock
•exchanges by this bill is not the power to regulate, but is, in fact, and
in great detail an absolute power to manage and to operate them.
Under its provisions there is no function of a stock exchange from
the admission of its members to their expulsion which is not subject
to the control of the Federal Trade Commission. The election pf
officers of exchanges and the appointment of their committees can
be regulated and representatives of the Commission have the right
to attend every meeting of every committee of all exchanges. Such
a power carries with it a corresponding duty and the Federal Government will be responsible for the operation of every security
exchange in the country.
Under the bill the Federal Trade Commission is given broad
power to control credit for the alleged purpose of preventing excessive speculation. The Federal Trade Commission was originally
established to administer legislation dealing with restraints of trade
and dishonest practices in commerce among the States. There is
nothing in the purposes for which it was founded or its history or
in the experience of its personnel to suggest that it is fitted to regulate security exchanges or to control credit by fixing the amount
that brokers and banks may lend upon securities.
The authority of the federal Trade Commission to deal with
credit is in conflict with the control already vested by law in the
Federal Reserve System and its member banks, and the vesting of
control of individual credit in the hands of a single administrative
body does violence to the principle on which our entire banking system is founded.
The power over credit granted to the Federal Trade Commission
is not absolute but is limited by inflexible margin requirements
ivhich will be low in times of stable or declining prices and in
periods of rising prices they will be so high as to prevent the flow
of capital into business
The immediate effect of these margin provisions will be the liquidation of a substantial part of the debit balances now carried for
customers by members of exchanges. There is no assurance that
markets subject to the restrictions contained in the bill could absorb
the volume of thi,s liquidation. Furthermore, if the bill should be
construed to apply to loans made by banks on security collateral,
the volume of liquidation may freeze our'security markets. No
good that can be anticipated from these provisions will compensate
for the harm they are certain to cause.
The power given by the bill to the Federal Trade Commission to
control accounting practices, to dictate the form of financial statements and the information of all kinds which must be submitted
whenever required, vests in the Federal Trade Commission the ability to dominate the management of all companies whose securities
may be listed on exchanges. The apparent purpose of these provisions is to correct the abuses in corporate procedure which exist
today because of the inadequacy of State laws. The remedy for this
situation is a national incorporation law applicable to all companies
doing business in interstate commerce^ This should be accomplished by direct Federal legislation. I t should not be dealt with
indirectly by delegating the regulatory power to an administrative
6584
STOCK EXCHANGE PRACTICES
commission, whose regulations will apply only to corporations which
li^t their securities on exchanges.
Under the provisions of the bill the securities of corporations cannot be dealt in on national exchanges unless they are not only listed
upon such exchanges but also registered with the Federal Trade
Commission. In connection with such registration the Federal Trade
Commission may, in its discretion, impose such conditions as it
may deem necessary in the public interest. It thus appears that
under the guise of establishing sound corporate practices, the Federal Trade Commission will be vested with absolute power to take
over thQ management of all corporations whose shares are listed
on exchanges, regardless of whether or not they are engaged
in interstate commerce. These provisions are not a necessary or
proper part of a law regulating stock exchanges. The mere fact
that they have been included suggests that the bill may have been
intended to establish indirectly a form of nationalization of business
and industry which has hitherto been alien to the American theory
of Federal Government.
The bill is predicated upon allegations that the facilities of security
exchanges have been abused. But the scope of the bill is not limited
to the correction of these abuses. They do not warrant the Federal
Government in taking over the security exchanges. They do not
warrant placing the control of credit in the hands of the Federal
Trade Commission. They do not justify the Federal Government in
using its power over interstate commerce and the mails as a lever
to regulate security exchanges, and through the control of exchanges
to regulate corporations which are not engaged m interstate commerce. I do not believe that the liberalism of today is predicated
on the conception of a national as opposed to a Federal Government.
I do not believe that this liberalism requires the Federal Government
to operate our exchanges, to control our credit and to regulate our
corporations. Reform should be limited to the correction of abuses
and should not retard recovery by unwise restrictions upon individual
initiative.
I t is the purpose of the New York Stock Exchange to assist in every
possible way in the prevention of fraudulent practices affecting stockexchange transactions, excessive speculation and manipulation of
security prices. We should be glad to see a regulatory body, constituted under Federal law, supervise the solution of these grave
problems. We suggest in principle, and subject to the requirements
of law and the constitutional power of Congress, an authority or
board to consist of 7 members, 2 of whom are to be appointed by the
President; 2 to be Cabinet officers, who may well be the Secretary of
the Treasury and the Secretary of Commerce; and 1 to be appointed
by the open-market committee of the Federal Reserve System; the 2
remaining members will be representative of stock exchanges, 1 to be
designated by the New York Stock Exchange and the other to be
elected by members of exchanges in the United States, other than the
New York Stock Exchange. Such a body would bring together a
personnel which would be properly coordinated with the banking
system and in other respects qualified to administer the broad supervisory power which our proposal would give. We suggest the inclusion in the power given to this body of authority to regulate the
STOCK EXCHANGE PBACTICES
6585
amount of margin which members of exchanges must require and
maintain on customers' accounts; authority to require stock exchanges
to adopt rules and regulations designed to prevent dishonest practices and all other practices which unfairly influence the prices of
securities or unduly stimulate speculation; authority to fix requirements for listing or securities; authority to control pools, syndicates,
-and joint accounts and options intended or used to unfairly influence
market prices; authority to penalize the circulation of rumors or
statements calculated to induce speculative activity; and to control
the use of advertising and the employment of customers' men or
other employees of brokers who solicit business. This body should
also have the power to study and if need be to adopt rules governing
those instances where the exercise of the function of broker and dealer
by the same person may not be compatible with fair dealing, as well
as the power to adopt rules in regard to short selling, if the supervisory body should become convinced that such regulation is necessary.
We believe that these regulatory measures will prevent abuses
affecting transactions on exchanges and will, at the same time, not
interfere with the maintenance of free and open markets for
securities.
This proposal represents the considered view of the New York
Stock Exchange adopted by its governing committee, which has
given me authority to present it to you. I say to you confidently
that the exchange will cooperate fully and by all the means in its
power to assist in the prevention of unwise or excessive speculation
and abuses or bad practices affecting the stock market.
Now, Mr. Chairman, if I may have your permission, I should like
to request that Mr. Thomas B. Gay, of Hunton, Williams, Anderson,
Gay & Moore, of Richmond, Va, speak to you, and at a later time
present a brief on the constitutionality of this pending bill.
The CHAIRMAN. Have you the brief that you are ready to submit
now?
Mr. WHITNEY. Not at the moment. I do not think Mr. Gay's
presentation will take too much of your time, and believe it will be
quite interesting to you.
The CHAIRMAN. I was trying to avoid both an oral argument and
a brief. In other words, if the brief will cover all of the points, I
should like to avoid the oral argument.
Mr. WHITNEY. The brief has not as yet been prepared.
The CHAIRMAN. Very well. We will hear Mr. Gay now.
Senator GORE. Mr. Whitney, you will subject yourself to questioning later, I take it?
Mr. WHITNEY. Oh, yes, sir.
Senator GORE. I was not here
when the committee resumed and
I did not know what the arrangement was.
Mr. WHITNEY. I shall be glad to submit myself to questioning at
the pleasure of the committee.
Senator CAREY. Have you any bill to present drawn along your
own lines?
Mr. WHITNEY. NO, sir. We thought it would be presumptuous on
our part to do that, but if there is any help we can give you we
stand ready in every way to do so.
Senator GORE. Mr. Whitney, I should like for you to submit
sometime, and perhaps it would be better in written form than by
6586
STOCK EXCHANGE PRACTICES
way of oral statement, a schedule of the abuses you referred to on
the stock exchange, I mean that could be connected with it or resorted
to under its activities. If you would make up a schedule of those,
with their definitions as you understand them, together with any
suggestions that you think would remedy them, it would be helpful.
There are a lot of technical terms which are not understood by the
public generally, or by members of this committee for that matter,
because we are laymen, and I should like to have a succinct statement of those things, such as wash sales, short sales, pools, and all
those things, just a succinct statement of what they are.
Mr. WHITNEY. Very good.
Senator GORE. If you will prepare it I should like to have it.
The CHAIRMAN. I understand that now, Mr. Whitney, you wish
to interrupt your own statement by introducing Mr. Gay who will
speak on the constitutionality of the bill.
Mr. WHITNEY. Yes, sir; if I may.
The CHAIRMAN Very well
Mr PECORA. May I ask Mr Whitney a
The CHAIRMAN. Certainly
Mr. PECORA. Mr. Whitney says in his
question, Mr. Chairman ?
prepared statement that it
was not his desire at this time to discuss the bill in detail. Is it
your desire to discuss the bill in detail at some future time, before
this committee?
Mr. WHITNEY After Mr. Gay has finished, any points in the bill
I will be glad to discuss. I propose to present to the committee the
prepared statement, with our objections incorporated in it, as to the
bill. Some of these objections have been more or less agreed to,
some of them I say, by Mr. Corcoran in his appearance of the last
two days.
Senator GORE. Mr. Whitney, there is no subtle implication, is
there, m the fact that you have a man named Gay to discuss the constitutionality of this question? [Laughter.]
Mr
WHITNEY. NO, sir.
(Mr. Whitney stood aside for the time being.)
The CHAIRMAN. Very well, Mr. Gay, you may come forward to the
committee table.
STATEMENT OF THOMAS B. GAY, ESQ., OF THE LAW FIRM OF
HTJNTON, WILLIAMS, ANDERSON, GAY & MOORE, RICHMOND, VA.
The CHAIRMAN Mr. Gay, if yoi^ have a brief on this subject it
will be unnecessary to deal at great length in an oral argument on
the constitutionality of the bill, I take it.
Mr. GAY AS Mr Whitney has stated, we should like to have leave
to file a brief, which we will do very promptly.
The CHAIRMAN. All right.
Mr. GAY. For the purpose of the record I will state that my name
is Thomas B. Gay. I am a practicing attorney in Eichmond, Va.,
and a member of the law firm of Hunton, Williams, Anderson, Gay
& Moore.
The constitutional aspects of this bill are so serious and far-reaching that Mr. Whitney has asked me to present in behalf of the New
York Stock Exchange some of the reasons which m our opinion
justify the belief that there is at least the gravest doubt of the
STOCK EXCHANGE PEACTICES
6587
existence in the Constitution of any delegation of power for its
enactment by the Congress.
May I preface what I shall have to say by a reference to the Tenth
Amendment to our Federal Constitution, which provides that—" The
powers not delegated to the United States by the Constitution nor
prohibited by it to the States, are reserved to the States respectively
and to the people."
Because of this constitutional provision we have a dual system of
government, dual in the sense that some powers are delegated to and
exercised by the Federal Government, and those not so delegated are
administered by the States through the voice of the people.
Ours is not a national government. I t is a Federal Government,
It is not national in the sense that it possesses inherent power. I t is
Federal in the sense that it exercises only delegated power, powers
which must be expressly found in the instrument or necessarily implied for the purpose of exercising those expressly conferred.
The importance of keeping in mind these constitutional principles
is quite necessary it seems to me in view of Mr. Corcoran's explanation of the objects of this bill. He summarized them, as I heard him
on yesterday, as embodying four mam purposes:
First. The control of credit that gets into the stock market.
Second. The protection of investors from stock market evils that
are possible under existing set-ups.
Third. The protection of investors from ignorance and exploitation by large inside operators.
Fourth. Regulation of over-the-counter markets, with resulting
protection to securities listed on registered exchanges.
While Mr. Corcoran discussed at some length the social problems
which he thought the accomplishment of those objects would solve,
he advanced no reasons that I heard for thinking that the conditions
which he described are proper objects of Federal regulation, nor did
he suggest that there was in fact any Federal power to legislate in
respect of them in the manner proposed in this bill.
Broadly speaking, the bill is designed to accomplish the objects
which Mr. Corcoran has discussed, in two ways:
First. The use of the mails or any instrument of interstate communication or transportation in interstate commerce for the purpose
of using the facility of a stock exchange, is prohibited unless that
exchange is registered under this act.
Second. The use of the same facilities, that is, the mails or any
instrument of communication or transportation in interstate commerce, for the purpose of making or creating a market in other than
listed securities, is also prohibited except under such rules and regulations as the Federal Trade Commission may prescribe as appropriate in the public interest or for the protection of investors.
Both means, if I may be permitted to say so, of accomplishing the
desired object are therefore predicated upon the power of Congress
either to control the mails or to control interstate commerce.
Now, may I ask whether either power may be invoked to accomplish the objects proposed?
The committee was told on yesterday that this bill was the result
of the efforts of Commissioner Landis of the Federal Trade Commission, and of Mr. Pecora and his associates. I mean from the
standpoint of draftsmanship. Now, Mr. Landis has testified before
6588
STOCK EXCHANGE PRACTICES
the House Committee on Interstate Commerce, and at the beginning
of his testimony he made this very frank and candid statement:
At the thieshold of this question theie seems to me to lie the question of
national power over exchanges I think this committee has to meet that and
to face that before it can go any further The question is not free from doubt.
Because, therefore, Mr. Chairman and gentlemen of the committee,
of the existence of this doubt in the minds of those primarily responsible for the existence of this measure, and because of the conviction
in our minds that there exists no power in the Congress to control
exchanges in the manner proposed in this bill, do we respectfully but
most earnestly submit that the legislation as proposed is not constitutional.
Now, the title of the bill states that it seeks—
To provide for the registration of national securities exchanges operating in
interstate and foreign commerce and through the mails and to prevent inequitable and unfair practices on such exchanges, and for other purposes
The first section embodies its title.
The second section is entitled:
Regulation of exchanges using the channels of interstate commerce and the
mails necessary in the public interest
This paragraph embodies what Mr. Landis stated to the House
Committee on Interstate Commerce was an argument for the enactment of this bill. I t is quite a long paragraph, and I shall not
detain you to read it but will merely say that it contains recitals of
fact which Mr. Landis suggested, and with which suggestion I entirely agree, would be very persuasive before any court in justifying
in point of fact the existence of a need for congressional action. I t
also embodies, however, conclusions of law which all of us know
would be binding upon no court and could not be relied upon to
support the constitutionality of the act.
I do want to read, with your indulgence, just two or three sentences which embody in my opinion pure conclusions of law and,
therefore, constitute no argument for the enactment of the proposed
bill. The first sentence of section 2 says:
Transactions in securities as commonly conducted upon securities exchanges
by means ot the mails or instrumentalities of tiansportation or communication in interstate commerce are affected with a national public interest
I respectfully submit that that statement begs the question, which
is whether transactions in secuntes through the mails or instrumentalities of transportation is interstate commerce. And our view of
the matter, and in the light of decisions which we think relevant
and pertinent, such is not the fact.
Later on m the paragraph
Senator GORE (interposing). Eight there, Mr. Gay, Congress cannot, by merely reciting a thing as a fact, make it a fact.
Mr. GAY Of course not, Senator Gore.
Senator GORE. In other words, the Congress, by enacting a law
that any industry or enterprise is affected with public interest, does
not make it so unless it is so.
Mr GAY Of course, Senator Gore, that is the case.
Senator GORE The Supreme Court has held that in some Louisiana
case; I believe, some sugar-refining case.
STOCK EXCHANGE PRACTICES
6589
Mr. GAY It is because of that fact that I am stressing to the committee the impertinence of these recitals when they are founded upon
what we think are " facts " that are not facts. In other words, to
£ay that transactions in securities by means of the mails or instrumentalities of transportation or communication is interstate commerce is, as I stated a moment ago, to beg the question, which is
whether or not transactions in securities through the mails and by
means of interstate communications is interstate commerce. And
we expect to show you, very briefly, that such is not the fact.
The CHAIRMAN. Suppose we were to write the word " emergency "
in the bill?
Mr. GAY In answer to your question, Mr. Chairman, I should like
to use the same statement that Senator Gore just used: The recital
of an emergency does not establish the fact. I t expresses the opinion
of Congress, but I do not believe it would be conclusive upon a court.
Senator WAGNER. It is very persuasive, however.
Mr. GAY. Undoubtedly, Senator Wagner.
Mr. PECORA. The courts have frequently so stated in upholding
the constitutionality of enactments of the Congress.
Senator GORE. DO you think that the Congress can allege an
emergency and then legislate certain powers to meet the emergency,
and thereby invest itself with powers it would not otherwise possess?
Mr. GAY. I certainly do not, Senator Gore.
Senator GORE. In the case of the Federal Government it used to
be a matter of delegated powers. It cannot add to its own powers
by a mere declaration.
Mr. GAY. That is the whole thesis of my argument, Senator Gore.
The CHAIRMAN. YOU may proceed, Mr. Gay.
Mr. GAY. The next sentence of this paragraph to which I invite
your attention is to be found on page 3, in the middle of the page:
" Such unreasonable fluctuations—"
Referring to those that arise out of so-called " manipulations "
upon exchanges—" constitute an obstruction to and a burden upon
interstate commerce."
In what way? Only if the use of the mails or instrumentalities of
communication and transportation in trading in securities constitute
interstate commerce, which, again, is begging the question.
The sentence continues: "Transactions in securities upon exchanges create a flow of securities in interstate commerce to and from
the places where such exchanges are located "
Again you have an assumption of fact which we think the law
does not sustain, an^d that is that trading in securities by means of
the mails or interstate communications does not constitute interstate
commerce.
Now, before addressing myself to what may be called the legalistic
aspects of this matter, it seeing to me important to state briefly what
the nature of the stock-exchange business is, as well as that of members who trade upon its floor. I am not undertaking, of course, to
discuss the technical operations of exchanges but merely those physical conditions which are really a matter of common knowledge,
which, however, constitute those basic facts upon which legislation
must operate if it be an instrument of interstate commerce.
6590
STOCK EXCHANGE PBACTICES
The New York Stock Exchange is, of course, located on Wall
Street. The buying and selling of securities on that exchange is
done by its members on the floor of the exchange. The securities
themselves which are so bought and sold are required to be delivered
and pstid for through the Stock Securities Corporation, a subsidiary
of the exchange, or at the offices of members of the exchange within
theammediate neighborhood. The business, in other words, is in the
nature of its transaction peculiarly local. I may also say that every
bond listed on the exchange and traded in by its members under the
rules of the exchange must be payable as to principal and interest in
the city of New York; and that every share of stock traded in by its
members must be capable of transfer and registration in the city of
New York.
Now, having regard to those physical conditions, it seems to me
there are transactions of three general characters that flow from
their use:
First. Those that are purely local in their nature. By that I mean,
that a citizen of New York City or of New York State gives to a
broker trading on the exchange an order to sell 100 shares of United
States Steel That broker executes the order by selling the stock to*
another broker who is buying for the account of a citizen of New
York, and the transaction is closed.
Now, whether that is a marginal transaction or one for investment,
both transactions are so essentially local in their nature that it seems
to me to be beyond question that they do not lie within the power
of Federal regulation if there be anything left under the Constitution for the States to control.
The next character of transaction we will say originates from
Richmond, Va., where a citizen gives an order to a local broker or
to the agent of a New York broker to sell 100 shares of United States
Steel on the New York Stock Exchange. That sale is executed
through a broker who buys for the account of a citizen of Boston.
Now, that transaction may have been for investment or it may have
been of a marginal nature, which is said to give rise to so much of
the abuse complained of and which justifies the enactment of a law
for the protection of speculators.
I call the committee's attention particularly t;o the provisions
defining interstate commerce as used in this bill and which appear
as a part of section 17, on page 8. I t is as follows:
For the purpose of this act (but not in anywise limiting the definition of
interstate commerce) a transaction in respect of any security shall be considered to be in interstate commerce if such transaction is part of that current of commerce usual in a security transaction whereby an order to purchase
or to sell a security originates from a person m one State with the expectation
that it will or may be consummated by the leceipt on an exchange of an order
to sell or purchase the same security onginatmg from another person in
another State'
Now, let us stop there for a moment. Is that anything more
than the communication of thought? Is it anything more than the
transmission of intelligence, whether the mails be used or whether
the telephone or the telegraph be employed ?
Senator GORE. Or the radio.
Mr. GAY. Or the radio, or airships. But you could not carry an
idea by airship, although they do move pretty fast.
STOCK EXCHANGE PRACTICES
6591
Now, that definition, it seems to me, is predicated upon the assumption that interstate communication is interstate commerce, and
you are seeking to give character to a business not by its essential
nature but by the mere fact that it uses the mails or the telephone
or the telegraph for its transaction.
Now, as I will show you in a few moments, the Supreme Court
has ofttimes stated that that is not enough to make a business, which
is not by virtue of its nature interstate, interstate in fact.
In New York Life Insurance Co. versus Deer Lodge County,
reported in 231 U.S. 495, dealing with insurance contracts—and I
shall have more to say on this case in another connection—the Court
said:
Nor, again, does the use of the mails determine anything
The court is addressing itself now to the contention of the insurance company that its business was interstate because its agents were
communicating with it in the city of New York from all over the
country for the purpose of conducting that business. Yet the court
says:
Nor, again, does the use of the mails determine anything Certainly not that
which takes place before and after the transaction between the plaintiff and
its agents in secret or in regulation of their relations But put agents to one
side and suppose the insurance company and the applicant negotiating or consummating a contract That they may live in different States, and hence use
the mails for their communications, does not give character to what they do;
cannot make a personal contract the transportation of commodities from one
State to another
And then the court cites a long line of decisions, beginning with
Paul versus Virginia.
Senator GORE. Will you read that again from the word " give "?
Mr. GAY. The court says:
Cannot make a personal contract the transportation of commodities from one
State to another
In other words, where I have communicated through my broker
m Richmond, Va., to sell securities on the New York Stock Exchange,
and that order has been executed by a subsequent sale to a citizen
of Boston, that personal contract on my part, says the court, cannot
be made an interstate transaction merely because interstate communication has been used in its consummation.
In the same volume, 231 U S. 314, the court, in the case of Fidelity
Co. versus Kentucky, upheld the license-tax statute of that State
upon commercial agencies and made this very broad statement of
law:
The circumstance that in a substantial number of cases, even if in the greater
number,, there is correspondence by letter or otherwise from State to Stale,
which might perhaps have an effect upon the conduct of other parties about
entering or not entering the transaction in interstate commerce, is not
controlling
So I say, Mr. Chairman and gentlemen of the committee, that this
definition contained in paragraph 16 of section 3 of the act seeking
to define interstate commerce as a transaction in—
That current of commerce usual in a security tiansaction whereby an order
to pui chase or to sell a security onginates from a person in one State with the
175541—34—PT 15
12
6592
STOCK EXCHANGE PEACTICES
expectation that it will or may be consummated by the receipt on an exchange
of an order to sell or purchase the same security onginatmg from another person in another State—
is in the teeth of the decisions of the Supreme Court of the United
States, which say that such communications do not constitute those
transactions interstate commerce.
There is a third transaction which involves the movement of securities from one State to another. I sell 100 shares of steel through
my broker in Richmond, or through an agent of a New York broker.
I t goes on through a broker on the floor of the exchange, and is sold
to a citizen of Boston. I send the certificate on to the New York
broker. He in turn delivers it to the broker who made the purchase, and it passes to the customer in Boston.
Let me emphasize here, if I may, the distinction which the Supreme Court has always in mind in discussing such matters.that the
movement of that evidence of light in the form of a certificate is a
mere incident to the transaction, and does not necessarily contemplate
it. In point of fact, I think the evidence would show that in most
transactions through the New York Stock Exchange the delivery is
made of a certificate then in New York, and not of a certificate m
the foreign State, where the local broker simply holds it for the
account of the New York broker, and the New York broker delivers
out of his own box a security to fulfill the transaction.
But let us assume that there is, in fact, a movement of securities
from one State to another. Are they of such a nature as to constitute elements or subjects of interstate commerce? The closest
analogy that may be drawn, it seems to me—it is not perfect, but it
affords a reasonable basis for argument, and I think sound reasoning—are the insurance cases. This decision of New York Life Insurance Co. against Deer Lodge County, to which I have referred,
involved that question, and crystallized the law in the Supreme
Court over a long line of decisions, that the business of insurance,
though it resulted in the issuance of contracts to indemnify people
against death, through contracts that had to move from the company
in New York to the insured, wherever he might be, did not constitute
interstate commerce.
That those decisions are very pertinent or persuasive in sustaining
the view that the movement of securities in such manner would likewise not constitute interstate commerce, is evidenced by a communication which I want to read in part to the committee, with leave to
file an original photostatic copy in the record. This is from Commissioner Landis, now Federal Trade Commissioner. I t was written
by him on the 22d of February 1932, to Messrs, Carter, Ledyard, and
Milburn, New York counsel for the New York Stock Exchange.
This letter was written expressing the opinion of Mr. Landis, who
was then a professor at the law school of Harvard University at
Cambridge, upon the question of the constitutionality of the
LaGuardia bill, and the reasons which he gives in this letter are so
convincing to my mind that they answer completely the argument,
if any can be advanced, why this bill is constitutional.
In the covering letter by which he transmitted this opinion—I
think, in fairness to Mr. Landis, I should read this paragraph, because
certainly we have no disposition to do anything more than bring
this! letter to the attention of the committee as the opinion of one of
STOCK EXCHANGE PEACTICES
6593
the draftsmen of this bill, one of those certainly most qualified to defend its constitutionality. From that letter I believe the conclusion is
inescapable that when divorced from his interest in the matter, and
his purpose to advocate its passage, his sound judgment was that the
measure is unconstitutional.
This covering letter, as I have said, contains this paragraph
[reading] :
I have confined myself to the consideration of the constitutionality of the
LaGuardia bill, for I am as yet unconvinced that a bill could not be drafted to
regulate security transactions on stock exchanges which would be constitutional.
The LaGuardia bill, however, bottoms itself upon a theory and conception of
interstate commerce that I am not prepared to accept
It is my purpose to show that the conception of this bill is not distinguishable, in fact, from the conception of the LaGuardia bill, and
to use Mr. Landis' opinion in support of that view.
Mr. PECORA. DO you deny to Mr. Landis the right to change his
opinion, which often is exercised by the judges of our courts?
Mr. (JAY. Certainly not, Mr. Pecora. I t is simply an evidence of
the infallibility of human judgment, but where that opinion is fortified by reason
Mr. PECORA. YOU mean evidence of the fallibility of human
judgment?
Mr. GAY. Yes.
Mr. PECORA. Applying to everybody.
Mr. GAY. But where the reasons which are advanced in support
of a view seem so controlling and convincing, as we think the reasons advanced in this letter by Mr. Landis are, in support of the
view that the LaGuardia bill was unconstitutional, we think it is
a matter for you gentlemen to decide which view to accept.
I want to return to the letter for the purpose of reading that part
of it m which Mr. Landis discusses the pertinency of the decision
of the Supreme Court in the insurance cases, that is, the decision
in New York Life Insurance Co. against Deer Lodge County, to
which I have just referred, in support of the view that the conception upon which the LaGuardia bill was drawn was shown to be
unconstitutional [reading] :
No additional warrant—
Says Mr. Landis
Senator GORE. Could you, just in a sentence, give us the conception
that was embodied in the LaGuardia bill?
Mr. GAY. That was that because corporations were engaged in
interstate commerce, Congress might control them through the control of their securities, and Mr. Landis was of the opinion that that
relationship was too remote to justify the exercise of Federal power
to control interstate commerce. Do I make myself clear, Senator?
Senator GORE. I think so.
Mr. GAY. Mr. Landis says [reading]:
No additional warrant for congressional power is to be gathered from the
fact that stock exchanges make use of such instrumentalities of interstate
commerce as the telegraph, telephone, and the mails for the transaction of
their business Such an argument was pressed upon the court in the insurance
cases but without effect.
6594
STOCK EXCHANGE PRACTICES
Then he makes this quotation [reading]
To accomplish the purpose there is necessarily a great and frequent use of
the mails, and this is elaborately dwelt on by the insurance company in itspleading and aigument, it being contended thai this and the transmission of
premiums and the amounts of the policies constitute a " current of commerce
among the States " This use of the mails is necessary, it may be, to the centralization of the control and supervision of the details of the business, it is
not essential to its chaiacter (New York Life Insurance Go v Deer Lodge
County, 231 US 495)
That is another way of saying, as I said a moment ago, that mere
interstate communication is not interstate commerce, and the character of a business is not changed and converted from mtrastate to
interstate merely because it uses the mails and instruments of interstate communication to carry on that business.
There are a great many other decisions which I shall not detain
you to read from that support that view. They will be recited and
relied upon in the brief which we expect to file.
I pass to my further point, which is this. Let me say, before leaving that, that bonds and stocks are not property. Stocks are mere
evidence of ownership in property. Bonds are evidence of debt.
They are both, however, subject to barter and trade. But do they,
in the opinion of the Supreme Court, constitute commodities or
objects of such a nature as to be capable of passing between the States
within the constitutional conception of interstate commerce? That
they are not seems to me clearly demonstrated by the Courts' decisions
in a number of cases upholding the validity of regulations by States
of exchanges, upholding the power of States to tax trading in them,,
and various other exertions of the State power to legislate.
Mr. PECORA. Mr. Gay, would you pardon an interruption?
Mr. GAY. Certainly.
Mr. PECORA. YOU say that bonds and stocks are not property. Are
there any laws in the State of Virginia which make the stealing
of bonds and stocks larceny ?
Mr. GAY. I say they are not property, Mr. Pecora, with the qualification which 1 made, that is, that they evidence property. Of
course, they represent property in the sense that they may be the
subject of larceny, of course.
Mr. PECORA. Presumably because they are property, or a thing of
value.
Mr. GAY. Yes; that might be quite true; but that still does not
give them a character such as is necessary to constitute the subject
of interstate commerce.
Mr. PECORA. There have been many persons who thought they
owned property when they owned stocks and bonds in recent years,
but afterwards found out they were wrong.
Mr. GAY. I do not see how that could affect the constitutional
question.
Mr. PECORA. YOU were making the assertion that stocks and bonds
are not property.
Mr. GAY. It may be a fact. Personally. I expect a great many
people, motivated as they are in passing this bill, are in that category,
and it may be that their enthusiasm and zeal arises from that fact.
Mr. PECORA. From what fact?
Mr. GAY. That they suffered the sort of loss that you visualized.
STOCK EXCHANGE PRACTICES
6595
Mr. PECORA. If you are leveling that remark at me, let me say you
are entirely mistaken.
Mr. GAY. I was not leveling it at you.
Mr. PECORA. Because no broker ever executed an order on any
securities for me or any member of my family.
Mr. GAY. TO refer briefly to the decisions which, in our opinion,
support the view, the Supreme Court's view, that securities, bonds,
and stocks, lack the commodity nature that an article must possess
in order to be a part of interstate commerce, I want to refer briefly
to this.
In Hatch v. Reardon (204 U.S. 152), the Supreme Court upheld an
act of the State of New York imposing a stamp tax of 2 cents on
$100 of face value of shares of stock when sold in New York by a
resident of Connecticut to a resident of the latter State doing business in New York, as not a burden on interstate commerce. The
Court said [reading]
The facts that the property sold is outside of the State and the seller and
buyer foreigners are not enough to make a sale commerce with foreign nations
or among the several States, and that is all there is here
Again, m Moore v. New York Cotton Exchange (270 U.S.), the
Supreme Court upheld, as not violative of the Federal antitrust
laws, which were, of course, designed to regulate abuses m interstate
commerce, a contract between the New York Cotton Exchange and
the Western Union Telegraph Co for the exclusive sale of quotations
in the sale of cotton on such exchange. The Court said [reading] :
Such agreements do not piovide for, nor does it appear that they contemplate the shipment of cotton from one State to another If interstate shipments are actually made, it is not because of any contractual obligation to that
effect
That is, if I may repeat, the basis of the argument that the sale of a
security on the New York Stock Exchange is not interstate commerce, because there is nothing inherent in the transaction which
necessitates the flow of stocks and bonds from a foreign state.
[Continuing reading ]
But it is a chance happening which cannot have the effect of converting these
purely local agreements, or the transactions to which they relate, into suboects
of interstate commerce
Citing Ware & Leland versus Mobile County, which said [reading] :
The most that can be said is that the agreements are likely to give rise to
interstate shipments. That is not enough.
I shall not multiply decisions on th^t point. They support, we
think, the view that the sale of securities on an exchange does not,
in and of itself, as a contract of barter and sale, necessitate the movement of securities in interstate commerce, and that is the test.
Senator CAREY. May I ask you a question, Mr. Gay.
Mr. GAY. Certainly.
Senator CAREY. Are you acquainted with the Packers and Stockyards Act ?
Mr. GAY. I am coming to that in just a moment, quite fully. I
am happy to say, Senator Carey, that I am just at that point now.
The proponents of this bill—I say the proponents of it. I should
confine myself more strictly to Commissioner Landis, basing my
6596
STOCK EXCHANGE PRACTICES
statement upon his evidence before the House Committee on Interstate Commerce—the proponents of this bill bottomed their argument that this act is constitutional upon the so-called "stockyard
cases and gram futures cases " decided recently by the Supreme Court
of the United States. I just want to read a paragraph from Commissioner Landis' testimony, in which he says, speaking of these
cases, the latter being Chicago Board of Trade versus Olsen, which
is reported in 262 United States, page 1 [reading] :
I think that upon the basis of conceptions of that tvpe, that the constitutionality of legislation such as is proposed here in H R 7852 must be sustained.
What were the conceptions of that type to which Mr. Landis referred? Briefly, they were these, addressing myself for the moment
to this gram-futures case:
Chicago, through the medium of the Chicago Board of Trade,
afforded a means through which gram grown m the West moved
eastward, through means of interstate commerce—I mean the instrumentalities of interstate commerce, the railroads—was sold, and
passed on to the consumer in the East. In other words, the exchange had a relation both to the industry and the commodity, which
constituted the nature of the business, and the railroads, which were
interested in the transportation of that commodity, which, in the
opinion of the Supreme Court, justified Federal regulation and control. Now, unless it can be admitted, or unless it is conceded that
securities are indistinguishable from commodities, these decisions
obviously have no pertinency. In this same letter from Mr. Landis
to which I have referred, he makes this most persuasive, if not convincing, statement upon that subject.
Senator GORE. Which is this? Is this his letter when he was a
professor at Harvard University or his testimony before the House?
Mr. GAY. This is his letter when he was a professor at Harvard
University, written to Carter, Ledyard & Milburn, New York counsel
for the New York Stock Exchange, upon the question of the constitutionality of the LaGuardia bill [reading] :
This consideration is emphatically brought out by Chief Justice Taft in the
Board of Trade case
Then he quotes [reading] :
The sales on the Chicago Board of Trade aie oust as indispensable to the
continuity of the flow of wheat from the West to the mills and distributing
points of the East and Europe as are the Chicago sales of cattle to the flow
of stock toward the feeding places and slaughter and packing houses of the East.
Then he continues [reading] :
The recognition that this is the basic principle undei lying congiessional
control over sales for future delivery and other practices on commoditv exchanges, m my opinion, distinguishes these exchanges from stock exchanges.
In the former type of exchange, the thing that is bought and sold is a commodity moving in interstate commerce The fact that for the moment, when
the transaction upon the exchange actually takes place, the commodity is at
rest and that no interstate delivery is required as between buyer and seller,
has been regaided by the court as immaterial in the light that at bottom there
is a current of interstate commerce in the commodity moving through and
beyond the exchange The stock exchange, however, presents ho such aspect.
Other than a physical certificate representing a chose in action, no commodity
is to move m interstate commerce as a consequence of a sale on the stock
exchange. Dealings upon that market will effect no additions to the cost of
STOCK EXCHANGE PRACTICES
6597
moving these certificates from State to State Indeed, the parallel between a
commodity exchange and a stock exchange is so absent that I cannot regard
these decisions as governing the stock-exchange situation nor as establishing a
principle applicable to transactions upon stock exchanges
I could make no better statement of the differences in the two
lines of decisions, or advance any more forcible argument why the
commodity aspect of those decisions affords no precedent for contending that stock exchanges dealing in securities may be subject to
Federal regulation and control because they are engaged in interstate commerce.
We therefore respectfully but most earnestly submit, Mr. Chairman and members of the committee, that the first means whereby
the evils which this bill is designed to correct, and which Mr. Corcoran has outlined, I may say with considerable eloquence, rests
upon the assumption that there exists in the Congress a power which
the courts have said does not lie there; and that there is no power
in the Congress, through its control over interstate commerce, to
prohibit the use of the mails or means of interstate communication
for the purposes of trading upon a stock exchange unless that
exchange has been registered upon the assumption that it is an
instrument of interstate commerce.
There is another aspect of Federal power, and that is the use of
the mails. I am speaking now of the power of Congress.
Senator GORE. Did you cite the stockyard case ?
Mr. GAY. TWO hundred and Sixty-two United States Reports,
page 1. I gave that, I think, Senator.
Senator GORE. I thought that was the board of trade.
Mr. GAY. The stockyard case is cited and quoted from at considerable length in the Board of Trade ease, Senator. They both
are predicated upon the same process of reasoning—the flow of a
commodity, which necessarily is the subject and object, and capable
of being a part of interstate commerce, the very commerce itselfy
as distinguished from the instruments through which that commerce
i$ carried on, to wit, the railroads.
I have discussed this question thus far—that is, the use of the
mails or instrumentalities of interstate communication—in its relation to the control of Congress over interstate commerce, and I have
endeavored to point out that the mere fact that a business makes
use of those instrumentalities does not characterize that business as
interstate in its nature.
There is another conception, however, upon which this bill is predicated, and that is what may be said to be the very general control
of the Congress over the use of the mails. The power to create post
offices and post roads has, of course, long been recognized by the
courts as conferring upon Congress the power to control the use of
the mails, and by its power to say what may be carried, it has been
regarded as possessing the power to say what may be excluded.
This power, however, as was so well said by the Supreme Court in
Ex parte Jackson (96 U.S. 727), must be exercised by the Congress
with due regard to the existence and the preservation of other rights
guaranteed by the Constitution and Bill of Rights, which embody
the first 10 amendments to the Constitution.
6598
STOCK EXCHANGE PEACTICES
In this case to which I have just referred, the Supreme Court said
treading]:
The right to designate what shall be carried necessarily involves the right
to determine what shall be excluded The difficulty attending the subject
arises, not from the want of power in Congress to prescribe regulations as to
what shall constitute mail matter, but from the necessity of enforcing them
consistently with rights reserved to the people, of far greater importance than
the transportation of the mail
Bottoming my argument upon that constitutional conception, I
would like to inquire what basis there is for the exertion of Federal
power in the manner proposed in section 14 of this act, dealing with
over-the-counter markets, so as to make it unlawful for anyone to use
the mails to make or create a market for unlisted securities without
complying with such rules and regulations as the Federal Trade
Commission may prescribe as in the public interest for the protection
of investors.
I was very much interested in Mr. Corcoran's statement, in reading that paragraph, that it was so indefinite in its object and
purpose as not to permit the present statement of how it would be
enforced. It is capable of enforcement in so extreme a manner, as
Senator Carey illustrated this morning in questioning Mr. Corcoran,
as to make it manifest that any effective use of it would destroy
those rights which the court said have been by the Constitution reserved to the people, and are of far greater importance than the
transportation of the mails.
So far as I know this power has not been exerted, or thus far exercised by the Congress, except in reference to activities of the postal
system, or except in excluding from the mails, or preventing their
use in respect to matters that might be said to be malum in se or
malum prohibitum within some power of Congress. TFhere is no
such limitation upon the broad powers of the Federal Trade Commission as conferred in this section, and its embodiment in this law
would, in our opinion, destroy rights more fundamental, more
essential and more important to the transaction of private business
than any public good which would arise by the enactment of this law.
Therefore, not to detain unduly in a legalistic discussion, but reserving the right to elaborate it in our brief, we respectfully submit
that the two means whereby the social problems which Mr. Corcoran
described, and which he stated this bill was designed to correct, are
sought to be corrected, involve the exertion by the Congress of
power, to wit, the power to control interstate commerce, and its
power over the mails, that may not be constitutionally exercised in
respect to the exchanges or the business of their members, for the
reason that it is not interstate in its character and cannot be made
so by legislative definition. In its relation to the over-the-counter
business, it would transcend those cenceptions of constitutional law
which our court has read into our jurisprudence, and which, it is
said, are of far more importance to the public and the private citizen in the transaction of private business than any public good that
might be obtained by the enactment of this law.
Senator GORE. I S there any analogy between the lottery cases and
those that you have pointed out?
Mr. GAY. The Jackson case, I should say, Senator, was the lottery
decision.
STOCK EXCHANGE PRACTICES
6599
Senator GORE. That is what I thought.
Mr. GAY. Yes, sir. That was predicated on the assumption, of
course, that the lottery was an activity detrimental to the public welfare, inimical to the public good, and because of that fact should be
regulated through the use of the mails.
There may be—and do not misunderstand my argument—the unquestioned power in the Congress to prohibit the use of the mails for
certain purposes, and I hope I shall not leave this table without
making that perfectly clear. Congress may define, as it did in the
lottery case by a specific application of its power, what in its opinion is inimical to the public welfare. This bill, in section 14, does
not contain any such enactment, but leaves it to the discretion of the
Federal Trade Commission to determine what shall be in the public
interest, or inimical to the public welfare, and leaves within its
power the right to control all private business merely because it
uses the mails in its transaction.
Mr. PECORA. Mr. Gay, on page 5 of the printed statement that was
read this afternoon by Mr. Whitney you find the following statement
[reading]:
It is the purpose of the New York Stock Exchange to assist in every possible
way in the prevention of fraudulent practices affecting stock exchange transactions, excessive speculation, and manipulation of security prices We should
be glad to see a regulatory body, constituted under Federal law, supervise the
solution of these grave problems We suggest in principle, and subiect to the
requirements of law and the constitutional power of Congress, an authority
or board to consist of seven members—
And so forth.
Do you think such an enactment as suggested there by Mr. Whitney
for the purpose of preventing the abuses that he referred to would
be in violation of the constitutional power of Congress to enact &
Mr. GAY. I do.
Mr PECORA. Then, you would accept a retainer from anybody to
argue against the constitutionality of the substitute that Mr. Whitney m behalf of the stock exchange, proposes, would you ?
Mr. GAY. NO; I am not arguing against that, Mr. Pecora, and
I want to make perfectly plain to the committee that this proposal,
qualified as it is by Mr. Whitney's statement, subject to the requirements of law and the Constitution, is made in the utmost good faith,
m the recognition that it is of doubtful constitutional right, but
as evidence of a willingness on the part of the exchange, notwithstanding that doubt, notwithstanding that limitation, to go along
in an effort to regulate what may be regarded as a public evil.
Mr. PECORA. There is a recognition of those evils m Mr. Whitney'$
statement, if I correctly interpret it. You are advanced here, a^ I
understand your appearance, to make an argument against the constitutionality of the measure that has been introduced in Congress,
the Fletcher-Rayburn bill.
Mr. GAY. Yes, sir.
Mr. PECORA YOU say m substance, and in fact, that the very
substitute which is recommended or suggested by Mr. Whitney for
the Fletcher-Rayburn bill would be subject to the same objections
that you are now advancing against the constitutionality of the
Fletcher-Rayburn bill.
Mr. GAY. But that fact
6600
STOCK EXCHANGE PEACTICES
Mr. PECORA. I am not questioning the good faith of anybody. I
merely wanted to get from you your own opinion about that.
Mr. GAY. I gave it to you as frankly as I could, Mr. Pecora, and
that is, that it would be predicated upon the existence of the same
sort of power that is sought to be exerted through the enactment of
this bill.
I also want to say, as Mr. Whitney has said, that the proposal,
notwithstanding its constitutional objections, is put forward in the
best of faith, and with the purpose and expectation that if the suggestions of the exchange are adopted, it will live up to them m the
best of faith.
Mr. PECORA. Which would not prevent any individual broker
from bringing an action to declare the enactment unconstitutional.
Mr. GAY. That statement seems to me to answer itself. Of course
not.
Mr., PECORA. I t is axiomatic.
The CHAIRMAN. Very well. We will receive the brief you want
to submit.
(Mr. Gay's brief will be found on p. 6647.)
Mr. GAY. Thank you, Mr. Chairman.
(Mr. Gay submitted for the record the following letter, dated
Feb. 22, 1932, from J. M Landis to Carter, Ledyard & Milburn,
41 Broad Street, New York City This letter will be found on p.
6647.)
STATEMENT OP RICHARD WHITNEY, PRESIDENT NEW YORK
STOCK EXCHANGEE—Resumed
Mr. WHITNEY. Mr. Chairman, I believe the clerk of the committee has received copies of the printed statement with regard to
the bill presented by me before the House committee last week. As
these bills are identical, I have asked him to give to you gentlemen
of the committee a copy of this statement, and I will proceed just as
you may desire, either in the way of answering specific questions
arising on particular sections of the bill, or I will read this entire
statement to you if that is your desire.
The CHAIRMAN. Of course, we can place the statement in the record without you reading it, but, at the same time, we will leave it to
you as to whether you wish to read this or make your own statement.
We will put the statement in the record anyway, and you can do just
as you lifre about that.
(The statement referred to is printed at the conclusion of today's
proceedings.)
Mr. WHITNEY. I think, Mr. Chairman, that I do not want to take
too much of the time of the committee. I presume there may be
various questions with regard to the bill and with regard to the
statements I have made in that relation, that the committee T^ould
like to question me about.
The CHAIRMAN. YOU seem to have dealt with it section by section
in the House
Mr. WHITNEY. Yes, sir.
The CHAIRMAN. HOW would
it do to take it up in the same way
here, without necessarily reading all you said there, but in your own
way, now, saying what you would like to say with reference to the
different sections?
STOCK EXCHANGE PKACTICES
6601
Senator GORE. YOU might at least state the more salient points
that are elaborated in this printed document.
Mr. WHITNEY. I think the first parts of the bill, up to section 6,
•deal with definitions, the explanation of its constitutionality, and
various matters that do not specifically—except generally—touch
upon matters that are at present practices of the New York Stock
Exchange and of other exchanges.
Section 6 of the bill refers, among other things, particularly to
the question of margins. If it is not your desire for me to state
specifically what I have said in this statement, may I make this
broad observation—that the margin requirement set forth in this
bill is not a margin requirement at all? One hundred and fifty percent margin, in my private opinion, totally prohibits what is commonly known as "margin trading", and will have the effect, as I
see it, of eliminating all speculation from security markets. If we
are to be faced with the elimination of all speculation from security
markets, then there follows from that, in my opinion, the result
that security markets will cease to exist; and if that is the desire,
as expressed by Mr. Corcoran, in the social interest or the social
philosophy, that certainly will be accomplished by the passage of
this bill with section 6 existing as it now reads.
Mr. PECORA. Mr. Chairman, I do not recall Mr. Corcoran expressing that as the desire of his bill.
Mr. WHITNEY. Mr. Corcoran, I think—without attempting, Mr.
Pecora, to quote him exactly—granted that the trading on margin
ivould materially decrease.
Mr. PECORA Decreasing it.and entirely stopping it are two different things.
Mr. WHITNEY. And I claim that it will stop it.
The CHAIRMAN Where do you get your 150 percent margin?
Mr PECORA That is the broker's formula, or term.
Mr. WHITNEY. I think that was granted by Mr. Corcoran, too.
Mr, PECORA. Yes; but it is not commonly understood by the public,
Mr. Whitney. Do you think it is?
Mr. WHITNEY Those who trade in the market understand it
Mr PECORA. The whole public is interested in this bill, I imagine.
Mr. WHITNEY. I think it is very easy of explanation. If I may
refer you to page 7 of my statement, the last paragraph on the page
reads as follows [reading] :
This subdivision might m certain circumstances permit securities to be
earned on a 25-percent margin which is less than the New York Stock Exchange now requires its members to demand and maintain If, however, we
imagine a different set of circumstances, the provisions of the bill will have
not an over-liberal but an almost piohibitive result For example, if a security
like General Motors, which has wilhm 3 vears sold at $7 a share and is
today selling at approximately $40 per share, should be presented to a broker
as margin after the effective date of the proposed act, the broker could only
lend $16 per share upon this stock because the 80-percent provision would be
rendeied nugatorv
by the low price which General Motors reached at the
worst period1 of the depiession In this case, the broker would have 150-percent margin, i e, he would advance $16 against a stock selling at $40, and the
difference between these two, or $24, would represent one and one half times
the amount owed him by his customer It is obvious that margins of 150
percent are not necessary for the purpose of insuring the safety of a customer's
account, and that should be the sole purpose of a margin provision
6602
STOCK EXCHANGE PEACTICES
How it works out, Mr. Chairman, in view of the depressed condition of prices a year ago, is that there are few stocks on the list
where at the present time a 150-percent margin would not be made
necessary under the terms of the pending bill.
Therefore, as I have stated, in my personal opinion that would
eliminate entirely margin trading.
Mr PECORA. Mr. Whitney, what you refer to as the 150 percent
margin requirement is referred to in the bill as the 60-percent margin
provided for?
Mr. WHITNEY. Yes, sir. The 60 percent is what the customer has
to put up in the case of General Motors selling at $40—$24—and the
40-percent margin stated by the bill is what the broker is allowed
to loan to the customer, or $16 in the case of General Motors selling
at $40.
Mr. PECORA. The only reason I asked was for the purpose of making it clear that when you referred to 150-percent margin you were
referring to the provision of the bill which would require a customer to put up 60 percent of the purchase price.
Mr. WHITNEY. I am referring, sir, yes, to the practical working
out of the law
Mr. PECORA. In the terminology of the broker, not the terminology
of the law.
Mr. WHITNEY. In the terminology of the broker and in all endeavors or instances that I have any knowledge of the margin is
reckoned from the amount owed—the ratio of how the amount owed
stands to the current guaranteed price of the securities in the loan.
The CHAIRMAN. What is the New York Stock Exchange rule on
margins ?
Mr. WHITNEY. At the present time on accounts of $5,000 or less,
50 percent, and on accounts above that amount, 30 percent of the
debit balance, which is the amount that is owed by the customer to
the broker.
The CHAIRMAN. That would be 50 percent instead of 150?
Mr. WHITNEY In the usual case, 30 percent against the 150 as
written in the bill.
The CHAIRMAN. DO you believe there ought to be any fixed margin
in the law at all ?
Mr. WHITNEY I believe that a minimum should be provided subject to flexibility. Our own rule is flexible The 30 percent that
we now^impose is based on active listed securities as collateral. For
unlisted securities or for listed securities that are extremely volatile
and that fluctuate violently, if they are included as collateral higher
margins are demanded; the basis of that rule being that the collateral
presented or carried by the customer m his account must be sufficient
when banked, when used as collateral in a bank loan, to meet the
debit balance owed by the customer to his broker That is the basis
that has to be fulfilled by all accounts
Mr. PECORA. During the first 6 months of 1929 there was a tremendous activity in the trading in securities on the exchange, was
there not?
Mr WHITNEY. Yes; and the last 6 months too.
Mr. PECORA. And it was attended by higher and ever-increasing
levels of security prices ?
STOCK EXCHANGE PRACTICES
6603
Mr. WHITNEY. In the mam; yes, sir.
Mr. PECORA. During the first 6 months
of 1929 was it ever ascertained by the stock exchange what margins were required of
customers ?
Mr. WHITNEY. AS a whole, Mr. Pecora, by inquiry as to all of our
members 2
Mr. PECORA. Yes.
Mr. WHITNEY. Not that
I remember. I do not want to state this as
a definite fact, but if my memory serves me, at or about that time, the
requirement of the stock exchange, although not published—the requirement of the business conduct committee was raised from 20
to 25 percent, but we had knowledge that a great majority of brokers
increased their margins individually, and we were also on knowledge that certain stocks selling at very high prices had their loan
values marked down by the banks, and therefore the brokers had to
take those prices for the basis of their loan values; had to pass that
on to their customers; our iule existing then, as today, that the collateral in each account must be sufficient to bank it.
Mr. PECORA. Let me read something from a speech delivered by
your predecessor, president of the New York Stock Exchange, Mr.
Simmons, on January 25,1930. I have a printed copy of that speech
which was furnished to me by your institution. The speech was
delivered before the Transportation Club of the Pennsylvania Kailroad, in Philadelphia. Among other things, he said [reading] :
Statistics taken off by the stock exchange from its members' questionnaires
over the first 6 months of 1929 show margins in customers' accounts averaged
40 percent of the market value of long stocks which they were carrying and
65 percent on their debit balances with the brokers I need scarcely point out
how enormous these margins were Never had margins in the New York
brokerage business averaged anything like such high figures
I presume it is fair to say that the reason those margin requirements at that time were stepped up to the highest figures theretofore known m the history oi the exchange was because of the very
commendable desire on the part of those responsible to put some
limitation, to put some stop to the feverish speculation that was
on at the time; and yet we know from events of 1929 that
§oing
lose high margins—40 percent of the market price, which at that
time was very, very high, and 65 percent of debit balances—did not
have the effect of sufficiently breaking the speculative movement.
Is not that so ?
Mr. WHITNEY. I think that is so, Mr. Pecora: I have never
granted, nor do I ever expect to grant, that the elimination even of
all speculation will prevent booms and panics and what takes place
before them and after them. We have seen that, certainly, in other
places, perhaps, than in the stock market. There is nothing to prevent the individual investor buying at the highest price at which a
security sells outright.
Senator GORE. They had some of those explosions even before there
were stock markets.
Mr. WHITNEY. Yes, sir.
Mr. PECORA. That in itself would be a brake.
Mr. WHITNEY. The high margin?
Mr. PECORA. They could not buy as much as they
bought on margins, where they bought outright.
could if they had
6604
STOCK EXCHANGE PEACTICES
Mr. WHITNEY. Perhaps an individual could not, but there are
other individuals or other corporations that might be in position to
buy I do not think, sir, that the elimination of speculation or the
curtailment of it by high margins is any guarantee whatsoever that
we will not have panics and booms and depressions in the future.
Mr. PECORA. That may be, but we can trade upon the experience of
the past, knowing that excessive speculation has led to panics, and
it was a very great contributing factor to the stock-market panic of
1929 which unquestionably made a very substantial contribution to
the present depression—perhaps the economic evil that Mr. Corcoran
had in mind and which he referred to as a social evil. I t is an
economic evil.
Mr. WHITNEY. We have contended for years, Mr. Pecora, that the
control of credit should be used in that regard; and that control
rests with the Federal Reserve System under the law. There were
many persons in 1929 who urged most emphatically the use of that
power and the curtailment of credit for that purpose.
Mr. PECORA. The brokers had that power. They could have refused to accept orders on margin.
Mr. WHITNEY. I believe many brokers used their best endeavors
to curtail.
Mr. PECORA. There was still a wave of speculation.
Mr. WHITNEY. By the elimination of speculation you do not
eliminate booms and panics and what results therefrom.
Mr. PECORA. But we eliminate one of the main contributing factors
to panics.
(Senator GORE. I S there any way to arrive at the source of the
mania and to eradicate this particular disposition on the part of
human beings to bet when they think they are going to win?
Mr. WHITNEY. I know of none, sir, any more than that a human
being can be prevented from taking a drink when he so desires, as
you said this morning.
Senator GORE. We did that for about 12 years
Mr. WHITNEY I think this bill is almost a full brother to the
other one.
Senator GORE. I would like to get at the root of the evil, but I am
thoroughly perplexed as to how to do it. When people buy stocks
selling 60 times their earning power, without knowing a thing on
earth about the stocks, I do not know how you can handle that sort
of people.
Mr. WHITNEY. May I present to you what I think I have stated
before to the committee, that the intent is really the important factor
that determines speculation 2 I t is just as possible for an individual
to buy on margin intending to speculate as it is also possible for
him to buy outright and have the intent of speculation.
Senator GORE. Yes. I would think it was speculation in either
case. They do it in real estate, for that matter.
Mr. WHITNEY. Yes.
Senator GORE We had
the South Sea Bubble and the Mississippi
Bubble and the Tulip mania.
Senator KEAN We had a little speculation down in Florida, also.
Senator GORE. I am willing to go as far as anybody to stop this
evil at the source.
STOCK EXCHANGE PRACTICES
6605
The CHAIRMAN. I think perhaps a hundred million dollars would
cover the entire outlay in Florida. There was a depression here of
29 billions on the 29th of October 1929.
Senator KEAN. HOW much depreciation in Florida ?
The CHAIRMAN. A lot of these people came to Florida and started
that boom. I t was not Florida people that started it.
Senator KEAN. NO ; I know.
The CHAIRMAN. A lot of them came there and made a lot of money
and took their money and went away with it.
Senator GORE. That is a good alibi, Senator.
Senator KEAN. If you had invested at their prices, would it not
have been billions of dollars?
The CHAIRMAN. A hundred million, I think, all told. But that
was a small performance compared with what took place on the
stock exchange in 1929.
Senator KEAN And we could not stop that
The CHAIRMAN. It stopped itself finally.
Senator KEAN. I would like to ask you this, Mr. Whitney. Banks
in 1929 raised the requirements on all their loans, did they not?
Mr. WHITNEY. In a great many instances, yes, they did.
Mr. PECORA. YOU have gone on record, have you not, in public addresses that you have delivered, subscribing to the opinion that the
speculation mama receded m October 1929 and led to great inflation
of securities prices ?
Mr. WHITNEY. Yes, sir.
Mr. PECORA. And that is an evil that
Mr. WHITNEY. If it can be; yes.
Mr. PECORA. DO you recognize that
ought to be eliminated ?
as one of the evils that the
Fletcher-Rayburn bill attempts to check?
Mr. WHITNEY. I recognize that that may be the desire, sir.
Mr. PECORA Well, do you think that that evil can be checked by
State action only and not by Federal action ?
Mr. WHITNEY. I think it goes beyond both, Mr. Pecora. I think
you are trying to deal with human nature.
Mr. PECORA. We may not be able, at any time short of the millennium, to reform human nature in its entirety, but that should not
deter us from efforts to check and prevent such abuses as we become
cognizant of currently. You do not disagree with that, do you?
Mr. WHITNEY. NO. We agree, and we will work to our full extent
of our endeavor to attempt to check such abuses; but I would like
to point out that the wealth of this country at times is valued at
three or four hundred billions. Of that wealth, I believe that some
one-hundred-odd-billions are in listed securities. I think there is a
very serious element, as I have stated in this statement and elsewhere, of doing away with the liquidity of our security markets if
this bill is passed. With the tremendous volume of wealth existing
in securities held by millions of persons in the United States, must
we not be exceedingly careful not to upset the market upon which
those people rely for the liquidation of their securities? I t is the
one market that I know of that has maintained its liquidity during
the last few years of the depression.
Mr. PECORA. It has been maintained in liquidity in the sense that
there was a market place where persons could buy and sell their
6606
STOCK EXCHANGE PRACTICES
securities outright or on margin; but it has also been a market place
where the economic security of the country has been imperiled by
the nature of the transactions conducted there under rules heretofore observed. I think we can point to the experience of 1929 and
the time that has elapsed since then as proof of that. You yourself
have recognized that in your public addresses. Your predecessor,
however, during 1928, when this period of excessive speculation was
in the process of making, apparently thought that the speculation
that had obtained up to that time was not an evil. I have before
me a copy of a speech that he delivered on January 30, 1928, before
the Engineers Society of western Pennsylvania, in which he said
among other things, as follows: [Heading:]
It is, therefore, perhaps inevitable that there is present in this country a
feeling of doubt concerning the permanence of prospenty and of our present
abundance of wealth and capital I may be accused, in referring to this
situation, of philosophizing about a process that is not yet completed and not
yet analyzed. I realize that even our profoundest economic thinkers usually
explain economic processes only when they have reached almost their full
flower; and yet I cannot help but raise a dissenting voice to the statement
we are hearing today that we are simply living in a fool's paradise
Senator KEAN. He was evidently mistaken, was he not?
Senator GORE. That was before the new era.
Mr. WHITNEY. That was hind sight, Mr. Pecora. There are lots
of us that can do that.
Mr. PECORA. We are profiting by that hind sight; and let us see
if we cannot adopt measures that will prevent a recurrence of these
things in the future. That is what this bill essentially aims to do.
Mr. WHITNEY. We agree with the general purposes of the bill,
as I have stated, but with its methods I do not agree.
Mr. PECORA. In that position you present eminent counsel who
makes a legalistic argument, and very capably, against the constitutionality of the bill. He also says that the substitute measure
that he proposes would be subject to the same objections as to its
constitutionality; and your own economist, Mr. Meeker, I believe,
lias stated m a report to the exchange that State action would be
ineffectual to correct these evils.
Mr. WHITNEY. I think you are attributing bad faith to the
exchange in your suggestion.
Mr. PECORA. Not bad faith, Mr. Whitney. I genuinely want to
assure you that I am not charging bad faith, but I do see an inconsistency.
Mr. WHITNEY. I do not. We are suggesting something which we
would back up.
Mr. PECORA. YOU advance an objection now before Congress based
upon the alleged unconstitutionally of the bill. You propose at
the same session of this committee a substitute measure, and your
counsel tells the committee frankly that that measure, m his opinion,
would be just as unconstitutional.
Mr. WHITNEY. But the New York Stock Exchange would abide by
such a bill.
Mr. PECORA. But you cannot control the action of any individual
member.
Mr. WHITNEY. We cannot; nor the public as a whole.
STOCK EXCHANGE PBACTICES
6607
Mr. PECORA. And as Mr. Gay very frankly admitted, the way
would be open, despite any action taken by your exchange or any
member of it or any individual not a member, as far as that is concerned, to present in court a case designed to overthrow the statute
on the ground of unconstitutionahty.
Mr. WHITNEY. Shall I proceed, Mr. Chairman?
The CHAIRMAN. May I suggest this, Mr. Whitney, in that connection. I gather the impression that the New York Stock Exchange
concedes that there are some abuses and some practices that it would
like to correct, but it goes a little further and says that it has not
the power to do the things that it would like to do. I get that
impression.
Mr. WHITNEY. I think we are talking here, sir. about all stock
exchange practices. They are not by any manner 01 means uniform.
On the other hand, the New York Stock Exchange puts itself on no
pedestal, but we are perfectly ready to sit down and endeavor, with
anybody of authority, to try to improve conditions and to prevent
abuses.
The CHAIRMAN. I understand that, but I am saying that I get the
impression that the New York Stock Exchange recognizes its limitations, that there are things it would like to do that it cannot do,
and for that reason it is in need of some power such as we may be
able to give it by this bill.
Mr. WHITNEY. I claim, however, that that power cannot be given
to it or cannot be exercised by the regulation of stock exchanges;
that many, if not all, of these abuses may be done outside of any
control of stock exchanges as such. That is the difficulty.
Senator GORE. We can get a line of demarcation marking off the
abuses committed by brokers and dealers. Some of your members
may be properly punished by the exchange; perhaps some by law.
Then, on the other hand, on the other side of the line, are abuses
that are committed by the stock exchange which the stock exchange
can correct, and those which it requires legislation, either State or
Federal, to correct. If we can get into the zone of abuses that the
Federal Government has power to regulate and prohibit, that would
simplify it, because I think everybody wants to prohibit all the
abuses we have the power to prohibit, without doing more harm than
good.
Senator COSTIGAN. In line with Senator Gore's suggestion, is it
your contention that the New York Stock Exchange has corrected
all the abuses over which it has the power of correction?
Mr. WHITNEY. I would hate to say that, Senator. I think the
whole evolution of stock exchange rules and regulations is one of
education within and without, and we are certainly only too ready,
as we always have been, if we see things being done that we can
correct by our own regulation, to take such action. I do not mean
to quibble, but, frankly, it would be impossible to say there was not
further progress that we might find it possible to make. I am sure
there will be as time develops.
Senator COSTIGAN. Will you be good enough to list again the evils
which in your judgment should be corrected?
175541—34—PT15
13
6608
STOCK EXCHANGE PRACTICES
Mr. WHITNEY. I mentioned those. We suggest the inclusion of
the power given to this body to regulate the amount of margin
which members of exchanges must require and maintain
Senator COSTIGAN. Will you indicate as you proceed whether the
New York Stock Exchange has acted in respect to each particular
evil that you now are proceeding to specify?
Mr. WHITNEY. We have on that one. Authority to require stock
exchanges to adopt rules designed to prevent dishonest practices
Senator COSTIGAN. "Kules and regulations", to use your exact
language.
Mr. WHITNEY. Rules and regulations, yes; to prevent dishonest
practices and all other practices which unfairly influence the price of
securities or unduly stimulate speculation. To the best of our ability
I believe we have passed such rules and regulations insofar as they
affect our members. I do not wish to imply, however, that we may
not see further ways in that direction.
Senator COSTIGAN. When were those rules and regulations adopted
by the New York Stock Exchange?
Mr. WHITNEY. They have been adopted, sir, over a period of years.
The latest, as I remember, was on February 13. I am not sure about
during the autumn
Senator COSTIGAN. Of what year ?
Mr. WHITNEY. 1934. There have been some changes to our rules
and regulations.
Senator COSTIGAN. Have those changes been presented to the committee, or is it possible for you to submit to the committee all rules
and regulations adopted since October 1929 ?
Mr. PECORA. Senator Costigan, we have, in answers to a questionnaire submitted to the stock exchange, considerable data which it
has submitted to us, and if it has not already been made a part of
the record it will be made a part of the record.
Senator COSTIGAN. Including the regulations made m February of
this year, Mr. Pecora ?
Mr. PECORA. I do not recall that those were included in the copy
furnished to us. Mr. Redmond can answer that readily, perhaps.
Mr. REDMOND. I think the copy that was furnished to you was
asked for in January.
Mr. PECORA. Yes; so it would not include these changes made in
February—I think it was February 14.
Mr. EEDMOND. February 13.
Mr. WHITNEY. Proposed on the 8th and passed on the 13th.
Senator COSTIGAN. I think it might be well to read it at this
moment, unless it is too long.
Mr. WHITNEY (reading):
Section 15, chapter 14. No member of the exchange or firm registered thereon
and no general or special partner of any such registered firm shall, directly
or indirectly, participate or have any interest in the piofits of a manipulative
operation No such members, firm, or partner shall manage or finance a
manipulative operation
For the purpose of this rule (1) any pool, syndicate, or joint account,
whether in corporate form or otherwise organized or used intentionally for
the purpose of unfairly influencing the market price of any security by means
of options or otherwise, and for the purpose of making a profit thereby, shall
be deemed to be a manipulative operation
STOCK EXCHANGE PRACTICES
6609
(2) The soliciting of subscriptions to any such pool, syndicate, or joint
account, or the accepting of discretionary orders from any such pool, syndicate,
or joint account, shall be deemed to be managing a manipulative operation
(3) Carrying on margin or over a long or short position any securities for
or the advancing of credit through loans of moneys or securities to any such
pool, syndicate, or joint account shall be deemed to be financing a manipulative
operation
Senator COSTIGAN. What was the evil that the rule which you have
read was designed to correct?
Mr. WHITNEY. A matter about which we had had discussion for a
period of years; and that was the participation of our members,
their firms or partners, in pool operations—a financial participation.
Senator COSTIGAN. Were those activities obvious as long ago as
1929, during the height of the speculative era?
Mr. WHITNEY. I think, Senator, if I understand your question,
pool operations have existed for manjr years; yes.
Senator COSTIGAN. I had more particularly in mind what you call
manipulative operations. Do you restrict those to pool operations?
Mr. WHITNEY. A manipulative operation might occur without its
being a pool operation.
Senator COSTIGAN. In other words, your rule covers a wider scope ?
Mr. WHITNEY. I t seeks to cover all participation in manipulative
operations that may be indulged in by members or their partners.
Mr. PECORA. That rule that was passed 2 weeks ago yesterday was
the result of years of consideration?
Mr. WHITNEY. Yes, sir.
Senator COSTIGAN. I was
just going to ask why the New York
Stock Exchange waited so long before adopting a rule or regulation
of that character.
Mr. WEDTNEY. Many of our rules and regulations and many parts
of our constitution are the result of long years or months of discussion and research into the facts as best we can find them, in order to
get a basis upon which to place our judgment.
Senator BULKLEY. What was the argument against this rule?
Mr. WHITNEY. This particular one ?
Senator BULKUBY. Yes.
Mr. WHITNEY. I do not suppose, Senator Bulkley, that there was
any argument.
Senator BULKTIEY. I t took several years. I thought there must be
some argument advanced against it.
Mr. WHITNEY. N O ; I do not think there was any argument.
Senator COSTIGAN. IS it one result of the stock-exchange investigation Mr. Whitney?
Mr. WHITNEY. I t might be so construed.
Mr. PECORA. Was it a mere coincidence that this rule was adopted
2 weeks ago yesterday, on the very eve of the presentation of evidence to this committee with regard to manipulative practices in
the so-called " alcohol stocks *' last summer ?
Mr. WHITNEY. I do not understand that those manipulative
activities were attributed to our brokers, sir, or members. It was
a coincidence.
Mr. PECORA. I S Mr. Ben Smith a member of the exchange ?
Mr. WHITNEY. Yes, sir.
Mr. PECORA. And Mr. Euloff
Cutten?
6610
STOCK EXCHANGE PRACTICES
Mr. WHITNEY. He is a member; yes. But your question does not
include the full subject, as I see it.
Mr. PECORA. He testified about options that were held covering a
period of 8 months.
Mr. WHITNEY. We do not prohibit our firms having options, sir.
We prohibit them from using them in manipulative operations unfairly to influence the market.
Mr. PECORA. But he testified that under those options he traded
on both sides of the market, buying and selling, with a view of distributing the stock covered by the options, which I recall was an
aggregate of 65,000 shares, at a profit.
Mr. WHITNEY. And then what did the stock do?
Mr. PECORA. I think you can give me more information on it than
I can give you.
Mr. WHITNEY. YOU have the record, sir. I have not read it.
Mr. PECORA. The stock went up, went down, then it went up, and
then it went down.
Mr. EEDMOND. Are you referring to American Commercial Alcohol, Mr. Pecora?
Mr. PECORA. Yes.
Mr. WHITNEY. I do
not think, however, that that necessarily indicates that the use of that option and the endeavors of the pool were
unfairly to influence the market or that anything was done to the
detriment of the public.
Mr. PECORA. They may not have succeeded in accomplishing all
that might have been intended by that, but Mr, Cutten was very
frank to say before this committee, under oath, that the market
operations that he conducted under that option were both on the buying and selling side and were conducted for the purpose essentially
of enabling him to make a distribution of the shares covered by the
option at profit to himself, which meant a distribution at prices
higher than the option price. The options covered a period of 8
months
Mr. EEDMOND. Mr. Pecora, check me if I am wrong, because I have
only read the record rather hastily; but as I remember it, Mr.
Cutten's option ran out on May 12, 1933.
Mr. PECORA. That is my recollection.
Mr. KEDMOND. And it had been granted, therefore, presumably
Mr. PECORA. In the preceding August or September.
Mr. KEDMOND. Let us say in September. In September 1932 the
price of American Commercial Alcohol, which had been fairly stable
through the latter part of August, was at that time about $20 per
share. On May 10 it was slightly under $20 a share, 19%.
Mr. PECORA. My last statement, Mr. Kedmond, was that Mr. Cutten
might not have succeeded in accomplishing all that he set out to do,
but he did say frankly what the object was of acquiring this option
on the stock, which included both buying and selling. The fact that
the public did not nibble does not in any way affect the purpose for
which that option was obtained; and as to the purpose of trading
under the option, he said frankly, as I recall his testimony before
this committee, that the purpose he had in acquiring that option
was to distribute the stock at a profit, which meant selling it at
prices exceeding the option price. I t covered a period of 8 months
and embraced 65,000 shares.
STOCK EXCHANGE PEACTICES
6611
Mr. REDMOND. I think it is also true, is it not, Mr. Pecora, that
in that same testimony Mr. Cutten said that he made an examination
of the company and that he thought the stock was worth that price
and was willing to attempt a distribution of it?
Mr. PECORA. Yes. I am glad you referred to that, because it
brings to my mind another little bit of evidence that was given
about that operation under those options, and that is that in the
report which he said he had made, the report of a survey of the
company in whose stock he was trading, the enterprise was referred
to as a speculative one. And there was further evidence presented to
the committee while Mr. Cutten was on the stand, that during the
8-month period of those options the firm with which Mr. Cutten was
connected as a partner recommended that stock to its customers in
its market letters, but not as a speculative operation.
Mr. REDMOND. IS it not also true, Mr. Pecora, that the evidence
showed that neither Mr. Cutten's partner nor his firm had any interest in those options? Is not that true as a part of the record?
Mr. PECORA.. They did all the trading and got commissions.
Mr. REDMOND. But they had no financial interest in the operation
at all, did they«
Mr. PECORA. They did. There was a corporation that Mr. Cutten
was interested in
Mr REDMOND I think he denied it.
Mr. PECORA. I am pretty sure he did not deny it. I can give you
the name of the corporation that he mentioned. The Cutten Trading Co., Ltd It is a Canadian corporation, by the way, that Mr.
Arthur W. Cutten referred to in his testimony before this committee
last fall.
Mr. REDMOND. We are talking, I think, about a minor point, and
I think we can easily check the record.
Mr. PECORA He also referred to another as being a corporation,
the name of which for the moment escapes me. That was the property of the trading company, one of the partners of the firm
Mr. REDMOND. I believe he mentioned that one of the partners of
the firm had an interest in a corporation which had a small participation. But Mr. Cutten, I think, did state affirmatively that neither he
personally nor his firm had any interest in it. I may be wrong. I
only read the record once.
Mr. WHITNEY. He had no interest in the Cutten corporation.
Mr. PECORA. IS Mr. Charles Wright a member of the exchange ?
Mr. WHITNEY. Yes, sir.
Mr. PECORA. I presume you
are familiar with his testimony that
he gave before this committee?
Mr. WHITNEY. Fairly familiar.
Mr. PECORA. And you know he executed orders
Mr. WHITNEY (interposing). As I understand you, Mr. Pecora,
you are denying the right of any distribution of securities if there is
any inherent worth in the securities. American Commercial Alcohol, in Mr. Wright's instance, if I remember it correctly, sold at
around a price of $35 a share, and then went up to above $70 a
share, well above it, and then dropped down, but is now maintaining a price well in excess of the $35 a share. I may be incorrect,
but the record shows, I think, that it is well in excess of the price of
$35 a share average at which that stock was distributed.
6612
STOCK EXCHANGE PEACTICES
Mr. PECORA. HOW about the option for 25,000 shares at $18 a
share given last May to Mr. Bragg by officers of the corporation ^
Mr. WHITNEY. Mr. Bragg is not a member of the exchange.
Mr PECORA. And carried on the account of W. E. Hutton Co as
account no. 296, which they traded as Mr. Ben Smith's account; Mr.
Smith being a member of the exchange. That was the option, Mr.
Whitney, you perhaps will recall which a partner of W. E Hutton
& Co. told your investigator was not a pool account.
We had another partner of that firm on the stand here week before
last who readily admitted that it had all the indicia of a pool
operation.
Mr. WHITNEY. Will you allow me to state that in a letter to you
we gave the information that we were still investigating that particular account in W. E. Hutton Co., and at a later date we
gave you all the information that was available to us and to our
accountants.
Mr. PECORA. YOU undertook that investigation, as I recall it, last
August ?
Mr. WHITNEY. At your suggestion.
Mr. PECORA. At my suggestion; and you very readily complied
with the suggestion. You gave us the fruits of your investigation
about October 16?
Mr. WHITNEY. Yes. Some 8 accountants out of our 20 worked
perfectly steadily on that one job.
Mr. PECORA. And among the documents that you transmitted to
xis as a part of the report of your investigation was a letter by the
head of your accounting division, a Mr. Dassau ?
Mr. WHITNEY. Yes, sir.
Mr. PECORA. In which he
said—and I think I can quote his exact
language—that there were no materially deliberate improprieties.
Mr. WHITNEY. There was a specific paragraph. I think the only
proper thing, as I see it, is to have the letter read into the record.
Mr. PECORA. That letter is part of the record already.
Mr. WHITNEY. There was a very specific paragraph.
Mr. PECORA. That whole letter was read into the record, as I
remember it.
Mr. REDMOND. The letter is here.
Senator BTJLKI>EY. Can we not have that paragraph read?
Mr. WHITNEY. I would like to have it, very much.
Mr. PECORA. I have a copy of the letter before me, Mr. Whitney.
I will read it. I t is dated October
1, 1933, addressed to the " Committee on Business Conduct, New1 York Stock Exchange "[reading] :
GENTUEMEN. In accordance with instructions, I have had examinations and
inquiries made in connection with trading operations during the period May
15,1933 to June 24,1933 in the following stocks: American Commercial Alcohol,
Commercial Solvents, Libbey-Owens-Ford Glass, National Distillers Products
Corporation, Owens-Illinois Glass, U. S Industrial Alcohol
Particular attention was directed toward the endeavor to ascertain whether
or not operations of a manipulative nature had occurred, especially the accumulation of large long positions by pools or syndicates, causing a rise in
price and subsequent operations which might be construed as unloading by
such pools or syndicates.
The examinations were based on information supplied by the Stock Clearing Corporation as to firms having any substantial balances to receive or deliver the above stocks Information as to the clearance by other firms was
sought, and records of the firms in question were inspected in sufficient detail
STOCK EXCHANGE PEACTICES
6613
to satisfy the examiner that all transactions for the period were exhibited
in each case
With the exception of the situations disclosed at Lehman Bros and Redmond & Oo, which situations also are reflected m a minor way in other hrms
used as their brokers, and the possible exception of the situation of W. E
Hutton & Co which is still under investigation, no material situation appears
While the limitations of time available for these examinations precluded a
detailed examination and tie-up of every transaction, it is my opinion that
there were no material deliberate improprieties m connection with transactions
in these securities Although the repeal situation appears to have created a
public interest in these stocks great enough to account for their activity, your
examiner was directed to watch out for any evidence of wash sales or of
other activities which might have stimulated improperly the activity of these
stocks Yet none were reported However, that you may have the facts in
detail, I have prepared a separate report on the examination made of each
of the firms shown, and list hereof is respectfully submitted
And this is a letter signed by John Dassow, accountant.
Mr. WHITNEY. And he called to our attention, which was given
to you with regard to the exception in the W. E. Hutton & Co. case.
Mr. PECORA. And there was also read into the record before this
committee within the past 2 weeks this letter addressed to the Committee on Business Conduct by Mr. B. J. Harriman, of your accounting department. When I say, "your accounting department", I
mean the accounting department of the exchange. I t is dated September 21, 1933, about 10 days prior to the letter of Mr. Dassow
[reading]:
GENTLEMEN* At your request a visit was made to the New York office of
Messrs W. E. Hutton & Co to determine the account which contained material
transactions during the period from May 15, 1933, to July 24, 1933, in the
following stocks * American Commercial Alcohol—
And five others, the same as I have heretofore alluded to.
Inspection of the security record and sale take-off of trades disclosed transactions in American Commercial Alcohol for B. E Smith no. 296 account,
schedule of which is annexed hereto I was informed that this account is m
reality the account of T. E Bragg and associates, as follows
Then follow the names of eight of the participants in that account,
all of whom have been identified here in testimony before this
committee.
From May 3, 1933, to July 24, 1933, approximately 29,000 shares of American
Commercial Alcohol stock were purchased and approximately 24,000 shares sold
for the B. E. Smith no. 296 account; 25,794 shares of this stock were taken
down from the following—
Then follows an enumeration of the various brokers' offices from
which the stock was taken down.
I was informed that these shares had been acquired from several of the
largest stockholders of the company.
To that he might have added that those larger stockholders were
all of them officers, directors, and executive officers of the company.
Additional transactions in American Commercial Alcohol follow—
And then are enumerated some transactions under the name of
no. 130 account, B. E. Smith, a member of the New York Stock
Exchange.
No other accounts were noted which contained material transactions in the
stocks under review.
6614
STOCK EXCHANGE PEACTICES
And this is the part I want to emphasize:
Mr. J. 0. Duncan, a partner—
That is, of W. E. Hutton & Co.—
stated that during the period under review the firm did not have any pool or
syndicate accounts on its books containing transactions in the stocks above
mentioned, nor did they hold or issue any options for their own or the account
of customers
That is the report of Mr. Harriman of your accounting department. And yet Mr. Foster, another partner of W. E. Hutton & Co.,
who testified before this committee, admitted very frankly from the
records produced from his own office, among other things, that the
operation under this 296 account was a pool or syndicate operation;
and they have in their files a letter from Mr. Smith—two letters in
fact, as I remember it were put in evidence—authorizing distribution of profits from that pool or syndicate account to designated
persons, presumably the participants. And in the face of those
records Mr. Duncan told your examiner there were no pool accounts
on their books operating in these stocks.
Now, I am not questioning the good faith of your accounting
department. I think they made every effort that they felt they
were called upon to make or should have made. But the fact of
the matter is that the investigation which they made did not reveal
the facts with regard to the existence of pool accounts which the
examining staff of this committee revealed as a result of their investigation, which was made in a much shorter period of time than
your accounting department had available to it and with far less
facilities than your accounting department enjoyed.
Mr. WHITNEY. I do not know, Mr. Pecora, what is the purpose
of this questioning. I thought I was here on a bill. I am perfectly
willing to answer questions insofar as my memory serves me. Not
having had a knowledge of what these questions are going to be,
I could not refresh my memory or get the records.
Mr. PECORA. What led up to this discussion were the questions
that Senator Costigan asked concerning the immediate need for the
enactment of this rule which was adopted by the governing board
of the exchange on February 13 last. You said it was the result of
several years of consideration.
Mr. WHITNEY. The general question of the pool; yes.
Mr. PECORA. Then I asked you if it was merely a coincidence.
Mr. WHITNEY. And I said no.
Mr. PECORA. And it was adopted on the very eve of the introduction of evidence m regard to the existence of this pool account
operated by members of the exchange.
Mr. WHITNEY. I had no knowledge there was going to be any
introduction of such evidence. You never told me.
Mr. PECORA. The newspapers were full of it, Mr. Whitney.
Mr. WHITNEY. A S to what it was going to be?
Mr. PECORA. Yes.
Mr. WHITNEY. I did not see that.
Mr. PECORA. The newspapers were full of reference to the fact
that we were going to present to the committee evidences of pool
operations in the alcohol stocks.
STOCK EXCHANGE PRACTICES
6615
Mr. WHITNEY. Well, the newspapers are more lucky than we
We did not have that information. It was purely incidental. 1
have granted to Senator Costigan that such rules may have been
well the result of the investigation one place or another.
The CHAIRMAN. Suppose we proceed along the line you were following there, Mr. Whitney.
Senator COSTIGAN. Mr. Whitney, you were helpfully listing the
stock-exchange abuses which you think should be corrected when
your testimony suffered this extended interruption.
Mr. WHITNEY. Yes, sir.
Senator COSTIGAN. Will
you be good enough to proceed and comment separately on action taken by the stock exchange with regard
to other abuses ?
Mr. WHITNEY. I do not want you to get a false impression, Senator, that these are necessarily all abuses. They may be abuses, but
they are also matters that we believe should have the authority of
this particular suggested authority.
And under that category the next suggestion of ours very exactly
fits authority to fix requirements for listing of securities. I n that
regard we have been passing requirements and rules for years. I
do not doubt the committee on stock list has under consideration
various further matters that may be the basis for further requirements. I am hoping tomorrow, or whenever time serves, to have
Mr. Altschul, chairman of that committee, go over the various
phases of their work and what they have done chronologically.
Senator COSTIGAN. What have you in mind with respect to the
listing of securities? What improvement can be indicated illustratively ?
Mr. WHITNEY. Well, the most recent one that I remember is the
requirement with regard to reacquisition of company stock by listed
corporations, that they may not be allowed—they are not allowed
to, if they have so acquired the stock—to place it again on the
market without a supplemental application to the committee on
stock list so that that information will become public.
Senator COSTIGAN. YOU mean they should not be allowed?
Mr. WHITNEY. They are not allowed, without permission, without that becoming public knowledge.
There have been many and numerous changes in the requirements
of the committee on stock list in one regard or another over a period
of years.
l think it is a fair thing to say that our listing requirements are
the most stringent of any exchange. The other exchanges throughout the country and throughout the world differ in many respects.
Some of them are almost exactly the same, but others differ in many
respects.
Senator GORE. D O you know of any publication that compares and
contrasts the requirements on the New York Stock Exchange and
others in other countries?
Mr. WHITNEY. NO, sir. [After conferring with an associate.]
So far as we know, Senator Gore, there is no single publication that
contrasts the two.
The next authority is to control pool, syndicate, and joint accounts
and options intended to unfairly influence market prices. That is
the matter that we have just been discussing.
6616
STOCK EXCHANGE PBACTICES
Senator COSTIGAN. Have you in your testimony at any time drawn
a line, which might be useiul to this committee, between what are
unfair and what are fair attempts to influence the market?
Mr. WHITNEY. I don't think I have.
Senator COSTIGAN. Could you be helpful to this committee at this
moment by making suggestions?
Mr. WHITNEY. I would prefer, so as to make it more coherent, to
try to present those after looking into the matter and having some
real basis that might be clear and informative.
Senator COSTIGAN. Doubtlessly you should be afforded that opportunity, Mr. Whitney, but there have been repeated references to
efforts to influence uniairly market prices.
Mr. WHITNEY. Yes.
Senator COSTIGAN. YOU
must have in mind some examples of that
sort which you might mention at this moment, reserving your fuller
statement, let us say, to a subsequent time.
Mr. WHITNEY. I think the operation which we term now " manipulative " referred to by Mr. Pecora, where there is an endeavor to
get great activity in the market by buying and selling, but through
proper change of ownership, that that may well unfairly influence
the market.
I do think, however, that practically each and every case must
rest on its own bottom. It is perfectly possible for an individual
or a joint account or a pool who believes that a security is selling
below the level at which it should sell to buy that security in volume
up to a point where they think the level is a proper one, and in
doing so they are going to unquestionably influence the market, but
in my opinion not unfairly.
Senator COSTIGAN. If every case rests strictly on its own bottom,
then it is impossible in advanve to deal by rule with unfair influence
on the market?
Mr. WHITNEY. Except, sir, insofar as perhaps the way—if a understand, not being a lawyer—the way common law was written. If
certain practices are deemed by the controlling committee to be
improper that will be done.
Senator COSTIGAN. In advance or after?
Mr. WHITNEY. AS decisions have been made, then they will be in
advance of further operations. In advance of them it would be
impossible to say.
Senator COSTIGAN. IS it your impression that rules of this sort must
wait as long as the common law of England to be effective?
Mr. WHITNEY. NO ; I think we work faster than that.
Senator COSTIGAN. What has the New York Stock Exchange done,
if I may ask you, up to this time to correct efforts unfairly to manipulate the market? Have you rules dealing with the subject outside
of the rule you read this alternoon?
Mr. WHITNEY. Yes, sir; we have.
Senator COSTIGAN. When were they adopted?
Mr. WHITNEY. Oh, years ago. Page 44—this is the constitution,
sir, article XVII, section 4, and, I believe, passed in 1925:
Purchases or sales of securities or offers to purchase or sell securities, made
for the purpose of upsetting the equilibrium of the market and bringing about
a condition of demoralization in which prices will not fairly reflect the market
values, are forbidden, and any member who makes or assists in making any
STOCK EXCHANGE PEACTICES
6617
such purchases or sales or offers to purchase or sell, with knowledge of the
purpose thereof, or who, with such knowledge, shall be a party to or assist in
carrying out any plan or scheme for the making of such purchases or sales or
offers to purchase or sell, shall be deemed to be guilty of an act inconsistent with
just and equitable principles of trade.
Senator COSTIGAN. In view of what happened after 1925, are you
not inclined to regard that rule as rather an ethical declaration than
a regulation of unfair practices?
Mr. WHITNEY. That is a difficult thing to answer.
Senator COSTIGAN. The question is, Was that rule effective from
1925 on in preventing unfair practices ?
Mr. WHITNEY. I am afraid the only way I can answer that, sir,
unless a specific instance is given me, is to refer you to what we all
know: that there was a terrific public speculation and participation
in the market at that time. If there were specific instances where
improper uses of the market were made, coming under that section
of the Constitution, and we did not act on them and had knowledge
of them, then I will grant that we should have. But if such instances did take place without the specific question, I do not think
I can possibly answer.
Senator COSTIGAN. Does not a large part of your testimony this
afternoon point in the direction of the continuance of the unfair
practices this rule was intended to prevent? You yourself have just
read a statement made by the governing committee of the New York
Stock Exchange in which this sort of practice is specified as something which should be corrected. If that were not true, would the
New York Stock Exchange now be directing the attention of this
committee to such practices?
Mr. WHITNEY. I do not think I know how to answer you, because,
without the specific case in mind, I do not see how one can say that
it was an unfair practice or that it unfairly influenced the market.
Senator COSTIGAN. Well, have you in mind no instances of that?
Mr. WHITNEY. I think in this very case that Mr. Pecora brings
up, if I remember rightly, the average price at which these securities
on option were sold to the public was 35, and thereafter the particular stock rose to eighty-odd dollars per share.
Mr. PECORA. Eighty-nine and seven eighths.
Mr. WHITNEY. Eighty-nine and seven eighth dollars per share;
then fell to around $32 a share, and since that time has maintained a
level between $40 and $70 per share.
Senator COSTIGAN. Has the governing committee of the stock exchange made any effort to determine whether there was an attempt
in that instance unfairly to influence the market?
Mr. WHITNEY. Without being able to answer absolutely one way
or the other, it is my belief they did.
Mr. COSTIGAN. DO you know what the conclusion was?
Mr. WHITNEY. That it was not an unfair influencing of the
market.
The CHAIRMAN. And yet the stock fell from 89 to something about
29% in 3 days. I t went to 29%.
Mr. WHITNEY. Yes, sir; that was when all stocks came down in
July.
Mr. PECORA. Did they all come down in the same proportion or
anything like the proportion? My recollection is from the evidence
6618
STOCK EXCHANGE PRACTICES
here that American Commercial Alcohol stock went from a high of
89% on July 18 to a low of 29 and a fraction on July 21.
Mr. WHITNEY. I don't think that can be attributed to the instances that you are citing. I do not see where that had anything
to do with it.
Mr. PECORA. NO ; but
Mr. WHITNEY (interposing).
In fact, I think Mr. Wright told
you that he tried to prevent that stock selling down, with great loss
to himself.
Mr. PECORA. Yes; Mr. Wright went so far as to say that in his
functions as a specialist seeking to protect the spread on July 18 in
that stock, he was " murdered "—I am using his own language—and
yet we found out a few questions after that that the " murdering "
process netted him something like $138,000 profit in 3 months' time.
Mr. WHITNEY. Nevertheless, that does not detract from Mr.
Wright's efforts in trying to support the price of that stock when it
fell. He did not have to do that. He did it of his own free will
and volition.
Mr. PECORA. TO a limited extent, Mr. Whitney. He did not follow
the stock down.
Mr. WHITNEY. Some 10,000 shares I do not call limited.
Mr. PECORA. TO a limited extent; not enough to wipe out profits
that he had made in this 3 months' period of trading in that very
stock.
Mr. WHITNEY. He could not gage, Mr. Pecora, how far that stock
might sell, however.
Mr PECORA. But he did not protect the stock all the way down.
The CHAIRMAN. HOW many rules or regulations did you make in
1933, Mr. Whitney; do you remember ?
Mr. WHITNEY. NO, Mr. Chairman, I haven't those before me I
did not know that was what was going to be asked here today.
The CHAIRMAN. I think you had one in August, one revision in
August.
Mr. WHITNEY. Three or four or five, I believe in August; yes, sir.
Mr. PECORA. That was with regard to margins and requiring members to report options.
Mr. WHITNEY. Yes, sir.
Mr. PECORA. DO you recall
those rules were adopted after I made
a suggestion to you that some such rules be adopted?
Mr. WHITNEY. In all honesty, I cannot remember that; no. If
you say it is so, I am perfectly glad to admit it.
Mr. PECORA. That is my very clear recollection. I suggested that
the exchange, in view of the collapse of securities values that occurred
in mid-July, might do something to check what apparently was
visible at that time.
Mr. WHITNEY. When did you say this to me ?
Mr. PECORA. I think it was during the first week of August.
Mr. WHITNEY. Yes; but these were put in effect on August 2, so
that would not quite work.
Mr. PECORA. Then I was down there before that, because I recall
distinctly that the announcement of these rules followed my visit
to you by a very few days.
Mr. WHITNEY. I do not deny it, Mr. Pecora, that you may have
suggested this. If you say so, that you did, of course you did. But
STOCK EXCHANGE PBACTICES
6619
I can frankly state that the rules adopted on August 2 were under
very acute consideration in the latter part of March 1933 and before.
Mr. PECORA. NOW, you recognize, don't you, that the rules and
regulations adopted by the stock exchange for the correction of these
evils and abuses cannot be enforced by the exchange against nonmembers ?
Mr. WHITNEY. I have always so claimed.
Mr. PECORA. And do you also recognize that those abuses are
available to nonmembers, the operation of these abuses is available to
nonmembers ?
Mr. WHITNEY. There is a possibility that they can abuse the facilities of the exchange.
Mr. PECORA. Yes.
Mr. WHITNEY. Yes, sir.
Mr. PECORA. SO that no
amount of rules and regulations adopted
by the exchange could possibly extend to control and restrain the
action of nonmembers of the exchange in operating in a manner that
produces these abuses ? That is so, isn't it, Mr. Whitney ?
Mr. WHITNEY. Nor can any law, sir.
Mr. PECORA. Well, at least the law can
punish those who violate it,
and insofar as the fear of punishment is a deterrent—and I think
everyone recognizes it to have some potency in that respect—it
might bring about a diminution of those abuses by nonmembers of
the exchange.
Mr. WHITNEY. It did not with prohibition.
Mr PECORA. That is a sumptuary law that I do not believe you
yourself would consider a fair analogy to this proposed legislation.
Mr. WHITNEY. I do not agree with you, Mr. Pecora. This is a
prohibitory law.
Mr. PECORA. SO IS every penal statute which defines an act to be a
crime and provides a penalty for its violation.
Mr. WHITNEY. That does not take away from me the right to an
opinion.
Mr. PECORA. If you are going to use that as a test, Mr. Whitney,
why, then every penal statute, because it does not absolutely prevent
the commission of a crime, is just a waste of time.
Senator GORE. There is a fundamental distinction, I think, there.
Any crime where both parties desire the thing to happen, as in the
purchase and sale of liquor, perhaps in the purchase and sale of
stocks, in separate offenses, it is almost impossible to prohibit. That
is the difference. If two people are participants in a murder and the
man that murders the other and the one that gets murdered both
wanted the murder to happen, it would be almost impossible to
prevent that.
Now, Mr. Whitney, do you think a substantial percentage of the
abuses are due to others than brokers? Mr. Pecora just asked you
the question. You said that you could not regulate those; that the
stock exchange itself could not regulate the abuses committed by the
nonmembers. Do they account for a good deal of the abuse of the
facilities of the exchange 9
Mr. WHITNEY. Senator Gore, I think that they account for a large
proportion of the so-called " abuses " that have been put at the
threshold of the New York Stock Exchange; yes.
6620
STOCK EXCHANGE PEACTICES
Senator GORE. That is what I was trying to get at, and I was
wondering this in reference to Senator Costigan's question: I t has
been a historical race, and a rather dramatic race, between the
burglar and the improvement of burglars' tools or " jimmies " on
the one hand, and the improvement and invention of burglar-proof
safes on the other hand, and when some new safety device has been
invented these burglars put their wits to work and invent some new
device to overcome it that could hardly have been anticipated. And
so the race goes on.
Senator COSTIGAN. Have you in mind the analogy of the stock
exchange in that illustration?
Senator GORE. Well, not entirely, because I was referring to the
nonmembers. It may apply to the members themselves, but I distinguish the members—even the members—from the exchange as an
institution, treated as a market place where people who want to buy
and sell can have the right to do so when they get ready. I think
we all want to preserve that. And that leads me to the question I
was coming to, Senator.
Now, I think it divides itself into this, Mr. Whitney: If you are
not prepared, I want you to think it over and give us your views—
there are several distinct groups that are responsible for these abuses
and the catastrophes that follow, and they are unspeakable tragedies;
the one in 1929 was.
Now, let us begin here: Buying is, of course—persistent buying—a
bull factor, and it puts prices up or tends to put them up, on the
one hand. On the other hand, selling—persistent selling—is a bearish factor, and it puts prices down or tends to.
Now, in this frenzy market of '29—and it is a contagion and a
frenzy—in that market nearly everybody, at least all classes, the
janitor and the judge and the waitress and heiress—everybody—
were buying stock, buying on margin, buying stock without any
reference to the company's assets or its management or its success
or its earnings or its future—buying today hoping to sell tomorrow
for more than they paid just a bit.
That is one group, and that is where the rivers1 rise, and they are
the ones, they are the victims in the long run. They create the evil
largely, or help to. Then they are the victims of their own mistakes.
Is there any way that you could limit the amount or fix a minimum below which nobody should trade at all; that they could not
buy less than a thousand dollars worth or $2,000 worth or a dozen
shares? Of course, the answer will be made: That will prevent
persons who want to invest and buy a few stocks. Could you limit
that class of people who buy in utter ignorance and help to create the
Frankenstein that destroys them? Could you by some rule or regulation or law remit them to the banks, where the banks would make
loans on a financial statement and perhaps give them some advice
and curb those people from rushing into this whirlpool ? Would that
do more harm than good ?
Mr. WHITNEY. I think it is an open question. I do think, Senator
Gore, that you would have to divide between speculation and investment, and if I may
S°nator GORE (interposing). If you could.
Mr. WHITNEY. If we could. I r I may take the second, the investment, it would seem pretty harsh on the small fellow who wanted
STOCK EXCHANGE PBACTICES
6621
to invest to deny him the ability to buy his securities that might be
listed on the New York Stock Exchange, or any other exchange, and
iorce him out of having the advantage of those securities.
Senator GORE. Yes. Now, that is the point. Could he go to the
bank—and in all reasonable cases where credit is desired and purchases ought to be allowed to be made by a prospective buyer, and
have his wants served by the banks and keep him out of the hands of
the dealers or brokers who have no concern except perhaps the
profit or commission they get? Would that do that character of
participant any serious harm, or would it afford him protection?
Mr. WHITNEY. Well now, if you will allow me, we are still talking
about the small investor?
Senator GORE. Yes; I want to start with him, because he is the
fellow about which we seem to be concerned most.
Mr. WHITNEY. I believe, again without drawing any odious comparison, that there are thousands of dealers throughout this country
in securities—thousands of them—that are righteous, upstanding
men, and they are not necessarily members of the New York Stock
Exchange, who will give their best advice to the small or to the
large investor.
And now, as to my desire not to make an odious comparison, I
truly and honestly believe that those men are more fitted to give
proper advice to the investor than are the banks throughout this
country.
Senator GORE. On that point, Mr. Whitney, let us admit all that
you say on that point. That still was not sufficient to safeguard
these people in 1929. They rushed in and were devoured in the
maelstrom. So that system does not meet the occasion nor prevent
the evil. Would the evil be minimized if you, reverting to my other
suggestion, sent those people to the banks, where they would have
to submit a financial statement and be denied credit where they were
not entitled to credit and could not carry on and protect themselves
in a break?
Mr. WHITNEY. Senator, they are not asking for credit, if we are
still talking about the investor. He has the money, and therefore
he does not have to seek any credit. All he seeks from the banker is
advice.
Senator GORE. The investor does not come in this category of margin dealers. Anybody that has a small amount of money and wants
to invest in a stock can buy and pay outright. So that category is
protected.
Now, it is the investor who wants to just overbid his hand, wants
to buy a little more than he can pay for, wants to buy on margin.
There is where he begins to get in the quicksand. Whether it would
be a protection to him to send him to the bank and keep him out of
the hands—he might fall into the hands of a good dealer or broker
and he might not. Some brokers look at the commissions. Perhaps
some look at the welfare of their customers. But I am just feeling
my way now to see if there are abuses that we could correct and
evils that we can safeguard these victims against.
Mr. WHITNEY. May I approach that side of the question which
deals with the little speculator?
Senator GORE. Yes.
6622
STOCK EXCHANGE PBACTICES
Mr. WHITNEY. If he is prevented—and I see no way of getting
toward this point without a rule of the exchange or of the law preventing his buying on margin through a firm or member of a securities exchange.
Senator GORE. I did not quite get that point, Mr. Whitney.
Mr. WHITNEY. I do not see any way of preventing his participation in speculation except through a rule of the exchange or exchanges or a rule under the law.
Senator GORE. Yes.
Mr. WHITNEY. I t has been suggested that a man not be allowed to
speculate unless he starts with an equity in his account of a thousand
dollars or two thousand dollars or three thousand dollars.
I am trying to give you the pros and cons. If such a limit, such
an initial fee is put up against him before he can enter this " club
of speculation ", then perhaps we can prevent his getting into the
exchange or dealing through the members of exchanges m that regard. But he goes somewhere if the urge of speculation is on him.
Senator GORE. Yes.
Mr. WHITNEY. NOW, he may go to his bank, and I think it would
be made more difficult for him to do it through his bank. But he
can go other places.
Senator GORE. Could he go around the corner and strike a bootlegger who established a business?
Mr. WHITNEY. He could go around the corner and meet the very
bootlegger—and we call him a bucket shop. Mr. Corcoran, either
this morning or yesterday, passed over the bucket shop rather glibly,
but it just so happens that in the recent past bucket shops have developed in various parts of the country.
Senator COSTIGAN. HOW recently, Mr. Whitney 2
Mr. WHITNEY. I beg pardon?
Senator COSTIGAN. HOW recently?
Mr. WHITNEY. Very; within the last week or two, and I think
within 3 weeks some 10 or more of them have been raided in New
York City alone.
Senator COSTIGAN. That is since Mr. Pecora assisted in suppressing
them?
Mr. WHITNEY. Yes, sir; and since, I think, we tried to help Mr.
Pecora.
Senator GORE. Mr. Whitney, frankly, I do not know that it can be
done. I have always doubted it. I am feeling out the situation to
see if we can protect the fool against his folly, because this was
perfect insanity. I t was social insanity that seized the people of
this country in 1929. They did not act with any sense at all. Now,
I am trying to invent some sort of device because the fool beats you
to his folly. He is ingenious in that. I am searching your mind to
see if there is any way on earth you can keep him out of trouble.
I t is an antisuicide serum that I am looking for, to be frank about it.
Mr. WHITNEY. I truly do not know of any antisuicide serum, because it seems to me that the public has indulged in the same suicide
in various other fields—in the real-estate field—and I am not referring to Florida. I have too great an interest in Florida myself.
But in the farm States there was terrific speculation, and that took
place long before 1929.
STOCK EXCHANGE PBACTICES
6623
Senator GORE. Men buying land on margin?
Mr. WHITNEY. On margin; yes, sir—on terrible margin, too.
Senator GORE. Yes; you are right about that.
The CHAIRMAN. What Senator Gore is after, it seems to me, is to
endeavor to distinguish between the investor or the speculator, the
real speculator, and the gambler.
Mr. WHITNEY. YOU want to separate gambling from investment?
Senator GORE. Yes; here is what I was driving at: Without bothering the committee, I will just state it and then I will let it go.
I wanted to treat the case of the small investor and the small speculator, divide them into groups, and provide safeguards for them.
Then, as I see it, as you remarked to Mr. Pecora a while ago, there
are dealers who deal through brokers, and I have assumed that they
are responsible for a good many of these pools and syndicates and
abuses of that type. Now, I do not know to what extent members
of the exchange are particeps criminis with them, how much they
share the guilt. If I could, I would deal with that group and lay
some limit on their activities, if it can be done. Then I would deal
with the brokers and the abuses they commit, if I could. And then
I would hold the exchange responsible only for the abuses which
it commits and for its failure to correct the abuses on the part of
others where it could be done.
If you get my line, it is along that line we ought to move some
way or other.
Let me ask you this, Mr Whitney: Are there a good many of
these pools and syndicates on the part of other than brokers that
you hear of after the crime has been committed, so to speak, that
you did not know of at the time ? Can you tell by the barber that
something is going on below ?
Mr. WHITNEY. Not necessarily so. And I do not want to give
an impression that our own members have not been—in other words,
that the exchange or its members are pure white lilies. We all had
the mania, I think ourselves as well as the rest of the country, in
1929, that money grew on trees, and we, just like everybody else,
have suffered drastically for that point of view.
Senator GORE. That mania was a contagion.
Mr. WHITNEY. I t was tremendously contagious; yes, sir. Where
it started the Lord only knows. But I think we agree with your suggestion, if it can be done, that it is a very broad and difficult problem
to solve.
Senator GORE. YOU say you do not know where it started.
Mr. WHITNEY. I am afraid we do not.
Senator GORE. I think you touched the tap root of all of it.
Mr. WHITNEY. I wish we did.
Senator GORE. I think it is a law of psychology that men buy on a
rising market. They watch it and buy and buy and buy. And they
sell on a falling market, and they sell and sell and sell. If you could
stop that you could stop the whole trouble.
The CHAIRMAN. I think we better take a recess now, Mr. Whitney,
until 10 o'clock tomorrow morning.
Mr. WHITNEY. Very good, sir.
(Accordingly, at 5 p.m., the committee adjourned until 10 a.m. on
the following morning.)
175541—34—PT 15
14
6624
STOCK EXCHANGE PBACTICES
STATEMENT OF RICHARD WHITNEY, PRESIDENT OF THE NEW YORK STOCK
EXCHANGE, IN REGARD TO H B
7852—THE SHORT TITLE OF WHICH I S
" NATIONAL SECURITIES EXCHANGE ACT OF 1934 "
Mr. Chairman and gentlemen of the committee, the New York Stock Exchange is vitally interested in the bill now pending before you which is called
the "National Securities Exchange Act of 1934" We have studied the bill
with great care and in stating our opposition to it, I shall, with your permission,
discuss: First, the general purpose of the bill and, without going into complete
detail, show how the provisions will affect all business and industry and all
investors as well as stock exchanges and persons dealing in securities. Secondly, I shall take up the particular provisions of the bill which affect most
directly stock exchanges and the business of members of exchanges.
We have arranged to have a number of gentlemen, who can speak authoritatively on the different phases of stock exchange members' business, appear
to inform you in this regard.
Each one of these gentlemen is thoroughly familiar with his own line of
business and I feel sure that they will be prepared to explain to you as fully
as you may desire not only the nature of their business but just how it would
be affected by the bill pending before you.
I trust you will not believe that our sole purpose in appearing before this
committee is to criticize, and I hope you will understand that we are anxious
to be helpful by way of explanation and the suggestion of a definite program.
Before taking up the bill section by section, I desire to say a few words on
the bill as a whole,and its effect upon the business and industry of this country.
H.R. 7852, although it is entitled "A bill to provide for the registration of
national securities exchanges operating in interstate and foreign commerce and
through the mails and to prevent inequitable and unfair practices on such
exchanges, and for other purposes," is far from a bill which deals solely with
stock-exchange practices. It affects a far wider field, unrelated in many ways
to transactions on stock exchanges.
The provisions of the bill which purport to deal with margin requirements
and brokers* credit might affect the entire credit system. This is due to the
fact that in an effort to prevent any evasion of the restrictions on margin
accounts contained in the bill similar restrictions have been placed on loans
made through banks or other persons. In like manner, the provisions of the
bill limiting the amount which brokers may borrow and requiring that brokers
must borrow only from members of the Federal Reserve System affect credit
in a much wider field. Not only will stock exchanges and their members be
affected by these provisions but also banks, industry and all investois.
I will not undertake to describe in detail the provisions of the bill affecting
banks and banking, as I am advised that the committee has heard, or will hear
shortly from persons who are expert on such matters.
The bill also directly affects all companies which may list their securities
upon a national exchange. It does so by requiring them to submit registration
statements and to furnish information to the Federal Trade Commission, which,
tinder the bill, is charged with the duty of enforcing its provisions. The extent
of the power given to the Federal Trade Commission to require listed corporations to furnish it with information and the control over corporate practices,
which is likewise given to the Commission, are so great that many of the functions of management are, in effect, transferred to an administrative department
of the Government. Certainly provisions having this effect form no part of
a bill dealing with the regulation of stock exchanges and stock-exchange practices. I understand that the onlcers of a number of important companies have
asked an opportunity to appear before this committee, and I feel suie that they
will point out the various provisions of the bill which affect them and discuss
these provisions fully with you.
I would, however, like to say very briefly a word on behalf of the great
number of investors scattered throughout the country who may not be represented before this committee. The bill, naturally, contains many provisions
which affect members of exchanges and dealers in securities. But I would like
to draw your particular attention to the fact that any regulation of stock
exchanges necessarily affects all investors Stock exchanges are organized as
public market places for securities, in which are concentrated the supply and
demand which arise from the willingness of owners to sell and the desire of
others to buy A public market by concentrating the buying and selling demand
creates fairer prices for the benefit of both buyer and seller and, therefore, the
STOCK EXCHANGE PRACTICES
6625
principle function of an exchange is to give the public the facility of selling
the securities which they own and of buying others. There are literally millions
of our citizens who own or are interested in listed securities The vast majority of them are investors and not speculators Among this great number of
persons you will find both rich and poor, but whether they are the owners of
thousands of shares or the owners of only a few shares of a single company,
they are all interested in the maintenance of a public market for securities.
Their interest is a real one, because the concentration of supply and demand on
exchanges results in creating a market in which securities are daily bought
and sold in volume This gives assurance to the holdef of securities lhat his
property can, if it is necessary, be turned promptly into money
Through the activity of exchanges securities have remained liquid throughout
the entire depression It is true that they have declined tremendously in value,
but in spite of declines securities have remained marketable. Real estate, on,
the other hand, became practically unsalable and at times it was impossible to
iind a buyer for mortgages or other forms of real-estate investment Holders
of listed securities, however, have been able to sell them whenever it was necessary to raise money The interest of these security owners in the bill to
regulate stock exchanges is, therefore, very direct and real To the extent that
this bill seeks to regulate exchanges to the point where it will destroy the free
and open market for securities the liquidity of the one form of investment that
lias remained liquid throughout the depression will certainly be impaired, if
not entirely destroyed I say, therefore, that this bill affects not only members
of stock exchanges and dealers m securities but the entire investing public
With your permission I will now discuss the bill in detail
Section 1 of the bill contains simply the title of the act.
Section 2 of the bill consists of a number of statements of fach which I
understand are included solely for the purpose of supporting the constitutionality of the bill. I disagree with some of these conclusions and doubt whether
they are true. As a layman, I am not competent to discuss questions affecting
the constiutitianality of the bill Mr. Gay, of counsel, however, is present and
will, if the committee will permit, make a brief exposition in regard to the
provisions of the bill, which, in his opinion, are not constitutional. I have
asked Mr. Gay to prepare a brief on this subject, which he will submit at a
later date.
Section 3 of the bill contains definitions of the terms used in the bill. These
definitions are unusually broad and sweeping. I call your attention particularly
to the first definition which defines the word " exchange" to include not only
the institution itself but also all of its members
The third definition defines a "member" of an exchange to mean not only
those persons who are actually members but also all persons who have a right
to use in person any facility of an exchange for the purpose of making purchases or sales thereon. This extension of the meaning of the term " member "
produces certain surprising results in some of the later sections of the bill.
The fourth definition reads as follows: "The term 'broker* means any
person engaged in a business of effecting transactions in securities for the
account of others." As a result our banks, which customarily act as agent
for their customers in buying and selling securities, may be subject to many
of the provisions which on their face regulate only stock exchanges and stockexchange practices.
The fifth definition defines the word " dealer " to mean any person engaged in
a business of buying or selling securities for his own account, and, therefore,
would include persons engaged in the business of buying and selling securities
tor investment. As in the case of the definition of the term "broker", the
arbitrary inclusion of those who buy and sell for investment in the category
of dealers, who buy purely for the purpose of resale, makes many of the later
provisions of the bill applicable to a large number of persons who are not, in
any sense of the term, dealers in securities.
The other definitions, which are likewise broad and general, should be made
more definite and specific, especially in view of the heavy criminal penalties
imposed by the statute.
Section 4 of the bill prohibits the use of the mails or any meansi of interstate
communication or transportation for the purpose of transacting any business
on an exchange which is not registered under the act.
Section 5 of the bill states the terms and conditions under which an exchange
may be registered with the Federal Trade Commission.
Subdivision (d), which appears on page 11 of the committee print, makes any
violation of a rule or regulation adopted by the Commission a ground for the
6626
STOCK EXCHANGE PEACTICES
suspension or expulsion of a member of the exchange. This provision is in
line with the general policy of the bill of vesting in the Federal Trade Commission power not to regulate but also actually to supervise and manage all
stock exchanges
Section 6 of the bill deals with margin requirements on long accounts and
deserves careful consideration
Subdivision (a) prohibits any member of an exchange or—and I draw your
particular attention to this fact—"any person who transacts a business in
securities through the medium of any such member, directly or indirectly ", to
extend or maintain credit to any customer on securities not registered upon a
national exchange
The immediate effect of this provision will be to make all unlisted securities
ineligible as collateral in margin accounts While it is true that the most
important companies in the United States usually have their securities listed
on one or more exchanges, it is likewise true that the securities of thousands,
if not hundreds of thousands, of perfectly sound business enterprises are not
listed on any exchange Few people realize what a relatively small number of
corporations are listed on our most important exchanges For example, there
are only 788 American companies which have stocks listed on the New York
Stock Exchange The number listed on other exchanges throughout the country
is surprisingly small, because only securities issued by corporations of substantial size which have secured a reasonable distribution among investors
are commonly dealt in on exchanges Local enterprises, even when they are
well established and profitable, do not necessarily list their securities on a
stock exchange and, therefore, this prohibition against brokers' extending
credit upon unlisted collateral will operate primarily to the detriment of
investors in local enterprises throughout the United States It is difficult
to understand why then securities should have no value in determining the
margin in brokerage accounts
The evident purpose of this provision seems to have been to discriminate
between brokers and other lenders of money in the amount of credit which can
be advanced upon unlisted securities, but it is capable of another interpretation
which would have even more serious consequences As I have pointed out,
a person who transacts a business in securities through the medium of a member of an exchange is likewise included in the prohibition of this subsection
If banks buying and selling securities for their own account or as agent for
their customers should be held to be persons transacting a business in securities,
then this prohibition would make all unlisted securities worthless as collateral
even in bank loans
There is one other important point in regaid to this section which requires
clarification The definition of the teim " security", which is contained in
section 3, subsection 10 (which appears on page 6 of the committee print)
excludes from the definition any " direct obligation guaranteed as to principal
or interest by the United States" For the purposes of this bill, therefore,
Government bonds are not securities and will not have to be registered on
an exchange and, therefore, brokers may extend ciedit on Government bonds
on such margins as they may elect If this interpretation is sound, then
section 6 does not prevent brokers extending credit against real property or any
form of personal property other than a " security " as defined by the act This
is obviously improper because it is well known that real estate and such
personal property are not normally as liquid as securities, and should not,
therefore, be the basis of this type of ciedit The New York Stock Exchange
has long recognized thrs fact, and rn determmmg the financial condition of
members our committee on business conduct does not place any value upon
real-estate holdings, furniture and fixtures, equipment of offices, or even upon
stock-exchange memberships We have felt that it was necessary to exclude
these items, which, although of undoubted value, are not capable of being
turned quickly into cash if we were to be sure that the capital of our member
firms was adequate to protect the accounts which they were carrying for their
customers
Subdivision (b) of section 6 makes it unlawful for any member of an
exchange or person who transacts a business in securities through a member
of an exchange to extend or maintain credit to any customer on securities
registered on a national exchange in an amount which at any time exceeds
(1) 80 percent of the lowest price at which such securities have sold during
the preceding 3 years or (2) 40 percent of the current market price, whichever
is the higher This subsection further provides that the Federal Trade Com
STOCK EXCHANGE PRACTICES
6627
mission may fix lower loan values during any stated period of time or in respect
of any specified class of securities
The minimum margins established by this subdivision have naturally been
one of the features of the bill which has evoked the greatest amount of public
discussion Few people, howevei seem to understand how this provision will
operate As I see it, the amount of margin which will become the minimum
depends upon the course of prices more than upon the percentages set forth
in the bill For instance, a security selling at $100, and which has not sold
for less than $100 dm ing the preceding three years, can be carried in a margin
account at 80 percent of its cuirent market price, because its current market
price and the lowest price leached within 3 yeais happen to be identical
If a broker advances 80 percent of the curient market price of such a security,
he will have only 25 percent maigin against the actual debit* balance He will
be advancing $80 against every $100 of value and the leeway or margin between
the amount which is owed him and the current value of the collateral will be
$20 or $25 percent of the sum which is owed him Many people have become
confused in discussing this question of margins and it is sometimes said that a
margin should represent a certain percentage of the value of the collateral
for the loan This method of computing maigms completely disregards the
essential nature of a margin When a person borrows money and pledges
securities as collateral he noimally computes the amount ot the margin as a
percentage of the amount owed Foi example, if I borrow $10,000 and give
as collateral $15,000 of Government bonds, I feel, and so does the lender, that he
has a margin of safety equal to 50 percent of the amount owed him In
brokerage accounts the amount owed is commonly called the debit balance and,
therefore, in determining the amount of a customer's margin, this figure is used
as the basic one just as a bank, in determining the margin for a loan uses
the face amount of the loan as its basic figure In eithei case, a percentage
of margin must mean a percentage of the amount owed
This subdivision might in certain circumstances permit securities to be carried on a 25-percent margin, which is less than the New York Stock Exchange
now requires its members to demand and maintain If, however, we imagine
a different set of circumstances, the provisions of the bill will have not an overliberal but an almost prohibitive result For example, if a security like General
Motors, which has withm 3 years sold at $7 a share and is today selling at
approximately $40 per share, should be presented to a broker as margin after
the effective date of the pioposed act, the broker could only lend $16 per share
upon this stock because the 80-percent provision would be rendered nugatory
by the low price which Geneial Motors reached at the worst period of the depression In this case, the brokei would have 150-percent margin, I e , he would
advance $16 against a stock selling at $40 and the difference between these
two or $24 would represent one and one hair times the amount owed him by
his customer It is obvious that margins of 150 percent are not necessary for
the purpose of insuring the safety of a customer's account and that should be
the sole purpose of a margin provision Such a margin requirement would have
the immediate effect of eliminating a great part of the speculative activity on
which the stability and useful function of the market depends, to the great
detriment, of couise, of all investors and stockholders
The effect on margins of this subdivision will depend upon the couise of
prices In periods of stability or of declining prices it will permit over-liberal
margins and in periods of rising pi ices it will fix prohibitively high margins.
As a practical matter and because most securities reached very low prices
within the last 3 yeais, the immediate effect of this subsection would be to
increase enormously the margins which brokers would have to demand from
their customers At the present time the total debit balances carried by members of the New York Stock Exchange for customers is approximately
$1,390,000,000 It is certain that a large part o%f this total has been advanced
against securities which sold at very low prices within the last 3 years, and,
therefore, the margins which existing customers will be called upon to put up
if their accounts are to meet the requirements of the bill will, of necessity, be
very substantial I am sure that many customers will find it difficult if not
impossible to provide the required amount of margin and will, therefore, be
compelled to liquidate a large part of their holdings at a time when no market
-capable of absorbing such liquidation may exist
The real difficulty with these proposed margin requnements is that they
attempt to set up a rigid formula for a subject which, by its very nature,
requires a very flexible rule The determination of proper margins requires
6628
STOCK EXCHANGE PBACTICES
the exercise of sound discretion. It is impossible to substitute for this discretion a mechanical rule based upon percentages of existing or former valuesA sound margin is one which will, in all probable circumstances, protect the
lender of money from the danger of loss if security prices should decline. To
arrive at a solution of this problem, many factors must be considered The
nature of the security, its activity in the market, the degree to which it is
held on margin or as collateral for loans, are all considerations which must
be taken into account In addition, there are special situations which may
affect the amount of margin which should be required There are certain,
securities which, because they fluctuate rapidly and by substantial amounts,
are considered volatile and therefore not entitled to as high a degree of value
for collateral purposes as more stable securities I could cite you many
instances in which these special conditions have made prudent lenders refuse
to advance even 40 percent of the current market value In the face of all of
these variable factors, it is humanly impossible to adopt any law which will
operate fairly in all possible circumstances.
I am convinced that the fixed minimums contained in subdivision (b) of
section 6 are utterly unworkable and will certainly operate in a manner
which will be detrimental to the public
In discussing these margin provisions, I have not overlooked the fact that
the Federal Trade Commission is given authority to fix lower loan values
for any stated period of time or in respect of any specified class of securities.
This power, while it would allow the Commission to make higher margins
mandatory, does not go far enough to give real flexibility I have already
pointed out how special considerations affect particular securities There is
no power, as I see it, given to the Commission by this section to provide
that any one security should have a lower loan value than the rest of its
class and yet that is precisely what banks and other lenders of money do in
actual practice For instance, in 1901, at the time of the Northern Pacific
panic, the proper loan value for Northern Pacific stock was only a fraction
of the price at which it was selling, but that did not mean that railroad
securities, m general, had to be written down for loaning purposes by an equal
amount. The same was true of Radio stock when it advanced very rapidly
in price a few years ago and there have been numerous similar instances in
the recent past If it should be suggested that this objection might be met
by giving the Federal Trade Commission power to fix the loan value of any
particular security, I thmk the provision would still be unworkable because
of the practical impossibility of any single administrative body being in
sufficiently close touch with all of the security markets of the country and
sufficiently familiar with the factors affecting the value of each security dealt
in on exchanges to determine promptly and soundly the value which should
be attached to each stock or bond for margin purposes In the last analysis,
the problem of fixing the loan value of particular securities is a local one which
must be dealt with by persons who are thoroughly familiar with local market
conditions and who are in constant daily touch with all the factors on which
loan values depend.
Subdivision (c) of section 6 makes it unlawful for any person to extend or
maintain credit upon any security registered on a national exchange which ha&
been acquired by the borrower within 30 days of the date of the loan, except in
an amount not exceeding that which a member of a national exchange may lend
to his customer pursuant to the provisions of the bill In effect this section
makes the rigid margin requirements set up by subdivision (b) applicable to
all banks, and other lenders, in respect of securities listed on exchanges which
have been purchased within 30 days As I believe the minimum margin requirements, which the bill imposes on brokers' loans, are unsound, I naturally feel
that the same provisions are equally unsound if applied to bank and other loans*
Furthermore, this provision, while establishing rigid minimums for securities
listed upon exchanges, apparently permits all lenders of moneys, except members of exchanges, to advance credit on unlisted securities on such terms as they
may think wise This discrimination against listed securities seems clearly
unsound Stocks and bonds, which are listed on exchanges, and enjoy an
active market, have proved to be the best and safest type of collateral for
loans The bill apparently completely disregards the experience of the past m
this respect and permits banks, and other lenders of money, to advance more
credit on unlisted securities than they can advance upon listed securities which
have been purchased within 30 days
STOCK EXCHANGE PBACTICES
6629
Some of the effects of this provision are anomalous. For example, a security
which the issuer proposes to list on an exchange cannot be registered with the
Federal Trade Commission until 30 days after the registration statement has
been filed. During this waiting period the security cannot be dealt in on an
exchange and, therefore, would not be deemed to be a registered security coming within the provisions of the bill It is possible, therefore, that a security
of this kind might be the basis of liberal credit advances by banks until the
effective date of the registration, when, automatically, the bank would have to
call its customer for additional margin merely because the security had become
entitled to a public quotation
I have already mentioned that the mandatory provisions of the bill in
regard to minimum margins would force the liquidation of a substantial part
of the $1,390,000,000 of debit balances currently carried by brokers for their
customers These same mandatory provisions would, likewise, force the
liquidation of part of the $3,500,000,000 of loans which banks have made to
their customers against security collateral. The effect on bank loans may be
less severe than upon brokerage accounts because many of the securities held
as collateral by banks have undoubtedly been held by the borrowers for more
than 30 days. On the other hand, there still remains the problem arising
from the common practice of persons who have borrowed money from a bank
to sell a security held by the bank as collateral and to reinvest the proceeds
in another security which is thereupon substituted as collateral for its loan.
Such substitutions will be subject to the bill and, therefore, changes of investment by persons who have borrowed from banks may become practically impossible It is difficult, if not impossible, to forecast precisely what the result
will be, but it seems probable that a substantial amount of liquidation of bank
loans will be caused by these provisions: of the bill.
Subdivision (d) of section 6 gives the Federal Trade Commission power
to determine how margins shall be computed; when they shall be paid and
what notice shall be given or method employed m closing out accounts These
powers would apparently apply not only to brokers but also to banks and
other lenders of money. The length of notice which must be given or the
method to be used m closing an account can seriously affect the safety of a
loan. Such unlimited powers should not be vested in any administrative body.
Section 7 of the bill deals with restrictions on members' borrowing and
contains six subdivisions The first prohibits any member of an exchange
or any person who transacts a business in securities through such a member
from borrowing from any person other than a member bank of the Federal
Reserve System The second subdivision prohibits such member or person
from incurring indebtedness which, in the aggregate, will exceed 10 times the
net current assets owned by the borrower and employed m his business. These
two provisions affect primarily the i elation between brokers and banks. I
understand that the committee will hear from persons who are more expert
than I in regard to the effect of these provisions upon our banking system.
From the brokers' point of view, the first subdivision seems unnecessary and
it will undoubtedly prohibit many small loans which are currently made between brokers I refer particularly to "odd-lot loans" which involve the
borrowing and lending of sums of less than $100,000
As far as the limitation upon borrowings by a broker in relation to the
amount of his capital is concerned, if the term "net current assets" means
the capital of the broker employed in his business, the provision of the bill is
less severe than the requirements of the Business Conduct Committee of the
New York Stock Exchange. In spite of this fact, I think the provision is a
bad one because of its mandatory and inflexible nature. In the experience
of our Business Conduct Committee, the capital ratio of members has sometimes fallen below our minimum lequirements. In such cases, the Business
Conduct Committee insists that additional capital be secured or then that the
liabilities of the firm be reduced by transferring customer's accounts to other
firms which have the necessary capital This provision, which makes it unlawful for a person to borrow more than ten times his capital and allows
a person who exceeds this arbitrary limit no opportunity to readjust his
affairs, will force the insolvency of firms which might otherwise be saved and
put again upon a solid foundation An insolvency is a serious matter for
customers even if they are ultimately paid m full because it deprives them,
at least temporarily, of the use of their securities and property.
No statutory provision can guarantee the solvency of brokers Constant care
and watchfulness are the best protection against insolvency The experience
6630
STOCK EXCHANGE PEACTICES
of our Business Conduct Committee throughout the entire depression amply
demonstrates the truth of this statement The questionnaire system, which the
exchange established in 1922, and which has from time to time been revised,
and extended and the examination of member firms which the Business Conduct Committee currently makes in order to verify the answers to these questionnaires, have been the means by which the exchange has been able to guard
against the insolvency of members. There have been a number of insolvencies
but the record of the members of the exchange m this regard is certainly an
outstanding one and if the committee is interested m these statistics I will submit for the record a tabulation showing in comparative form the number of
insolvencies of members of the exchange and of National banks and State banks
The third subdivision ot section 7 prohibits a member of a national exchange
or a person engaged m the securities business through such a member from
using his capital, if he be acting as a broker, to carry or finance securities
for himself or for any partner or employee It is not quite clear whether this
prohibition is intended to prevent a broker from investing his own capital in
securities or from contributing capital to his firm in the form of securities
If this subdivision should be given any such broad interpretation, it would
operate most unfairly and would, in effect, require a broker to use in his
business only cash capital
In any event, violations of these provisions should not be made criminal
offenses, because as soon as such a penalty is1 attached any person lending
money to a broker might find himself involved in a criminal act
Subdivisions (d) and (e) of section 7, which deal with the hypothecation of
customers' securities, are the same as the existing law of the State of New
York and the rules of the New York Stock Exchange Subdivision (f), which
deals with the lending of a customer's securities without consent, makes
effective another ruling of the New York Stock Exchange The final part of
this paragraph, however, provides that the account of the customer whose
securities are loaned must be credited with "the interest received on account
of such lending" This provision, quite frankly, is meaningless The lender
of securities does not receive interest but pays interest It is only when
stocks are lending at a premium that the lender of securities receives any
direct compensation for the loan It has frequently been urged that brokers
should account to their customers for any premiums so received, but the
practical difficulties of doing so are almost insuperable If the committee is
interested m this subject, I can readily give them an example of how impossible
it is for a broker who receives a premium on a loan of stock to apportion
it among the persons who might theoretically be entitled to a part of it
Section 8 of the bill deals with certain prohibitions against the manipulation of security prices Subdivision (a) contains nine specific subsections
which I will refer to as briefly as possible
The first prohibits fictitious transactions which, of course, include "wash"
sales That is already the penal law of the State of New York and is, likewise,
prohibited by the rules of the New York Stock Exchange
Subsection 2 prohibits the purchase and sale on an exchange of a listed
security at substantially the same time and substantially the same price, unless
the transaction is made only as a matter of record and is reported in a specified
manner It is not quite clear whether this section is intended to prohibit more
than " matched orders ", which, in effect, are a form of fictitious transaction
whereby two or more persons, by prearrangement, enter orders at about the
same time to buy and sell a certain security with the intention or design that
these orders will meet and be executed one against the other. This practice
we consider is a violation of our rule prohibiting transactions which do not
involve a real change of ownership. If, on the other hand, this section is given
a broader interpretation and will operate to prevent a man m the course of a
single day buying and selling the same security at about the same price, it will
prevent perfectly legitimate and honest transactions Many purchases are
made with the idea of selling again as soon as market conditions change, and it
frequently happens that in the course of a single day a man who has bought
in the morning may deem it advisable to sell m the afternoon There is no good
reason why he should not do so
Subsection 3 deals with transactions made for the purpose of raising or
depressing the price of securities, or for the purpose of creating a false or misleading appearance of activity. I think we will all agree that such practices
should be forbidden when they involve an intentional effort to unfairly influence
the price of securities for the purpose of making a profit The rule adopted by
STOCK EXCHANGE PRACTICES
6631
the New York Stock Exchange on February 13 not only forbids members from
participating in transactions of this kind but, likewise, prevents them from
either managing or financing such activities for others.
Subsection 4 deals with the dissemination of rumors as a means of stimulating market activity Such acts are already prohibited by the rules of the
exchange.
Subsection 5 seems to prohibit false or misleading statements, but the definition is so general that it is difficult if not impossible to say what statements
would fall withm the scope of this prohibition We all agree, I am sure, that
the dissemination of talse information to induce the purchase or sale of securities
is fraudulent The difficulty with this subsection, however, is that it may cover
perfectly honest statements as well as fraudulent ones In effect, it may mean
that no person—and I ask you to note that it is not only members of exchanges
and brokers who are subject to this provision but every citizen of the United
States—can make any statement in regard to any listed security unless he shall
have first made an investigation and exercised reasonable care to determine that
what he says is entirely accurate
Subsection 6 prohibits any payment being made to any person for the purpose
of procuring the dissemination of information to the effect that the price of any
security is likely to rise or fall because of the activity in the market of any one
or more persons The New York Stock Exchange has a rule prohibiting its
members making any payment to secure inspired publicity This section, which
accomplishes substantially the same result, would simply carry into the criminal
law and make general a rule which the Exchange has alieady put in force in
regard to its own members I hesitate to express any opinion in regard to the
feasibility of enforcing this provision
Subsection 7 prohibits any person engaging m a series of tiansactions intended
lo peg or stabilize the price of any listed secunty, unless the details of such
operation shall have first been leported to the Federal Trade Commission and,
presumably, approved by i t Transactions aimed at maintaining a certain price
or at stabilizing the price of a security have heretofore been considered legitimate when connected wth the distribution of securities or the maintenance of
a fair market for secunties This subsection would appaiently make such
operations illegal unless they were first submitted to and approved by the
Federal Trade Commission
In spite of the critical comments that have been made about stabilizing
security prices, no one can doubt that such practices have been considered
legitimate in the past They were generally indulged m by our own Government when the Liberty Bonds were being sold during the war and, more
recently, it has been the custom of our Federal Reserve Banks to intervene
in the Government bond market to maintain and stabilize prices in anticipation
of new Treasury issues The ethical character of such opeiations cannot,
therefore, be questioned
It is, at least, doubtful whether any restriction should be placed upon purchases and sales made to support a market in connection with the distribution
of securities The maintenance of a price having some reasonable relation to
the offering price through the medium of actual purchases and sales in the
market, really operates to the benefit of investors in that it allows them to
freely buy and sell while the process of distribution is still in progress Many
people believe that when such operations terminate, the market necessarily
lecedes and that the existence of such stabilizing orders must operate to mislead the public These people overlook the fact that a distributor of securities,
who undertakes to stabilize the market price of the security he is selling, is
backing his judgment that the price at which he is offering the security to the
public is a fair one If he is mistaken and the security has been offered at
too high a price, the net result of the stabilizing operation will be an accumulation of securities by the issuer and this may, in some instances, lesult in his
lepurchasmg the entire issue which he has offered to the public If, on the
other hand, his judgment is justified and the public is willing to pay the price
at which the security is offered, the only result of the stabilizing operation will
be the maintenance of a fair market while distribution is being effected, Certainly, this question is one which deserves greater study before it is condemned
by being included among the criminal provisions of the bill
There is one other normal and useful practice which would seem to be within
the scope of this subsection I refer to arbitrage transactions which frequently
play an important part in the market. Aibitrage is possible between different
markets and, likewise, between different securities For example, a security
6632
STOCK EXCHANGE PRACTICES
like the stock of the American Telephone & Telegraph Co is dealt in m Boston
as well as in New York If there should be more buyers than sellers for this
stock in the Boston market there would be a tendency for the price ot this
stock to rise on that exchange. At the same moment, however, there might be
more sellers of this stock than buyers on the New York Stock Exchange, so
that, m effect, the price of the same stock might be rising in Boston at the very
moment that it was declining in New York
The function of the arbitrageur is to bring the two markets into relation
with each other and, m the example which I have cited, he would buy in
New York and sell in Boston, with the result that the price in New York
would not decline and the price in Boston would not rise This, as I see it, is
a beneficial service which creates a better market for the public on both exchanges. The example which I have cited between two exchanges in this
country is commonly called "domestic arbitrage." Similar transactions frequently take place between our markets in this country and the great European
financial centers and these international transactions are usually called " foreign
arbitrage." Of the two different types, the latter is infinitely more important,
because it brings together the supply and demand of international centers and,
at the same time, plays a stabilizing role; in foreign-exchange rates. I appreciate that this subject is a highly technical one and will not elaborate upon it
unless the committee desires me to do so Foreign arbitrage is, however, genershould bear a very direct realtion to the price of the stock in connection with
ally recognized as a legitimate and useful activity, and even during the
last year, when restrictions were placed upon foreign-exchange transactions,
every means was used to facilitate the business of foreign arbitrageurs
Aibitrage takes place not only between markets but also between securities.
For instance, a corporation like the American Telephone & Telegraph Co. may
offer its stockholders rights to subscribe to additional stock. These rights may
be valuable and some stockholders may wish to exercise their rights while
others may decide to sell them It is obvious that the value of the rights
which they were issued, but at any given moment ther may be more people
who wish to sell rights than there are buyers of rights and therefore the price
of the rights might decline even if the price of the stock should remain stable.
The arbitrageur by buying the rights and selling the stock keeps an equilibrium
between these two securities, just as the domestic arbitrageur maintains an
equilibrium between markets within this country. This is an important function and there are many instances where arbitrage is necessary to prevent unfair markets I have used as an example a case involving rights to subscribe,
but arbitrage applies also when stock dividends are declared or stocks are
split-up, in cases of merger and consolidation and also when part-paid certificates are issued at a time when full-paid certificates are already being traded in.
There is no evidence that the different types of transactions falling under the
ban of this subsection 7 have operated to the disadvantage of the public. On
the contrary, we know that they have been of real benefit to investors Certainly, it would be most unwise to outlaw such useful practices
Subsection 8 prohibits any person acquiring substantial control of the floating
supply of any listed security for the purpose of increasing the price by means
of such control There is no definition of what constitutes the " floating supply" of a security. If the real intention of this subsection is to prohibit
corners, I would like to point out that the best means of preventing a corner
is not to make it a criminal act to provide that contracts in the security
which has been cornered may be settled by the payment of a fair cash value
rather than by actual delivery of the security Such a provision makes corners
unprofitable and prevents them more effectively than any criminal penalty.
The stock exchange adopted such a rule in the general revision of its constitution in 1925.
Subsection 9 prohibits all forms of option contracts The purpose of including
such a sweeping prohibition was undoubtedly the prevalent belief that options
have customarily been used as a means of unfairly influencing market prices
in connection with manipulative pools This does not justify, however, an
arbitrary prohibition of all forms of option contracts Options which are
used for manipulation might well be prohibited, without preventing the use
of options for legitimate and proper purposes.
The balance of section 8, subdivisions (b), (c), (d), and (e), contain provisions imposing severe civil penalties upon persons who violate the specific
prohibitions which I have just discussed I am advised that these civil
penalties introduced a new and vicious principle into our law While the
STOCK EXCHANGE PEACTICES
6633
enforcement of the criminal law has sometimes been made more effective by
granting to personsi who have been injured by the criminal act a right to
recover penal damages, there is not, I am told, any known case in which civil
penalties of a punitive nature have been granted to persons who have not
suffered direct injury from the criminal act
In substance, these provisions allow any purchaser or seller of a security,
the price of which may have been affected by any one of the prohibited
transactions, to bring suit to recover the difference between the price at
which he bought his security and the lowest price at which the security sells
during 90 days before and 90 days after the date of purchase, or, in the
case of a sale, the difference between the sales price and the highest price
at which the security sells during 90 days preceding and 90 days following
the sale. These amounts can apparently be recovered irrespective of whether
the person has suffered actual damage or not, and it is obvious that these
sections will result in allowing any purchaser or seller of a security, the
price of which may have been affected by a prohibited transaction, to recover
vastly greater damages than he could have suffered. In fact, it is oven conceivable that a person might buy a security and sell it again at an insignificant
loss and then claim, as a buyer, the difference between the lowest price at
which the security sold withm a 6 months' period and the price that he paid
for it, and, as a seller, the difference between the highest price reached within
the 6 months' period and the price at which he sold it. An illustration will
make this example even clearer Suppose I should buy 100 shares of Allied
Chemical & Dye at 121 and should sell it again at 120, thereby losing $100;
and that within 90 days before and 90 days after my transaction this stock
had sold at a low of 105 and a high of 155 If I should discover that somebody had engaged in one of the numerous transactions prohibited by section
8, I could sue him for $1,600, as the difference between the price at which
I bought the stock and the lowest price at which it had sold. I could, likewise, sue him for $3,500 as the difference between the price at which I sold
the stock and the highest price at which it had sold In the aggregate I
could recover $5,100 as my damages, although, in fact, my actual loss was
only $100
It is obvious that provisions of this character will be productive of endless
litigation and innumerable blackmail or " strike " suits.
Section 9 of the bill contains three subdivisions Subsection (a) forbids
short selling except m accordance with the rules and regulations to be laid
down by the Federal Trade Commission Subdivision (b) prohibits stop-loss
orders except in accordance with like rules or regulations, and subdivision
(c) allows the Federal Trade Commission to prohibit the employment or the
use of any contrivance or device which it shall determine to be detrimental
to the public interest
I have in the last 3 years spoken so often in regard to the necessity and
usefulness of short selling that I hesitate to burden you with further statements on this subject We have consistently maintained that short selling is
an essential part of a free and open market in securities We have collected
exhaustive statistics in regard to the short position in all stocks listed on the
exchange These statistics have been widely published and prove conclusively
the value and necessity of short selling In every great crisis covering by
short selling has assisted the market to recover The most recent illustrations
of this tendency of short sellers to buy when liquidation is heaviest occurred
in February and March 1933, just prior to the banking holiday, and again in
July when the market suffered a very severe and rapid decline In the 2
weeks preceding the 4th of March 1933, the short interest covered 412,000
shares of stock, and it was a notable fact that the stock market remained
active and strong right down to the 4th of March, when the closing of all the
banks in the country necessitated the closing of the exchange Last summer
a violent break in prices occurred in the latter part of July, and in that
month the short interest declined by 445,000 shares This furnished substantial buying power to the market in a very critical period. In the face
of this record, short selling should certainly not be prohibited
The prohibition of stop-loss orders would, in my opinion, facilitate the work
of brokers and particularly the work of specialists on the floor of the exchange
However, I think it would deprive persons who are not m close touch with the
market, of a perfectly proper means of having their selling orders executed
when certain prices are reached There is no evidence that the existence of
stop-loss orders tends to accelerate a decline or a rise in prices. In any event,
6634
STOCK EXCHANGE PRACTICES
the economic value of stop-loss orders should be carefully weighed, and nv>
change should be made until the matter has been given further consideration*
The final subsection, giving the Federal Trade Commission unlimited power
to make unlawful any device or contrivance which it may deteiminef is detrimental to the public interest, is a surpiismg delegation of power, particularly
as any violation of the rules or regulations of the Commission would be a
criminal act which might result in heavy fines and imprisonment
Section 10 of the bill purports to deal with the segiegation and limitation,
of the functions of broker, specialist, and dealer In fact it prohibits any
member of an exchange and any person who, as a broker, transacts a business
in securities through a member of an exchange from acting at all as a dealer
in or underwriter of securities. The sweeping character of this prohibition
can only be realized when reference is made to the definitions to which I referred when discussing section 3 of the bill The unusually broad definition
given to the words " broker " and " dealer " result, in this instance, in prohibiting a member of an exchange from buying or selling securities for his own
account.
Even if some segregation of the functions of members of exchanges may
be desirable—and I would like to say parenthetically that the New York
Stock Exchange has been studying that problem for nearly 2 years—there
is certainly no justification for such an arbitrary prohibition as the one contained in this section.
The consequences of the enactment of this section would be veiy grave.
It would absolutely prohibit the odd-lot business, which today provides a
market for all purchasers and sellers of listed stocks in amounts of less than
100 shares There are literally millions of investors who hold odd lots of
securities, and it would be grossly unfair to deprive them of the benefits of a
market on the exchange purely for the purpose of separating completely the
functions of broker and dealer Mr Hetherington will speak to you more m
detail in regard to this subject, but I would like to give you certain statistics
which prove what an important part of the market consists of the purchases
and sales by small investors In the year 1929, when the total reported sales
on the York Stock Exchange amounted to 1,124,000,000, our odd-lot houses
bought in odd lots more than 142,000,000 shares and sold in odd lots more than
158,000,000 shares Together, these small purchases and sales exceeded in
that year 300,000,000 shares The year 1929 was unusual because it included
a period of rising prices followed by a panic This fact, however, did not
unduly affect the volume of odd-lot transactions and odd-lot purchases and
sales have been as important, if not more important, throughout the entire
depression From April 1 to August 1, 1933, odd-lot sales aggregated nearly
57,000,000 shares and, in the same period, odd-lot purchases were nearly
56,000,000 shares, or a total m odd-lot transactions of nearly 113,000,000 shares
in a 4 months' period. During these same months the total sales reported
on the New York Stock Exchange were 408,000,000 shares
This section also makes it unlawful foi a specialist to trade for his own
account and prohibits him from accepting ordeis except at a fixed price Mr
Sprague will explain this particular business This prohibition will completely
destroy the specialist system, as we know it today and would have serious
consequences for the whole market This system originated many years ago
when a member who had met with an accident was unable to move around the
floor He, therefore, sat in a chair at one post and offered to accept oiders
from other brokers and execute them as the market permitted It was soon
found that he could render better service in executing oiders at limited prices,
and that he could also execute market ordeis more rapidly than the average
broker because he was constantly present at the post Other persons imitated
his example and there were soon many specialists At the present time there
are about 325 members of the exchange who act regularly as specialists and
there are two or more competing specialists in every important active stock
The existence of the specialist system facilitates trading and is, in my opinion,
an essential part of any important market for securities
The greatest criticism which has been leveled against specialists, and apparently the evil at which this section of the bill is aimed, is that they are allowed
to buy and sell for their own account the stocks in which they accept orders
from others Most people believe this allows a specialist to trade against the
orders which have been intrusted to him and that, therefore, he is buying and
selling to the disadvantage of his customers This, of course, is not true
For many years the rules of the exchange have prohibited a specialist from
STOCK EXCHANGE PRACTICES
6635
trading against his customers' orders He is allowed to take stock or to supply
stock on oiders which have been intrusted to him only when the price 1$
justified by market conditions and when the broker who gave him the order
has been sent for and approves the transaction Furthermore, before executing
any such transaction, the specialist is required to bid and offer in the open
market at the lowest possible differential away from his order before he can
eith r take or supply stock on orders intrusted to him This open bidding and
offering insure the fact that no better price could be obtained for the customer
It has frequently been suggested that we should prevent specialists from dealing for their own account We have been unwilling to adopt such a rule because
we are convinced that the transactions of specialists make for a closer and
better market which, in the last analysis, is greatly in the public interest It
frequently happens, for example, that the best bid and offer, even in well-known
stocks, are a point or more apart At such times a stock may be quoted at 30
bid and 32 offered
In this situation, if the specialist were not allowed to trade a buying order
could not be executed except at 32, and no selling order would realize more
than 30 The custom of the specialist is to buy and sell in between the bid and
offered prices and, in the example which I have suggested, he would probably
make a market at 30^-31% In other words, he would be willing to buy stock
half a point above the best offer made by others and to sell stock half a point
below the price at which others were offering to sell This would give to the
public an advantage of an approximate average price between the bid and the
offer. I do not see see that this operates unfanly to the persons who have intrusted orders to the specialist, because they themselves have limited the price
at which they are willing to buy or sell I know critics have said that if the
specialist did not trade the person who had entiusted his order to him would
realize his price and they imply that, from this point of view, the trading of
the specialist is a disadvantage to his customer. This may be theoretically
true, but this argument entire^ overlooks the fact that the advantage which
this customer gets is at the expense of some other member of the public As I
pointed out m the example above, if a specialist were not allowed to trade when
the market was quoted at 30 bid—32 offered, any person buying would have to
pay 32, while any seVer would realize only 30 The specialist by trading gives
the public a fairer price than would otherwise be realized, and this is of value
to all persons who are buying or selling securities.
It is, likewise, commonly believed that specialists by reason of the information which they secure from the orders intrusted to them have a great advantage in trading for their own account. If anything, the contrary is true,
because the specialist is bound to execute his customers' orders before he
may trade for his own account As a practical matter, he cannot refuse to
accept orders and, therefore, when he trades he runs the risk that he may
receive additional orders which will prevent his changing his position until
after the market may have moved against him. The best proof that specialists
do not have a tremendous advantage over the public and other members, is the
fact that the officers of the exchange have, on many occasions, had to persuade
members to act as specialists even in important stocks While it is possible
that specialists might take advantage of the information intrusted to them,
the chance of their successfully doing so is remote. Their work is necessarily
pei formed on the floor of the exchange under the constant scrutiny of the other
members who have intrusted orders to them These members are naturally
interested in seeing that their orders are executed at the best possible price, and
they are quick to report to the governors of the exchange any transaction
which is in the least degree suspicious When specialists trade between the
bid and offered prices, they have a chance of making a profit out of small
differences, but in order to do so they assume very definite risks.
There is another aspect to the work of specialists which is overlooked by
critics of the exchange and that is the obligation on the part of a specialist
to take full responsibility for any errors or negligence on his part If a
specialist fails to execute an order that has been entrusted to him when he
had a reasonable opportunity of doing so, then he must, at the election of his
customer, either take the transaction for his own account or cancel it In
other words, when a specialist makes an error the customer has the election
to insist that the transaction be carried through if it is to his advantage, or he may, if the market has turned against him, require to the
specialist to cancel it.
6636
STOCK EXCHANGE PEACTICES
I would like also to call your attention to the devastating effect which the
prohibition against a specialist accepting market orders will have The function of a specialist is to stand at a partcular post on the floor of the exchange
and receive from other members such orders to buy or sell as they may elect
to send him Many of the orders so entrusted to a specialist are market orders
for immediate execution They are given to the specialist because the floor
members of firms cannot cover the entne floor Some firms do not even
attempt to execute any orders on the floor but give out their entire business
to specialists and floor brokers If no market order could be executed by a
specialist, the delay which would occur between the receipt of an order and
the time when a broker could be found who would be able to execute it might
be great and would operate to the disadvantage of the customer It is not
unusual for a large house to receive market orders in 300 or 400 different
issues, all of which are to be executed at the opening of the market If
each such large house had such a volume of orders, the number of brokers required to execute all of them promptly would run into the thousands The
membership of the exchange could not be increased so as to meet this situation because, although the floor of the exchange is one of the largest in downtown New York, it is already overcrowded by the approximately 800 members,
who are present almost every day As a practical matter, this prohibition
would be so unworkable that the market would be completely disorganized
Specialists make, in a certain sense, a market within the market and the concentration of the buying and selling orders which are entrusted to them
makes it possible for all oiders to be executed quickly and at the price then
prevailing in the market In ordinary tunes, an order is executed withm a
minute or two of the time when it is received on the floor Any such rapidity
of execution would be impossible if specialists were forbidden to accept market
orders and this would naturally operate to the disadvantage of investors and
the public in general
This section, likewise, includes a prohibition against specialists disclosing
the orders that have been entrusted to them, unless such information is available to all members of the exchange On February 13, the governing committee of the New York Stock Exchange adopted a rule prohibiting specialists
disclosing the information contained in their books to anybody except a member
of one of the standing committees of the exchange, acting in an official capacity.
Sections 11, 12, and 13 of the bill deal primarily with questions which affect
listed corporations Section 11 requires, among other things, every corporation
listing securities on the exchange to file a registration statement with the
Federal Trade Commission Section 12 specifies the current information which
a listed corporation must furnish to the Commission, and section 13 deals with
proxies in connection with the securities of any corporation listed on an exchange I am advised that the officers of a number of corporations have asked
for an opportunity to appear before this committee and they will undoubtedly
point out to you the burdens which these requirements would place upon listed
corporations I might point out, however, the fantastic result which section 13
would have in the case of a large corporation. This section requires every
person soliciting a proxy to file a statement with the Federal Trade Commission which shall include a list of the names and addresses of the persons from
whom proxies are being solicited and then requires that a copy of this statement shall be included as a part of every solicitation of a proxy. In effect,
therefore, a corporation sending proxies to its stockholders would have to
accompany the proxy with a complete stockholders' list. Insofar as these
provisions seem to affect the listing requirements of exchanges, Mr. Altschul,
chairman of the committee on stock list, is here and will deal fully with these
questions.
Section 14 of the bill purports to make it illegal for any person to use the
mails or any means of interstate communication or transportation
for the purpose of making a market in any security, whether listed1 on a national exchange
or not, without complying with such rules and regulations as the Federal Trade
Commission may prescribe This is an attempt to regulate the "over-thecounter" markets which exist in every financial center of the country. I ana
advised by counsel that the constitutionality of this section is extremely doubtful Even if it should be constitutional, " over-the-counter " markets can exist
without the use ot the mails or of any means of interstate transportation or
communication The bill, therefore, would not effectively regulate the entire
security business of the United States, and I am fearful that the penalties
which the bill imposes upon brokers and listed corporations would result in
STOCK EXCHANGE PRACTICES
• 6637
stimulating to an enormous degree the business of the completely unregulated
" over-the-counter " markets In this connection I should, perhaps, remind you
that some of the manipulative pool operations, disclosed by the investigation
carried on by the Senate Banking and Currency Committee, which received the
greatest degree of public criticism, involved securities which were not listed on
the exchange, but which were dealt in " over-the-counter." In at least two
striking instances these securities had been listed on the stock exchange before
the manipulative transactions took place but were removed from listing by
formal action of the directors and stockholders of these companies
Section 15 of the bill deals with transactions by directors, officers, and principal stockholders of corporations whose securities are listed on a national
exchange The provisions of this section affect primarily listed corporations and
will undoubtedly be discussed by the company officials who have asked for an
opportunity to appear before you. To the extent that these provisions seek to
prevent dishonest acts, they are undoubtedly sound, but regulations of this
character have no proper place in a bill regulating stock exchanges and stockexchange practices. They belong in the laws governing the incorporation and
management of companies. The New York Stock Exchange has long realized
that many of the bad practices connected with the management of corporations
have been due to loose provisions of State laws governing the incorporation
of companies. It is generally recognized that these laws have in some instances been drafted for the express purpose of making incorporation easy and
attractive to large enterprises In spite of the fact that the dangers inherent
in such policies have been publicly discussed for years, no perceptible improvement has resulted. The New York Stock Exchange has long been aware of
these evils and, despairing of effective amendments to the laws of all States,
we have urged that this situation be cured by the passage of a Federal law
governing the incorporation of companies I am firmly convinced that this
step is not only desirable but is really necessary to prevent abuses of the kind
referred to. The United States is today the only great commercial country
which has no national corporation law. While I appreciate that the provisions
of the bill dealing with officers, directors, and principal stockholders of corporations may be a first step toward such a law, I am convinced that they go
too far in some directions and do not effect real reforms in many others.
Furthermore, the bill attempts to do indirectly what should be done directly,
if at all. There is no logical reason for imposing criminal penalties on certain
practices when indulged in by officers, directors, and stockholders of corporations listed on a stock exchange and allowing similar practices of officials of
unlisted corporations to go unpunished What is wrong in one instance should
be made wrong in another, and unless this is done corporations may hesitate
to list their securities on an exchange and thereby subject their officers, directors, and stockholders to penalties both civil and criminal which they would
avoid entirely by removing their securities from listing
Section 16 of the bill requires every member of an exchange and every person
transacting business through such a member to keep such accounts, books, and
records as the Federal Trade Commission may require It also gives the
Federal Trade Commission unlimited power to examine these records. While
we are in hearty sympathy with the requirement that brokers should keep
adequate books and records and have, in fact, adopted a rule to that effect,
the provisions of this section are objectionable because of the unlimited powers
vested in the Federal Trade Commission Not only may the Federal Trade
Commission prescribe the nature of every record which a broker shall keep
but it may make such examinations as in its unrestricted discretion it may
determine All expenses of these examinations, including even the compensation of the persons employed by the Commission itself, must be paid by the
exchange or the member whose records are examined There is no requirement limiting the extent of these examinations or their expense to what is
reasonable or necessary and, in effect, therefore, the Federal Trade Commission
can arbitrarily dictate the extent and scope of these examinations and compel
the person examined to pay whatever expense may be incurred An inquisitorial power of this kind is, of course, capable of abuse, and if abused would
be equivalent to a power to destroy.
Included in this section, which purports to deal with reports and examinations, there is a provision giving any representative designated by the Federal
Trade Commission the right to attend any meeting or proceeding of an
exchange or any committee thereof As I will point out in a minute, section 18
gives the Federal Trade Commission power to make rules and regulations in
6638
STOCK EXCHANGE PRACTICES
regard to every aspect of exchange management, and also to make such investigations as the Federal Trade Commission may deem necessary or proper.
Apparently not satisfied with these powers, it was thought necessary to include
this extraordinary provision which would allow any person designated by the
Federal Trade Commission as its representative, to actually supervise and, by
his personal presence, influence every act taken in the management of exchanges
Section 17 of the bill deals with the liability of any person who shall make
or be responsible for making any statement in any report or document filed
with the Federal Trade Commission, which was " in the light of circumstances
under which it was made, false or misleading in respect of any matter sufficiently important to influence the judgment of an average investor." The
penalties provided for a violation of this vague and indefinite provision are both
criminal and civil. The civil penalties permit any person who, without knowledge that the statement was false or misleading, shall buy or sell " a security
the price of which may have been affected by such statement" to sue and
recover damages which shall be the difference in price between the amount
paid and the lowest price at which the security shall have sold during 90 days
before and 90 days after the purchase, or, in the case of a sale, the difference
between the amount realized and the highest price at which the security shall
have sold during 90 days before and 90 days after the sale. The person sued
shall be liable unless he can sustain the burden of proof that he acted in good
faith and in the exercise of reasonable care had no ground to believe that such
statement was false or misleading. In view of the unlimited character of the
information which the Federal Trade Commission has the right to require
exchanges and persons transacting business in securities, as well as all corporations listed on a national exchange, to file with it, it will be humanly impossible to determine what facts may, in retrospect, be deemed to be sufficiently
important to influence the judgment of an average investor. Even supposing
the best of good faith and the exercise of all care which would seem reasonable
at the time a statement or document is prepared, some subsequent event may
make some part of the statement appear to be misleading. We all know that
hindsight is easier than foresight The really objectionable feature of this
provision is that the civil penalties may be recovered by persons who have not
relied upon the inaccurate or misleading statement, and the amount which can
be recovered will not be the actual damage, but a penal sum, which will far
exceed any damage which they may have suffered. If any civil penalties are
deemed necessary, then they should be limited to the actual damages suffered
by persons who have been misled by the false or inaccurate statement The
imposition of a criminal penalty upon mere mistakes of judgment likewise
seems indefensible.
Section 18 of the bill grants certain special powers to the Federal Trade
Commission. Subdivision (a) of this section grants broad powers to the
Commission to adopt rules and regulations, and apparently contemplates that
in prescribing the form and contents^ of registration statements and reports the
Federal Trade Commission may discriminate between different classes of
exchanges, members, securities, and corporations whose securities may be
listed on national exchanges Subdivision (b) gives the Federal Trade Commission power to prescribe the form of the financial statements which will be
submitted to it, and in this connection allows it to specify the items and details
which must be shown and the accounting principles which must be applied.
Without going into detail, it is sufficient to say that this right to compel
corporations to use such methods of accounting as the Federal Trade Commission may arbitrarily select will, in effect, deprive the officers and directors of
corporations of the power to manage their companies A variation in the
method of valuing assets or determining depreciation or in the amount of
recurring and nonrecurring income and other similar matters may vitally affect
the accounts of corporations In each case matters of this kind essentially
involve the exercise of the discretion of management, and while it is proper to
require that management should adopt and apply a consistent policy in regard
to accounting methods, it is impracticable to vest in one administrative body
the power to prescribe rules and regulations of universal application
Subsection (c) gives the Federal Trade Commission authority to adopt rules
and regulations in regard to exchanges, their members and persons transacting
a busines in securities through such members. This long section, which specifies in detail some of the powers which the Federal Trade Commission may
exercise, clearly is not a regulation of stock exchanges and the brokerage
business, but, in fact, gives the Federal Trade Commission power to manage
STOCK EXCHANGE PEACTICES
6639
exchanges and dictate brokerage practices. There is no single activity of a
stock exchange from the admission of members to their suspension or expulsion that may not be controlled under this subsection. The election of the
officers of an exchange and the appointment of its committees are likewise
within the control of the Federal Trade Commission. This is not regulation
but domination
Subsection (d) makes the rules and regulations of the Federal Trade Commission effective upon publication, in such manner as the Commission shall
prescribe. This, in effect, might result in rules and regulations, the violation
of which is a criminal act, becoming effective without any proper notice It
is another instance of the arbitrary character of the powers vested in the
Federal Trade Commission by this bill Subsection (e) gives the Federal
Trade Commission broad power of subpena witnesses and compel the production
of books and papers for any investigation which in its opinion is necessary or
proper. These investigations can apparently be carried out not only by the
Federal Trade Commission or any member of it but also by any officer or
officers designated by it and the power to subpena witnesses and compel the
production of books and papers may be exercised by these subordinate officials
as they see fit The final sentence of this subsection makes it a misdemeanor
for any office participating in such an inquiry and also for any person examined
as a witness to disclose to any person other than a member or officer of the
Commission any information obtained upon such inquiry, except as directed
by the Federal Trade Commission or one of its officers The purpose of this
extraordinary provision is apparently to make all investigations by the Federal
Trade Commission secret proceedings and, in addition, to impose a criminal
penalty upon any witness who might disclose, even to his own attorney, what
had transpired during such an inquisition
Section 19 of the bill imposes liability upon persons controlling any other
person liable under the provisions of the bill when such control exists through
stock ownership, agency, 01 otherwise, or by any agreement or understanding
These provisions seem to apply more particularly to corporations and officers,
directors, and stockholders of corporations than to exchanges or brokers There
is, however, one extraordinary provision which might directly affect brokers.
Subdivision (d) provides that the acts of a husband, wife, or child, or parent
residing with a person subject to any provision of the bill, or a trustee for
such person of property used in the transaction in question, may be imputed
to such person unless he shall sustain the burden of showing that the acts were
not done with his approval or for the purpose of evading the bill In view of
the numerous provisions of the bill, to which criminal penalties are attached,
and the fact that a violation of many of them could occur through inadvertence,
this provision, which makes a man responsible not only for his own acts, but
for the acts of independent persons, may operate in a grossly unfair manner.
Section 20 of the bill authorizes the Federal Trade Commission to investigate
for the purpose of determining whether any person has violated, or is about to
violate, any provision of the bill. It further gives to the Federal Trade Commission certain remedies whenever it is satisfied that a person is violating or intends to violate any provision of the bill or any rule or regulation adopted by the
Federal Trade Commission These remedies include, first, the right to secure an
injunction; second, the right to suspend any national exchange from registration for a, period not exceeding 12 months or to withdraw its registration, altogether; and, third, the right to suspend for a period of 12 months or order the
expulsion from a national exchange of any member or officer who the Federal
Trade Commission finds has violated any provision of the bill or any rule or
regulation thereunder, or who has effected any transaction for any other person
who he has reason to believe is violating any of the provisions of the bill
or any of the rules and regulations adopted pursuant to it These powers to
suspend an exchange or to terminate its registration and to suspend or require
the expulsion of a member or officer of an exchange may apparently be exercised
whenever the Federal Trade Commission is convinced that the exchange or an
officer or member* of it has violated any provision of the bill or any of the
rules or regulations which the Federal Trade Commission may adopt, irrespective of whether such violation is material or immaterial or willful or inadvertent.
The determination of the Federal Trade Commission in such cases is apparently
hnal because the later provision which permits an aggrieved person to review
in the courts the orders of the Federal Trade Commission specifically provides
175541—34—PT 15
15
6640
STOCK EXCHANGE PEACTICES
that the findings of the Commission as to facts, if supported by evidence, shall
be conclusive This section, therefore, gives the Federal Trade Commission
complete control of exchanges and puts every officer and member of an exchange
at the mercy of the Commission
Sections 21 and 22 of the bill provide that all hearings before the Commission
shall be public and that all information received by it shall be public records.
The latter provision, which would seem to require that all information which
the Federal Trade Commission may receive from corporations must be made
available to any person who wishes to examine it, may result in putting
American business at a distinct disadvantage in competing with foreign enterprises. We all know that every important business has trade secrets and
processes and formulas which have value chiefly because they are not available
to competitors In like manner, many of the statistics in regard to the operations of companies are of little value to stockholders and investors, but of inestimable worth to competitors These provisions requiring publicity may,
therefore have very serious consequences
Section 23 of the bill provides that any person aggrieved by an order of the
Federal Trade Commission may have it reviewed in the courts, but, as I have
pointed out, the value of this right of legal review is to all intents and purposes
destroyed by the provision that the findings of the Commission as to the facts,
if supported by evidence, shall be conclusive The acts of the Commission
would in almost every instance involve a determination of matters of fact
rather than of matters of law This provision gives a semblance of protecting
the rights of persons subject to the power of the Federal Trade Commission,
but in fact does not in any way restrict the absolute power of the Federal
Trade Commission under the bill.
Section 24 of the bill deals with the criminal penalties which may be imposed
for any violation of any provision of the bill or of any rule or regulation which
the Federal Trade Commission may adopt pursuant to it The maximum penalties are fixed at a fine of $25,000 or imprisonment of not more than 10 years,
or both, except in the case of an exchange, when a fine of not exceeding $500,000
may be imposed. These extraordinarily heavy penalties are made applicable
to persons who make or are responsible for making any statement in a report
or document filed with the Commission, which, in the light of the circumstances
under which it was made, was false or misleading in any matter sufficiently
important to influence the judgment of an average investor The vagueness
of this definition, on which the criminal liability of citizens may depend, makes
the harsh penalties of the bill cruel and unusual Finally, while these penalties
apply only to willful violations of a provision of the bill or of a rule or regulation adopted by the Federal Trade Commission, or to a person who willfully
is responsible for a false or misleading statement in a paper filed with the
Commission, apparently there is no such protection afforded to a person who
makes a statement to the Federal Trade Commission and he will be liable
whether his act was willful or not
Section 25 of the bill vests in the District Courts of the United, States and
the United States courts of any Territory and the Supreme Court of the District
of Columbia jurisdiction of offenses and violations of any provision of the bill,
and also of suits brought to enforce any liability or duty created by it
Section 26 of the bill purports to deal with the effect of the bill on existing
law. Subdivision (a) provides that the rights and remedies created by the bill
shall be in addition to existing rights and remedies and attempts to declare that
any State laws providing for the supervision or regulation of the administration
or the conduct of the business of any exchange shall be superseded by the provisions of the bill I am advised that the constitutionality of any such provision
can be questioned.
Section 27 of the bill deals with the validity of contracts, and subsection (a)
declaies void any contract or condition binding a person to waive compliance
with any provision of the bill Subsection (b) declares void every contract
made in violation of any provision of the bill or of any rule or regulation
adopted by the Federal Trade Commission, and also attempts to provide that
even contracts, which were lawful when entered into, shall likewise be void in
respect of any cause of action arising after the effective date of the bill or of
any rule or regulation adopted pursuant to it.
Section 28 of the bill attempts to control transactions on foreign exchanges
by making it unlawful for any broker or dealer to make use of thel mails or
of any means of interstate transportation or communication for the purpose
of executing a transaction on an exchange outside of the United States, except
STOCK EXCHANGE PEACTICES
6641
in accordance with such rules and regulations as the Federal Trade Commission
may prescribe As in the case of section 14, which attempts to control over-thecounter markets, the validity and effectiveness of this provision are open to
grave doubt
Section 29 of the bill requires every registered exchange to pay as a license
fee one five-hundredth of 1 percent of the aggregate dollar amount of transactions taking place on such exchange during the preceding calendar year.
This sum is described as a registration fee and is to be paid, not to the Treasury
of the United States, but to the Federal Trade Commission itself. In effect,
this is not a registration fee but a tax upon the security business, which is
already subject to special taxes by Federal and State Governments. There is
no means of accurately computing what this tax would amount to in the
case of the New York Stock Exchange because there are no statistics showing
the aggregate dollar amount of the sales of securities which took place upon it*
A rough estimate, however, would indicate that it might approximate some*
where between $500,000 and $1,000,000.
Section 30 of the bill authorizes the Federal Trade Commission to employ
and fix the compensation of an apparently unlimited number of employees and
further exempts all such employees from the provisions of the civil-service act.
Sections 31 and 32 oi the bill merely provide for the separability of its.
provisions in the event that any of them are invalid and make October 1, 1934,
the effective date of the bill
The New York Stock Exchange, as I stated in my opening remarks, has
constructive suggestions to make in regard to the pending legislation for the
legulation of stock exchanges These suggestions are naturally subject to the
question oi the constitutional power of Congress to enact legislation regulating
the business of stock exchanges and their members
The purposes to be accomplished by such legislation are First, the prevention
of fraudulent practices affecting stock exchange transactions, second, the
prevention of the use of an excessive amount of credit for security speculation;
and third, the elimination of practices which, though not fraudulent, permit the
manipulation of security prices.
The most important question in regard to any regulatory legislation is the
determination of what body shall exercise the regulatory power. Obviously,
this body, whether it be called a commission or an authority, must include
persons who are familiar with credit conditions throughout the United States,
and also persons who are fully conversant with the technical problems connected with the operation of stock exchanges. In addition, a majority of the
members of such a body should be outstanding individuals who would represent
the public Having this in mind, we suggest the creation of a stock exchange
coordinating authority to consist of seven members.
We suggest that this authority be composed of 2 members appointed by the
President; 2 Cabinet officers, who might well be the Secretary of the Treasury
and the Secretary of Commerce; 1 person appointed by the Open Market Committee of the Federal Reserve System, and 2 persons representing stock exchanges, 1 to be designated by the New York Stock Exchange and the other to
be elected by the members of those exchanges in the United States other than
the New York Stock Exchange, that primarily offer a market place for securities. Such an authority would not only represent the interests of the
public but would have the benefit of the opinions and advice of two Cabinet
officers, and through its connection with the Open Market Committee of the
Federal Reserve System would be in clo&e contact with credit conditions
throughout the United States It would also include men who had detailed
technical knowledge of exchange operations
We suggest that this coordinating authority be given plenary power to control
the amount of margins which members of exchanges must require and maintain
on customers' accounts; and further, that it should have plenary power to
require stock exchanges to adopt rules and regulations preventing not only dishonest practices but also all practices which unfairly influence the price of
securities or unduly stimulate speculation Without attempting to define, at
this time, the scope of these powers, we believe that they should include the
power to fix the requirements for the listing of securities; the control of pools,
syndicates, and joint accounts and also options intended or used to influence
market prices; the power to control the circulation of rumors or statements
calculated to induce speculative activity, the use of advertising and the employment of customers' men or other employees who solicit business; to the end
that all practices which may tend to create unfair prices may be eliminated.
6642
STOCK EXCHANGE PEACTICES
This authority should also have power to study, and, if necessary, to adopt rules
in regard to those cases where the exercise ot the function of broker and dealer
by the same person is not compatible with fair dealing and to adopt rules in
regard to short selling, if it should become convinced that regulation of this
practice is necessary.
These suggestions represent the considered view of the New York Stock
Exchange and I have been authorized to present them by the governing
committee of the exchange I can say confidently that the exchange will
cooperate fully m attempting to prevent unwise or excessive speculation and
abuses or bad practices affecting the stock market.
I appreciate the courtesy which the committee has extended to me in
affording me this opportunity to state fully the position of the exchange in
regard to this bill. I trust that the committee will feel free to ask for any
information which it may desire from the exchange or its officials.
I can
assure you that all of the records of the exchange of every character- and
nature will be made fully available to you and, in addition, not only the
officials of the exchange but all of its technical experts are at your disposal.
Respectfully submitted
RICHARD WHITNEY,
President of New York Stock Exchange.
FEBRUARY 22-23, 1934
LAW SCHOOL OF HARVARD UNIVERSITY,
Cambridge, Mass, February 22, 1932.
CARTER, LEDYAKD & MILBURN,
New York, N.Y.
(Attention: Mr. W. H. Jackson )
DEAR SIRS: I am enclosing herewith, in accordance with your request, my
opinion on the constitutionality of H R 4, the LaGuardia bill to regulate the
short selling of securities on exchanges
I have confined myself to a consideration of the constitutionality of the
LaGuardia bill, for I am as yet unconvinced that a bill could not be drafted
to regulate security transactions on stock exchanges which would be constitutional The LaGuardia bill, however, bottoms itself upon a theory and conception of interstate commerce that I am not prepared to accept
Naturally the pressure of time has prevented my giving as thorough a consideration to the subject as I should have liked. I believe, however, that I
have considered all the pertinent authorities and given them their due weight.
Subsidiary matters I have neglected inasmuch as they fall within the category
of details whose validity will hinge upon the central question
Faithfully yours,
J. M. LANDIS
CAMBRIDGE, MASS., February 22,
19S2.
CARTER, LEDYARD & MILBUBN,
41 Broad Street, Neiv York, N.Y.
(Attention of Mr. W. H Jackson.)
DEAR SIRS • In reply to your request for my opinion as to the constitutionality
of House bill no. 4, a bill to protect banking and commerce against short sales
of securities issued by corporations engaged therein, I beg to summarize my
conclusions in the following manner:
THE NATURE OF THE BUX
The bill deals with the short sales upon stock exchanges of the securities of
banks organized under the laws of the United States and/or members of the
Federal Reserve System, and of corporations engaged in interstate or foreign
Commerce. It acts upon the conception that the practice of short selling is a
means of manipulating the market values of such securities, which, by producing arbitrary and abnormal declines, induces their needless liquidation. This
manipulation of market values, assumed not to reflect those that would be
produced by the normal operation of the law of supply and demand, is considered as a means whereby credit extended upon the face of such securities
STOCK EXCHANGE PEACTICES
6643
Is destroyed, thereby imperiling the general credit structure necessary to the
adequate functioning of commerce and banking, producing hoarding, and making
it more difBcult for such corporations whose secuiities have been depressed by
short selling to finance operations pursuant to carrying on interstate commerce
and banking. To the end of controlling the practice of short selling, the bill
seeks to attach a certain degree of publicity to the making of short sales.
Further provisions of the bill seek by drastic methods to enforce these
requirements
THE CHAKACTER OF STOCK EXCHANGE TRANSACTIONS
An understanding of the constitutional problems raised by the bill requires
a working conception of the nature of transactions upon stock exchanges The
central fact of a stock exchange is that it is, in essence, a market for a particular thing—the security Persons desirous of buying and selling securities
are here assembled more readily to facilitate their aims In the modern
exchange the number of such persons admitted to the market and privileged
actually to buy and sell upon that market is limited to a defined group. These
members of the exchange, in the mam, act as brokers or agents for other
persons Between themselves, however, they deal as principals. Contracts
of sale are made only between members upon the floor of the exchange, and
the delivery of the securities, whether or not cleared through some form of
clearing house, is made only between members. The fact that many transactions on stock exchanges concern marginal purchases or sales by customers
does not alter these essential characteristics Delivery of the security and
transfer of the purchase price follows in either event.
The transactions on the exchange are thus not only geographically limited
to the locality where the exchange is located, but they do not concern an
article moving in interstate commerce Such movement in interstate commerce
as results from stock exchange transactions occurs from the fact that either
subsequently to a purchase of securities by a broker, the securities may actually
be delivered to a customer in some other State directly by that broker or
through the medium of a corresponding broker, or that preparatory to a sale
securities may be forwarded to the broker negotiating such sale Furthermore, instrumentalities of interstate commerce, such as the telegraph, the
telephone, and the mails, are employed by brokers on the exchange in the
effectuation of sales and purchases, and in the wide dissemination of market
prices of securities in order to inform thei** own customers or customers of
corresponding brokers of the prices at which securities can be bought and
sold on the exchange Such wide dissemination of market quotations is
obviously necessary in order that purchasers and sellers may know the prices
which securities are commanding on the exchange and thus be induced either
to buy or sell securities upon the exchange
Since the existence of a well-organized market has the economic effect of
centering sales and purchases at such a market, the major portion of security
buying and selling takes place on stock exchanges Uniformity in security
prices throughout a wide geographical area is thus secured But the process
by which this is achieved is the interchange of securities in a local and limited
geographical area
THE THEORY OF THE BILL
The bill (HE 4) recognizes the local characteristics of actual exchange
transactions It does not seek to attach to them an interstate character arising
from the interstate nature of the devices used to facilitate transactions on
the exchange or from the fact that the physical certificates actually bought
and sold are thereby transferred from State to State Instead, it seeks to
attach an interstate character to transactions in securities arising out of the
fact that such securities represent either obligations of or aliquot shares in
businesses engaged in interstate commerce, or incorporated under national
banking laws or possessing peculiar privileges as being members of the Federal Reserve System Dealing in such obligations on exchanges is considered
by the bill to be so intimately related to interstate commerce as to permit
Congress to regulate it It thus makes no effort to regulate transactions in
securities of corporations not engaged in commerce between the States
6644
STOCK EXCHANGE PEACTICES
THE EXTENT OF CONGRESSIONAL POWER OVER INTERSTATE COMMERCE
The essence of Congressional power over interstate commerce, apart from
control over instrumentalities of such commerce as the railroads and the telegraph, resides in the control that the Federal power possesses over the free
movement of commodities from State to State To that end direct and substantial interference by the States with interstate Commerce is forbidden,
whether through direct regulation or taxation. Also power is possessed by
Congress to remove and control obstructions to the free movement of such
commodities through the accustomed channels of trade
The application of these principles is well illustrated by reference to the
control exercised by Congress over commodity exchanges. The Packers and
Stockyards Act and the Gram Futures Act, whose constitutionality has been
upheld, sought to control certain practices m the live stock and grain exchanges.
The basis for such control did not rest upon the fact that such transactions
of themselves constituted interstate commerce. Instead, the Supreme Court
has repeatedly recognized that mere transactions even upon commodity exchanges do not constitute interstate commerce (Hill v Wallace, 259 U S . 44;
Hopkins v. United States, 171 U S 578). But it is their effect upon the stream
of commodities moving in interstate commerce that makes them subject to
congressional control (Stafford v Wallace, 258 U S 495; Board of Trade v.
Olsen, 262 U S 1; United States v. Coffee Exchange, 263 U S 611; Tagg Bros,
v. Morehead, 280 U S 420; United States v Patten, 226 U S 525; Chamber of
Commerce v. Federal Trade Commission, 13 F (2d) 673). This consideration
is emphatically brought out by Chief Justice Taft in the Board of Trade ease:
" The sales on the Chicago Board of Trade are just as indispensable to the
continuity of the flow of wheat from the West to the mills and distributing
points of the Bast and Europe as are the Chicago sales of cattle to the flow
of stock toward the feeding places and slaughter and packing houses of the
East" (Board of Trade v Olsen, supra, at 36 )
The recognition that this is the basic principle underlying congressional
control over sales for future delivery and other practices on commodity exchanges, in my opinion, distinguishes these exchanges from stock exchanges.
In the former type of exchange, the thing that is bought and sold is a commodity moving in interstate commerce The fact that for the moment, when
the transaction upon the exchange actually takes place, the commodity is at
rest and that no interstate delivery is required as between buyer and seller,
has been regarded by the court as immaterial in the light that at bottom there
is a current of interstate commerce in the commodity moving through and
beyond the exchange The stock exchange, however, presents no such aspect.
Other than a physical certificate representing a chose in action, no commodity
is to move in interstate commerce as a consequence of a sale on the stock
exchange. Dealings upon that market will effect no additions to the cost of
moving these certificates from State to State Indeed, the parallel between
& commodity exchange and a stock exchange is so absent, that I cannot regard
these decisions as governing the stock exchange situation nor as establishing
a principle applicable to transactions upon stock exchanges.
Bill H B 4 seems implicitly to recognize this distinction It does not
proceed upon any theory that short selling on stock exchanges concerns the
movement of commodities in interstate commerce On the contrary, its restricted application to securities of corporations engaged in interstate commerce regards transactions with reference to such securities as being sufficiently
related to the interstate commerce engaged in by the corporations as to enable
Congress to deal with the transactions as interstate commerce.
THE RANKING FEATURES OF THE BELL
The ground for supporting the constitutionality of the instant bill would seem
to me to rest primarily upon congressional power under the interstate commerce
clause, and not upon the recognized congressional power to charter and operate
banks. The power of Congress to charter and operate banks is, m essence, no
more than the power of any State to charter a bank It can, of course, give its
banks peculiar powers which it may deny the States to give to their banks, and
its banks possess peculiar privileges arising from the fact that they are Federal
instrumentalities It can consequently command the banks that it charters
to observe certain regulations with reference to the conduct of the banking
STOCK EXCHANGE PRACTICES
business.
6645
(American Bank & Trust Co v. Fedeml Reserve Bank of Atlcmta,
262 U S 643; Ratohle v Federal Reserve Bank, 34 F (2d) 910) But under
its power to charter banks, it is difficult to see any basis for an msistance that
the securities of such banks must not be traded in a particular fashion. To
derive such a power from the power to charter banks would imply that the
States possessed a like power with reference to banks operating under their
charters It would also imply a like power with reference to corporations
chartered by the various States Such conclusions lead me to the opinion that
the basic power upon which the instant bill must be supported is the power of
Congress over interstate commerce.
RELATIONSHIP TO INTERSTATE COMMERCE AS A BASIS FOB CONTBOIi
It is a commonplace of constitutional law that a particular activity, though
not actually involving the movement of goods or commodities in interstate
commerce, may have such an intimate relationship to that movement so that
it becomes "interstate commerce" for the purposes of determining whether
Congress can exercise control over it But it is equally true that not every
matter which concerns the movement of goods in interstate commerce is to
be regarded as subject to congressional control, for otherwise hardly any aspect
of mercantile activity would be immune from Federal control Upon the
nature of this relationship, no definite pronouncement can be made It is,
in the last analysis, a question of degree which must be determined in the
light of the applicable decisions. With reference to the bill under consideration, the question is thus presented whether the transactions on the exchange
to which the bill is applicable have such an intimate relationship to the movement of commodities in interstate commerce by the corporations concerned as
to permit such transactions to be regarded as interstate commerce.
That the relationship between the activity in question and the movement of goods in interstate commerce must be of an intimate nature is demonstrated by several decisions involving the applicability of the Sherman Antitrust Act A restraint placed upon the production of goods which are to move
m interstate commerce is of itself insufficient to make such a restraint a re-
straint of interstate commerce (United Mine Workers v Coronado Goal Go, 259
U S 344; United Leather Workers v. Herkert, 265 U.S 457; Konecky v Jewish
Press, 288 Fed. 179). The intent to affect the current of goods moving in interstate commerce is necessary to bring such a restraint within the ambit of
congressional control (Coronado Goal Co. v United Mme Workers, 268 U S
295) Similarly a combination designed to restrict the placing of advertising
matter in a magazine circulating throughout the Nation is not a restraint
of interstate commerce (Blumenstock Bros Advertising Agency v Curtis PubUshmg Co, 252 U S 436 Compare Ward Bakmg Co v Federal Trade Com-
mission, 264 Fed. 330). These cases are illustrative of the closeness of the
nexus that must exist between the activity concerned and the movement of
goods in interstate commerce.
Further light upon this relationship is thrown by a series of cases involving
the power of the States to regulate and tax activities connected with the
movement of goods in interstate commerce It is, of course, true that such
cases do not necessarily, in their assertions that the activity concerned is not
interstate commerce deny that the Federal Government under the commerce
clause possesses no authority to regulate them The spheres of State and
Federal regulation overlap to a certain extent. But the assertion that such
activity is not immune from State regulation on the ground that it is not
interstate commerce, inferentially leads to an assumption that it is not subject for congressional regulation on the ground that it is interstate commerce
At an early date the court held valid a license tax imposed by a State upon a
broker dealing in foreign bills of exchange, despite the contention that the tax
was upon foreign commerce (Nathan v Louisiana, 8 How 73 ) The strength
of this decision is more fully appreciated when it is realized that had the tax
been upon a broker dealing in foreign commodities, it would have been invalid.
The principle there involved that the mere fact that certain dealings may subsequently lead to the movement of commodities in interstate or foreign commerce, does not of itself make such dealings mtei state commerce, has been
repeatedly affirmed by the Court (Engel v O'Malley, 219 U S 128; Williams
v Fears, 179 U S 270; Hemphitt v. Orloff, 277 U S 537 ) The principle found
a distinct application in Ware & Leland v Mootte County (209 U S 405), where
6646
STOCK EXCHANGE PRACTICES
the court upheld a State tax on brokers engaged in buying cotton for future
delivery on exchanges situated outside the State, despite the contention that
the tax was unconstitutional as being on interstate commerce
Perhaps the most illuminating series of cases are those setting forth the
general doctrine that insurance is not interstate commerce (Paul v Virginm,
8 Wall 168; Ducat v Clwoago, 10 Wall. 410; Liverpool Ins Co. v Massachusetts, 10 Wall 566; Philadelphia Fwe Ass'n v. New York, 119 U S 110; Hooper
v California, 155 US 648; Nodle v. Mitchell, 164 U S 367; New York Ufe
Ins Co V Cravens, 178 US 389, Nutting v. Massachusetts, 183 U S 553; New
York Life Ins Co v Deer Lodge County, 231 U S. 495.) The significance of
these cases is to be appreciated only after consideration of the enormous significance of insurance to interstate commerce That it is interwoven with our
whole commercial life is not even open to argument Marine insurance in one
form or another serves the purpose of promoting commercial transactions by
vastly extending the use of credit Fire insurance performs the same function.
Life msuiance even more so, extends out and accumulates the savings of many
into large funds aggregating hundreds of millions of dollars to be loaned in
turn or used as productive capital These facts were presented to the court
with all the ability that counsel could command in a recent effort to induce
the court to overturn its earlier decisions to the 4effect that insurance did not
constitute interstate commerce, but without success (New York Life Ins Co v*
Deer Lodge County, supra) The considerations leading the court to take a
contrary view are important to notice They were pointedly set forth by Mr.
Justice White •
" * * * the general rule (that insurance is not commerce) and its exceptions are based * * * (upon) the difference between interstate commerce
or an instrumentality thereof on one side and the mere incidents which may
attend the carrying on of such commerce on the other This distinction has
always been carefully observed, and is clearly defined by the authorities cited.
If the power to regulate interstate commerce applied to all the incidents to
which such commerce might give rise, and to all contracts which might be
made in the course of its transaction that power would embrace the entire
sphere of mercantile activity m any way connected with trade between the
States, and would exclude State control over many contracts purely domestic
in their nature The business of insurance is not commerce The contract of
insurance is not an instrumentality of commerce The making of such a contract is a mere incident of commercial intercourse, and in this respect there is
no difference whatever between insurance against fire and insurance against
' the perils of the sea'" (Hooper v California, supra, 655 )
These cases, of course, only establish that the business of insurance is not
immune from State regulation as being interstate commerce The corollary
that the business of insurance cannot be regulated by the Federal Government
on the ground that it is not interstate commerce would seem to follow The
question has, however, never been judicially tested. But a Senate Judiciary
Committee unanimously reported that insurance was not interstate commerce so as to permit Federal regulation of it (SRept No 4406, 59th Cong.,
1st sess )
A further case deserving notice is the decision of the Court holding the Child
Labor Act unconstitutional. (Hammer v Dagenhart, 247 U S 251) That like
considerations there prevailed with the court is evidenced by the court's
language when it stated: " Over interstate transportation, or its incidents, the
regulatory power of Congress is ample, but the production of articles, intended
for interstate commerce, is a matter of local regulation " The distinction between such a case and the cases upholding the constitutionality of the Lottery
Act (The Lottery Case, 188 US 321), the White Slave Act (Hoke v United*
States, 227 US 308), and the Pure Food and Drug Act (Hipohte Egg Co v.
United States, 220 US 45), seems to reside in a degree of differentiation as to
the relationship of the movement of commodities and persons in interstate
commerce to the practices sought to be reached by Congress
The application of the principles here enunciated to the bill in question leaves
in my judgment little room for dispute The relationship between market
transactions of securities of corporations engaged in interstate commerce and
the actual movement of goods of those corporations in interstate commerce,
certainly presents no closer bond than the relationship between means and
methods of production and such transportation, nor between insurance and the
movement of insured goods in interstate commerce, when insurance as an
instrument of credit is practically necessary to secure any such movement.
STOCK EXCHANGE PRACTICES
6647
Indeed, to trace the effect of market manipulations in a security upon the
movement of any particular commodity in interstate commerce would require
an ingenuity far beyond the average economist To see that the market value
of securities has a bearing and influence upon trade generally is, of course, a
matter of common understanding But the exact effect of the practice of short
selling upon the movement of commodities in interstate commerce is not even
specified in the bill Only general allegations that the practice affects banking
and commerce are contained in the bill. In the light of such uncertainty as to
the effect of such practices, even assuming that the matter was within the
congressional power of regulation, doubts as to constitutionality would arise
under the fifth amendment.
Thus far the Supreme Court has not regarded as interstate commerce,
activity which does not have a clear, definable relation to the movement of
particular commodities in interstate commerce It has consistently refused
to take a different attitude although urged to do so. It has declined, as Mr.
Justice White stated, to extend the concept of interstate commerce so as to
bring within the possible ambit of exclusive Federal control such matters as
insurance, banking, means and methods of production, the chartering of manufacturing corporations engaged in interstate commerce, supervision over the
issuance of their securities, and the like But such a trend of thought would
be necessary to sustain the constitutionality of the bill in question The central theory upon which it posits the existence of congressional power, namely
the fact that because certain corporations are engaged in interstate commerce
Congress can regulate transactions in their securities upon exchanges, seems
to extend congressional power over interstate commerce to a point not warranted by the decisions or expressions of the Supreme Court, nor in accord
with a likely view, so far as one may judge the immediate future, that the court
would entertain.
No additional warrant for congressional power is to be gathered from the fact
that stock exchanges make use of such instrumentalities of interstate commerce as the telegraph, telephone, and the mails for the transaction of their
business Such an argument was pressed upon the Court in the insurance
cases but without effect
" To accomplish the purpose there is necessarily a great and frequent use of
the mails, and this is elaborately dwelt on by the insurance company in its
pleading and argument, it being contended that this and the transmission of
premiums and the amounts of the policies constitute a * current of commerce
among the States' This use of the mails is necessary, it may be, to the
centralization of the control and supervision of the details of the business;
it is not essential to its character" (New York Lvfe Insurance Oo v Deer
Lodge County, supra, 509 )
This is not to say that Congress may not regulate abuses in the use of
instrumentalities of commerce by stock exchanges, insurance companies, or
any business, but it is a clear recognition of the fact that the mere use of
such instrumentalities to effectuate a transaction not otherwise interstate
commerce does not make it interstate commerce.
I shall not take occasion here to comment upon other features of the bill.
The bill would seem to stand or fall upon the justification for its central
theory, and, due to the pressure of time, I have confined myself to a consideration of that theory. Other features contained in the bill of doubtful constitutionality need therefore no particular attention.
Respectfully yours,
J. M LANDIS.
BKIEF ON BEHALF OF NEW YOKK STOCK EXCHANGE UPON THE CONSTITUTIONALITY
OF S 2693. AND H R 7852, SEVENTY-THIRD CONGRESS, SECOND SESSION, ENTITLED
" T H E NATIONAL SECURITIES EXCHANGE ACT OF 1934", HUNTON, WILLIAMS,
ANDERSON, GAY & MOORE, COUNSEL; THOMAS B GAY, OF COUNSEL
BEFORE THE CONGRESS OF THE UNITED STATES—IN THE MATTER OF THE CONSTITUTIONALITY OF " THE NATIONAL SECURITIES EXCHANGE A*0T OF 1934 " (S 2693 AND
H R 7852.)
The apparent purposes of the " National Securities Exchange Act of 1934 ",
now pending before the Congress, are the regulation and control of stock exchanges and the business of their members, the control of credit through restrictions upon the use of securities, and the control of all corporations through
6648
STOCK EXCHANGE PKACTICES
requirements for the listing of their securities on exchanges, or, if not so listed,
through limitations upon their use as a basis of credit.
Broadly speaking, these objects are sought to be accomplished in one or both
of two ways:
Fvrst: The use of the mails, or of any means or instrumentality of communication or transportation in interstate commerce, for the purpose of using any
facility of any securities exchange is prohibited by Section 4 of the Bill unless
such exchange is registered as a National Securities Exchange under the provisions of Section 29 thereof, and the registration fee therein provided for is
paid.
Second: The use of the mails, or of any means or instrumentality of communication or transportation m interstate commerce, for making or creating a
market for any security whether or not listed on any National Securities Exchange is prohibited under the provisions of Section 14 of the Bill unless compliance is had with such rules and regulations as the Federal Trade Commission
may prescribe as appropriate in the public interest, or for the protection of
investors.
Both means of accomplishing the desired objects are, therefore, predicated
upon the power of the Congress over interstate commerce, or its control of the
use of the mails May either power be constitutionally exercised in the manner
proposed? The purpose of this brief is to demonstrate that it may not
In his testimony before the House Committee on Interstate Commerce, the
Honorable J. M. Landis, Commissioner of the Federal Trade Commission, and
one of the draftsmen of the bill, stated very frankly that:
"At the threshold of this question, there seems to me to he the question of
national power over the exchanges. I think this Committee has to meet that
and face that before it can go any further. The question is not free from
doubt" (Tr., pp. 2-3 ) (Italics supplied )
The need for regulation, in view of many social and economic evils now
alleged to arise from and exist by reason of practices indulged in by those
engaged in the buying and selling of securities, whether as members of stock
exchanges or in the over-the-counter markets, is being pressed upon the Congress as a justification for the enactment of the proposed bill. Public necessity
does not, however, give rise to federal power.
The Government of the United States is not a national, but a federal Government Not national in the sense that it possesses inherent power, but
federal in the sense that it possesses only those powers expressly, or by necessary implication, delegated to it'by the States All powers not so delegated
are by the Tenth Amendment to the Federal Constitution expressly reserved
to the States respectively, or to the people
CONSTITUTIONALITY UNDER THU COMMERCE CLAUSE
Article I, Section 8, of the Constitution of the United States confers upon
the Congress power " to regulate commerce with foreign nations and among
the several states * * * ."
Commissioner Landis, in his testimony before the House Committee on Interstate Commerce, testified in this connection that*
" In order to spell out an appropriate power for Congress to deal-with stock
exchanges, you have to show the intimate relationship of these transactions
on the exchange itself to interstate commerce
I speak primarily of the interstate commerce power, beoaMse I do not believe
that legislation of this type can be based effectively 1upon any other power
than the congressional power over interstate commerce. * (Tr., p 4.) (Italics
supplied.)
In justification of the attempted exercise of the power of the Congress over
interstate commerce, Section 2 of the Bill contains a recital of facts which
are declared to make the regulation of exchanges using the channels of interstate commerce necessary in the public interest To the extent that this
section embodies findings of fact it will, of course, go far in satisfying judicial
inquiry into the need for such legislation, but to the extent that the section
contains mere conclusions of law upon the facts recited therein, it establishes
nothing and would have no controlling effect upon the decision of any court
that might be called upon to decide whether such conclusions were, in point of
law, correct
The findings of fact in this section that "transactions in securities as
commonly conducted upon securities exchanges by means of the mails or
STOCK EXCHANGE PBACTICES
6649
instrumentalities of transportation or communication in interstate commerce,
are affected with a national public interest", are predicated upon the conclusion of law that transactions in1 securities by means of the mails or instrumentalities of transportation or communication are interstate commerce. If
such is not the case, congressional declaration to the contrary does not make it
so as a matter of law.
Again, the section provides that " Transactions in securities upon exchanges
create a flow of securities in interstate commerce to and from the places
where such exchanges are located ". Here, again, is found a conclusion of law
that such flow of securities as may m fact result from stock exchange trading,
constitutes interstate commerce. If such is not the fact, it isn't made any
more so by congressional declaration. Finally, the section provides that
" Regulation of transactions in securities! conducted upon exchanges by means
of instrumentalities of transportation and communication in interstate commerce of the mails is imperative in the public interest fdr the protection of
interstate commerce * * *." The regulation of transactions in securities
thus declared as imperative in the public interest, presupposes that the transactions so to be regulated constitute interstate commerce. It they do not,
Congress cannot by legislative fiat ascribe to them legal characteristics which
they do not otherwise possess.
Putting aside, however, what may be said to be a legislative attempt to give
to the business of securities exchanges, and that of their members, factual
characteristics which they do not possess, but which are admittedly essential
to any lawful exercise of the power of the Congress to control interstate
commerce, a general statement o± the nature of such businesses is necessary in
order to properly determine whether they are in tact so interstate in character
as to constitute interstate commerce. That they are not is fairly demonstrable.
THE NATURE OF THE BUSINESS SOUGHT TO HE REGULATED
The business of a stock exchangte is to centralize the purchase and sale of
securities. Sales are made only between members of the exchange and, in the
case of the New York Stock Exchange, the transactions occur only in its
building in the City of New York. The purchases and sales made by members
on the floor of the New York Stock Exchange are completed by actual delivery,
either through the place for central delivery maintained by a subsidiary of
the Exchange or directly between the offices of the members which, under the
rules of the Exchange, must be located in its immediate vicinity. Therefore, the
actual contracts of purchase and sale take place only in New York City, and
all deliveries of securities and payments of money in connection with the
performance of these contracts likewise occur solely in New York City.
The immediate objects of sale are bonds or certificates of stock In the
case of bonds listed on the New York Stock Exchange, not only are the instruments themselves evidences of debt, but, under the rules of the Exchange, the
issuing coiporations must maintain offices or paying agencies in the City of
New York at which both principal and interest are payable. In the case of
certificates of stock, they are constituents of title and. under the rules of the
Exchange, the issuing companies must maintain transfer agents and registrars
in New York City where such certificates may be transferred of record.
In the use of the Exchange's facilities, transactions of three general classes
occur
First Transactions where seller and buyer are "both residents of the City
and State of New York. Transactions of this nature are obviously local in
character and, therefore, solely within the control and regulation of state laws.
Boothe V. Illinois, 184 U S 425; Otis v Parker, 187 U S 606; Hatoh v. Reardon,
204 U S. 152, Brodmax v. Missouri, 219 U S. 285; House v. Mayes, 219 U.S. 270.
Second. Transactions where seller and buyer are residents of different states
but no actual shupment of securities occur because payment for the buyer's
account is effected through some means of -financing requiring the securities
to remain in New York Marginal transactions are of this character.
In transactions of this nature nothing more than buy and sell orders pass
between the states through use of the mails or other instrumentalities of
communication, such as telephone or telegraph
This form of interstate communioatvon is sought to be made interstate commerce by the provisions of Paragraph 16 of Section 3 of the bill defining such
commerce as
6650
STOCK EXCHANGE PEACTICES
* * * * * transaction in respect of any security shall be considered to be
in interstate commerce if such transaction is part of that current of commerce
usual in a security transaction whereby an order to purchase or to sell a
security originates from a person in one state with expectation that it will
or may be consummated by the receipt on an exchange of an order to sell,
or purchase the same security originating from another person in another
state * * *."
As thus defined, interstate communication would constitute interstate commerce. Indeed, it is declared to exist upon a mere expectation Such, of
course, is not the law. In United States Fidelity Go v Kentucky, 231 TJ S 394,
in which the constitutionality of a Kentucky license tax upon commercial
agencies was upheld, the court said:
** The circumstance that in a substantial number of cases—even if in the greater
number—there is correspondence, by letter or otherwise, from state to state,
which may perhaps have an effect upon the conduct of other parties about
entering or not entering into transactions of interstate commerce, is not
controlling" (P. 398)
In New York Life Insurance Company v. Deer Lodge County, 231 U S. 495,
the Supreme Court upheld the validity of a Montana statute imposing a tax
upon insurance premiums collected in that sitate, and in disposing of the
contention of the insurance company that its business was interstate because
conducted in large measure through the use of the mails, it was said at page
509:
"To accomplish the purpose there is necessarily a great and frequent use
of the mails, and this is elaborately dwelt on by the insurance company in its
pleading and argument, it being contended that this and the transmission of
premiums and the amounts of the policies constitute a * current of commerce
among the States/ This use of the mails is necessary, it may be, to the centralization of the control and supervision of the details of the business; it is
not essential to its character" (Italics supplied )
In Gfranitevttte Manufacturing Co v. Query, 44 Fed. (2d) 64 (affirmed 283
U. S. 376), it is said that the " sending of notes by mail or otherwise from
one state to another does not constitute • interstate commerce" See also
Blumenstock Bros v Curtis Publishmg Co, 252 XJ S 436, Engel v O'MaMey,
219 U S. 128
The above decisions clearly demonstrate that interstate communication is
not interstate commerce. It is the character of a business and not the fact
that the mails, or other means of communication may be employed in its
conduct, that determines whether such business constitutes interstate commerce The mere use of the mails, or other means of communication, for the
purpose of effecting the purchase or sale of securities between citizens of
different states through the facilities of the New York Stock Exchange, where
no actual shipment of securities takes place is not, therefore, interstate commerce and cannot be made so by mere legislation fiat
Third: Transactions where buyer and seller are residents of different states
and the transaction of sale and purchase results in actual shipment of securities between the states Transactions of this character involve the question
whether stocks and bonds are commodities in the sense that they may be the
subject of commerce between the states
It is believed that they are not in view of the decisions of the Supreme
Court of the United States in respect to substantially similar businesses
A closely related series of cases are those setting forth the doctrine that
insurance, in all its forms, is not interstate commerce Paul v. Virginia, 8 Wall.
168; Ducat v. Chicago, 10 Wall. 410, Liverpool Ins. Co v Massachusetts, 10
Wall. 566; Philadelphia Fire Ass'n v. New York, 119 U S 110; Hooper v. CaMfornia, 155 U S 648; Noble v Mitchell, 164 U. S 367, New York Life Ins. Co. v.
Cravens, 178 U S 389; Nutting v Massachusetts, 183 U S 553; New York Life
Insurance Co v Deer Lodge County, 231 U S. 495
In the latter case, it was urged with great ability upon the Supreme Court
that the enormous importance of insurance to interstate commerce, particularly
its relationship to the interstate shipment of goods, justified the reversal of its
earlier decisions holding that insurance was not interstate commerce The
court, however, affirmed the doctrine announced in Hooper v California, supra,
where it was said*
* * * * * the general rule (that insurance is not commerce) and its exceptions are based * * * (upon) the difference between interstate commerce
or an instrumentality thereof on one side and the mere incidents which may
STOCK EXCHANGE PEACTICES
6651
attend the carrying on of such commerce on the other. This distinction has
always been carefully observed, and is clearly defined by the authorities cited.
If the power to regulate interstate commerce applied to all the incidents to
which such commerce might give rise and to all contracts which might be made
in the course of its transaction, that power would embrace the entire sphere of
mercantile activity in any way connected with trade between the States, and
would exclude state control over many contracts purely domestic in their nature
The business of insurance is not commerce The contract of insurance is not
an instrumentality of commerce The making of such a contract is a mere
incident of commercial intercourse, and in this respect there is no difference
whatever between insurance against fire and insurance against 'the perils of
the sea'"
These decisions establish that the business of insurance is not immune from
state regulation as being interstate commerce The corollary, that the business
of insurance cannot be regulated by the federal government because it is not
interstate commerce, would seem to follow Indeed, a committee on the
judiciary of the United States Senate unanimously reported that insurance was
not subject to federal regulation as interstate commerce (Senate Report No.
4406, 59th Congress, first Session )
In Nathan v Louisiana, 8 How. 73, it was held that a hroker engaged in the
use of the mails in buying and selling foreign bills of exchange " is not engaged in commerce, but in supplying an instrument of commerce "
In Hamphtll v Orloff, 277 U S 537, a " Massachusetts trust", doing a business of buying and selling negotiable notes in various states, was held not engaged m interstate commerce in respect to the ownership of notes of a resident
of Michigan wheie it undertook to enforce them without having first complied
with local law requiring domestication of corporations The court said:
" Upon the facts disclosed the court below held the trust was carrying on a
business of dealing m negotiable notes within the State of Michigan; and we
find no reason for rejecting that conclusion Such business is not interstate
commerce Nathan v Louiswna, 8.How 73, Paul v Virginia, 8 Wall 168;
Hatch v Reardon, 204 U S 152, 162, Blumenstocte Bros v Curtis Publishmg
Co, 252 U S 436, 444."
In Graniteville Manufacturing Co v Query, 44 Fed (2d) 64, the validity of a
South Carolina stamp tax was upheld as not imposing a burden on interstate
commerce in respect of a series of notes executed by the plaintiff over a period
of years—between 1923 and 1930—and sent by it to banks outside of the state
tor discount The District Court of the Eastern District of South Carolina,
said.
" The plaintiff contends also that the laying of the tax in question is a burden
upon interstate commerce But under the decisions of the Supreme Court it is
plain that the notes in question did not constitute interstate commerce. They
are mere personal contracts The making of such a contract is a mere incident
of commercial intercourse, and sending the notes by mail or otherwise from
one slate to another does not constitute interstate commerce. See New York
Life Ins Co v Deer Lodge County, 231 U S 495, 34 S Ct 167, 58 L Ed. 332.
where the subject is fully discussed and the decisions reviewed "
The foregoing decision was affirmed in 283 U S. 376
The authorities determine that the negotiation of insurance contracts, the
buying and selling of foreign bills of exchange and of negotiable notes through
the medium of the mails, or other means of interstate communication, is not
interstate commerce, and it would seem to follow by analogy that the buying
and selling of securities in similar manner is likewise not interstate commerce,
and, therefore, not subject to federal regulation or control.
The basis of congressional control over interstate commerce, as distinguished
from its control over the instrumentalities of commerce such as railroads, telegraph, telephone, etc., arises from the power which the federal government possesses to insure the free movement of commodities, or subjects of such commerce, between the states To this extent direct and substantial interference
by the states is prohibited.
These principles have found application in the Packers and Stock Yards Act
and the Gram Futures Act, the constitutionality of which have been upheld,
exercising federal control over certain practices on live stock and gram exchanges. The transactions made the subject of federal regulation by these acts
were not themselves regarded as interstate commerce, although the live stock
or gram to which they related necessarily moved in interstate commerce. In
fact, the Supreme Court has repeatedly held that transactions upon commodity
6652
STOCK EXCHANGE PEACTICES
exchanges do not constitute interstate commerce. EopMns v. United States,
171 U.S 578; Hill v. Wallace, 259 US 44; Moore v. New York Cotton Exchange,
270 US. 593. It is the effect of such) transactions upon the stream of commodities moving in interstate commerce that makes them subject to federal
regulation. Swift & Co. v. XJmted States, 196 U S. 375; United States v. Patton,
226 U.S. 525; Stafford v. Wallace, 258 U S. 495; Board of Trade V. Olsen, 262
U.S 1; United States v. Coffee Exchange, 263 U S. 611; Tagg Bros and Marshall
v. United States, 280 U.S 520. This is made manifest by the statement of Chief
Justice Taft in Board of Trade v. Olsen, supra, when he said:
" The sales on the Chicago Board of Trade are just as indispensable to the
continuity of the flow of wheat from the West to the mills and distributing
points of the East and Europe as are the Chicago sales of cattle to the flow of
stock toward the feeding places and slaughter and packing houses of the East"
In the foregoing cases Congress undertook the regulation of transactions in
commodities raised or produced with the expectation that they would move
through instruments of commerce, the railroads, and become a part of the
flow of such commerce between the states. Consumption of such commodities
withm the state of their origin, except to a very limited extent would be impossible. Their production, marketing and sale to the ultimate consumer
necessarily constitutes an interstate business. It is constant in its relation to
the law of supply and demand and any interruption of that relationship
through transactions of the character prohibited by the acts referred to, would
necessarily constitute an interruption of and burden upon interstate commerce. The transportation and terminal facilities of the railroads are likewise dependent upon continuity in the flow of such commodities in interstate
commerce.
None of these conditions obtain in respect to the business of buying and
selling securities. There are no circumstances requiring securities to move
from state to state in order to be dealt with in stock exchange transactions.
They may find a ready market on exchanges, or in over-the-counter trading,
in the state of their issue Nor are the facilities of the railroads in any sense
dependent upon the movement of securities between the states
Tn a letter of February 22nd, 1932, from Commissioner Landis, then a protessor in the Law School of Harvard University, to Messrs Carter, Ledyard
& Milburn, counsel for New York Stock Exchange, a copy of which letter has
been made a part of the record in the hearings upon this bill before the Senate\
Committee on Banking and Currency and the House Committee on Interstate
Commerce, Mr. Landis says:
" The recognition that thisi is the basic principle underlying Congressional
control over sales for future delivery and other practices on commodity exchanges in my opinion distinguishes these exchanges from stock exchanges.
In the former type of exchange, the thing that is bought and sold is a commodity moving in interstate commerce. * * * The stock exchange, however, presents no such aspect. Other than a physical certificate representing
a chose in action, no commodity is to move in interstate commerce as a consequence of a sale on the stock exchange Dealings upon that market will effect
no additions to- the cost of moving these certificates from state to state.
Indeed, the parallel between a commodity exchange and a stoch exchange is so
absent, that I cannot regard these decisions as governing the stoch exchange
situation nor as establishing a principle applicable to transactions upon stock
exchanges" (Italics supplied.)
This reasoning is logical and sound. Coming from one of the persons largely
responsible for the drafting of the Metcher-Rayburn bill it should be highly
persuasive in support of the view that the decisions of the Supreme Court in
the Stock Yard and Grain Futures cases constitute no 1authority for the contention that the buying and selling of securities through the medium of stock
exchanges constitute interstate commerce.
The fact that dealing in securities through the medium of the New York Stock
Exchange, or in over-the-counter trading, may consist of purely local transactions where both buyer and seller are residents of the same state, or involve
transactions between residents of different states, either with or without the
actual shipment of securities from state to state, demonstrates that such transactions of purchase and sale do not provide for, nor do they necessarily contemplate, the shipment of securities between the states If interstate shipments
are actually made, it is not because of anything growing out of the making of
the contract of purchase and sale on the New York Stock Exchange. The necessity for any such shipment is not implicit in the transaction Under such
STOCK EXCHANGE PEACTICES
6653
circumstances the Supreme Court has repeatedly held that trading, even upon
commodity exchanges, does not constitute interstate commerce.
In Hopkms v. Vmted States, 171 U S. 578, transactions on the Kansas City
Live Stock Exchange, an unincorporated association, having to do with the
purchase and sale of cattle, hogs and other live stock, were held not interstate,
the court saying:
" The selling of an article at its destination, which has been sent from another
state, wJule it may bet regarded as an interstate sale and one which the importer
was entitled to make, yet the services of the individual employed at the place
where the article is sold are not so connected wnth the subject sold as to make
them a portion of interstate commerce, and a combination m regard to the
amount to be charged for such service* is not, therefore, a combination m
restramt of that trade or commerce." (Italics supplied )
In Hatch v. Beardon, 204 U S. 152, an Act of the state of New York imposing
a stamp tax of two cents on the $100 of face value of shares of stock, when sold
m New York by a resident of Connecticut to a resident of the latter state doing
business in New York, was held not a burden on interstate commerce, the court
saying:
u
The fact that the property sold is outside of the state and the seller and
buyer foreigners are not enough to make a sale commerce with foreign nations
or among the several states, and that is all that there is here "
In Ware & Leland v Mobile County, 209 U S 405, a statute of Alabama imposing a license tax on stock and cotton exchanges and the persons trading thereon
for the purpose of buying and selling futures, was held not a regulation of
interstate commerce although such purchases or sales were executed through
the medium of an agent in Mobile, Alabama, on the New York or New Orleans
Cotton Exchanges. The court said:
"The appellants are brokers who take orders and transmit them to other
states for the purchase and sale of grain or cotton upon speculation. They
are, in no just sense, common carriers of messages, as are the telegraph
companies For that part of the transactions, merely speculative and followed by no actual delivery, it cannot be fairly contended that such contracts
are the subject of interstate commerce; and concerning such of the contracts
for purchases for future delivery, as result in actual deUvery of the grain or
cotton, the stipulated tacts show that when the orders transmitted are received in the foreign state the property is bought in that state and there held
for the purchaser The transaction was thus closed by a contract completed
and executed in the foreign state, although the orders were received from
another state When the delivery was upon a contract of sale made by the
broker, the seller was at liberty to acquire the cotton in the market where
the delivery was required or elsewhere He did not contract to ship it from
one state to the place of delivery m another state And though it is stipulated that shipments were made from Alabama to the foreign state in some
instances, that was not because of any contractual obligation so to do. In
neither class of contracts, for sale or purchase, was there necessarily any
movement of commodities m interstate traffic, because of the contracts made
by the brokers.
"These contracts are not, therefore, the subjects of interstate commerce,
any more than in the insurance cases, where the policies are ordered and
delivered in another state than that of the residence and office of the company.
The delivery, when one was made, was not because of any contract obUginq
an interstate shipment, and the fact that the purchaser might thereafter
transmit the subject-matte^ of purchase by means of interstate carriage did
not make
the contracts as made and executed the .subjects of interstate commerce1' (Italics supplied.)
In Moore v. New York Cotton Ewhange, 270 U S 593, it was said:
" The New York exchange is engaged in a local business. Transactions
between its members are purely local in their inception and in their execution
They consist of agreements made on the spot for the purchase and sale of
cotton for future delivery, with a provision that such cotton must be represented by a warehouse receipt issued by a licensed warehouse in the
Port of New York and be deliverable from such warehouse Such agreements do not provide for, nor does it appear that they contemplate, the
shipment of cotton from one state to another. If interstate shipments are
actually made, it is not because of any contractual obligation to that
effect; but it is a chance happening which cannot have the effect of
converting these purely local agreements or the transactions to which they
6654
STOCK EXCHANGE PEACTICES
relate into subjects of interstate commerce Ware & Leland v. Mobile County,
209 U S 405, 412-413 The most that can be said is that the agteements are
likely to give rise to interstate shipments. This is not enough Engle v
O'Malley, 219 U S 128, 139 See also SopUns v Umted States, 171 U S 578,
588, 590; Anderson v United States, 171 U S 604, 615-616" (Italics supplied )
These authorities determine the unconstitutionality of the Bill as an
attempted regulation of the business of buying and selling securities, whether
conducted through the medium of stock exchanges or in over-the-counter
markets. Such business is essentially local in character The fact that the
mails, or other means of communication or transportation, may be employed
in its conduct does not give it a different character Interstate communication
is not interstate commerce Nor does the fact that transactions in securities
on stock exchanges, or in over-the-counter markets, may give rise to shipment
of securities from one state to another constitute such transactions interstate
commerce, since there is nothing in the transactions of purchase and sale that
necessitates or requires such shipments.
CONSTITUTIONALITY UNDER THE POWER OF THE! CONGRESS TO CONTROL THE USE OF
THE MAILS1
Section 4 of the Bill prohibits the use of the mails " in interstate commerce "
for the purpose of using the facilities of any securities exchange unless such
exchange is registered as a national securities exchange under the provisions
of the Bill. Section 14 of the Bill prohibits the use of the mails " in interstate
commerce" for the purpose of making or creating a market for any security
whether or not listed on any national securities exchange except upon compliance with such rules and regulations as the Federal Trade Commission may
prescribe as appropriate in the public interest, or for the protection of investors.
Both inhibitions are, therefore, against use of the mails " in interstate commerce " If trading in securities listed upon securities exchanges, or whether or
not so listed, is not interstate commerce the use of the mails for such purposes
would not seem to constitute an inhibited use.
Furthermore, as the prohibition against the use of the mails for the purpose
of using the facilities of any securities exchange is predicated upon the assumption that there exists in the Congress power to require such exchanges to
register under the provisions of the Bill because engaged in interstate commerce, it would seem to follow that if such business is not interstate commerce
and that power to require registration does not, therefore, exist, the inhibition
against the use of the mails for the purpose of making use of the facilities of
any such securities exchange is ineffective
Assuming, however, for the sake of discussion, an assumption which we
have shown to be contrary to the facts, that the business of stock exchanges
and that of their members, as well as dealing in over-the-counter markets, is
interstate commerce, and that because of this fact the proposed Bill undertakes
to prohibit the use of the mails in connection with the transaction of such
business, does the control of the Congress over4the use of the mails warrant the
exercise of that power in the manner proposed ?
Article I, Section 8, of the Constitution confers upon the Congress power
" to establish post offices and post roads "
The power thus conferred has been held to comprehend the right to regulate
the postal system of the United States and generally to determine what may
or may not be carried in the mails Ex Parte Jackson. 96 U S 727
Cases in which this power of the Congiess his been upheld have very
generally related to matter which might be excluded because properly considered contrary to public policy or inimical of the public welfare, such as
matter concerning the lotteries, Ex Parte Jackson, supra; matter involving
schemes to defraud, Public Clearing House v Coyne, 19£ U S 497; matter of
a scurrilous or defamatory nature, Warren v. United States, 183 Fed. 718;
matter tending to incite treason or forcible resistance to the laws of the
United States, Milwaukee Publishing Co v. Burleson, 255 U S 407; and matter
of an obscene or indecent nature, Coomer v Umted States, 213 Fed. 1; Tyormes
Publishing Co v. Umted States, 211 Fed. 385; Umted States v. Journal Co, 197
Fed 415
The provisions of the Bill attempting to exclude from the mails correspondence, or other matter relating to the business of buying and selling securities,
would, therefore, involve an extension of this power of the Congress in a
STOCK EXCHANGE PEACTIOES
6655
manner not heretofore attempted, and, it is respectfully submitted, without
warrant under the Constitution
The provisions of the Bill in this respect would seem to be founded upon
some such assumption of power as that contended for by the Government in
Lewis Publishing Go v. Morgan, 229 U S 288, which, as paraphrased in the
opinion of the court, was said to constitute:
" * * * an exertion by Congress of its power to establish post offices and
post roads, a power which conveys an absolute right of legislative selection as
to what shall be carried in the mails and which therefore is not in anywise
subject to judicial control even although in a given case it may be manifest
that a particular exclusion is but arbitrary because resting on no discernible
distinction nor coming within any discoverable principle of justice or public
policy "
In refusing to adopt the view that the power of the Congress to control the
use of the mails involved any such unlimited application, the court said at
page 316:
« • * * because there has developed no necessity of passing on the question, we do not wish even by the remotest implication to be regarded as assenting to the broad contentions concerning the existence of arbitrary power
through the classification of the mails, or by way of condition embodied in the
proposition of the Government which we have previously stated "
The power of the Congress to control the use of the mails may not be
exercised m such manner as to deny or destroy rights, either guaranteed by
other provisions of the Constitution, or expressly reserved to the people by
the Tenth Amendment
In Ex Parte Jackson, 96 U S 727, the court said at page 732
" The right to designate what shall be carried necessarily involves the right
to determine what shall be excluded
The difficulty attending the subject
arises, not from the want of power in Congress to prescribe regulations as to
what shall constitute mail matter, but from the necessity of enforcing them
consistently with rights reserved to the people, of far greater importance thaw
the transportation of the mail" (Italics supplied )
Nothing in the opinion of the court in Milwaukee Publishing Company v.
Burleson, 255 U S 407, is at variance with this doctrine as stated in the
dissenting opinion of Mr Justice Brandeis, at page 430
" The power to police the mails is an incident of the postal power Congress
may, of course, exclude from the mails matter which is dangerous or which
carries on its face immoral (expressions, threats or libels It may go further and
through its power of exclusion exercise, within limits, general police power over
the material which it carries, even though its regulations are quite unrelated to
the business of transporting mails In re Rapier, 143 U S 110, Lewis Publishing Go v Morgan, 229 U S 288 As stated in Ex Parte Jackson, 96 U S 727,
732 * The difficulty attending the subject arises, not from the want of power
in Congress to prescribe regulations as to what shall constitute mail matter, but
trom the necessity of enforcing them consistently with rights reserved to the
people, of far greater importance than the transportation of the mail' In other
words, the postal power, like all its other powers, is subject to the limitations
of the Bill of Eights
Burton v Unite® States, 202 U S. 344, 371. Compare
Adair v United States, 208 U S 161." (Italics supplied )
The power of the Congress to control the use of the mails may not, therefore, be constitutionally exercised so as to generally prohobit their use in connection with the buying and selling of securities, through the medium of stock
exchanges or in over-the-counter markets Such power may be properly exercised only for the purpose of prohibiting specific transactions or methods of
trading in securities when expressly declared to be contrary to public policy
The only specific transactions and practices condemned in the Bill are those
which occur in connection with trading in securities " registered on a National
Securities Exchange ", which, of course, presupposes the power of the Congress
to require such exchanges to register because engaged in interstate commerce
If the power to require registration does not exist, and the transactions and
practices condemned in the Bill are not, therefore, in securities " registered on
a National Securities Exchange ", they would not fall within the inhibited use.
There is, however, a general inhibition in the Bill against the use of the mails
for making or creating over-the-counter markets in unlisted securities without
complying with such rules and regulations as the Federal Trade Commission
175541—34—PT 15
16
6656
STOCK EXCHANGE PEACTICES
may prescribe as appropriate in the public interest. So broad a delegation of
power must, if constitutional, be exercised by the Commission in the same
manner and with the same regard to other rights guaranteed by or reserved to
the people under the Constitution, as would be required of the Congress under
like circumstances.
It is not believed, therefore, that the Commission could, under color of the
power thus conferred, prescribe rules and regulations destructive of the constitutional rights of those engaged in the buying and selling of unlisted securities in over-the-counter markets. To hold otherwise would concede to the Commission a power which the Congress does not possess and which might be
exercised in such manner as to hinder and delay, if not in fact render impossible
of transaction, important business of a purely private nature, the conduct of
which is as much in the public interest as is the correction of the economic
conditions which the Bill is designed to remedy.
CONCLUSION
The following conclusions are fully justified from what has been shown:
Fvrst: The Government of the United States is not national but federal in
character, and may not exercise through the Congress powers not expressly
granted, or by implication necessarily conferred, by the Constitution
Second: The power of the Congress to regulate interstate commerce, broad
though it is, must be exercised in relation to transactions or businesses essentially interstate in character, or so directly related to interstate commerce as to
be fairly comprehended within the power of the Congress to regulate such
commerce. The business of stock exchanges and that of their members may
consist of purely local transactions between buyers and sellers residents of the
same state. It may also involve transactions between residents of different
states, either with or without the actual shipment of securities between the
states Interstate communications may be employed in the conduct of such
business but interstate communication is not interstate commerce The nature
of the business of stock exchanges and that of their members does not provide
for, nor does it necessarily contemplate, the shipment of securities between the
states. If interstate shipments are actually made, it is not because of anything
growing out of the making of the contract of purchase and sale of securities
The necessity for any such shipment is not implicit in the transaction. There
is no flow of securities through channels of interstate transportation such as
that made the subject of regulation in the Stock Yard and Grain Futures Acts,
nor are securities commodities in a commercial sense. Under the decisions of
the Supreme Court of the United States in fairly analagous cases, the business
of stock exchanges and that of their members is mtrastate in character and not
interstate, and, therefore, not subject to regulation or control by the Congress as
interstate commerce.
Third: The power of the Congress to control the use of the mails, like all
other federal power, is subject to the limitation of the Bill of Bights. Broad
though it is, this power has never thus far been, nor may it now be, constitutionally exercised through the medium of the Federal Trade Commission or
directly by the Congress, as is proposed in the Bill, in such manner as to hinder
or delay, if not in fact render impossible of transaction, important business of a
purely private nature, the conduct of which is of far greater importance to the
general public than the correction of the economic conditions which the Bill is
designed to remedy.
Fourth: The Bill as a whole is clearly unconstitutional
Respectfully submitted.
HUNTON, WILLIAMS, ANDERSON, GAY & MOOKE,
Mectrio Building, Richmond, Virginia,
Counsel for New York &och Exchange
THOMAS B. GAY,
Of Counsel
MABOH 1ST, 1934.
STOCK-EXCHAME PEAOTICES
THURSDAY, MARCH 1, 1934
UNITED STATES SENATE,
COMMITTEE ON BANKING AND CURRENCY,
Washington^ D.O.
The committee met at 10 a.m., pursuant to adjournment on yesterday, in room 301 of the Senate Office Building, Senator Duncan U.
Fletcher presiding.
Present: Senators Fletcher (chairman), Wagner, Barkley, Bulkley, Gore, Costigan, McAdoo, Adams, Townsend, Carey, and Kean.
Present also: Ferdinand Pecora, counsel to the committee; Julius
Silver and David Saperstein, associate counsel to the committee; and
Frank J. Meehan, chief statistician to the committee; also Roland L.
Redmond, counsel to the New York Stock Exchange.
The CHAIRMAN. The committee will come to order, please. Now,
Mr. Whitney, you may proceed, if you will, just in your own way.
STATEMENT OF EICHABD WHITNEY, PRESIDENT OF THE NEW
YOBE STOCK EXCHANGE—Resumed
Mr. WHITNEY. Mr. Chairman and gentlemen of the committee,
yesterday we covered in some detail section 6 of the bill dealing with
marginal requirements.
Section 7 of the bill deals with restrictions on members' borrowings, and contains 6 subdivisions. I think this entire section has
been very thoroughly covered by Mr. Corcoran, and I think it would
be repetitious for me to go into all the details unless it is the pleasure
of the committee, or there are any particular questions.
The CHAIRMAN. There seem to be no questions. You may proceed.
Mr. WHITNEY. Section 8 of the bill deals with certain prohibitions
against manipulation of security prices. Fundamentally we are in
agreement with the purposes contained in this section, except that
there are certain details that need clarification, in many of which
cases it was agreed to by Mr. Corcoran; perhaps specifically in that
connection, the necessity for arbitrage between various markets,
which under subsection 7 seemingly would be prohibited.
Senator GORE. Subsection 7 of what section?
Mr. WHITNEY. Subsection (7) of section 8.
^
The CHAIRMAN. All right.
Mr. WHITNEY. Section 9 of the bill contains three subsections having to do with short selling, stop-loss orders, and the employment or
use of any contrivance or device that the Federal Trade Commission
deems detrimental to the public interest.
Short selling we have covered time and time again by way of
explanation and stating our opinion of its necessity to a market.
6657
6658
STOCK EXCHANGE PBACTICES
As to stop-loss orders, we believe that any prohibition of them
would be to the great detriment of the public.
Now, as to section
Senator GORE (interposing). Mr. Whitney, I do not suppose it
would do to make them compulsory. I have sometimes thought it
might be better to make them compulsory than to abolish them.
Mr. WHITNEY. DO you mean stop-loss orders ?
Senator GORE. Yes. But I understand that that would have a
tendency to freeze your market in a way. But I did not mean that
suggestion seriously, even though I have thought it might be better
to make them compulsory than to abolish them altogether.
Mr. WHITNEY. Well, Senator Gore
Senator GORE (continuing). But, you understand, I did not mean
to make the suggestion seriously that you should make them compulsory.
Mr. WHITNEY. Section 10 of the bill purports to deal with the
segregation and limitation of the functions of brokers, specialists,
and dealers.
Now, as to the dealer, it is my understanding that various gentlemen have requested permission to appear before you to explain specifically wherein that materially and vitally affects their doing the
business they are accustomed to engage in.
As to specialists, with your permission I request that a specialist
of the exchange may have permission to appear and explain in detail
just how he functions in the execution of orders intrusted to him.
At the moment I think he is appearing before the House Committee
on Interstate Commerce, so that if I may have your permission I
will ask him later on to come before you.
The CHAIRMAN. All right.
Mr. PECORA. Mr. Whitney, how many specialists are there on the
New York Stock Exchange?
Mr. WHITNEY. I believe about 350.
Mr. PECORA. Are there any who are specialists for more than one
security?
Mr. WHITNEY. Yes, sir. Some have manjr, many stocks. Where
a specialist has only one stock the presumption is that he has competition with other specialists in the same stock.
Senator GORE. I should like to ask one question right there on
this stop-loss order business: I have heard it alleged that speculators would find out that there were a number of short stop-loss
orders in, those who were on the short side of the market, and would
redouble their efforts to hammer prices down so as to reach those
stop-loss orders and thereby to avail themselves of the increased
pressure by having stop-loss orders add pressure to the downward
drive on the stock. Now, does one broker know of stop-loss orders
on the part of others, or how is that arranged?
Mr. WHITNEY. Unless by some underhand means an individual
should find out the fact that stop-loss orders exist on a specialist's
books, I do not know how one could arrive at the information you
suggest,* 'Senator Gore. Specialists have never been allowed to
divulge to anybody the fact that stop-loss orders exist on their books,
or any kind of stop orders.
Senator GORE. I notice in the market reports ofttimes that one will
see mention of the fact that stop-loss orders were reached in the
STOCK EXCHANGE PRACTICES
6659
downward trend of a stock, and that that accelerated the downward
tendency of the price of the stock. I suppose it becomes news after
it happens.
Mr. WHITNEY. After it happens, yes; and the same thing can take
place in a rising market as well.
Senator GORE. I do not get the point. Please explain it more fully.
Mr. WHITNEY. Stop orders exist to buy stock at a price as well as
to sell stock at a price. And if a man is short of a stock and wants
to put in a stop order he puts it in to buy at a price stop, where it
becomes a market order, as soon as that price is reached or a higher
price is reached.
Senator GORE. He puts in a market order to buy above the market
price, is that it?
Mr. WHITNEY. Above the market price, presumably; yes, Senator
Gore.
Senator GORE. Why would he do that?
Mr. WHITNEY. I will try to explain that: If a man sells 100 shares
of General Motors short at 40, he may wish to limit his loss to 1
point. So he puts in an order to buy 100 shares of General Motors at
41 stop. That is the reason why they are called stop-loss orders.
Senator GORE. And that is true of a rising as well as of a falling
market, is it?
Mr. WHITNEY. Yes, sir.
Senator GORE. I did not
know that. I thought the use of it was
to protect themselves in that sort of case.
Mr. WHITNEY. Perhaps they may, but of that I am not acquainted.
Senator GORE. They do that on the gram market I know, and I
supposed that they did it on the stock market.
Mr. WHITNEY. I t is very usual in such a case for them to use a
stop-loss order.
The CHAIRMAN. Mr. Whitney, in reference to specialists, do I understand that a stock may have more than one specialist on the floor?
Mr. WHITNEY. Yes, sir. Any menuber of the exchange may become a specialist in any stock that he may desire to specialize in.
That is his entire personal prerogative.
The CHAIRMAN. SO that there may be more than one specialist in
any particular stock?
Mr. WHITNEY. There are sometimes as many as 10 specialists. I
think there have been 10 specialists at one time in the United States
Steel common. Aiid I believe there are
Senator GORE (interposing). Mr. Whitney, I wish you would state
their functions, what they do, and how they qualify to become recognized as specialists. What action has to be initiated in order to
become a specialist?
Mr. WHITNEY. What they do in order to become a specialist, Senator Gore, is to advertise, to send out cards, I imagine very similar
to what a lawyer or a doctor does, that they are going to enter that
particular business. And they advise members of the exchange, and
very often advertise it in the papers, that they intend as of a certain
date to set themselves up as specialists in a particular stock.
Senator GORE. And they can do that of their own motion without
any authorization to do it; is that so?
Mr. WHITNEY. Absolutely, sir. They then, as of that particular
date, hope to receive orders in that particular stock, and they place
6660
STOCK EXCHANGE PEACTICES
themselves at the particular post where that stock is designated to
be traded in.
Senator GOKE. NOW, Mr. Whitney, will you kindly cover their
activities in your statement?
Mr. WHITNEY. They receive and execute buying orders, selling
orders, stop-loss orders, market orders, as well as limited orders,
although the majority of the orders received by specialists are
limited. They also have the privilege to buy and sell, as has any
other broker on the exchange, for their own account.
Mr. PECORA. Mr. Whitney, would you mind, just for the sake of
the record, defining for us the term " limited order " which you have
just referred to ?
Mr. WHITNEY. TO give you an instance of a limited order: I t is
an order to buy, let us say, 100 shares of United States Steel at 56,.
or to sell 100 shares of United States Steel at a fixed price. Such
orders, if given to buy below the market, are almost invariably given
to a specialist. And if it is a selling order, and if above the market
and limited as to price—which because of their nature must be
limited—it is also given almost invariably to a specialist. These
orders are entered in their books, that is, the specialists' books, which
will be more specifically explained to you by the specialist I hope
you, will hear from; and when the market reaches those prices, if
on a declining scale he buys the stock for the broker who gave him
the order on behalf of his customer; or if on a rising market, he
sells that stock which he has on order.
Senator GORE. NOW, Mr. Whitney, if he has an order to sell
United States Steel at 50, and if he also has an order to buy United
States Steel at 50, does he have to give his customer preference
instead of taking it himself? That is, the specialist cannot take the
stock up in that sort of situation, can he?
Mr. WHITNEY. NO, sir. He may not buy stock at 50 for himself
if he has an order to buy for anybody else. Likewise, he may not
sell stock at 50 for himself if he has an order to sell for anybody
else at 50.
Senator GORE. That is my understanding of it.
Mr. YfrnTKEY. He also may not buy any stock for his own account
if he has a market order, until that market order is filled; and, vice
versa, he may not sell any stock for his own account if he has a
selling order at the market, until that order has been filled.
Senator BULKLEY. DO you mean at any price? In other words,
if he had an order to buy at 50 do you mean that he could not buy
at 60%.
Mr. WHITNEY. Yes. But we will say that he has a buying order
at the market, and then he may not trade for himself at any price
until he has executed that order.
Senator GORE. But when he has corresponding orders, to buy and
to sell, then he can buy and sell for himself, I take it?
Mr. WHITNEY. Yes; as may any other broker in the market.
The CHAIRMAN. NOW, Mr. Whitney, in regard to separating the
functions of these people mentioned in section 10 of the bill, I should
like to get your view as to whether that is wise or not, I mean to
attempt to do that. That is, as to whether a broker shall do a
brokerage business, and a dealer shall deal in stocks.
STOCK EXCHANGE PBACTICES
6661
Mr. WHITNEY. Mr. Chairman, I think that is a tremendously
broad question. I personally feel that the elimination of trading
for his own account insofar as the specialist is concerned, would be
to the infinite detriment of the public.
Senator GORE. HOW is that? Will you please repeat that? I did
not catch it.
Mr. WHITNEY. I feel that if a specialist were prohibited, as he
is under the bill, from trading for his own account, subject to the
rules of the exchange, it would be to the very real detriment of the
public. I readily grant that there are divergent opinions on that
subject in the same way perhaps as to other persons acting as dealer
and broker. I think, as we have suggested, that that is a matter for
real study, for great additional study I would add, before it is
definitely prohibited.
Senator JBTJLKJLEY. What harm would it be to the public?
Mr. WHITNEY. I believe the public would not receive the same
markets, as gjood markets, particularly in semiactive and inactive
stocks. I believe if the market, as I have stated, for a stock was
bid 30 and offered at 32, and the specialist were prohibited from
trading for his own account, then if an order were received to sell
at the market the immediate sale would have to be at 30. And
the next order might be a market order to buy 100 shares, and it
would be immediately executed at 32. The buying order would
have to be immediately executed at 32. If, as is the present custom,
the specialist wished to make a market between those figures it would
be to the advantage of the customer, the public who wanted to trade.
Mr. PECORA. Mr. Whitney, is there any obligation on the specialist
to do that under the existing rules of the exchange?
Mr. WHITNEY. There is no obligation, but that is the fairly universal practice.
Senator BARKLEY. I S there any possible conflict of interest between
the specialist as a trader in his own name and in his representative
capacity.
Mr. WHITNEY. There is in one regard, Senator Barkley; and if I
may explain it?
Senator BARKLEY. Please do so.
Mr. WHITNEY. If a specialist has limited orders to buy stock, and
let us say again to buy Steel at 50, or to sell Steel at 5(%, and he
buys that stock from his customer or sells that stock to his customer,
both being brokerage houses representing the public, he does it only
after a bid and offering in the open market so that if anybody else
wishes to trade or intervene m the trade they may do so. I mean
any other broker. And he has to send for the representative of the
customer, the other broker, and get confirmation and approval of
the trade and the price. And the contract is then entered into between the specialist and the other broker who represents the public.
The individual who puts his order in to sell, let us say, at 5 0 ^ , the
stock which the specialist takes from, him, has of his own volition
and election to put that order in to sell it at 50y2. To my mind I
cannot think there is any conflict of interest that can enter in there,
because he can only sell that stock at the price that the customer has
elected to sell it at, or at a higher price. He cannot sell it at less.
Senator BARKLEY. Suppose that I, through some broker here in
Washington, give an order to sell 100 shares of Steel at 50, and that
6662
STOCK EXCHANGE PRACTICES
is telegraphed up to New York and is then turned over to a specialist. Suppose that specialist in his own name happens to be long
of 100 shares of Steel and he sells to me his 100 shares instead of
buying it on the open market. He ceases then to be a public representative and becomes simply a dealer between himself and me,
doesn't he? Does that ever occur?
Mr. WHITNEY. That may occur, sir; but the fact is, if I understand
your question correctly, you have elected to buy 100 shares at 50.
The specialist then bids 50 for the stock and offers 100 shares at
50% in the open market. And, as I say, anybody else can take
his 100 shares at 50% and sell to you at 50
Senator GORE (interposing). Mr. Whitney, will you please state
that again?
Mr. WHITNEY. A specialist having the order bids 50 for 100 shares
and offers 100 shares at 50%. Any other broker may offer to take
the 100 shares at 50% or to sell 100 shares at 50. If anybody does,
then the broker, in the instance suggested, sells 100 shares at 50.
Now, as I understand it, that was your election, to buy that stock
at that price, and I cannot see any conflict of interest.
Senator BARKLEY. It may not make any difference to me for I
am in the market for 100 shares at 50; if he sells to me and if it
so happens that the specialist on the floor at the time has 100 shares
and is willing to sell them to me instead of buying 100 shares from
somebody else for me. It may not make any difference to me individually, but it does seem to me to establish a dual capacity there,
in which it is very hard to draw a line of demarcation between him
as the representative of me, or as the go-between between me and
somebody else who wants to sell 100 shares of Steel, but there is that
relationship between buyer and seller that exists if he has 100 shares
and I want to buy.
Mr. WHITNEY. There does exist a dual capacity, but that is surrounded by very stringent rules of the exchange, as to how he may
so trade, and as I have said, I shall now repeat—-—
Senator BARKOIY (interposing). Of course, if he trades in his
individual capacity he has to sell what he buys to somebody.
Mr. WHITNEY, Yes, sir.
The CHAIRMAN. NOW, let
us say that a specialist has an order to
sell at 30 and an order to buy the same stock at 32. Then he can
buy the stock at 30 and sell it at 32 himself, can't he ?
Mr. WHITNEY. NO, sir. If he has an order to sell any stock at 30
and an order to buy the same stock at 32, he cannot trade for his own
account to the disadvantage of either of those customers.
Mr. PECORA. HOW would he execute those orders?
Mr. WHITNEY. That would entirely depend upon the market at
the time.
Mr. PECORA. Well, assuming that that was the market.
Mr. WHITNEY. And that the last sale was
Mr. PECORA (interposing). Assuming that the offer to sell was
at 30 and that the offer to buy was at 32.
Mr. WHITNEY. And that the last sale, let us say, was at 30?
Mr. PECORA. Yes,
sir.
Mr. WHITNEY. The presumption is that those two orders would
be crossed in the techmcal term by the dealer at the price of 30, unless
he could buy the stock at a cheaper price for the 32 buyer.
STOCK EXCHANGE PBACTICES
6663
Senator BARKMJY. If he were able to sell in a coincidental transaction 100 shares at 30 while he represented a man who put in an
order to buy at 32, wouldn't it be his duty to buy those 100 shares
at 30 or anything below 32 that he could get the stock for ?
Mr. WHITNEY. Absolutely yes; as I have said
Senator BULKLEY (interposing). In that particular case, where
he has an order to sell at 30 and an order to buy at 32 there would
be nothing to prevent him from buying for his own account at 30%,
which would give the customer one eighth more than he offered,
and then to sell that stock to the other fellow for, say, 30%.
Mr. WHITNEY. NO, sir; he could not do that. If he had an order
to sell 100 shares at 30 and also had an order to buy 100 shares of
the same stock at 32, those two orders would have to be taken care of
before he could trade for his own account.
Senator MCADOO. That is a rule of the exchange, is it?
Mr. WHITNEY. Absolutely.
Senator GORE. In that case he would buy at 30 instead of at 32.
Mr. WHITNEY. He would buy at 30, or less, if he could, in the
market for the benefit of his purchasing customer who put in an
order to buy 100 shares at 32.
Senator BULKLEY. IS the general result of a specialist trading
for his own account a profit to the specialist?
Mr. WHITNEY. That is very difficult to answer because I do not
know the answer. I would say that if a specialist is correct in his
judgment as to the trend of the markets, then he will make money.
But as to whether specialists as a group have made money over the
last few years, my belief is that they may have made a living or
they may have lost money. At any rate, I do not know of any very
opulent or rich specialists.
Senator BARKLEY. That observation might be applied to everybody else who has been in the market over the last 4 years, I take it.
Mr. WHITNEY. I do not think they are any exception to the general rule. I do not think they are any wiser than anybody else.
Senator GORE. It would seem to me that if he could segregate
orders, and operate on his own account, with the direct object of
making a profit in the transaction and at the same time accommodating his customers and placing himself in a position to accommodate them in the future, that that might have a part in it.
Mr. WHITNEY. I do not think I understand your question, Senator
Gore.
Senator GORE. Well, I am not sure that I do myself. [Laughter.]
That is the reason I am searching my mind. I am seeking the motive, and I do not know whether it exists or not. That is, whether
a specialist might operate on his own account in a given transaction
with the hope of getting a profit for profit's sake in that particular
transaction, or that he might sometimes operate in order to accommodate customeis, buying and selling, and thereby put himself in
the situation to continue to accommodate them.
Mr. WHITNEY. I think your question is a double question. I, of
course, grant that specialists trade for their own account in the belief that they are going to make money thereby. Now, to answer the
second part of your question, it is my firm belief that specialists
who trade for their own account are the ones who get orders from
commission houses because such houses believe that by giving orders
6664
STOCK EXCHANGE PRACTICES
to specialists who do the trading, their customers will be the better
served.
Senator GORE. In regard to the second part of my question, which,
as you say, may be a double question, I thought he might carry on
just if he broke even, without a specific profit in a particular case,
in order to carry on nis business of accommodating his regular customers.
Mr. WHITNEY. I think that is often true, as well as in order to
create a market.
Mr. PECORA. Mr. Whitney, the outstanding virtue that is claimed
for the right of the specialist to buy and sell stock that he handles
is that it enables him to keep a closer market in the stock, isn't it? ,
Mr. WHITNEY. Yes, sir; and to create markets.
Mr. PECORA. And to create markets.
Mr. WHITNEY. Yes,
sir.
Mr. PECORA. Well, now, in view of the fact that there is no obligation upon him to buy or sell for his own account for the purpose
of keeping a closer market or to create a market, what would
persuade or tempt him to make a transaction in his own behalf?
Mr. WHITNEY. AS I have stated
Mr. PECORA (interposing). In other words, does he do it for the
altruistic purpose of keeping the market close or of creating a
market?
Mr. WHITNEY. I think he does it for two purposes, perhaps as
suggested by Senator Gore; certainly because he believes in the main
that he can make money, that his judgment is right, just as we all
use our judgment in our business, whatever it may be, that we think
we are going to be right, and yet sometimes, quite naturally, we
are very wrong. So it is in the case of the specialist. And I
do frankly believe that the specialist in attempting to trade for
himself attempts to create a market, which is probably to the advantage of all concerned, himself included.
Mr. PECORA. Which would be altruistic.
Mr. WHITNEY. In some cases that is true without question.
Mr. PECORA. NOW, in view of the fact that he might have a double
motive, one being self gain and the other the altruistic purpose of
preserving a more orderly market for the general public, it is pretty
hard to say, isn't it, to what extent the motive of self gain or profit
might prevail over the other one, the altruistic one?
Mr. WHITNEY. I grant that. And as I have already said, I think
this is a very deep and involved subject and deserves tremendous
study from the people who are going to pass upon it from the point
of view of making the bill restrictive.
The CHAIRMAN. Isn't it true that where the specialist can make
money by trading on his own account he ceases to serve other people;
that he could make that profit for his customer if he saw fit to do it
instead of making it for himself?
Mr. WHITNEY. NO, sir. In that case the customer must of necessity get a lesser price. That is, the customer would get a lesser price
if the specialist did not trade for his own account.
Senator KEAN. Mr. Whitney, I should like to ask you this question: Isn't it true that, in order to obtain orders from commission
houses, a specialist often will buy for his own account; and when
he is doubtful as to whether he can sell again that, in order to get
STOCK EXCHANGE PBACTICES
6665
orders from commission houses, he often makes a market so as to
show them that he is really doing business?
Mr. WHITNEY. Exactly. And that is what I mean by the altruistic point of view of creating the market.
Mr. PECORA. In other words, transactions undertaken in that spirit
by a specialist have a tendency to build up goodwill.
Mr. WHITNEY. I think so.
Mr. PECORA. Among other brokers and the public as well.
Mr. WHITNEY. Yes. Just the same as any broker seeks to execute
an order entrusted to his care to the best of his ability.
Mr. PECORA. Well, frankly, I have discussed the question of the
right of the specialist to trade in stock that he handles with persons
having diverse views on the subject, and it does seem to me there are
benefits that would accrue to the public from the right of the specialist to buy and sell for his own account. A.t the same time I think
that right ought to be restricted in such fashion as to either entirely
eliminate whatever evils may be incidental to that right, or restrict
him as much as possible. Now, Mr. Whitney, could you suggest any
formula by which that can be done? In other words, by which the
benefits that flow from the right of the specialist to buy and sell for
his own account could be preserved and the evils or incidental evils
that may arise therefrom could be eliminated or restricted?
Mr. WHITNEY. Well, Mr. Pecora, I regret to state that the answer
to that query is no. We have done everything we know by way of
restricting trading by specialists to the end that the basis of such
trading may be proper. If you will tell us, or if anybody else will
tell us, what further should be done in that regard so that a specialist
might still have the ability to create markets by trading for his own
account we will be indeed grateful. But after years of the most
serious consideration of this subject we do not know of any system
that could be put into effect upon the floor of the exchange which
would be better than the present system.
Mr. PECORA. Suppose you were to adopt a rule making it obligatory upon the specialist to report at the end of each day his own
trades in the stock he is specializing in, I mean his trades for his
own account. Is there such a ru?e in existence now ?
Mr. WHITNEY. NO, sir.
Mr. PECORA. Well, do you
think that the adoption of such a rule
might help toward reaching that desideratum ?
Mr. WHITNEY. Mr. Pecora, you must have some idea in mind in
on, ov,
so'Ia. can only answer by asking you what
asking such a question,
you think will help. We are
Mr. PECORA. I am merely advancing a thought. I think you are
better qualified to arrive at a judgment as to whether or not the
thought if consummated, the idea if consummated, would be helpful.
Mr. WHITNEY. I do not quite see how it could be done. If you
will explain what your idea is, perhaps I will get a better idea of
what you have in mind.
Mr. PECORA. In this sense, that if the business-conduct committee
of the New York Stock Exchange, for instance, were to have furnished to it every day a statement by each specialist of his trades
for his own account, the members of that committee might be enabled thereby to determine fairly and equitably whether or not the
trades were calculated to benefit the public more than otherwise;
6666
STOCK EXCHANGE PBACTICES
and if a specialist's transactions as reported by him showed a too
direct tendency in favor of self-gam on the part of the specialist,
they might make suggestions to him that he abate a little bit in his
trades, and so forth, at given times.
Mr. WHITNEY. If what you have in mind is to be used as a basis
for further study of this entire subject, possibly that might do some
good. But may I impress upon you that if a specialist trades for
his own account m reference to any order that he has, that is, if he
takes stock on sale at 50% because he has an order to sell it at that
price, he must send for the broker who gave him that order, or the
representative of that broker, who has to come to the specialist, and
he has it within his power and it is his obligation to inquire as
to the time when that trade was made, find out if the price was fair
in keeping with the market, and must confer and approve that trade
on behalf of his customer; and thereby at that time he makes a
contract with the specialist that he has sold to the specialist on behalf
of his customer 100 shares of Steel, let us say, at 50%. Now, it is
my opinion that
Senator GORE (interposing). Mr. Whitney, will you please state
again) the first point m your proposition, the first assumption about
the transaction?
Mr. WHITNEY. The broker who gave the specialist the order to sell
100 shares of United States Steel, let us say, at 50%, or the broker's
representative, must go to the specialist's post, and he, representing
and acting for the customer, who is an individual of the public, you
understand
Senator GORE (interposing). Yes; the man who wants to sell the
stock at 50%.
Mr. WHITNEY. Yes. He goes to the specialist, from whom he has
had a message: Please come regarding so-and-so. And then upon his
being assured, I mean the broker being assured in his own mind
that the price was fair and in keeping with the market, says, " I
agree to sell you 100 shares of Steel at 50% ", thereby giving his confirmation and approval to the trade, and making a contract on
behalf of his customer.
Senator BARKLEY. Does the specialist ever execute orders that are
not limited, market orders?
Mr. WHITNEY. Yes, sir; particularly at the opening of the markets, particularly, sir, when the floor broker gives him an order to
execute at the market, because the floor broker has the belief that
the specialist can execute that order in the interest of the floor
broker's customer better than the floor broker could do it himself.
Senator BARKLEY. Well, now. is this possible through a specialist?
Suppose a specialist happens to have a number of shares of Steel
that, let us say, he has purchased at a price below 50, and he wants to
sell them as high above 50 as possible when he gets out, and he
has an order to execute for some purchaser at 50. Does the selfinterest of the specialist impel him to try to run that Steel up sufficiently high to enable him to make a personal profit, with the
result that his customer would not be able to buy it at 50? Could
that happen?
Mr. WHITNEY. If I understand you correctly, the specialist could
buy stock at 50%, 50%, 50%, 50%, if he wanted to; yes.
STOCK EXCHANGE PRACTICES
6667
Senator BARKLEY. But that is not my point. I am asking if the
specialist might be deeply enough interested in the stock because of
its own performance, either prior or concurrently, that through his
own efforts to make a profit himself he could be instrumental in
advancing the stock sufficiently, rapidly, and high so that the man
who had put an order in at a given price might not be able to have
it executed, and in that way there might be a conflict between the
specialist's personal interest and his representative interest.
Mr. WHITNEY. He could not do that without buying stock.
Senator BARKLEY. He has already bought it.
Mr. WHITNEY. But he has got to buy some more in order to
influence the price and make it higher.
Senator BARKLEY. That is true; he could do that?
Mr. WHITNEY. That he could do. But he has got to get out of
that stock
Senator BARKLEY. If it goes up otherwise than by his own efforts,
he is not responsible. But I am wondering if he might be so
interested in the stock, because of its own performance, either prior
or concurrently, that in order to make a profit himself he might be
instrumental in advancing the stock so that the man who had put
an order in at a given price might not be able to have it executed,
and in that way cause a conflict between the specialist's personal
interest and his representative interest.
Senator KEAN. IS it not true that if he advances the price and the
stock sold at the price that he also had an order in for, he would
be obliged to put it in at that price ?
Mr. WHITNEY. Yes, sir.
Senator BARKLEY. IS your answer to my question " yes " or " no " ?
Mr. WHITNEY. The answer is, I think, yes; that he might buy
stock at a higher price than the limited order that he has on his
books, but of course he is accumulating stock at the same time and
he has got to get rid of it again some time, and the seller gets a
better price.
Senator BARKLEY. Of course; but the man who wanted to buy at
a given price has been deprived of the opportunity because the
specialist may have advanced the stock beyond the price where he
could buy it.
Mr. WHITNEY. That is true, Senator Barkley. So may any other
individual who came in and wanted to buy. But as I see it, the
individual who puts the order in to buy 100 shares at 50 elects to
do so; and if that stock sells at 50 he will pay that much. So what
happens in the market other than selling at 50 is of no particular
interest to that particular man.
Senator BARKLEY. If the market went only at a normal pace
without any artificial stimulation, he might get his stock at 50; but if
the specialist happens to be long or thinks it is going to advance so
he can make a profit and so he is encouraged to purchase for his
own right, he might create a situation where the customer, who in a
normal situation would be getting his stock at 50, because of this
artificial stimulation could not get it at 50?
Mr. WHITNEY. I grant that it might happen; but the specialist is
taking a very real risk in buying in that additional stock.
Senator BARKLEY. Let me ask one other question. How is the
specialist compensated?
6668
STOCK EXCHANGE PEACTICES
Mr. WHITNEY. He is compensated by a floor brokerage set by the
exchange, which varies somewhat with the price of stock.
Senator BARKI^IY. I S it a sort of commission basis?
Mr. WHITNEY. It is a commission basis; for the execution of every
order per hundred shares he is paid a certain commission.
Senator BARKLEY. Who pays him that?
Mr. WHITNEY. The broker who gave him the order.
Senator BARKLEY. I S that a part of the commission that the broker
charges the customer, or is that added to it ?
Mr. WHITNEY. I t is a part of it. In other words, the customer
pays $15 a hundred, let us say, for the execution of the order for
100 shares of Steel at 50. If the house to whom the customer gave
that order gives it out to a floor broker or to a specialist, and the
order is executed, the house pays $2.50 to the floor broker or
specialist.
Senator GORE. Let me ask you this: Is the primary function of a
specialist in a way to match the bids and offers that come in from
customers, to try to join their minds and hands a»d enter into a
consummated transaction?
Mr. WHITNEY. Yes; partly, sir.
Senator GORE. Apart from that, he gets an offer but has not got
a bid. Then he can trade on his own account, can he not?
Mr. WHITNEY. Yes, sir.
Senator GORE. And if he
has both buyers and sellers it is his first
duty to bring them together into the transaction; is that true ?
Mr. WHITNEY. Yes, sir; if they can be brought together.
Senator GORE. And he cannot figure on his own account in that
sort of a situation until that situation has changed ?
Mr. WHITNEY. Not if his buyer and seller can get together first;
no, sir—if I understand you correctly.
Senator MCADOO. I just want to say, Mr. Chairman, that I am
obliged to go to the Finance Committee, and I will ask you to excuse
me.
Senator GORE. I have to go too, Mr. Chairman.
Senator KEAN. I would like to ask you this question in connection with Senator Barkley's question. Suppose the market is 49%
and a man puts an order in at 50. The specialist cannot buy
Senator GORE. IS that an order to buy, or sell, Senator? Pardon
me. ^
Senator KEAN. An order to buy. The specialist cannot buy for
his own account at 50; he must take the order that the customer put
in to sell at 50; is that right?
Mr. WHITNEY. I think I will have to ask you to repeat that, Senator Kean. I do not think I followed it.
Senator KEAN. If the market is 49% for Steel, bid, and you put in
an order at 50 to buy 100 shares at 50, the specialist cannot bid that
stock up to 50% because if the stock is sold at 50 he must put the
order in at 50 for the customer?
Mr. WHITNEY. If I understand you correctly, Senator, the bid
in the original case is 49% ?
Senator KEAN. Yes.
Mr. WHITNEY. Then an order comes in to buy 100 shares at 50.
The specialist may not buy stock for his own account at 50 until he
has bought the stock for his customer at 50.
STOCK EXCHANGE PRACTICES
6669
Senator GORE. But he would not be allowed to buy at 50 even if
the price is 49% ?
Mr. WHITNEY. If he has a bid of 49% and that is the best bid he
can get, he can buy for his own account above 49%. He may not buy
at 49% until his order is executed.
Senator GORE. But as I understood Senator Kean's question, suppose the price was 49% and the specialist received an order to buy
at 50 for his customer: would he be allowed to do that?
Senator KEAN. NO ; the specialist cannot buy.
Senator GORE. But would he be allowed to buy for the customer %
Senator KEAN. I am talking about Senator Barkley's position.
He made the proposition that the specialist could bid this stock up
to 50% for his own account. I say that if he bid it up over 49%
and past 50 he would have to take all the stock offered at 50 before
he could make the quotation above 50.
Mr. WHITNEY. That is correct.
Senator GORE. I misunderstood your question, sir. I thought you
said that if the price at the last sale was 49% and he had an order
to buy at 50. I do not see why he would execute that order unless
somebody was going to try to move the market up.
Senator KEAN. Senator Barkley's position was that the specialist
could buy this stock up for his own account without taking the orders
on the way. That was the point.
Mr. WHITNEY. He certainly would have to take all stock that was
offered to him or that he had on his books on the way.
Mr. PECORA. Does a specialist receive so-called "discretionary
orders"?
Mr. WHITNEY. Sometimes, sir; yes.
Mr. PECORA. Would you mind defining discretionary orders as
distinguished from fixed price orders or market orders or limited
orders ?
Mr. WHITNEY. May I give an instance?
Mr. PECORA. If you will. That probably would be the best exposition of the term.
Mr. WHITNEY. Supposing the customer of a house had 10,000
shares of stock to sell and t i e ruling price of the stock was around
30. He might say, " I will give an order; if you can sell this stock
for me at 30 or better, use your discretion." That same order might
be handed over to a specialist, and the specialist, as he felt in his
judgment the trend of the market might be upwards, would sell that
stock at 30 or at a price higher than 30.
Mr. PECORA. And likewise with the buying?
Mr. WHITNEY. Yes; likewise with the buying. The same discretion, Mr. Pecora, exists in any market of a sufficient size to warrant
discretion.
Mr. PECORA. There have been evidences submitted to this committee, and doubtless you are familiar with some of them, anyway,
where specialists have been participants in pools or syndicate accounts to trade in the stock that is to be handled as a specialist.
That is true, is it not?
Mr. WHITNEY. I believe so, in the past.
Mr. PECORA. Under the rule which was adopted by your exchange
on February 13 a specialist is no longer permitted to be a participant
in a pool or joint syndicate account; is not that a fact?
6670
STOCK EXCHANGE PEACTICES
Mr. WHITNEY. Yes, sir; that is correct.
Mr. PEOORA. I presume that the adoption of that rule was due to
knowledge that had come to the governing authorities that specialists
in the past had been participants in pools or joint or syndicate accounts ?
Mr. WHITNEY. I presume so.
Mr. PECORA. And the board of governors I also presume felt that
the conditions required the adoption of the rule they put into effect a
little over 2 weeks ago, prohibiting a specialist from being a participant in any such pool, joint or syndicate account m the stock he
specialized in?
Mr. WHITNEY. I presume so; yes.
Mr. PECORA. YOU said that one of the useful functions of a specialist is that of making the market or creating the market?
Mr. WHITNEY. Creating a market; yes, sir.
Mr. PECORA. What is to prevent a specialist from creating a
market in a manner calculated to improve his own position or
interest?
Mr. WHITNEY. By buying stock or selling stock?
Mr. PECORA. By trading for his own account; yes, sir.
Mr. WHITNEY. I do not suppose that if that is done so as not to
unfairly influence the market, there is any prohibition against it. He
takes a risk whenever he buys or sells, as we all do.
Mr. PECORA. But specialists who have been examined here—one of
them, at least, indicated very frankly that because he was a specialist
he could tell the trend from the orders that he had on his books.
Knowing the trend, that gives him a very substantial advantage in
trading in stock for his own account.
Mr. WHITNEY. He was a very boastful man, sir.
Mr. PECORA. He might have been boastful, but I think perhaps his
own performances, as admitted by him here, show that it was not an
idle boast m his case.
Mr. WHITNEY. May I ask the gentleman's name?
Mr. PECORA. Mr. Wright.
Mr. WHITNEY. Did he not tell the committee that when he had
some 50,000 shares currently to sell at the market he was long on
stock for himself? Would that point out that his judgment was
affected by the orders he had on his books or that he had gone
contrary to them?
Mr. PECORA. He went even a little bit further than that in his testimony here. To refer to his language, he said he was " murdered "
at one time.
Mr. WHITNEY. Yes.
Mr. PECORA. But nevertheless, despite the assassination, it left him
$138,000 to the good, net, which I think rather demonstrates that it
was not an idle boast on his part that he could tell the trend of the
market from the orders on his books.
Mr. WHITNEY. He undoubtedly had been right in that instance.
Mr. PECORA. NOW, if the specialist were required
Mr. WHITNEY. I take exception, sincere exception, to that.
Mr. PECORA. TO what?
Mr. WHITNEY. That he could tell the trend of the market by the
orders on his books; and I don't think Mr. Wright made any such
statement.
STOCK EXCHANGE PBACTICES
6671
Mr. PECORA. What statement do you think he made?
Mr. WHITNEY. I think he said he was correct in his judgment of
the trend of the market, but not that his books showed it. There I
disagree, sir.
Mr. PECORA. We can refer to his testimony on that. I will not
stop now to hunt it up, but I will later on, so that there will be no
shadow of doubt between us as to just what he said.
Mr. WHITNEY. I am not questioning what he said specifically, but
my contention is that it was not what his book told him as to the
trend of the market; it was his general knowledge.
Mr. PECORA. His general knowledge was based, at least in part,
on the orders he had on his book?
Mr. WHITNEY. At least in part; yes.
Mr. PECORA. SO that the orders on his book made a contribution to
his general knowledge that enabled him to determine the trend and
to determine it so accurately in the instance that we have in mind
that he certainly profited very substantially, despite the fact that
he was slaughtered or murdered, to use his expression, on July 18
last.
Mr. WHITNEY. I think you are using a very strange example to
prove your case.
Mr. PECORA. A strange example?
Mr. WHITNEY. Yes, sir. When a man has thousands and tens of
thousands of shares of stock to sell at a price, and in spite of that he
goes considerably long in the stock, you think that is an invariable
rule of information to the specialist?
Mr. PECORA. Have I said it was an invariable rule of information to the specialist?
Mr. WHITNEY. YOU implied it, sir.
Mr. PECORA. I am merely telling you what Mr. Wright testified to.
Mr. WHITNEY. I claim that it was his experience and not
Mr. PECORA. That was the very evidence adduced here.
Mr. WHITNEY. I claim, sir, that it was his experience and that
showed him the trend, and not what his books showed him necessarily.
Mr. PECORA. YOU admitted just a few moments ago that the
knowledge that he had from the orders on his book was a contribution to his knowledge of the trend. s
Mr. WHITNEY. It might be in part; yes, sir.
Mr. PECORA. Don't you think that if a specialist were required
to report to the governing committee or some other suitable authority of the exchange his daily transactions, the governing authorities
would be in a better position to determine how far his own transactions were actuated by self interest or desire for self gain and
how far they contributed to the maintenance of a fair market in
the public interest?
Mr. WHITNEY. If you believe, Mr. Pecora, that there would be
some advantage, I am readily g^lad to take your advice.
Mr. PECORA. I am not offering any advice, because I would not
be so presumptuous. I have not had any experience on the exchange.
Mr. WHITNEY. And yet you wrote this bill?
Mr. PECORA. I wrote the bill? I sat in at the conference and made
my modest contributions to it. I think, however, that the evidence
that has been presented to this committee in the past year or two
175541—34—PT 15
17
6672
STOCK EXCHANGE PRACTICES
would qualify almost any person possessed of knowledge of that evidence to make suggestions with regard to the evils which should
be curbed, eliminated, or restrained.
Mr. WHITNEY. Certainly, sir; but as I understand it
Mr. PECORA. That there are evils is readily acknowledged by you
and by your confreres. That we agree in large part upon those evils
and are able to designate them, I think, must be conceded, too. The
only question, then, is how to deal with the evils. I am merely submitting to you now for your consideration—you can trample on it
all you want; I have no pride of opinion about it—the thought of
having specialists, if they are to be permitted in the public interest
to buy and sell for their own account, report their trades daily to
the governing authorities of the exchange so that those authorities
would be in a better position to determine whether or not the specialists trading have functioned in the public interest at any given
time or period of time, and, if they have not, they may make appropriate suggestions, if you please, to the specialist that would cause
him to modify his way.
Is there anything wrong with that; or are there any disadvantages
that would flow from the adoption of that rule 9
Mr. WHITNEY. I do not think so, Mr. Pecora. The bill prohibits
specialists trading.
Mr. PECORA. I am now seeking to get your judgment as the judgment of a seasoned, experienced mind, on the matter of preserving
to the specialist by appropriate revision to the bill the right to trade
for his own account and at the same time in a manner that would
not be detrimental to the public interest.
Mr. WHITNEY. I am in entire accord.
Mr. PECORA. I have already indicated, Mr. Whitney, that the
thought that I have personally given to this subject has left me somewhat in doubt as to whether or not a specialist should be permitted
to trade for his own account.
Mr. WHITNEY. I have suggested, and I think, entirely admitted,
that this is a subject upon which there are very real differences of
opinion; and if your suggestion in your belief would bring further
light to the subject, it might be very wise to do it. But you appreciate that it would be a considerable task upon the specialist or
his office. I t would not be in the hands of the business conduct committee until well after the fact. I t would then have to be compiled.
Whereas specific cases are immediately available to the business conduct committee at the present time if there is thought on their part
that the specialist has misused his rights.
I am entirely open-minded on any suggestion that is going to shed
more light on this question of the specialist trading for his own
account. I believe he should be allowed to do so; but we grant that
there are other points of view, and we therefore believe that thorough and sincere study should be made on the subject as we have
suggested.
Mr. PECORA. Frankly, I think the right of a specialist to trade for
his own account is neither an unmixed evil nor an unmixed blessing.
Mr. WHITNEY. Quite right.
Mr. PECORA. I am trying to get a formula that will preserve the
blessings and minimize the evils.
Mr. WHITNEY. We are with you there, entirely.
STOCK EXCHANGE PRACTICES
6673
The CHAIRMAN. D O you know from your experience whether it
would be practicable to require a specialist to report daily to the
committee ?
Mr. WHITNEY. Whether it would be practicable?
The CHAIRMAN. Yes.
Mr. WHITNEY. Well, as I said, Mr. Chairman, it would mean more
work upon them; and I think that such things should be considered,
as to whether in asking them or requiring them to do so any benefit
would result. It is entirely within the power of the exchange to
demand that, of course, if that is what you mean.
The CHAIRMAN. Not only that, but maybe we are requiring a
thing to be done that cannot be done. I do not know how much
work these specialists have to do or whether it would be possible
for them to make daily reports.
Mr. WHITNEY. I t would be possible; yes.
Senator KEAN. But it would probably require another clerk on
their part?
Mr. WHITNEY. I t might well do so, during times of activity;
yes.
I am not trying to advance any argument against it, except the
slight one that it would be additional work; and I think there are
so many reports demanded now, that, unless good would result, I
think it would be harsh to require it. Good might result.
Mr. PECORA. I was merely advancing it for your consideration and
I was rather hopeful you would be able to give us your judgment
on it now. But if you think it requires further thought on your
part, of course you should have the opportunity of giving it further
consideration and deliberation.
Mr. WHITNEY. I think it would, Mr. Pecora.
The CHAIRMAN. NOW we will proceed with the bill.
Mr. WHITNEY. Sections 11 ; 12, and 13 of the bill deal primarily
with questions which affect listed corporations. In that connection
it is my understanding that there may be representatives of these
corporations appear before you to show their side of the question.
Particularly with relation to section 13, I had planned to tell you
the real hardship the proxy rule would brings upon corporations, but
Mr. Corcoran admitted that he thought it a wardship, too; so I will
forget it.
Senator GOLDSBOROUGH. Are not sections 15,17, and 18 in the same
category?
Mr. WHITNEY. A similar category.
Senator GOLDSBOROTJGH. They all have an effect upon American
business enterprise ?
Mr. WHITNEY. Very much so.
I do want to say for the record, please, that Mr. Corcoran referred to my statement before the House committee to the effect
that I said any corporation with a $5,000,000 capital might have to
pay between $500,000 and a million dollars per year for auditors,
as required under the bill. That was said in answer to a question
which I may have misunderstood; but in any event my answer
Was made in the light that even a corporation of that size might
be engaging in a type of business which would involve such a very
high cost of audit—I was not seeking to exaggerate—it will be
a large cost because of the necessity of independent audits quarterly.
6674
STOCK EXCHANGE PRACTICES
Mr. PECORA. HOW about independent audits semiannually or
quarterly reports? That is, every 6 months, with a quarterly report submitted, audited, and the other two quarterly reports not
audited ?
Mr. WHITNEY. Mr. Pecora, this is my personal opinion: I am
very shortly going to ask Mr. Altschul to state certain opinions
and facts to the committee, with the permission of the committee;
but my personal opinion is this, that an independent audit once a
year by a corporation gives enough of the auditing aspect to the
public. If you demand an independent audit semiannually or
quarterly
Mr. PECORA. We will say, semiannually.
Mr. WHITNEY. Semiannually—the value of that to my mind is
going to be largely lost to the public. I am informed by the American Telephone & Telegraph Co. that if they had to give an audit
quarterly—we will apply it semiannually—an independent atidit
quarterly, that for the first quarter of this year ending on March
31, they could not possibly have it in the hands of the public until
July or August of this year. A balance sheet, something prepared
by themselves, with truth, naturally, and not subject to the necessary review of an independent auditor, could be put in the hands of
the public far more promptly. As I see it, the benefit that you and
we are striving for is that the public shall have currently the facts
with regard to corporations. We are in entire agreement with that.
Mr. PECORA. Mr. Whitney, in taking the example of the American
Telephone & Telegraph Co., are you not taking a rather extreme
case and seeking to generalize from its base?
Mr. WHITNEY. I t is an extreme case, without question; but I believe, sir, that certainly our experience—but I would like to ask
you to hear Mr. Altschul, because he knows far more about it than
I, he being chairman of the committee on stock list. But company
after company, not of great size, where they have to present to the
exchange independent audits, insofar as my knowledge and belief
are concerned, do not give them to us for some months after the
period which they cover they are set. The same thing is true of our
own questionnaires of firms.
They are always set for the last day of the month or the first of the
next month, and they do not have to be filed until the 20th of the
month, and in many, many instances with the larger houses they ask
for 10 days' or 2 weeks' extension because of the physical impossibility
of the individuals compiling such documents.
Mr. PECORA. YOU recognize that when a corporation lists its securities on an exchange it impliedly extends an invitation to the public
to become partners in its business, so to speak?
Mr. WHITNEY. I grant that; yes.
Mr. PECORA. It invites them to buy its shares and thereby become
part owners of the business.
Mr. WHITNEY. I t places its shares in position to be bought. Quite
right, sir.
Mr. PECORA. And when such an invitation is extended to the public,
you agree, I presume, in principle at least, with the thought that
such a corporation should be required to give definite information
at frequent enough periods so that the public that by implication
STOCK EXCHANGE PRACTICES
6675
is invited to buy its shares and become a part owner of its business,
might with more intelligence buy its shares ?
M L WHITNEY. YOU and I are in entire agreement; yes.
Mr. PECORA. Then the only question is in what form that information, and how frequently that information, should be conveyed to
the public.
Mr. WHITNEY. SO that it will not work an unfair hardship on the
company and upon the shareholders who own the company.
Mr. PECORA. In order to keep the investing public that is invited to
buy the shares not too much in ignorance.
Mr. WHITNEY. Or, sir, to give them information that is current.
I think you used the word " current."
Mr. PECORA. Yes.
Mr. WHITNEY. And
independent audits would delay that current
aspect of the facts regarding the company which you wish to give to
the public.
Mr. PECORA And they would also have a better check, would they
not, on the soundness of the information ?
Mr. WHITNEY. I am not at all sure, unless you believe that fraud
is practiced by our companies.
Mr. PECORA. I am afraid that we are impelled to that belief, in the
light of evidence that this committee has heard within the last
fortnight.
Mr. WHITNEY. That is not fair. All American companies? That
is a harsh statement.
Mr. PECORA I did not say " all American companies."
Mr. WHITNEY. YOU are predicating your statement on fraud,
though, as I see it.
Mr. PECORA. I know and Mr. Altschul knows, because he was in
this room when the evidence was submitted to this committee in the
past fortnight, that such frauds have been perpetrated.
Mr. WHITNEY. Mr. Altschul will be here in a minute. I cannot
speak for him.
Mr. PECORA. But Mr. Altschul has already expressed to this committee his opinion, based upon the evidence that he heard here.
Mr. WHITNEY. Then it is a matter of record.
Mr. PECORA. I am not making a general accusation that all corporations are engaged in the practice and custom of peddling out
or giving out false information. I do not believe that for one minute. Neither do I believe that corporations' officials become sacrosanct and free from all the frailties of human nature merely because
they become corporation officers. We pass laws prohibiting the
commission of certain acts which we define to be crimes in the
public interest; not because we believe that all men are criminals.
Mr. WHITNEY. We advocate just such laws, and have done so for a
long time. A year ago today, as I stated to this committee, you will
remember
Mr. PECORA. But if these reports are audited either quarterly or
semiannually rather than annually, don't you think that the auditing
of the reports would give greater assurance with respect to the
authenticity, accuracy, and reliability of information that you admit
the public should have?
Mr WHITNEY. Assurance, yes; current knowledge, no.
6676
STOCK EXCHANGE PEACTICES
Mr. PECORA. Current knowledge or information, unless it is honesty is apt to do more harm than good, is it not, because of the false
reliance that the public places upon it?
Mr. WHITNEY. Mr. Pecora, even accountants may not be honest.
Mr. PECORA. We are not going to enter into a discussion about
the frailties of human nature.
Mr. WHITNEY. But you are right in that discussion now with
respect to certain corporation officers.
Mr. PECORA. We have evidence to base my observation on, Mr.
Whitney.
Mr. WHITNEY. I am not denying it.
Mr. PECORA. I am not making an idle statement when I say it is
based upon evidence presented to this committee within the last 2
weeks.
Mr. WHITNEY. That is granted, of course; one case.
Mr. PECORA. The one case we investigated, Mr. Whitney. I could
cite others.
Senator GOLDSBOROTTGH. But it does not follow that we have discovered that everybody is dishonest.
Mr. PECORA. Certainly not; and I have been very careful to maintain that. I do not say, because the American Commercial Alcohol
board gave information to the stock list committee of the stock
exchange last summer on at least three occasions that did not square
with the facts, that all corporations do that thing; certainly not.
Senator GOLDSBOROTJGH. NO. I quite agree that you are not making
the implication go that far, I am sure.
Mr. PECORA. NO. But if the public is invited to subscribe to shares
of a corporation through the facility of haying those shares listed on
a public exchange, I submit that the public should be safeguarded
as much as it can reasonably be accomplished in the information
which is given to it and that it would enable the public to arrive at
an intelligent judgment.
Mr. WHITNEY. We absolutely agree.
Mr. PECORA. Then, the only question is whether these reports
should be audited once a year or twice a year ?
Mr. WHITNEY. Yes, sir. Well, let us say four times, by the bill.
Mr. PECORA. I am now suggesting my own thought on the matter
when I say twice a year rather than four times a year.
Mr. WHITNEY. And we are in no disagreement, as I believe, in
that regard. The first question to be solved is whether it is too great
a hardship or not.
Senator KEAN. But if this audit—and they do take long periods
of time, I know—if this audit takes 4 months or 3 months, a great
deal could happen to a company before the public would know what
happened to it through an audit?
Mr. WHITNEY TOO much can happen; yes, sir.
Senator KEAN. SO would it not be a good thing for the public—
we are trying to protect the public—if the company submitted its
statement promptly every quarter or every 6 months, and then
that they also had that statement checked by an auditor? Would
not that be a good suggestion?
Mr. WHITNEY. I think all these questions resolve themselves on two
points: The unfair hardships that might result to the corporation
and then, too, to its shareholders who are the public. Let us not
STOCK EXCHANGE PEACTICES
6677
forget that. Any money the corporation has to pay is out of the
shareholders' pockets.
And number 2: Whether or not the information given will be current enough so that it will be of value to the investing public. It
all resolves itself, as I see it, in the last analysis, on what is to the
best interest of the public; and you and I, Mr. Pecora, I think
entirely agree.
Mr. PECORA. I think so.
The CHAIRMAN. Very1 well. We will pass from that.
Mr. WHITNEY. NOW, Mr. Chairman, with your permission, may I
ask Mr. Altschul to make a statement in regard to the listing requirements of the exchange which affect very generally these particular
sections ?
The CHAIRMAN. I think that would be in order. We have had
Mr. Altschul before us.
Mr. WHITNEY. Yes, sir.
Mr. PECORA. Mr. Altschul's
prior appearance had to do with certain limited acts and transactions. Now, I think Mr. Altschul is
being offered to give the committee, from, his own judgment and
experience, his views with regard to these particular provisions of
the bill.
STATEMENT OF FRANK ALTSCHUL, CHAIRMAN, COMMITTEE ON
STOCK LIST, NEW YORK STOCK EXCHANGE, NEW YORK, N.Y.
Mr. ALTSCHUL. Mr. Chairman, I have prepared a brief statement
which, with your permission, I would like to read to the committee.
[Reading:]
J
I would like to submit to you herewith a document covering the organization
and work of the committee on stock list, the listing requirements of the exchange
as they exist today, and an account of the changes in listing requirements and
policies of the committee which have been made from 1926 to December 1933.
This material has been assembled on short notice; it is at present in process
of correction and revision With your permission, as soon as this work is
completed we shall furnish you with copies in their final form. This material
has been brought together in order to make available to you in convenient form
the fullest possible information
I would like to draw your particular attention to the section entitled " Outline of Revisions and Extensions, etc" The reason I do this is because this
section will serve to give you some indication of the extent to which my committee has been engaged in a continuing effort to accommodate its listing requirements, agreements, and policies to the ever-changing aspects of American
corporate procedure.
You will note a reference to action of the governing committee taken on
January 27, 1926, in the matter of the issue of common stock without voting
power. This device was being increasingly used to lodge control in small
issues of voting stock, leaving ownership of the bulk of the property divorced
from any vestige of effective voice in the choice of management
The committee felt that this tendency ran counter to sound public policy,
and accordingly decided to list no more nonvoting common stocks. With this
action of the committee, the period of the creation of nonvoting common stocks
came to an end.
The section to which I refer contains a running account of such endeavors
on our part. In a growing and developing economy like our own, corporate
procedure is ever changing and at times its changing nature is accompanied
by experiments of a character which require close scrutiny and sometimes
prompt action if the public interest is to be served. To keep abreast of such
developments, and occasionally possibly to anticipate them, requires a high
degree of flexibility. In my opinion, this flexibility is most readily found in
some such body as the committee on stock list, and such a committee is
6678
STOCK EXCHANGE PRACTICES
peculiarly well adapted to consider and to resolve new problems as they arise
because it is composed of men who are in intimate and daily touch with the
world of business and finance.
I believe that flexibility in the formulation of these rules is of the utmost
importance. Rules m this domain must of necessity be capable of adaptation
to conditions which change from day to day. A statute crystallizing m law the
rules of today may be utterly ineffectual to deal with the conditions of tomorrow. Such rigidity might easily obstiuct the normal development of American corporate procedure where the object should be not to obstruct but to
influence, in the public interest, the direction of such development
Notwithstanding the efforts made by the comm ttee on stock list, evidence
of which you will find in the document which I have placed in your hands,
we recognize that there is much that we have not been able to accomplish.
One of our difficulties has its roots in the lack of uniformity in the corporation
laws of the various States The competition between States in this field is a
matter of common knowledge, and the tendency of many States to liberalize
the provisions of corporate charters with a view to making their laws attractive
for the incorporation of companies has led to practices which have often given
us concern At times we have been able to resist such practices with a fair
degree of promptness, but more often we have had to wait until, either as a
result of our efforts or otherwise, public opinion had developed to a point where
it would support determined action on our part
The remedy for much of this we have long felt lies in a Federal incorporation statute. We recogn ze the enormous political difficulties in the way of
such legislation, but the importance of it from the point of view of the protection of investors generally is so great and the advantages of it are so obvious
that we would, with all respect, like to urge upon you the desirability to having
this question fully explored
Such an act would, for instance, furnish the means of clarifying and codifying such complicated questions as those growing out of preemptive rights,
stock dividends, the par value ot stock, or stocks of no par value It would
permit the development and imposition of uniform methods of accounting
within industries, a matter of great importance to investors generally. Furthermore, it would permit the general adoption of a desirable and simple provision to the effect that auditors should be responsible to the stockholders of
a corporation rather than to its management, and should only be removable
after a full hearing before a stockholders' meeting
Instances of deliberate misrepresentation in connection with listing applications have, insofar as we know, been camparatively rare, that they have
occurred, however, admits of no dispute We are sympathetic to legislation
providing penalties for false statements contained in listing apphcat ons or in
documents submitted in support of these; and I believe that such legislation
would not alone be helpful to us in the work that we are trying to do but
would prove an enormous safeguard to the investing public. Legislation which
will act as a deterrent and will at the same time provide adequate punishment for transgressors—taken in conjunction with such legislation as I have
suggested above—will, I believe, be most effective to accomplish the purposes
which are being sought in the relevant sections of the bill Regulation which
takes the form of an attempt at continuing supervision of corporate activities
in order to prevent every conceivable kind of fraud will, in my opinion, not
only fail to prevent fraud but will of necessity hamper the conduct of honest
business
I have come prepared, Mr Chairman, to make a complete statement to you in
regard to those provisions of the bill under consideration which relate most
directly to the work of my committee If your time permits I would like very
much to read this statement to you now, in order that you may have an opportunity of questioning me fully in regard thereto in case you care to I
believe that such a discussion would prove most helpful to all concerned.
Now, Mr. Chairman, I have a statement dealing with the sections
of the bill in detail, which I will hand to you for your convenience.
The CHAIRMAN-. Very well.
Mr. AiiTSCHuii. I believe some of these points have already been
covered, and it may be expedient if when we get to them I skip
over them.
STOCK EXCHANGE PRACTICES
6679
Mr. Pecora, I will be very glad if you interrupt at any time in
this statement to discuss the particular matters that we happen to
be on.
Mr. PECORA. Mr. Altschul, would you pardon postponement of
your reading of this statement just long enough to enable me to ask
you one or two simple questions with regard to the statement you
just read?
Mr. ALTSCHUL. Certainly.
Mr. PECORA. YOU say:
Instances of deliberate misrepiesentation in connection with listing applications have insofar as we know been comparatively rare, that they have occurred, however, admits of no dispute. We are sympathetic to legislation providing penalties for false statements contained in listing applications or in
documents submitted in support of these; and I believe that such legislation
would not alone be helpful to us in the work that we aie trying to do, but
would prove an enormous safeguard to the investing public
When you made that statement did you have in mind State legislation or Federal legislation?
Mr. ALTSCHUL. This statement was made in connection with a
discussion of the Federal statute, and what I had in mind was that
some of the benefits which you are obviously seeking in that statute,
and with which we entirely agree, you would find a way to incorporate something in the statute which would cover. 1 am not a
lawyer.
Mr. PECORA. YOU had in mind the Federal legislation?
Mr. ALTSCHUL. I was discussing the bill.
Mr. PECORA. DO you recognize that State legislation would be
comparatively ineffectual?
Mr. ALTSCHUL. I recognize the difficulties, but I am not a lawyer.
I am a layman. I cannot deal with the legal questions very thoroughly.
Mr. PECORA. And just one other question: In your reference in
this statement to the efforts m the past made by the Committee on
Stock List to keep off the board of your exchange stocks that contain
no voting power, does that include voting trust certificates?
Mr. ALTSCHUL. I t does not include voting-trust certificates.
Mr. PECORA. DO you recognize that that is a species of security
which for a limited period of time at least deprives the purchasers,
the stockholders, the public in other words
Mr. ALTSCHUL. Quite right.
Mr. PECORA. Of an effective voice in management ?
Mr. ALTSCHUL. Quite right.
Mr. PECORA. And it is an evil comparable to the one of nonvoting
stock, except that the evil is limited as to time ?
Mr. ALTSOHUL. NO, sir. I think there is another important difference there. In the case of a nonvoting stock the purchaser buys
an instrument that has been deprived of a vote in perpetuity right
at the start of the operation.
Mr. PECORA. Yes.
Mr. ALTSCHUL. In
the case of the voting-trust certificate it gener*
ally comes into being as a voluntary exchange of the voting-trust
certificate for a stock certificate that had the voting power, and
presumably the holder of the stock certificate who makes that exchange is making it for considerations that seem to him persuasive.
Mr. PECORA. HOW about the case of the Pennroad Corporation?
6680
STOCK EXCHANGE PRACTICES
Mr. ALTSCHUII. Well, I am not familiar with the case of the
Pennroad Corporation.
Mr. PECORA. Their certificates are listed, are they not?
Mr. REDMOND. Not listed on the New York Stock Exchange.
Mr. ALTSCHUL. I am not familiar with that.
Mr. PECORA. Then they are on the Curb, and I think they are
listed on one of the New x ork exchanges.
Mr. REDMOND I think they have been dealt in on the Curb.
Mr. PECORA. Those were voting-trust certificates at the outset.
Mr. ALTSCHOT.. There are two fundamental distinctions. In the
case of the voting trusts the laws of the various States on voting
trusts are set up providing limits of time at the end of which the
stockholder again returns to his former status.
The second point is that in a great many cases and in most of
those that we have seen in the stock exchange, voting-trust certificates are issued in exchange for the stock and the exchange was made
voluntarily by the stockholder, who exchanged his voting right for
what he considered to be a good reason, and there are at times good
reasons of that sort.
We do not feel that that has any of the same general implications
that the nonvoting stock has.
I shall attempt to place before you my views concerning those provisions of the proposed legislation which relate most directly to the
work of my committee. I find myself in accord with certain of
these provisions. As I shall point out in detail later, others appear
to me to go much too far and to be of such a nature as to suggest
the possibility that they may defeat the purposes of the measure.
I am heartily in favor of such measures as will afford the maximum degree of protection to the investing public. The efforts of the
committee on stock list have constantly been directed to this end.
While I feel that in the main these enorts have been constructive
and helpful, I would be the last one to suggest that further progress cannot be made. To the extent to which the provisions oi this
bill represent such further progress, these provisions of course meet
with my approval.
Briefly, the committee on stock list has developed certain standards
and requirements which must be satisfied by applicant companies if
their securities are to be eligible for listing at all. These standards and requirements are matters of gradual evolution, responsive
to the changing aspects of American business life and to the constant development of corporate procedure.
In connection with an initial listing application, the committee
requires a formal printed listing application containing such information and supported by the documents which you will find described
in detail in the memorandum which I have submitted to you. In general, the listing requirements are designed to furnish information
concerning the character and background of the business, the nature
of its assets and operations, the record of its earnings and such other
pertinent material as seems likely to assist the investor.
If the securities of a company have been admitted to the list and
the company applies for the listing of additional securities, a similar
listing application is required; and in this application there must be
up-to-date financial statements of the applicant company together
with a statement of the purposes of the issue applied for, a copy of
STOCK EXCHANGE PRACTICES
6681
the resolution of the board of directors authorizing such issue, and an
opinion of counsel, not an officer or director of the company, as to the
validity of the issue contemplated. A strong and usually successful
effort is made, in connection with the application for listing of additional securities, to have the company comply with the then current
requirements. Such compliance is often made a condition of the
listing requested.
While we have occasion to consult our own attorneys on many
points, we do not have an independent staff of lawyers to determine
whether all the legal requirements for the issued securities have been
complied with, and while we take up many accounting questions with
our consulting accountants, we do not have an independent staff of
accountants to audit the accounts of applicant corporations. In the
absence of contrary evidence, we accept the legal opinion furnished
to us by responsible lawyers in connection with listing applications,
and we accept the audits prepared in behalf of applicant companies
by independent auditors.
In connection with applications for additional listings, we do not,
in the absence of evidence of bad faith, seek to examine into the
actions of boards of directors with a view to arriving at an independent determination as to whether they have acted in pursuance
of sound business judgment or in accordance with proper standards
of conduct; nor do we attempt to control such action.
It is the board of directors, not we, who are elected by and responsible to the stockholders for the outcome of their policies; the record
of the company which persuaded stockholders to invest is the record
of the management of the company, not our record. In my opinion,
no central body, whether the stock-list committee or the Federal
Trade Commission, can possibly succeed in performing the functions
of the managements of all listed companies.
If there is anything in the application which appears to the committee to be open to question, then the committee makes every effort
to have the question resolved in accordance with its views; but we
have conceived our chief responsibility to be to see that the facts
have been fully and adequately disclosed, and if this disclosure indicates nothing which appears to the committee to be unsound or
improper, we do not undertake an independent investigation of the
facts themselves. In other words, we accommodate ourselves to the
general spirit of American institutions in dealing with persons
appearing before us on the theory that they are honest until evidence
to the contrary is adduced.
I approach the consideration of the pending legislation with the
general view that stock exchanges perform a useful and an essential
function in our national life. This I conceive to be primarily the
furnishing of a market place for securities with a view to facilitating enterprises in filling their legitimate capital requirements and
with a view to enabling investors to purchase and sell securities
readily in response to their needs or desires.
I recognize that abuses have grown up about the market place
which require correction in order that the public may be afforded
proper protection, and I believe that the object of farsighted legislation should be to afford such protection while placing as few
obstacles as possible in the way of the normal functioning of this
important part of our economic mechanism. I suppose that there
6682
STOCK EXCHANGE PBACTICES
would be general agreement with the principle that, to the extent
that the provisions of the proposed legislation are so onerous in
their application as to render it impossible for corporations to
comply with their terms, these provisions must be looked upon as
inconsistent with the conception of the useful and essential qualities
of security exchanges and that accordingly such provisions should
be either modified or eliminated.
With this general background, I proceed to an examination of
the provisions of the bill before you insofar as they relate to the listing of securities on security exchanges. My comments should be
read in the light of the foregoing general discussion. And before
going into the particular discussion, Mr. Pecora5 it may be that you
have some questions that you would like to take up now on what
we have covered.
Mr. PECOEA. I have made some notations, but I think perhaps we
could more advantageously enter upon a discussion after you have
completed the reading of this document.
Mr. Ai/rscHuii. Section 11—Registration requirements for securities:
I draw your attention to section 11 of the bill entitled " Registration Requirements for Securities." Before entering into a detailed
comment upon these requirements, I would like to consider this
section in its broader aspects. One effect of this provision is to
require that all existing securities now listed on any exchange shall
be registered in accordance with the provisions of the act at least
30 days prior to its effective date if they are to continue to be traded
in thereafter on the exchanges on which they are now listed.
Securities now listed are held today in various ways largely in
reliance upon the fact that there is a market for them on recognized
exchanges. To deprive these securities, or any considerable part of
them, of the market which investors and lenders alike have relied
on would be disastrous. On this account, it is important to point
out, m the first instance, that the registration requirements for
securities, taken in their entirety, could very easily in a large number of instances have this effect.
In my opinion, it is a dangerous thing to impose onerous requirements m connection with the registration of new issues, as this so
easily has the effect of damming up the capital market of the country, with resultant hardships to industries seeking capital for expansion or for meeting maturities. However, it is tar more dangerous
to impose such requirements upon existing securities because this
can obviously have the effect of freezing a large part of the liquid
capital of the country, with the most deflationary consequences
to individual holders, banks, financial institutions, no less than to
the industry of the country as a whole.
Difficult as the administrative features of the act are insofar as
they apply to new issues, they are infinitely more difficult when they
apply to that great bulk of securities already outstanding. If section 11 is read in conjunction with section 32, it becomes apparent
that if any securities now issued are to be traded in on any security
exchange after the effective date of the act, October 1, 1934, applications for registration thereof must have been made before September 1, 1934. The act presumably contemplates that applications
so filed and the documents supporting them are to be reviewed by
STOCK EXCHANGE PRACTICES
6683
competent persons. So stupendous would be this task that I am
convinced that the work involved, if conscientiously done, would
consume years rather than months, if it can be actually done at all.
Beyond this, I am convinced that the delegation to a Federal body,
not in immediate and daily contact with the current operations of
the country's business, of authority to pass upon the registration of
all securities to be dealt in—old and new alike—is unnecessary for
the protection of the public. I consider that this protection can be
better secured by other means, and that the contemplated method
places obstacles in the way of the normal functioning of our business
machine so serious in their nature that they will unfavorably affect
the very interests of that public which these measures seek to protect,
SEO 11 (a) It shall be 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 in accordance with the provisions of this act and the lules
and regulations made by the Commission thereunder and unless such security
has been issued.
The effect of this provision, read in conjunction with section (b),
would appear to be to prevent dealings in any security until 30 days
after the stock exchange had certified to the Commission that the
security had been approved for registration and listing. In the
case oi new issues this 30-day delay might place such an added
risk upon underwriters as to raise a serious question of whether
the business of underwriting new issues for the purpose of financing
the capital requirements and the maturities of existing corporations
could go forward at all.
Apart from the question of underwriters, we have frequently had
before us, in the past, applications for listings where prompt action
on our part, in order to make possible the early issuance of the
securities in question, was essential to the carrying out of an entirely
legitimate corporate purpose highly in the interests of the security
holders.
I am apprehensive that the delays imposed in connection with the
underwriting of new issues and of the issuance of new securities
at times without underwriting will place an obstacle in the path
of perfectly legitimate transactions helpful to American business.
I am uncertain of the precise effect of the words "unless such
security has been issued ", but I assume that they are intended to
prevent a " when, as, and if issued " market. While the New York
Stock Exchange has, in recent years, been reluctant to list on a
" when, as, and if issued " basis, and has only done so infrequently,
and then only when it seemed largely in the public interest, we
believe that the " when, as, and if issued " market has a legitimate
place in the business of providing capital for industry, and we feel
that any abuses that is sought to correct in connection with such
a market are capable of being dealt with without eliminating such
a market altogether.
Beyond this, I should point out that many types of securities
are now listed for which it would appear that under no circumstances
is it likely that a registration statement would be filed. The removal from the list of these securities already outstanding in the
hands of investors under such a retroactive law would, in many instances, affect the interests of investors most unfavorably.
6684
STOCK EXCHANGE PRACTICES
The following possibilities which might result from such a provision of the law should be considered. Stocks and bonds of many
companies that are in the hands of receivers might be forced on
the list because of the fact that the original issuer had no longer
any power to file a listing application or registration statement, and
it is uncertain how far the receivers would go in doing so. In many
instances, these securities have been kept on so as to not use the
influence of striking to force minority stockholders into reorganizations or into deposit agreements of protective committees. If this
section of the law remains unchanged, even if the registration requirements were modified, many situations might arise where the
new company, protective committee, or voting trustees might elect
to register the securities which they have issued for listed securities,
but no person would be in a position to apply for registration of the
listed securities themselves in their original outstanding form.
Thus, possibly quite unintentionally, pressure would be brought
upon minorities to deposit under plans of reorganization in a way
in which the stock exchange has always been reluctant to bring
pressure itself.
In other rases, where, through the exchange of shares, a company
has acquired a very large percentage of stock of another company
and desires to have the stock of its subsidiary removed from the list,
this provision of the act might well result in the acquiring company
making no provision for the registration of the securities of the
underlying company, and in this manner dissenting minorities might
well be forced into a consolidation or exchange of shares contrary to
their expressed wishes, merely in order to obtain a listed security.
I t has been the consistent policy of the committee on stock list not
to permit its listing facilities to be used to club minorities into
action in this manner.
Furthermore, it is difficult to see why foreign governments or
foreign corporations which have issued bonds so many years ago
and which have no further present need of the American capital
market should apply for registration.
The amount of such securities that might be forced off the list
through the operation of the provisions of the bill as now drawn
is, as you know, very considerable.
SEC 11. (a) A security may be registered with a national securities exchange
upon application by the issuer, by filing with such exchange and with the Commission such undertakings, information, and documents as the Commission may
by its rules and regulations require in the public interest and for the protection of investors together with such additional undertakings, information, and
documents as the exchange may require. It the exchange authonties cerrify
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 nlmg of such certification with the Commission: Provided, That if it appears to the Commission prior to the expiration of such thirty days that the
application for registration does not comply with the provisions of this Act
or the rules and regulations made by the Commission hereunder, it may, after
appropriate notice and opportunity for hearing within such period, enter an
order denying the application for registration unless the issuer shall withdraw
its application or consent to the Commission's deferring action on its application for a stated period longer than such thirty days.
The difficulties which I find with this section are already covered
by my preceding comment.
SEC. 11. (c) The rules and regulations of the Commission in regard to
* * *
registration shall require
STOCK EXCHANGE PEACTICES
6685
(I) An undertaking by the issuer to comply with and so far as is within
its power to enforce compliance by its officers, directors, and stockholders with
the provisions of this Act and any amendments thereto and with the rules and
regulations made or to be made by the Commission thereunder and, unless the
issuer is a member bank of the Federal Beserve System, not to lend any funds
in the money market of any exchange or to any member thereof or to any
person who transacts a business in securities through the medium of any such
member except in accordance with such rules and regulations as the Commission may prescribe.
That is a provision that requires an undertaking by the issuer
that he will comply with all present and future regulations and will
use his best efforts to have other parties comply with them as well.
I have grave doubt as to whether it is reasonable to exact any such
far-reaching commitment in connection with an application for registration. This clause in itself may operate powerfully against
registration.
SEC.
11. (c) (II)
Subject to detailed comment below on subtitles 1 to 11,1 feel that
information of the character specified in this subsection should obviously be available to investors and stockholders. This would seem
to me to go little beyond what might properly be considered reasonable in connection with listing on the New York Stock Exchange.
I recognize, however, that of necessity of requirements which appear
reasonable as a prerequisite to listing on the country's primary
security market, may be unduly burdensome when applied to many
of the small exchanges of the country which, in their communities,
perform a very useful function.
Accordingly, it would seem desirable to omit rigid requirements of
this nature from the act itself, and to delegate the authority to
prescribe listing requirements suitable to the needs of each exchange
considered in the light of its own special problems to whatever
agenqy may be designated by law to administer the provisions of
the act. I am convinced that experience will prove this degree of
flexibility to be essential if business is to go forward. In my opinion
the New York Stock Exchange could then readily accept listing
requirements drawn in accordance with the provisions of section
II (c) (II) subject to such modifications as I have indicated as
• desirable or essential in my detailed comment which follows:
SEC. 11 (c) (II) Such information as to the issuer and affiliates in respect
of:
(1) The organization, financial structure, and nature of the business;
(2) Particulars regarding the terms, position, rights, and privileges of the
different classes of secunties outstanding;
(3) Particulars regarding terms on which securities have been or are to
be offered to the public.
In my opinion, information covered by (1), (2), and (3) above
should without question be available to investors.
SEC 11 (c) (II) (4) particulars regarding the directors, officers and principal securityholders and underwiiters, their remuneration and their interests
in the securities of and material contracts with the issuer and affiliates.
I have some question as to the wisdom of that part of (4) which
would appear, when read in conjunction with other sections of the
act, to provide for the publication of the remuneration of officers of
registered corporations generally.
6686
STOCK EXCHANGE PEACTICES
I can see that in certain instances such publication may be desirable
and in the public interest. Yet, it places a serious competitive
handicap on corporations which are listed or registered as against
privately owned business in that the salaries which they pay to
executives will be disclosed for the benefit of their more fortunately
situated competitors. That instance is equally true between any
companies that are listed. One has a chance to see what the other is
paying for executives.
feeyond that, it is hard for me to believe that by and large officers,
merely because they happen to be connected with registered companies, should be subject to a form of publicity which other citizens
are protected from.
SBO 11. (C) (II) (5) particulars regarding remuneration to others than
directors and officers exceeding $20,000 per annum
There is some question m my mind whether the compensation paid
for professional services should be given publicity, and my objection
is based on the same general consideration as I urge in connection
with the compensation of officers.
SEO 11. (c) (II) (6) Particulars regarding bonus and profit-sharing arrangements.
I am in sympathy with the full disclosure of bonus and profitsharing plans and the aggregate cost thereof to the company However, I can see little reason why the distribution under these plans
to the individuals participating in them should ordinarily be disclosed. I can see, of course, that in some instances it might be wise.
Such a disclosure might at times prove a source of needless embarrassment to management in connection with the operations of
the company.
Senator KEAN. What do you mean by that ?
Mr. AiiTSCHuii. We have had before us in committee at times—
first of all, I would like to say this: We have discussed many times
the desirability of the stock-list committee itself taking some forward step in the matter of these profit-sharing and bonus plans, and
in connection with the study that we have carried forward there we
have had occasion to discuss more or less informally with managements the viewpoint of managements. We have not so far reached ,
a very definite conclusion, but we have found that in many cases
reasons are advanced which would indicate that full disclosure
would be undesirable.
There are cases inside a corporation, for instance, that have been
drawn to our attention, where officers are getting compensation which
the management considers adequate, where an officer is getting compensation which the management have determined upon, the executive officers have determined upon, as being the proper compensation
for that man. The man happens to be a man who is very unpopular
in the organization but very effective, and they consider him a very
important element in their business. The disclosure of an additional amount of compensation that he receives through the operation
of the profit-sharing plan has been urged upon us as being likely to
create a situation where either they would lose a half dozen other
men or that man would have to go. The total amount that is involved in the profit-sharing plan in the aggregate we would have
no objection disclosing, but if we had to go into the refinement of
STOCK EXCHANGE PEACTICES
6687
showing that Mr. John Jones gets $10,000 additional, then we would
have Mr. Smith and all the others disaffected, and we would have
a lot of trouble within the company.
There are practical reasons of that sort that have come to our attention ever so often that bid us pause in this matter. We have been
studying it and we are interested m it.
Mr. PECORA. DO you think those reasons that are based upon possible personal embarrassment to the individual whose compensation
is sought to be disclosed outweigh the advantages to stockholders
of full information with regard to compensation paid to those whom
they put in management of the company, or who are in the management of the company, whether with or without the will of the stockholders?
Mr. ALTSCHUL. YOU raise a very broad question, Mr. Pecora.
Mr. PECORA. That is the question involved here.
Mr. ALTSCHUL. Yes, naturally; but I want to separate it for a
moment. In a limited sense that I was discussing the question, I
would say that many times you will find occasions where the publicity as to the individual amounts would be harmful to the company
itself and, therefore, to the stockholders. I do not say that is at all
preponderating in the number of cases, but there are many cases
that are distinctly advantageous to the company. We have had
those drawn to our attention.
Mr. PECORA. YOU recognize, though, that in any question that is a
question of public policy the rights of the individual must yield to
the benefits of the community or the public?
Mr. ALTSCHUL. Quite right. Oh, we stand strong on that platform, of course.
Senator KEAN. The question is whether we can protect the rights
of the public by giving simply the amounts instead of the names
and the individuals.
Mr. AiiTscmjii. My thought on that, Senator, would be—but, first
of all, in answer to Mr. Pecora's question: In this competitive world
the disclosure of these facts as to the salaries of officers, by and
large, is going to be an adverse factor from the point of view of
stockholders.
To put it differently, it is going to have certain very important
adverse elements in it from the point of view of stockholders generally. I am not now limiting it to this one case of John Jones, but
by and large the disclosure of these salaries} is going to be a disturbing factor and have certain elements that would unfavorably
affect the interests of the very investors whose interests you are trying to protect; because, in the first place, as between listed companies both of whom have to disclose the tacts, it immediately sets
up the possibility of sniping for management and disrupting organizations and going and taking a man hero and letting him go there.
Mr. PECORA. DO you think that goes on anyhowl
Mr. ALTSOHUL. Oh, it goes on anyhow, but this is an open invitation. However, that may be a matter of opinion, and I do not think
I am prepared to argue that.
Beyond that there is the serious factor that there are lots of privately owned concerns that have to give no such information, and
they have an enormous competitive advantage then as against the
175541—34—FT 15
18
6688
STOCK EXCHANGE PEACTICES
concerns that have to publish the amounts that they pay to their
important executives. In a competitive industry people appraise
pretty accurately the value of the services of the outstanding performers in that industry, and if you have a company, just because
it is listed on the New York Stock Exchange or because it is listed
with the Federal Trade Commission, having to disclose that they
pay Mr. Jones a hundred thousand dollars, while some private company who has Mr. Smith does not have to say how much they are
paying him, the private company has a distinct advantage.
Mr. PECORA. Don't you think such information has been cribbed
in the past, and perhaps is apparently being cribbed from employees
of private companies?
Mr. ALTSCHUL. I do not at all wish to be understood as suggesting
that I know what salary is known to anybody else. I am sure a lot
of information gets around, but this is equivalent to advertising on
the front pages of newspapers so that nobody can possibly miss it,
and it has certain difficulties.
I quite understand what the abuse is that you are aiming at, from
disclosures that have been brought forth in various investigations
in regard to bonuses of such a magnitude that stockholders would
be interested in knowing about them. Those are perfectly patent.
I t might be that if the aggregate amount was set forth, then some
properly constituted body would be able to determine whether the
facts as to the distribution which was disclosed in confidence to
them were of such a nature in special instances that they should
be drawn to the attention of stockholders.
Mr. PECORA. Mr. Altschul, so far as you have gone you emphatically favor publication of particulars regarding bonus and profitsharing arrangements.
Mr. ALTSCHUL. The amounts, the total amounts.
Mr. PECORA. Yes. In the past that has been a device resorted to to
conceal compensation given to executive officers from the salary list.
Mr. ALTSCHUL. I did not understand that.
Mr. PECORA. In other words, in the past the device of giving an
executive officer a bonus or a profit-sharing arrangement that yields
him a substantial compensation in addition to his fixed salary has
been adopted in order to conceal from stockholders the fact that
such executive officers were getting a compensation that was not recited by the salary which they received, and which salary might have
been made public to the stockholders.
Mr. ALTSCHUL. Mr. Pecora, I do not agree with that statement
at all. The amounts of salary that the executive officers have been
getting have in general probably been disclosed equally. The basis
for the bonus and profit-sharing plan, as I have always understood
it—I believe this to be the fact—the real basis for it has been to
provide some means beyond the fixed salary by which unusual ability
and unusual success in the conduct of business could be rewarded.
Mr. PECORA. Well, in instances that undoubtedly has been the reason, but in many other instances that so-called " reason " has been a
mere pretext to permit of the payment of a compensation in a secret
fashion.
Mr. ALTSCHUL. Of course, I have no knowledge of any such instances. I think the reasoning applied, broadly speaking, has been
the reasoning I have given you, and I cannot see why we should per
STOCK EXCHANGE PRACTICES
6689
mit of the payment of this compensation in a manner secret from
the stockholders, when the compensation they get by way of salary
is not secret.
Mr. PECORA. I do not think any of those things should be secret.
Mr. ALTSCHTJL. My point is that this does not add any new element of secrecy. You suggested that this was a device to provide
for an element of secrecy in this distribution.
Mr. PECORA. I think it has been in the past, very frequently.
Mr. ALTSCHUL. They do not need any such device.
Mr. PECORA. Except that the salary might leak out, whereas
bonuses or profit-sharing arrangements are more circumspectly
guarded. As a matter of fact, in the case of the National City Co.,
which I recall at the moment, the evidence presented to this committee showed that the officers of that company participated in the
distribution of the so-called "management fund", wnich enabled
that company to pay huge sums in addition to very substantial salaries, to certain executive officers. The payment of those distribution shares in the management fund is effected through checks drawn
upon a deposit account kept in another bank, so that even the employees of the bank through the clearance of those checks, would be
able to know or find out, or even suspect, the existence of that management fund.
Senator WALCOTT. Let me add another thing. In one particular
•case we have in mind here the people who did the work did not get
the extra bonuses. It was in proportion to the amount of salaries
that they received in the holding or parent institution.
Senator COSTIGAN. What instance was that, Senator Walcott.
Senator WALCOTT. The National City Bank.
Mr. ALTSCHUL. DO not misunderstand me, Mr. Pecora. I think
full information in regard to bonuses and profit-sharing plans should
be disclosed. If you want to go beyond that and have the details
of distribution placed in the hands of the commission, or whatever
authority is going to be concerned with the administration of the
provisions of this act, I think that is a perfectly reasonable request,
t u t I do not think that the disclosure of the distribution should be
made mandatory. I think that should be a matter of discretion, only
to be used when there is some situation that you see, from the figures,
is a situation the stockholders ought to be advised about.
Mr. PECORA. I do not think any company should be ashamed to
make known to its stockholders the compensation it pays its executive
officers, whether the compensation be in the form of salaries, bonuses,
or profit-sharing arrangements, or what not; nor should those officers
be ashamed to have their compensation which they receive made
known to the stockholders.
Mr. ALTSCHUL. My objection to the provision has nothing to do
with any question of shame. My objection is purely a practical one.
In the competitive world, where you have companies that are listed
on exchanges and companies that are not listed on exchanges, from
the point of view of the investor himself, in the companies that are
listed, I do not like to see the facts in regard to the compensation
paid outstanding executives disclosed, so that their competitors, who
have no such disclosure to make, have an important fact at their
disposal which the managements of listed corporations do not have
in respect to their own
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STOCK EXCHANGE PEACTICES
Mr. PECORA. Mr. Corcoran day before yesterday referred to certain statements made by some gentleman who appeared before the
House committee on this bill last week, in which that gentleman made
reference to the wide-spread system of espionage among competitive
enterprises that virtually places, to a practical extent, not completely,.
such secret information as we are now discussing in the hands of all
competitive corporations or businesses. Do you think that gentleman was venturing an observation not supported by fact?
Mr. ALTSCHUL. I do not know who the gentleman was, and I did
not hear his observation. Of course, I know that in the competitive
world an attempt is made by business men to inform themselves currently, as well as they can, about the operations of their competitors,
but whether it goes to the extent of planting employees in places in
order to get information or not I very much question.
Mr. PECORA. Not alone planting employees. A bookkeeper or employee in the accounting division of a corporation or private business, by reason of the nature of his employment, can learn these
facts, and perhaps could readily be induced to make them known to
some competitor.
Mr. AiiTSCHuii. Mr. Pecora, while I think that the executives of
leading American concerns are very zealous to protect the interests
of their company, I am naive enough to believe that they would
consider it highly indecent to embark upon a policy that could be
designated as espionage. I do not know whether there is any espionage, or any counter-espionage. I think those things are more or
less fantastical.
Mr. PECORA. I have no doubt that is your candid belief, Mr. Altschul. The only observation I venture to make about that is that
you would probably find it enlightening if you could sit m the complaint room of the district attorney's office in any large community,
say, a month or two.
Senator COSTIGAN. Mr. Altschul, is it not your view that it is in
the interest of stockholders and in the public interest to be advised
as to whether a corporation is efficiently or extravagantly conducted?
Mr. ALTSCHUL. I do, sir.
Senator COSTIGAN. I have
reference now to information as to the
payment of bonuses and other compensation, other than the ordinary
compensation
Mr. ALTSCHUL. I entirely agree. The stockholders ought to be in
a position to judge as to whether their company is being efficiently
or extravagantly managed. I think, however, that that result can be
accomplished short of giving these particular details of distribution
as between individuals. We have tried, in the stock list committee,
to prevail upon corporations to set up their accounts in such a way
that the administrative expenses would be set forth as a separate
item. We have made some progress, and here and there we have been
able to accomplish it. We have not been able to enforce a general
rule to that effect. That is one of the very things that would be
covered by the uniform system of accounting within industries, and
I think the results you are seeking are results we are entirely in
sympathy with. I only raise some doubt as to the wisdom of going
quite so far.
The CHAIRMAN. DO you think that a uniform system of accounting
is advisable?
STOCK EXCHANGE PEACTICES
6691
Mr. AiiTSOHUL. I think, within industries, a uniform system of accounting should be developed and should be insisted on. We have
tried very hard to bring it about. At present one of the things we
have been doing is to try to get the oil industry, for instance, as a
sort of test case, to adopt uniform principles. I t is a question that
requires an enormous amount of study in respect to each particular
industry, to be sure that when you come out with your uniform system of accounts they do lead to a comparison between companies,
and really mean something. You get into such ramifications, for
instance, as finding companies that are in several different kinds of
industries at the same time. On the other hand, I am entirely in
favor of it. I think that while it is a thing we are not able to enforce
to the degree we would like to see it done, it is one of the things we
have always been urging.
Senator WALCOTT. Would you not add to that your statement that
it must be by industries?
Mr. ALTSCHTJL. I do say by industries.
There is one point in this connection that I thmk is worth making.
There has been a disposition in some of these discussions—I do not
know just where I have come across it; I think over in the House
committee—there has been a disposition to point to the standardization of accounts in the Interstate Commerce Commission, and to
suggest that the railroads handle their accounts this way, and public
utilities handle their accounts this way, and industry should handle
its accounts similarly.
There is, of course, one enormously practical point of difference.
The raikoads, after all, are a public utility. In fact, they have their
rate structure fixed; they have their expenses determined by the
Labor Board and by other agencies; and they have a monopolistic
phase. There is no competition between them. When you get into
those industrial concerns, you find that if you adopt a system that is
as inflexible as the Interstate Commerce Commission system for accounts of railroads—with which I am entirely in sympathy—you
then run into danger because you are applying the same system
under which the railroads have worked, to a competitive industry,
and you are handicapping companies as against one another—and,
more important, companies as against some of their foreign competitors.
We come next to the clause that has to do with material contracts, not made in the ordinary course of business, and material
patents.
From a theoretical viewpoint, compliance with this section is not
impossible. Practically, it presents such difficulties as to make compliance extraordinarily difficult, if not actually impossible. This
section provides that the registration statement shall set forth " particulars regarding material contracts not made in the ordinary
course of business, and material patents." If it were possible to
determine in advance which contracts and patents are material,
and which are not, and which are made in the ordinary course of
business, and which are not, then it might be possible to comply
with the provision. But who will take the risk of determining
whether a contract is or is not material, or is or is not made in the
ordinary course of business, particularly when a mistake may prove
so costly. The result must be that, if compliance is attempted at
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STOCK EXCHANGE PRACTICES
all, all contracts and all patents will have to be summarized. This
is the only safe method of procedure. I t might well require the
summarizing literally of thousands of contracts and tens of thousands of patents on the part of each of countless corporations. If
we were to apply this provision to the case of a street railway company, for example, the company would have to summarize its easement contracts, its agreements for the placing of telegraph wires
on the poles, the use of its property jointly with another carrier,
and the agreements for the maintenance of crossings and of bridges,
together with practically every element of operation which is covered
by contracts.
In the case of businesses involving large numbers of patents, such
as American Telephone & Telegraph Co., General Electric Co., or
Radio Corporation of America, the work involved in such summarization would appear to be staggering beyond belief. In the aggregate, if this failed to discourage registration completely, it would
still place an enormous burden upon applicant companies, and would
result merely in the accumulation in Washington and in various
exchanges of a mass of material so great that even the caring for it
would present a problem and the digesting of it would be a matter of
complete impossibility. I can see no practical advantages to be
obtained for the security owners of the country from this provision.
I have considered the possibility of amending the section, but I am
unable to suggest any amendment which would seem to make it
workable, and, accordingly, with all due respect, I am forced to the
conclusion that it should be eliminated.
We now pass to the balance sheets for preceding years, and thft
profit-and-loss statements for preceding years.
I am uncertain just what is meant by the term " for preceding
years " in the foregoing sections. Where companies have not been
in the habit of having their accounts regularly certified, the task of
getting merely the preceding year certified will in many instances
itself present a difficulty. When it comes to extending this beyond
the preceding year, many companies otherwise eligible for listing
and registration may find themselves unable to comply with the provision either because of the expense involved or otherwise. In this
connection I think I should point out that while the stock list committee has for a long time been urging on corporations the necessity
of having audited financial statements, we. did not have the support
of public opinion to such an extent as to be able to make this a
condition prerequisite to listing until very recently. We have now,
of course, as you know, done so.
We come next to the section relating to copies of articles of incorporation, and also to the striking of securities from the list.
The documents referred to in paragraph 1 above should, in my
opinion, clearly be made available to investors.
In connection with paragraph 2, I believe that the prompt exercise of this power is at times so necessary in the public interest that
the stock exchange should have unquestioned authority to act in
matters of this sort.
We now come to the question of annual, quarterly, and monthly
reports. The first subsection in that has to do with requests for
information of a general nature, unspecified.
STOCK EXCHANGE PBACTICES
6693
This provision is so broad in its implications as to vest the designated agency with authority to exact information and documents
from a company, the preparation and submission of which might
prove extremely burdensome. Accordingly, I think this authority
should be very much circumscribed, and perhaps defined.
Now we come to the thing that has been up for discussion a great
deal this morning, annual and quarterly reports, including, among
other things, a balance sheet and profit and loss statement certified
by an independent public accountant.
This section imposes upon corporations requirements which I
would be inclined to think could not be complied with m practice.
As I understand it, it provides for the filing with the exchange, as
well as the Commission, of quarterly reports, including a balance
sheet and profit and loss statement certified by independent public
accountants. If either the quarterly balance sheet or the quarterly
income account has to be certified to, serious problems arise, not
the least of which is that in many instances a physical inventory
must be taken, and the actual disturbances involved in many industries in the year-end stocktaking would merely be multiplied fourfold. The cost of this work, which must ultimately fall upon the
public either as stockholders or consumers, would be burdensome in
the extreme, and in the case of many corporations, it would be unbearable. Beyond this, the cost would be great out of all proportion
to any benefit that our practical experience in the matter of accounts
would lead us to believe could be obtained for the investing public.
Quarterly reports are frequently more misleading than they are
informative, on account of the distortion that of necessity occurs in
an attempt to allocate earnings to too short periods of time. While
we are in favor of obtaining quarterly income statements wherever we
are satisfied that their publication is of real benefit to the investor,
and when no disadvantages involved in their publication are apparent, we believe that a rigid provision requiring such publication in
all instances would, on the whole, do more harm than good.
My experience with these matters leads me to the conclusion that
there is a further intensely practical situation weighing against the
inclusion of this provision in the bill. I am informed that there are
not enough qualified accountants in the United States of America
adequately to perform the work involved.
The suggestion might well be considered that as the agency designated by the Government to administer the provisions of this act is
vested with broad powers to determine accounting requirements,
these requirements need not be made in themselves rigid provisions of
the act. I t is altogether probable that flexibility in this regard may
prove to be essential in the public interest.
Beyond this the question might well be considered whether such
designated agency ought not at an early date to initiate a study
looking to the development of uniform accounting practices within
industries; and that when and as uniform accounting practices for
an industry have been determined upon, corporations engaged in
that industry, the securities of which are registered, be required to
prepare their accounts in accordance with such uniform practices.
A measure advocated for some time by the New York Stock Exchange might also well be considered in this connection. I have
already covered that in my early memorandum. I will not take your
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STOCK EXCHANGE PBACTICES
time with that. As I understand, competent accountants will be
heard by your committee in detail with regard to the accounting
provisions of this bill.
Mr. PECORA. Mr. Altschul, before you leave that portion of your
statement to pass on to a consideration of the next provision of the
bill, would the arguments that you have made here with regard to
quarterly reports, audited quarterly reports, apply to semiannual
audited reports?
Mr. ALTSCHUL. Mr. Pecora, it would apply, not quite to the same
degree but m theory it would apply. The expense item is reduced
by half. The difficulty is reduced by half, but I think you still run
several dangers. I do not think it serves any useful purpose.
We get annual audited reports now, and we make it a prerequisite
of listing, and insofar as companies do not have audited reports, we
are trying to bring them to the point where they do give us audited
reports.
Mr. PECORA. My suggestion would simply involve the additional
expense incident to two audited reports per annum instead of one.
Mr. ALTSCHUL. I think the only way one can view a question of
that sort is to consider the item of cost, and the burden on the concern, on the one hand, in relation to the benefits to the public on the
other. Mr. Whitney has pointed out that one of the disadvantages
of this thing would be, even in the case of semiannual reports, the
delay in the preparation of figures. I think that is a real disadvantage. We have audited reports from a very large number of companies today. We get quarterly unaudited reports from the preponderating majority of those companies. When we take the four quarterly reports put out by the company officers and tie them m with
the annual report, in a case where there is any discrepancy that cannot be explained, such cases are extraordinarily rare. When a company has a company auditor, in most cases, while they do not certify
to the quarterly reports, the same methods are applied uniformly
by the company throughout the year, and we have the experience
oi seeing these things come in all tne time, and taking the four
quarterly reports, or the three quarterly reports that have come
in before the annual report, and tieing the thing together to see
whether the results of the year substantiate the figures that have
come out of the quarterly reports. These cases where we see any
discrepancy that cannot be explained aye extremely rare. I do not
remember one at the moment.
The cases in which you can see that there were a few year-end
adjustments, in connection with the stocktaking, and all the normal
incidents to corporate accounting, and where you can see that the
quarterly reports have been fair and are representative of the true
condition, are the rule.
There is another disadvantage in the semiannual report, and that
is the same disadvantage that applies to the quarterly report, except
in the matter of degree. A year, in most industries, at best is a
short enough time to which to try to allocate earning power. When
you begin to split that up into naif year, or quarter year, you run
the risk of attaching an importance to those figures, merely because
of the fact that they are certified, that the figures are not entitled
to have in themselves. The figures may be accurate, certified, or
xincertified.
STOCK EXCHANGE PBACTICES
6695
Mr. PECORA. That feature would attach principally to corporations
conducting businesses that are seasonal in character.
Mr. ALTSCHUL. I t is partly a question of the seasonal character of
the business. It is very striking in corporations conducting businesses
of a seasonal character; but beyond those conducting businesses of a
seasonal character, fluctuations within any short period of time other
than a business year are likely to be very deceptive, so much so that
while the New i ork Stock Exchange has been urging, as you know,
the publication of quarterly reports for years, and has been gradually getting more and more corporations to meet its views, there are
a number of times when corporations come to us and give us reasons
which, as reasonable people, we must accept, showing that the publication of these figures would mislead the investor almost every time
they are released.
At times that is because of the seasonal character of the business.
At other times it is because, let us say, a department store put on a
sale in March one year, and did not put it on until April the next
year. You get the comparative figures completely out of kilter, and
if you were to try to explain those figures away, and make them
mean something, nobody would understand what it was all about
anyway.
Mr. PECORA. That applies to quarterly reports, even if they are
not audited.
Mr. ALTSCHUL. Yes, it does; but my only point was
Mr. PECORA. Your committee has striven ior years to induce corporations whose securities are listed to make published quarterly
reports.
Mr. ALTSCHUL. We believe in quarterly reports, and we think, in
general, they should be made available; but we do not believe a rigid
requirement should be introduced in legislation making them mandatory, because anybody, whether it is the body designated by law to
administer this act, or the stock list committee, would, every now
and then, have presented to it facts which would lead it to say that
in the interest of investors themselves that requirement ought to be
waived. That does not happen infrequently. That is a matter of
fairly frequent occurrence. The distortion of earnings in short
periods of time would be likely to mislead investors, and create
movements one way or the other in market prices and have no relation to anything that was real at all.
Mr. PECORA. HOW would you deal with the problem in the aggregate?
Mr. ALTSCHUL. On the basis of judgment. In the case of corporations where the quarterly reports are informative—which I
think is the case with the bulk of the companies that now publish
them—we would have them published. In cases where they come
and give us a persuasive reason which shows that the publication
of those quarterly reports is going to mislead the investor we are
seeking to protect, we give them relief.
The CHAIRMAN. YOU would have the power in the Commission
to waive that requirement?
Mr. ALTSCHUL. I think that would be essential. You would find
times when the condition of the quarterly report would be very
damaging to the investor, and whoever had the responsibility would
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STOCK EXCHANGE PRACTICES
be the first to say, " Well, we do not want that done, because there
would be a great deal of undue enthusiasm or concern." •
Senator WALCOTT. When you speak of quarterly reports, do you
mean a balance sheet or a profit and loss statement?
Mr. ALTSCHUL. The quarterly reports that we get are quarterly
income accounts. Occasionally there is a balance sheet included,
but more generally it is purely an income account.
Senator WALCOTT. DO they include the gross sales?
Mr. ALTSCHUL. Most corporations that we deal with object very
strongly to giving gross sales.
Senator WALCOTT. That is one of the points that has been raised
here. They do not depend upon a physical inventory?
Mr. ALTSCHXJL. NO. The year-end report always catches up the
inventory adjustments. Short of a physical inventory four times
a year, or twice a year, there is no other way they can deal with that.
We have devised another scheme. We have felt that these quarterly
reports in certain cases were misleading. Then we have suggested
to corporations, when we are satisfied that these reports would be
misleading, that they give us quarterly cumulative annual reports—
in other words, that they give us, every quarter, the tie-up of the
first three quarters, and the last quarter, annually, so that we get a
certain continuity and avoid the distortion that you get in providing
for the actual quarterly income accounts. That is another illustration of the fact that whatever agency deals with this subject must
have a great degree of flexibility. Otherwise you will find that the
rigid rules you have provided to protect the public in many cases
will operate in such a way that if you had the power to change them
they would have operated far better.
The CHAIRMAN. Proceed.
Mr. ALTSCHUL. The comment with respect to section 12 (a) (3) is
practically repetition. I do not think it is important to go into that
now.
Mr. PECORA. That merely gives the regulatory body discretionary
power—that is, power which it may exercise in its discretion.
Mr. ALTSCHUL. A S I read it, it said " monthly reports including,
among other things, a statement of sales or gross income." I did
not think it was discretionary from the point of view of sales or
gross income. A statement of monthly sales is one of the most
misleading things we run into.
Mr. PECORA. I am referring to subdivision (a) (4) of section 12.
Mr. ALTSCHUL. (a) (3) was the one I said was repetition. I
had not finished with (a) (3). (a) (3) is repetition, and I do not
think there is any need of going into it.
My feeling with respect to (a) (4) is that this provision is so
broad in its implications that it vests the designated agency with an
authority to demand reports the preparation and submission of
which might prove extremely burdensome, and accordingly, I feel
that this provision should be very much circumscribed, if not entirely
omitted.
I have a similar feeling in regard to one other thing
Mr. PECORA. AS I read your comment with regard to section 12
(a) (4), it is, in substance, that because the power lodged in the
regulatory body by this section might be capable of abuse, that no
power at all should be delegated. That is true of any statute.
STOCK EXCHANGE PRACTICES
6697
Mr. AiiTSCHinu Of course, the effect of that in this particular
statute is the thing that bothers me, Mr. Pecora. While it is almost
unthinkable, you might say, that corporations would refuse to register, there are some provisions, like this, that make it almost unthinkable that they would register. The whole object must be, it
seems to me, to try to draft that clause in such a way that they will
give you what you are seeking without making it impossible for
corporations to comply.
Mr. PECORA. I think some of these comments conjure ghosts.
Mr. ALTSCHUII. I think you will find the American executive is a
pretty good ghost conjurer when it comes to sending in these certificates. I try to place myself more or less in the position of the
man who will have to look at this thing and decide what he is going
to do about it.
Section 12 is not important.
With regard to proxies, there is no use in reading my comment
on that. Mr. Corcoran dealt with that very adequately yesterday.
Mr. PECORA. DO you differ with Mr. Corcoran's views ?
Mr. ALTSCHUL. NO. We made, in general terms, the same recommendation as to the change he suggested yesterday. We went a little
further, but that is a matter of no importance at this time.
The section I would like to cover is the section with regard to
liability for misleading statements, because that, I think, is a very
important section.
Mr. PECORA. A section that has teeth.
Mr. ALTSOKDii. Yes. It has jnore than teeth, I believe. I have
covered that without any hesitation, because I think you know that
the stock exchange is just as interested in avoiding the promulgation
of false or misleading statements as th& committee.
This section appears to me to be fundamentally unsound in principle in several particulars. In the first place, it makes liability
result not only from a statement that is false, but from a statement
which, while true, is found to have been misleading. The question
of the truth or falsity of a statement is a question of fact; the question of the misleading character of a statement is clearly a question
of judgment. To expose individuals to a liability for what may be
a mere difference of opinion, and in the absence of any evidence of
wrongful intent, seems repugnant to our ideas of fair play.
Mr. PECORA. I do not think the section, as worded, is subject to that
criticism.
Mr. ALTSOHXTL. My disadvantage is in reading this section as a
layman, Mr. Pecora. That was what it meant to me.
In the second place, this section permits recovery, whether damage
has been suffered or not and whether damage, if suffered, had an
actual connection with the statements complained of. Beyond this,
tl^e measure of damage seems to me to be arbitrary and speculative.
These considerations, taken together, expose individuals whose
function it is to exercise judgment to risks so serious, so unfair and
so impossible to guard against as to be calculated to make those
competent to accept such responsibility unwilling to do so.
I am of the opinion that the provisions of this section, as drafted,
are of such a character as to be likely to render it impossible for
corporations to comply with their terms. As now drawn, it would,
I think, operate to prevent directors of corporations generally from
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STOCK EXCHANGE PEACTICES
authorizing the filing of an application for registration, and in this
manner it would tend to defeat the purposes of the act.
Accordingly, it would seem to be essential that section 17 be modified. In my opinion, it is only fair that the law should provide a
remedy for one who has been misled by any misrepresentation willfully made contained in an application, report, or document filed
in accordance with the requirements of the act. As I understand ity
today such remedy, either does not exist or is only with the greatest
difficulty enforced. The law should clearly go so far; but I can see
no reason why it should go farther than this.
I t seems to me possible that the civil provisions of the British
companies act and those sections of the British larceny act, under
which I am informed convictions of companv officials have been
obtained m Great Britain might well prove a helpful guide to
legislators.
In this connection, it might be worth considering the provisions
of the British Statute permitting the court to require security for
costs and to award costs in its discretion. This is a provision intended to restrict the filing of strike suits while placing no obstacle
in the way of the poor man who has a bona fide action which he
wishes to initiate.
In regard to the effective date, there is nothing to be said about
that. I will just close with my comment, if you have a minute to
spare, Mr. Chairman.
So far, in my review of specific provisions of the bill, I have?
made an effort to recognize the reasonableness of certain features
relating to the work of the committee on stock list and to offer
suggestions designed to improve other features which appear to me
to be burdensome or unworkable. However, I would not wish to be
understood as implying that if the suggestions I have made are
adopted the resulting provisions would embody my ideas as to what
is required at the present time in relation to the matters with which
they deal. Far less would I wish to appear as other than opposed
to the bill as it stands and the philosophy which seems to me to
underly it.
I recognize the gross abuses that grew up in the period o± rank
and unhealthy development that followed the war, and I heartily
favor measures which will prevent or heavily penalize any repetition
thereof. I do not believe, however, that in order to correct these
abuses it is either necessary or wise to enact a law which threatens
so seriously to destroy the normal functioning of a business mechanism which has been built up over a long period and which cannot
be replaced overnight. On the contrary, it seems to me that in drawing such measures it is of the utmost importance to frame provisions
which, while having the required deterrent and punitive effects, will
not discourage the more responsible persons who will come under
the law, nor subject them to such unjustifiable burdens and hazards
as possibly to cause them to withdraw from the exercise of their
responsibility.
In my opinion the restrictive character of the pending legislation,
applying as it does to securities already listed, may profoundly decrease their present value and freeze a large portion of the Country's
liquid capital. The deflation and partial paralysis which this con
STOCK EXCHANGE PBACTICES
6699
notes is a condition which I am satisfied your committee would not
willingly help to bring about.
The CHAIRMAN. I t has been suggested that these provisions should
not apply to existing contracts.
Mr. ALTSCHOL. Oh, yes. I understand that, sir.
I make this argument not merely as a member of the New York
Stock Exchange but as a business man and investor profoundly
interested in the welfare of American business. In view of the
position which I have occupied and the practical experience which
I have gained with such matters as are covered by this memorandum,
I feel that I have the responsibility of expressing to you how profoundly I am convinced that the enactment of legislation such as
that contemplated by the bill under discussion would be an adverse
and deflationary influence tending to a great and unpredictable
extent to counteract the progress that has been made toward recovery.
Thank you very much for your patience, Mr. Chairman and
gentlemen.
Senator WALCOTT. May I ask you one question? Do you not think
that a bill that is as stringent as this, and which places such broad
powers in the lap of a Federal commission, whose personnel we
know today and do not know tomorrow, but which is changing from
year to year, would tend to disrupt an open market and force a
great many businesses, large and small, to be even more secretive
than they are now in their methods and as to what they are doing,
by keeping away from the stock exchange ?
Mr. ALTSCHUL. I think so, without question.
Senator WALCOTT. I do not think any point has been made of that
liere, and it seems to me that would be the natural effect of a bill of
this character, unless it were severally modified.
Mr. ALTSCHUL. I think that is true without any question. I think
much of the pioneer work the stock exchange has conducted in trying
to get information from corporations would be upset by many of
those corporations simply withdrawing into their shells and going
back into some sort of closely held private concerns.
There is just one other thought that I want to mention in connection with these accounting provisions. As you know, we discuss these
questions all the time with our consulting economist, because we are
not accountants ourselves, and try to get the best information we can
on these questions. Mr. May, of Price, Waterhouse & Co., or some
of the accountants, were going to come down and discuss some of
these questions with you, but there was one point Mr. May made in
discussion with me which I would like to bring to your attention,
because it is a very constructive feature.
He suggests that it might be possible to consider a rule for the
publication of quarterly reports, one of which should be audited,
leaving then, to somebody like the stock list committee, to decide
with respect to different companies and industries, which quarterly
report they wanted audited. That one, then, becomes part of the
annual report.
The advantages of that are, in many cases, practical, because today the year-end work on accountants is perfectly terriffic, and if
there were certain corporations whose business could be accounted
for better from July i to June 30, it would make accounting practice
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STOCK EXCHANGE PRACTICES
throughout the country much better, because the better men would
be available to do the work.
Mr. PECORA. In other words, they would stagger their work?
Mr. ALTSCHUL. They would stagger their work. And if, beyond
that, there were some discretion in changing the dates once in a
while, perhaps, you would get some of these benefits that you are
seeking in quarterly audited reports. Mr. May's suggestion specifically was four quarterly reports, one of which should be audited.
I think that is all I have.
The CHAIRMAN. Mr. Altschul, you will be back at 2 o'clock, please,
for a few minutes. Right after that we want to hear from the Baltimore people for about 15 minutes, and then Mr. Whitney will
resume.
The committee stands adjourned until 2 o'clock.
(Whereupon, at 1 p.m., Thursday, Mar. 1,1934, a recess was taken
until 2 p.m. of the same day.)
AFTERNOON SESSION
The committee resumed at 2 p.m. on the expiration of the recess.
The CHAIRMAN. The committee will please come to order. I believe Mr. Altschul is with us.
STATEMENT OF TR&NK AITSCHTIL, CHAIRMAN COMMITTEE ON
STOCK LIST, NEW YORK STOCK EXCHANGE—Resumed
Mr. PECORA. Mr. Altschul, on page 4 of your elaborated statement
on certain provisions of this bill, you say:
In my opinion no central body, whether the Stock List Committee or the
Federal Trade Commission, can possibly succeed in performing the functions
of the managements of all listed companies
Do you make that statement because it is your opinion that the
bill in question places upon the Federal Trade Commission, or purports to place upon the Federal Trade Commission, the responsibility
of the management of all listed companies?
Mr ALTSCHXTL. There seems to me to be in the bill a number of
provisions that are so far-reaching they would be a burden on the
administrative body, such a burden as would be very similar in many
cases to that of the management.
Mr. PECORA. What, for instance?
Mr. ALTSCHUL. If you take, for example, the various bits of information that are supposed to be furnished to the Federal Trade Commission as parts of the business of registration I have gone on the
assumption that they were not simply to be furnished for the purpose
of being filed, but were to be furnished because the administrative
body, whatever it is to be, was going to consider those things and
reach some conclusion in respect of them, and possibly take some
action or fail to take some action because of the conclusions they
reach.
The information that will be asked according to the bill is so farreaching in scope that it would seem to me that unless you conceive
of that body as a body that would be qualified to examine that information coming to them with an informed business judgment in
respect thereto, of the sort I would expect a management to exercise,
STOCK EXCHANGE PEACTICES
6701
it is difficult to see just what value it will be to them at all. And
if they are supposed to take some action after examining all that
material, with the background of informed business judgment in
respect of the material that comes to them, then their decision is
going to be one that a management in the first instance makes. I am
thinking particularly of the provision of the bill in regard to contracts and patents, which I have discussed rather extensively.
Mr. PECORA. The requirement of the bill that such information
be furnished does not necessarily mean that such contracts are going
to be left to the approval or revision or rejection of the Commission.
You understand that, don't you ?
Mr. ALTSCHXJI/ I understand that, Mr. Pecora, but I do not understand
Mr. PECORA (interposing). Those reports are called for in some
instances for their informative character, and for the enlightenment
they might give to stockholders and the investing public. Now, do
you feel that under those circumstances the provision requiring the
filing of such reports and information with the Commission is equivalent to placing upon the Commission the right as well as the burden, duty, and responsibility of managing the businesses of all listed
companies ?
Mr. Ai/TSCHUL. I went on the general assumption that in asking
for this information you are asking for information that is going
to lead to a decision by the Commission, whether in the course of 20
days or of 30 days, that registration will be granted or not. Just
to have all that data placed on file without its having any bearing
on the Commission's decision, would seem to me to be a burden that
was not warranted, unless it was going to influence the Commission's
decision, and that, therefore, the Commission would have to review
those different documents occasionally with that idea in mind, and
reach decisions.
However, that is not the only provision to which I am referring,
and it may have been a misinterpretation of mine, although I do not
think so.
Mr. PECORA. YOU say on page 5, no, near the bottom of page 4:
If there is anything in the application which appears to the committee to be
open to question—
Meaning the stock list committee of the New York Stock Exchange—
then the committee makes every effort to have the question resolved in accordance with its views; but we have conceived our chief responsibility to be to
see that the facts have been fuUy and adequately disclosed, and if this disclosure indicates nothing which appears to the committee to be unsound or
improper, we do not undertake an independent investigation of the facts
themselves
Now, you are referring there, I think, particularly to the procedure of the committee in passing upon applications for additional
listings, aren't you?
Mr. ALTSCHTJL. Well, I think that refers m general to all applications.
Mr. PECORA. Well, how could you possibly tell without inquiry if
the facts you desire have been not only fully disclosed but truthfully
disclosed?
6702
STOCK EXCHANGE PBACTICES
Mr. ALTSCHTJL. Well, of course, that is a thing we can only tell
about on the basis of our experience, and I think our experience
justifies us in the belief that by and large thejr are fully disclosed.
However, anything that could be introduced into legislation that
would make assurance doubly sure, such as some punitive provision
of this legislation in regard to making a false statement, I think
would be very welcome. I do not know whether that answers your
question or not.
Mr. PECORA. On page 5 you say further:
I recognize that abuses have grown up about the market place which require
correction in order that the public may be afforded proper protection, and I
believe that the object of far-sighted legislation should be to afford such protection while placing as few obstacles as possible in the way of the normal
functioning of this important part of our economic mechanism.
What were the abuses you had in mind when you wrote that?
Mr. ALTSCHUL. Well, that was a very general sentence. I had in
mind not only the particular abuses that have occasionally cropped
out in connection with listing activities, but I had more generally in
mind the various abuses that have grown up in the market place itself
and which Mr. Whitney suggested a means of dealing with through
this body that he has recommended be set up; I mean that he himself has recommended in his memorandum. That covers practically
the whole field of stock-exchange activities as I see it. And in whatever field abuses have occurred, as I have read his recommendations,
machinery was to be set up for coping with them. And large numbers 01 them are being coped with by the stock exchange today.
Mr. PECORA. What my question was more particularly designed to
elicit was your own view based upon the advantages 01 the observations you nave had as a member of the exchange, as well as a member of one or more of its committees, as to just what the abuses were
that you think have grown up about the market place and which
require correction in the public interest. In other words, in order
that the Congress might properly deal with the abuses, I should like
to know what the members of the exchange themselves think the
abuses are
Mr. ALTSCHUL. I think some of them have been brought out in
your own investigation. The recently adopted rules of the exchange
are an attempt to deal, as I understand it, with some of those abuses.
I do not know whether I could undertake to make an inventory for
you at this moment of them, but, for instance, the rule of the exchange recently adopted preventing participation in pool operations by specialists. That obviously was aimed at that kind of abuse
which had been brought to the attention of the Government, and
it was acted upon.
Mr. PECORA. Couldn't you enumerate the abuses that have grown
up about the market place which requires correction in your opinon?
Mr. ALTSCHTJL. Well, Mr. Pecora, I did not come prepared for
that. I came to deal fully with stock listing questions. I should
really want to be much more fully informed of the testimony which
has been brought out in these hearings to attempt to deal with that.
I think if you will permit me I will just glance through these sug-
STOCK EXCHANGE PRACTICES
6703
gestions which Mr. Whitney made in regard to the power that
might be given to the body he suggested. For instance, he suggests:
The inclusion in the power given to this body of authoiity to regulate the
amount of margin which members of exchanges must require and maintain on
customers' accounts
But I am going a little off my beaten path and I hope you will
pardon me.
Mr. PECORA That is what I want you to do.
Mr. ALTSCHTJL. An attempt has been made m the bill to deal
with the question of margin in a rather rigid manner. I t seems to
me that a very strong argument could be made there, as in the
case of the most of these provisions, for flexibility. If you take, for
instance, an illustration from another field: No law provides rigidly
that Federal Keserve banks should establish a certain discount rate
and that that should be maintained. The discount rate is changed
from time to time m accordance with conditions. In the same way
it would seem to me quite reasonable to have a provision that margin
requirements should not be made rigid but left capable of being
adjusted from time to time m order to accommqdate itself to the
day-to-day or month-to-month development m the speculative market. In that case when things get to a point where the margin requirement should be obviously raised, the power would be vested
in some authority to raise the margin requirement; and when the
time came for the enforcement of such a margin requirement, when
such a high margin requirement we might say was no longer necessary or desirable from the standpoint of economy as a whole, then
there should be authority in some board to adjust it downward again.
Mr. PECORA. Don't you think it would be in the public interest
that there should be a minimum margin requirement embodied in
the statute, without reference to any particular minimum now? I
am addressing myself to the principle of including in the bill a
provision for a minimum margin requirement, with a degree of flexibility above that minimum.
Mr. ALTSCHUii. Are you speaking now of a minimum margin requirement on accounts as a whole ?
Mr. PECORA. YOU might classify them in any way you see fit. But
I am addressing myself to the principle of some minimum margin
requirement, either one which will apply to all margin accounts or
where the minimum might vary in accordance with the necessities of
individual kinds of securities or bases of securities.
Mr. Ai/rscHUii. Of course, you will understand I am very much out
of my field here, because I do not know anything about the margin
business as such. Therefore I hesitate to express a very positive
opinion in regard to the matter. But it would seem to me that a minimum, if set sufficiently low to allow of a reasonable degree of flexibility to the body that was finally or from time to time to determine
the minimum amount of accounts as a whole, would be a reasonable
provision.
Mr. PECORA. Can you suggest what the minimum should be ?
Mr. ALTSCHIIL. I could not. I think the experience of those in the
stock exchange, who deal with margin questions from day to day,
would be much more valuable to you as a guide than any suggestion I
might attempt to give you.
175541—34—PT 15
19
6704
STOCK EXCHANGE PBACTICES
Senator KEAN. Let me suggest if that were the law, and a stock of
a customer went down below that minimum, of course, you would
have to sell him out at once, just because that would be the law.
Mr. PECORA. YOU would have to sell him out in accordance with
the rules and regulations the commission may prescribe under the
terms of this bill, Senator Kean.
Senator KEAN. I say, you would have to sell him out at once.
Mr. PECORA. That is what brokers do anyway when their customers' accounts become undermargined. They sometimes send them
an hour's notice, and unless they make good they are sold out.
Senator KEAN. But as a rule a broker tries to get them to put up
an additional margin, and if the quotation is only a very small
amount below the margin, 1 percent or something of that kind, why,
they may carry him over for a short time. But they could not do it
if there were a rigid minimum provided in the law.
Mr. PECORA. AS brokers see the market for the stock being approached, don't you think the broker would be keen to remind his
customer and suggest that he put up additional margin so as to
protect his accountsrom becoming undermargined ?
Senator KEAN. Surely. But very often there is a sudden drop m
the market and a man may be under a little bit, and if you send him
notice and he cannot get around until the next day, the broker carries
the account over with the idea that the market will go up again,
which it generally does after a bad break.
Mr. PECORA. That might be an argument for a minimum margin
requirement which would be substantial so as to lessen the danger of
that point being reached
Senator KEAN NO. I t does not make any difference what your
margin is, if it is the law that a broker shall not carry an account
below the minimum margin. He would then be in duty bound to
sell his customer out. He could not wait.
Mr. PECORA. That, I think, would be putting into a law what has
actually been done in practice.
Senator KEAN. I do not think so.
Mr. PECORA. Except, perhaps, under the power given to the Federal Trade Commission to prescribe rules and regulations for the
selling out of an account of a customer, he might get a better break,
so to. speak, than he gets now from a broker.
Senator KEAN. Well, I know lots of people who do not sell people
out right away.
The CHAIRMAN. Wouldn't this provision be rather a relief to the
broker ? In other words, he could answer any complaining customer
that the law required hum to make the sale and not expect him to
put up a margin.
Senator KEAN. That is true, but it would be pretty hard on the
customer. For very often while the market may drop suddenly, it
may come back again and never drop that low again for a long time.
Mr. ALTSCHUL. I think that Senator Kean's point just again illustrates the dangers of rigid provisions, whatever they may be, because
circumstances change from day to day and a rigid provision which
might be put into a bill with the idea of protecting the investor
might by accident result otherwise.
Mr. PECORA. Heretofore brokers themselves have arbitrarily fixed
minimum margin requirements and imposed those requirements
STOCK EXCHANGE PBACTICES
6705
upon their customers. There hasn't been any hard and fixed rule
about that. I t is left to the arbitrary judgment or determination by
each broker, except within the limits of the rules recently promulgated by the New York Stock Exchange. Now, the investing public
has been at the mercy of this arbitrary determination about margin
requirements fixed by brokers themselves.
Mr. ALTSCHUL. Well, of course, as I say, you are now taking me
out of my own field.
Mr. PECORA. Well, if you prefer not to go out of your field, I do
not think it would be fair to ask you to do it.
Mr, Ai/DSCHUii. Well, I know very little, in fact, I might say I do
not know anything about the margin business.
The CHAIRMAN. YOU may proceed, Mr. Altschul.
Mr. ALTSCHUL. The second point that Mr. Whitney makes is:
Authority to require stock exchanges to adopt rules and regulations designed
to prevent dishonest practices and all other practices which unfairly influence
the prices of securities or unduly stimulate speculation
Again the striking thing about that suggestion is that it vests m
somebody a degree of flexibility. And my argument throughout has
been that the danger of rigidity in all these things is easily apparent.
That is, the practices which you may want to regulate, or which
may arise, you do not contemplate the stock exchange is very
alert about and is trying to prevent them. I t is in sympathy with
legislation that will tend to prevent practices which may unfairly
affect prices of securities.
Mr. PECORA. On that point it might be well to recall that yesterday afternoon Mr. Whitney informed this committee that one or
more rules promulgated by the New York Stock Exchange on February 13, last, was or were the result of several years' consideration
of the subject. Senator Bulkley then asked him what opposition had
been expressed to the formulation of the particular rule that was
then under discussion, and Mr. Whitney said, " None, that he knew
of." So, apparently, with regard to a rule as to which there was no
opposition it required several years' consideration before it was promulgated.
Mr. ALTSCHUL. Mr. Pecora, I do not want to try to amplify or
change the draft of Mr. Whitney's remarks, and I am not sure that
I understand the situation correctly. My recollection of that was
that he said the particular transaction had been undertaken within,
oh, the last 6 months, and the information elicited by the business
conduct committee, which gave them facts upon which they could
proceed. While the thing had been under discussion, the actua?
incidents that led to the reform were much more recent than that*
Isn't that correct?
Mr. PECORA. I am simply calling attention to the statement Mr.
Whitney made. He was the one who said that the rule was the outgrowth of several years' consideration of the question.
Mr. ALTSCHUL. Well, I am not familiar with that.
Mr. PECORA. NOW
Mr. ALTSCHUL (continuing).
Mr. Pecora, I think when any body
such as the one suggested by Mr. Whitney, is vested with the right
to do the definite things that Mr. Whitney suggests should be done,
you will accomplish the maximum amount of good with the mini
6706
STOCK EXCHANGE PRACTICES
mum amount of disturbance. And the reason for that, I want to
repeat, is because it leaves the thing flexible, and because it does
not crystallize in law at the given moment a number of rules which
might be totally inadequate tomorrow.
Mr. PECORA. NOW, just one or two more questions about the statement that appears on page 20 of your elaborated printed statement.
You say:
I recognize the gross abuses that grew up in the period of rank and unhealthy development that followed the war and I heartily favor measures
which will prevent or heavily penalize any repetition thereof
Now, again, I want to ask you what were the gross abuses that
you had in mind when you penned that particular portion of your
statement.
Mr. ALTSCHXTL. Well, broadly speaking, I would say all the devices
that developed which took on the nature of the fomenting of undue
speculative activity. But my general idea is that speculation is a
necessary part of an economy that functions as ours does, and that
a stock exchange is a place where that speculative impulse should
be allowed to express itself freely.
Mr. PECORA. YOU say freely.
Mr. Ai/rscHuii. Yes; should be allowed to express itself freely.
I think that while criticism may be leveled at speculation as such,
there are times when the normal expression of the country takes a
speculative turn. It may be necessary as a preliminary to recovery.
I t may be necessary as a concomitant of a new period of forward
movement and growth. When you get beyond that normal expression of speculative impulse that finds its urge in developing economy
itself, and get into the different things that tend to foment it in an
unnatural and exaggerated manner, those things generally constitute the abuses I was talking about. Some of them have been dealt
with; yes, many of them I think have been dealt with; bujb they may
take new forms tomorrow, and I think it onljr fair that somebody
should have a change to review them as'they arise.
Mr. PECORA. I want you to enumerate what you call in this portion
of your statement:
the gross abuses that grew up in the period of rank and unhealthy development
that foUowed the war.
Mr. AiiTSCHuii. I think that the testimony given before your committee has brought out a good deal of information in regard to the
speculative devices of trading against options, pool activities, and so
on. I am not familiar with that testimony, and as to the most of it
with me it is a matter of hearsay. But from what I have heard there
is abundant evidence in that investigation to point to the character of
the abuses I have in mind. They are mostly things that would be
covered now by the recent regulations of the exchange, having to do
with its operations.
Mr. PECORA. YOU recognize don't you, that the rules and regulations of the exchange are binding upon and enforceable only
against its members, and that those same abuses might be perpetrated with similar detriment to the public interest by persons not
connected with the exchange as members, but who employ the facilities of the exchange through brokers who are members. Now, in
view of that, those abuses could only be dealt with, by legislation,
STOCK EXCHANGE PEACTICES
6707
m order to reach all classes of persons, whether members of exchanges or nonmembers, who were guilty of such abuses; don't you
think so ?
Mr. ALTSCHUL. I may be again speaking out of turn, but I would
say that insofar as the exchange has recognized an abuse and tried
to deal with it and to prevent it 30 far as its members are concerned, I cannot conceive that it would be otherwise than welcome
if others were prevented by law, if they were prevented from indulging in abuses our own members cannot indulge in.
Mr. PECORA. Well, you realize that a law could not be made to
apply simply to nonmembers of the exchange.
Mr. ALTSCHUL. Oh, no.
Mr. PECORA. I wish you
would enumerate what you conceive to
be the gross abuses that grew up m the period following the war.
Mr. AMSCHUL. Well, that, of course
Mr. PECORA (continuing). Instead of referring us to the record
of this committee's investigation, which covers thousands and thousands of pages and millions of words. In other words, I should like
to have the public, as well as the members of this committee, get the
benefit of your observations and your knowledge with regard to those
gross abuses, and get it in a phrase or two from you by means of your
enumeration of those abuses. You cannot expect the public to read
those thousands of pages of testimony taken by this committee.
Mr. ALTSCHUL. Well, of course, I have the feeling that the thousands of pages of testimony taken before the committee have been
very well summarized to the public almost daily through the press.
But apart from that, if I had come here with a view to speaking
about topics beyond the particular scope of the committee on stock
list, I would have tried to prepare for you a statement on that point.
On short notice I would hesitate to do so, because I would be afraid
I might include something I should not include, or leave out something that possibly I should include.
Mr. PECORA. I thought you had already given some consideration
to the development soon after the war because of the reference you
made in your prepared statement of a recognition of those " great
abuses " ?
Mr. ALTSCHUL. I have given a great deal of consideration to it,
but before such a body as this I would hesitate to try to put that
consideration into words on short notice. In general, I would consider within the category of abuses the different things which tend
to unduly foment speculation and which would affect natural and
normal development.
Mr. PECORA. DO you think that margin requirements have that
tendency—I mean, to unduly foment speculation ?
Mr. ALTSCHUL. No. I do not think that margin requirements have
a tendency to unduly foment speculation any more than I think
the discount rate of the Federal Reserve Board has a tendency to
foment business.
Mr. PECORA. Why did the exchange authorities themselves during
the first 6 months of 1929, or rather the individual members of the
exchange, raise their margin requirements in a manner that created
a minimum or an average of 40 percent of the market price of
securities then being traded in by the public as their margin?
6708
STOCK EXCHANGE PEACTICES
Mr. ALTSCHUL. Well, I do not believe that normal margin requirements unduly foment speculation. But I think it is quite
apparent that as speculation develops a tightening of margin requirements is a force that operates against speculation.
Mr. PECORA. Against the practice of undue speculation?
Mr ALTSCHUL. It ought to be, I think; yes, it ought to be anyway,
in my opinion.
Mr. PECORA. Very well. Now
Mr. ALTSCHUL (continuing). In the same way again as the raising of the discount rate to a very high rate tends to slow up business
at a time when business has gotten out of bounds. It seems to me
the mechanism is very similar in character. But we have evidence
before us that a low discount rate itself, when conditions are unpropitious, does not start a business revival.
Mr. PECORA. YOU add a saving clause to your answer, when conditions are not propitious.
Mr. ALTSCHUL. Yes. I do not think that low margin requirements
or normal margin requirements, whatever they may be, will of themselves stimulate speculation if there is no disposition because of
other circumstances for more speculation to develop.
Mr. PECORA. It might prevent giving impetus to speculation that
would make it necessary to apply a brake with such sudden force
and energy that the cart might be overturned.
Mr. ALTSCHUL. Oh, yes. But I again point out there that I do
not think speculation is of itself under all circumstances a necessarily
evil thing. On the contrary, it may be a very necessary thing at a
time when business is liquidated and revival is being sought; and
there may be a good many reasons why margins and speculative impulses are nothing more than a symptom of revival and growing
economy.
Mr. PECORA. Well, if you think that speculation should be permitted do you think it should be permitted on a broad scale with
other people's money?
Mr. ALTSCHUL. I know of no reason why a person should not borrow other people's money and use it to finance purchases of securities, just as he does to finance purchases of real estate. The only
important thing is whether the loan is secure in that case, and beyond
that, of course, the question whether the amount being used in that
manner is growing so unduly in regard to the economy as a whole
as to create disturbance in the business structure. Those are things
that the Federal Reserve, cooperating with some other organization,
such as Mr. Whitney suggested the creation of, could be dealt with
in that manner.
Mr. PECORA. Let us confine ourselves to the stock market. Do you
think that speculation in that mart should be encouraged with other
people's money ?
Mr. ALTSCHUL. When you use the words " should be encouraged"
Mr. PECORA (interposing). That is, encouraged by low margin
requirements, by lowering your margin requirements more, and on
other people's monev that the speculator uses in his particular operations ; isn't that so ?
Mr. ALTSCHUL. Well, I don't think so. When you say " lower
margin requirements " you are using a relative term.
STOCK EXCHANGE PEACTICES
6709
Mr. PEOORA. Yes; I am.
Mr. Ai/rscHuii. Take, for instance, the normal requirements in
normal times of the stock exchange. I think if those normal requirements are enforced at times when there is great speculation
and when there is very little speculation, the fact that they exist,
in my opinion, does not stimulate speculation any more than the low
discount rate stimulates business. To follow your thought in regard
to this bill, I think speculation, which may be a perfectly normal
concomitant of our economy in its early stages, or as it runs
along, may at some stage reach a point where for many reasons it
may be dangerous or is threatening to become dangerous, and at such
a time ability to change the margin requirements, by reason of flexibility vested in some such authority as Mr. Whitney has suggested,
would be a very helpful thing.
Mr. PECORA. Well, it is a rather trite thing to observe that the
lower the margin requirement the greater the temptation to the
speculator to speculate. If a person desiring to speculate in the
stock market is required to put up his own funds only to the extent,
say, of 20 percent of the purchase price of the security he is buying,
he would buy twice as much as if he were required to put up 40 percent. I think that is obvious.
Mr. ALTSCHUII. It is a trite observation, I concede, but I think it
is an inaccurate one.
Mr. PECORA. Why?
Mr. AiiTSCHuii. Because I do not think that the fact that the
margin requirements are low is in itself a temptation to speculate.
Mr. PECORA. YOU think the temptation to speculate is inherent in
the person who speculates?
Mr. ALTSCHTJL. No; I think the temptation to speculate is either
inherent in the situation or is not inherent in the situation. I t
emerges at times in response to all sorts of factors.
Mr. PECORA. I S not the volume of speculation engaged in affected
by the margin requirements?
Mr. ALTSCHUL. There is no question about that; I agree on that.
Mr. PECORA. That is the only point I was trying to make.
I have no further questions.
The CHAIRMAN. That is all. You may be excused now, Mr.
Altschul.
STATEMENT OP RICHARD WHITNEY, PRESIDENT OF THE NEW
YORK STOCK EXCHANGEr-Resumed
The CHAIRMAN. Proceed, Mr. Whitney, where you left off when
you were interrupted.
Mr. PECORA. YOU gave up to Mr. Altschul for the purpose of taking up listings requirements.
Mr. WHITNEY. May I point out with regard to the matter recently
discussed, about margins, that I think Mr. Pecora has the wrong
impression that the exchange had no requirement as to margin
during the panic and that brokers themselves raised their margin
requirements at will. The exchange did have a minimum requirement. Brokers did also raise at will their margin requirements.
I think it is fair to point out, because it is interesting, at least, perhaps, that in spite of the margin requirements, the raising of them
6710
STOCK EXCHANGE PRACTICES
by the brokers at their volition, nevertheless speculation continued
in even greater and greater sum total in spite of those increased
margins.
Mr. PECORA. Because of the mania that then afflicted the speculating public?
Mr. WHITNEY. Quite right, sir. Mr. Altschul also said that the
surrounding conditions had a very great bearing on the situation,
and the imposition of higher margins did not, though perhaps it
would have been desirable—perhaps it was the idea back of the
brokers raising their margins, but it did not prevent the increase of
speculation; which is just what I tried to show to you yesterday.
Mr. PECORA. That might have been due to the fact that the impetus which had been given to speculation because of the ease and
facility with which persons could engage in it with money that did
not belong to them had become so strong and so great and powerful
that when you tried to apply the brakes they were burned, and the
result was that we had a wreck; the car crashed into a tree and went
into the ditch.
Mr. WHITNEY. YOU have argued here—and I have not taken exception to it, because I think it is a part of the entire situation that
has a very direct bearing upon it-—but you have, I think, argued
here that the use of higher margins will stop speculation just at
those times when it should be stopped; but I am stating, purely as
a matter of interest, the facts as I remember them happening in 1929
in that particular regard, merely in passing.
Mr. PECORA. But I am not confining myself to a consideration of
what was done with regard to the raising of margin requirements in
1929. The thought that I am suggesting is that the reason that
those increased margins proved ineffective to reduce or control the
excessive speculation that undoubtedly went on was because prior
to 1929 brakes had not been applied and the economic machinery of
speculation had attained a speed, through the impetus given to it
throughout the preceding 2 or 3 years of the so-called " bull market",
that when the attempt was made to apply the brakes the brakes
either proved ineffectual or they were burned out. The desirable
thing would be not to permit the economic machinery to reach that
dangerous rate of speed where the sudden application of brakes
would be ineffectual or would only bring a stoppage with a serious
jolt to the occupant of the car.
Mr. WHITNEY. Then no brakes are effective.
The CHAIRMAN. Oh, yes.
Mr. PECORA. The bralces
will be effective if the rate of speed is
not permitted to grow without limit.
The CHAIRMAN. The same thing happened, according to the admission of the Federal Reserve Board, when they were late m checking
this undue inflation. If they had started earlier, they might have
prevented it.
Mr. WHITNEY. True, sir.
Senator KEAN. The stock exchange has existed for how long ?
Mr. PECORA. A hundred and forty-two years.
Mr. WHITNEY. Thank you. A hundred and forty-two years.
Senator KEAN. During that period margins were never called for
beyond 20 percent, during all that period ?
'Mr. WHITNEY. I do not think so, Senator.
STOCK EXCHANGE PRACTICES
6711
Senator KEAN. Until this last time.
Mr. WHITNEY. We have had very serious panics during those 142
years, besides the one in 1929.
Senator KEAN. SO that the business has gone on successfully and
has developed, and our industries and our railroads and our various
industrial activities have increased all during those years with the
assistance of floating securities, without any trouble ?
Mr. WHITNEY. Very materially; and I think speculation has played
a very important part in the setting-up of our corporations and our
industries throughout this country; our railroads perhaps more than
any others.
Mr. PECORA. The fact that the country has continued and has recovered from these various panics and depressions is comparable to
the experience of the average human being, that in the course of his
lifetime he runs into periods of lUness and recovers from them—
which is no reason why such illness should not be averted if it can be.
Senator KEAN. That is correct; but, Mr. Whitney, is it not true,
also, that nobody in the world has yet succeeded in preventing upturns and downturns of the market, owing to the financial conditions that occur all over the world ?
Mr. WHITNEY. I do not know of any formula that has ever been
devised; and I think we would be the first to like to see such a
formula.
Senator KEAN. I S it not also true, Mr. Whitney, that during the
war there was a tremendous amount
of capital destroyed, and that
therefore the world had less capital1 to operate on, and that to try to
bolster up things various governments expanded credit in every way
they could so as to try to keep prices level with what they were
before the war?
Mr. WHITNEY. I think that is true.
Senator KEAN. And when the final crash came it was a question
of a large percentage of the savings of the world, of the capital of
the world, having been destroyed, and we had a new measure of
value to which everything had to be regulated ?
Mr. WHITNEY. I think that is so.
Mr. PECORA. IS that all with the purpose of suggesting the thought,
Senator Kean, that stock market speculation had nothing to do with
the panic and with the depression since 1929 ?
Senator KEAN. That is only an incident. The price of wheat, the
price of land, the price of houses, the price of everything else all
over the world had to go down to be measured by the loss of capital
which had been destroyed in the war.
Mr. PECORA. Senator, I shall be able to bring to your notice, and
I propose to do it at the proper time, public expressions of opinion,
not only by Mr. Whitney but by his predecessor, the president of
the New York Stock Exchange, in which they very frankly avowed
the responsibility of the speculation mania which preceded October 1929, before the depression—not the sole responsibility, but as a
contributing factor.
Senator KEAN. Did that affect the prices in France?
Mr. PECORA. Did what affect the prices in France ?
Senator KEAN. The speculative mania on the stock exchange in
New York.
6712
STOCK EXCHANGE PEACTICES
Mr. PECORA. Insofar as the whole world is more or less interrelated in an economic system, I venture to say it had its repercussions
in France and every other land with which we do business.
Senator CARET. What percentage of margin do the New York
banks require when a person makes a loan on securities with a bank?
How much will they loan ?
Mr. WHITNET. At the present time, and taking the same stock that
we demand 30 percent on debit balance for, their requirement is 30
percent of the loan.
Senator CAREY. SO if we put a limit on the stock exchange, a man
will probably go to a bank and borrow on the securities?
Mr. WHITNEY. I believe so. As I granted yesterday, it might
make it more difficult. Perhaps various things would be looked into
by the bank, and there might be other agencies built up that would
loan to him.
Senator CAREY. IS there a limit in the bill as to banks ?
Mr WHITNEY. The limit in the bill is the same as brokers with
relation to securities listed and members of security exchanges.
Mr. PECORA. If the borrowing is for the purpose of buying securities; yes But the bill provides that a man may go to a bank and
borrow on collateral to an extent exceeding the so-called " margin
requirements " in the bill, provided the securities that he offers as
collateral have not been purchased by him within 30 days prior to
the time of the borrowing.
Mr. WHITNEY. Thereby not allowing to such borrower any power
of substitution of those securities that he might during that period
buy.
Mr. PECORA. And thereby not allowing the borrower to overcome
the margin requirements of the act.
Mr. WHITNEY. There is one point, Mr. Pecora—I did not think we
were going to get into an economic discussion here—that I do think
has a very great bearing, and I would like to state it, on all boom
and panic periods, and I think it is fundamental, and that is that
the earning power of corporations is bound to be reflected in their
price; when they have good earnings, in an increase in price, and
when they have bad earnings, a decrease. There is nothing in the
world, to my knowledge, that is going to prevent prices going up,
whether there is speculation or not, if the earnings of the corporation
are great; and there is nothing in the world to prevent the prices of
the shares of corporations going down if they fail to earn money.
Mr. PECORA. But those increases in price, where they are based
upon actual earnings, and hence corresponding increases in earnings,
would be justified by sound economic factors; but where the increases
in price are brought about solely by speculation, I venture to say
that your own opinion and belief is that those increases in price
levels of securities are not wholesome.
Mr. WHITNEY. Yes; but the period of time one is talking about,
whatever time, naturally has its direct effect upon all corporations.
In other words, the general tendency is to earn money, and there are
good times for the corporations That brings others perhaps not in
that category, and vice versa
Mr. PECORA. The moneys earned, whether realized or translated
from paper profits into actual profits during the speculative mania
that preceded 1929, were not reflected in the earnings of corporations,
STOCK EXCHANGE PEACTICES
6713
as has been pointed out in documents issued by the stock exchange
itself.
Mr. WHITNEY. I have a document here, if I may put it into the
record, which shows composite earnings index of 166 companies from
the first quarter of 1929 to the last quarter of 1933, and on it also is
shown a monthly average of weekly stock price index of 421 stocks.
During that period—it shows the height of the boom period and the
depth of the depression—earnings fell faster and farther than did
prices, and when earnings started to improve so did prices start
to improve; but earnings went faster than prices. I merely bring
this in, sir, as having a very important bearing upon a subject
which is one of economics and in which there are many, many
factors, as I think everybody will agree.
The CHAIRMAN. DO you wish that inserted in the record ?
Mr. WHITNEY. I would like to have it in the record, Mr. Chairman.
The CHAIRMAN. I t will be admitted.
(Photostatic copy of a graph showing monthly average of weekly
stock price index for 421 stocks and a composite earnings index of
166 companies was received in evidence, marked " Whitney Exhibit
No. 1, Mar. 1, 1934 ", and will be found reproduced at the end of
today's record, in the committee's copy thereof.)
The CHAIRMAN. I think, Mr. Whitney, that the ordinary buyer
of stocks of corporations on the market has very little conception
of the actual earnings of those corporations. He just buys because
it is his disposition to speculate, or what not; he does not go to the<
trouble to find out the actual, real value of stocks by the earnings
of the corporation. Is not that true generally of the ordinary
buyer ?
Mr. WHITNEY. Mr. Chairman, I will agree that that may be more
or less true, certainly in a period when the country is swept by a
speculative mania. I think, during the times we have been passing
through in the last 3 years or more, where he have seen the perfectly
extraordinary increase in the number of stockholders in our larger
corporations, where speculation was largely nonexistent, as shown
by the debit balances of brokerage firms, those people have bought
because they had faith in the companies' prospects, or on what they
believed was a particular company's earning power. I do not think
that those purchases were made from a speculative point of view
at all. We have had perfectly terrific increases in the number of
stockholders who own their stock and in whose name the stock is
registered and for which cash was paid, and it was not bought on
borrowed money.
Mr. PECORA. Has not that been due in part to the necessity for
large holders of stocks to dispose of their holdings ?
Mr. WHITNEY. There is always a seller for every buyer; yes.
Mr. PECORA. But you are putting the emphasis on the larger number of stockholders.
Mr. WHITNEY. I do not know any facts to verify your statement.
It may be true.
Mr. PECORA. DO you think it is a violent assumption, based upon
your own observations & You know there have been disbursals of
large holdings of stock in the last 3 or 4 years.
Mr. WHITNEY. Yes; but I think that takes place at all times.
6714
STOCK EXCHANGE PBACTICES
Mr. PECORA. Exactly. Don't you think it has been much more evident in the last 3 or 4 years ?
Mr. WHITNEY. I don't know, if you are asking my personal
opinion.
If I may proceed, we come to section 14 of the bill which purports
to make it illegal for any person to use the mails or any means of
interstate communication or transportation for the purpose of making a market in any security whether listed on a national exchange
or not; in which, as I see it, complete control is given to the Federal
Trade Commission on over-the-counter or outside market transactions.
That has been very fully gone into by Mr. Corcoran and I think
there is but one point that I can add. As I see it, this gives to the
Federal Trade Commission complete power to regulate the trading
of State, county, municipal, and other governmental bodies, other
than the United States Government, complete power to regulate
the markets and how they shall be conducted in the indebtednesses
or bonds of States and municipalities. I think that is a very dangerous power to give anybody, and might work to the terrific detriment of those particular governmental bodies.
Mr. PECORA. D O you know how markets are made generally in
the over-the-counter market on securities that are traded in?
Mr. WHITNEY. Specifically, in what type of securities?
Mr. PECORA. Take any type that you want to use as an illustration
of how markets are made m the over-the-counter market.
Mr. WHITNEY. Well, we will take JSTew York State bonds. There
are, I suppose, 5, 10, or perhaps 15 organizations—oh, there are
more, but there are that many that deal actively and largely
Mr. PECORA. Sort of specialize m it?
Mr. WHITNEY. Yes—in that type of securities. They make bids
and offers and they very often send out lists as to their bids and
offers. I am not sure they do it now, on account of the Federal
Securities Act. Of if you inquire over the telephone, they will
give you a bid and offer on these securities; and that is based
largely on the question of the rate and worth of money at that
particular time, taking into consideration, of course, the standing
of that particular governmental body.
Mr. PECORA. There was some testimony presented to this committee last February—I think the witness whom I have in mind
especially was a broker named Robinson who gave some rather
illuminating testimony on how the over-the-counter market was
operated. Do you happen to have read his testimony? I know you
were down before the committee just about the time he was testifying.
Mr. WHITNEY. NO ; I do not think I read it.
Mr. PECORA. YOU may have heard him testify.
Mr. WHITNEY. I do not think I read it.
Mr. PECORA. Well, it is in the record.
Senator GOLDSBOROTJGH. With regard to section 14, relating to
over-the-counter markets, do you mean that that section would make
it practically impossible to control the activity of nonmember dealers
and that it would create a bootleg market ?
Mr. WHITNEY. I will take it from two points of view. If the bill
is enacted in its present form it would give the Federal Trade Commission, as I see it, complete authority to pass rules and regulations
STOCK EXCHANGE PRACTICES
6715
with regard to over-the-counter markets in securities not listed; and
I also feel that there is a very real danger that listed securities might
be dealt in over the counter in bootleg markets, as you say; and as
has been stated here by others, I think it very probable that under the
conditions of this bill with reference to what you spoke about this
morning, the imposition of rules and regulations upon corporations
in order to be listed, their shares would also go into the bootleg or
over-the-counter market.
Mr. PECORA. Mr. Whitney, if section 14 were to be modified so as
to exclude from the operation of this provision Government bonds.
State bonds, or bonds issued by any political subdivision, what would
you say then?
Mr. WHITNEY. That would be progress in the right direction.
The CHAIRMAN. Has the New York Stock Exchange any rules or
regulations with respect to open-market operations?
Mr. WHITNEY. I do not know just how to make myself perfectly
clear to you. Our rules apply in the conduct of our members
wherever they operate; but as to the securities that they shall
deal in over the counter there is no rule, sir, if that is what you mean.
The CHAIRMAN. Yes.
Senator CAREY. DO you
not read the bill to prevent anybody from
selling any securities that were not listed on the exchange?
Mr. WHITNEY. A S the definition now is, I think it would be subject
to some review in a court as to whether that would not be so. Certainly one would be at his peril in selling any security over the
counter unless done under the provisions set forth by the Federal
Trade Commission, whatever they may be. They are not cited here.
Senator GOIJ>SBOROTJGH. I gather from what you say that the market would be somewhat affected for municipal bonds and equipment
trust certificates, bank stocks and insurance stocks?
Mr. WHITNEY. Very materially affected; yes, sir.
Senator KEAN. Would it not be practically impossible to trade in
them?
Mr. WHITNEY. I think it would be impossible for any member
of the securities exchange to trade in them, many of whom specialize, as part of their business, in that type of market. I t happens
to be true of myself. Therefore, I refrain from making any particular objection to it.
Senator KEAN. I t is true of me, too.
Mr. WHITNEY. Section 15 comes under the remarks that Senator
Goldsborough made this morning, in that it deals entirely with" transactions by directors, officers, and principal stockholders of corporations and is very broad in its effect.
Section 16 requires every member of an exchange and every person transacting business, and so forth, to keep accounts, books and
records such as the Federal Trade Commission may require.
Mr. PECORA. Pardon me, Mr. Whitney, but have you any opinion
to express with regard to the provisions" of section 15 ?
Mr. WHITNEY. We entirely approve, and as we suggest in offering
the Federal incorporation law as a suggestion, we believe that anything to control dishonest acts should be done in that direction.
But this is very broad. It goes into detail under which, in my belief,
it would be extremely difficult for a management to operate.
6716
STOCK EXCHANGE PRACTICES
Frankly, I do not think that such a subject should be incorporated
in a stock exchange bill.
Mr. PECORA. YOU recognize the difficulty of any speedy enactment
of the Federal incorporation law, do you notf I t has been adverted to by representatives of the exchange who have already
appeared beiore us.
Mr. WHITNEY. I do not know, sir, whether such a bill has ever
been presented in either the Senate or the House for consideration.
Mr. PECORA. N O ; but there are very serious legal constitutional
questions that are involved in that.
Mr. WHITNEY. Yes; I think there are very serious questions probably involved in the passage of any bill, just as I think we find very
difficult questions arising in the consideration of rules and regulations to be adopted by the exchange.
Mr. PEOORA. YOU am suggesting, if I correctly understand you.
that the provisions of section 15 should not be found in a measure of
this character?
Mr. WHITNEY. And other provisions.
Mr. PECORA. They more logically should find lodgment in a Federal incorporation bill? Is that the point you are making?
Mr. WHITNEY. Yes.
Mr. PECORA. If there is a rainstorm, and an umbrella is not handy,
% newspaper might sometimes give shelter temporarily, anyway?
Mr. WHITNEY. Possibly.
Senator GOLDSBOROTJGH. Under section 16 to which you referred a
moment ago, the records of corporations are subject to inspectors,
are they not, by the Federal income-tax representatives ?
Mr. WHITNEY. Oh, yes.
Senator GOLDSBOROUGH.
Are the people who are to be so inspected
required to pay the expense of the inspectors ?
Mr. WHITNEY. NO, sir. I was coming to that. I think this imposes a very, very severe hardship upon members of exchanges and
the exchanges themselves. Besides, as we will get to later, there is a
so-called " fee " imposed upon exchanges, which is nothing more nor
less than an additional tax on the purchase and sale of securities;
and we now have in New York a Federal tax, a State tax, and also
in some other States there are taxes affecting exchanges other than
the New York Exchange.
Mr. PECORA. I think the fee you have mind is five-hundredth
of 1 percent?
Mr. WHITNEY. Yes, sir; but in our case, taking a fair average, it
would amount to $500,000 to $1,000,000 a year. Perhaps that is a
small sum when we talk of billions, but it is pretty large to us.
Mr. PECORA. I just want to call attention to the fact that what you
refer to as a tax amounts to one five-hundredth of 1 percent.
Mr. WHITNEY. I don't think that really changes the question, does
it? I t is what that develops into in dollars and cents. In the case
of the New York Stock Exchange it would be large. Presumably
not in every case.
Mr. PECORA. Because of the great volume of business transacted
there?
Mr. WHITNEY. Yes; and it is, nevertheless, in the last analysis,
presumably another tax upon the people who trade there.
STOCK EXCHANGE PRACTICES
6717
Mr. PECORA. This provision that Senator Goldsborough has referred to, section 16, is somewhat similar to the provision we find in
the National Banking Act which imposes the cost of examinations
of banks upon the banks.
Senator GOIIDSBOROTJGH. I t being based on the capital resources of
the institution?
Mr. WHITNEY. This is not based upon the capital resources of any
member of the exchange, nor in any way limited to the business to be
conducted in the particular office under inquiry It is terribly broad.
Mr, PECORA. I t was freely acknowledged 2 or 3 days ago here
when Mr. Corcoran was discussing this section that a calculation
might indicate that this fee of one five-hundredth of 1 percent might
yield a revenue that would defray the cost of these examinations so
as not to impose a burden on the subject of the examination.
Mr. WHITNEY. Section 17 deals specifically with the responsibility
of persons making any statement in any report or document filed
with the Federal Trade Commission which is, in the light of the circumstances under which it is made, false or misleading. I t can
impose, as I see it, a very tremendous responsibility upon officers
of corporations.
Mr. PECORA. I S it a responsibility that should not attach to them
if they make false and misleading statements to the damage or detriment of one who relies upon them?
Mr. WHITNEY. I think it is so worded, sir, that what might be
perfectly true at the time might prove at a later time to have been
misleading; and I think the breadth and scope of the provision impose a terrific responsibility.
Mr. PECORA. TO what particular language do you attribute that?
Mr. WHITNEY. Perhaps I can give an instance
Mr. PECORA. Why not take the language of the bill itself that you
think has that effect?
Mr. WHITNEY. I have just read it, sir—" false or misleading in
respect of any matter sufficiently important to influence the judgment of an average investor."
I beg your pardon. I did not read that last part. I t is conceivable that a director or an officer of the corporation might authorize an accountant or certain junior officers to give out statements
regarding the company or information regarding the company that
was considered perfectly proper at the time. I t might happen that,
innocently or otherwise, the junior officer might have issued something that was false or misleading, and yet the directors or officers
of the company who had been responsible for having such a report
or statement issued would be held liable under the very severe penalties in this provision of the bill.
Mr. PECORA. Aren't you overlooking this provision in subdivision
(a) of section 17, which provides:
unless the person sued shall sustain the burden of proof that he acted in good
faith, and in the exercise of reasonable care had no ground to believe that such
statement was false or misleading
Mr. WHITNEY. I recognize that qualification, sir, but I still think,
as I said, that there is a very severe possibility of penalty to be
imposed.
Senator GOLDSBOROUGH. I S that where the 2-year provision is
made?
6718
STOCK EXCHANGE PEACTICES
Mr. PECORA. NO, sir; that is subdivision (e) of section 17.
Senator GOLDSBOROTJGH. Under section 8 have you a 2-year term of
liability based upon the discovery of alleged violations of the act?
Mr. PECORA. That is subdivision (e) of section 17.
Senator KEAN. Was it not agreed, practically, that we would
change that?
Mr. PECORA. Yes; I think it is one that might very well be
considered.
Senator GOLDSBOROTJGH. An order might be given over the telephone and not come to light for 2 years.
Mr. PECORA. Subdivision (e) of section 17 reads as follows
[reading]:
No action shall be maintained to enforce any liability created under this
section unless brought within 2 years after the discovery of the violation
upon which it is based
There might well be added a provision that " in any event such
action will be brought within 6 years of the alleged violation."
Senator CAREY. In line 8 on page 32 it says [reading] :
Unless the person sued shall sustain the burden ot proof that he acted in
good faith
That means that the man who is sued has to prove that he is
innocent, rather than the man that sues has to prove that he is guilty?
Mr. PECORA. He has the burden of proof imposed upon him.
Senator CAREY. IS that fair?
The CHAIRMAN. He must show first that the statements are false
or misleading. That establishes your cause of action. He can be
relieved of that if he can show that he acted in good faith.
Mr. PECORA. And evidence showing that he acted m good faith
is obviously, in such an instance, more under his control and available of development than would be evidence to show that he did not
act in good faith under the control or power of the Government or
the plaintiff. There are many counterparts of this provision in various branches of the law, even in the criminal law. There are
criminal statutes whose constitutionality has been upheld, where the
burden of proof is placed by the statute upon the defendant, in
apparent violation of the rule that the burden of proof shall never
shift to the defendant in a criminal case.
Senator CAREY. Does this not mean that anyone can charge a man
with having made a false statement ?
Senator BULKLEY. He has got to prove the statement and the
falsity of it.
Senator CAREY. The man that makes the charge ?
Senator BULKLEY. Yes.
Mr. PECORA. Or the misleading character of it.
Senator CAREY. I think the misleading part is the most serious
part.
Mr. PECORA. The defendant can show on his own behalf that he
did not make such false or misleading statement wilfully and that
he acted in good faith by putting out a statement that was in fact
false or misleading, and no liability would attach.
The CHAIRMAN. There is the same provision in the Securities Act.
The defendant can put in a plea of confession and avoidance.
STOCK EXCHANGE PRACTICES
6719
Senator GOLDSBOROTTGH. YOU drew a distinction between a misleading and a false statement. I did not catch that.
Mr. WHITNEY. I said that the word " misleading " was one that
presented grave difficulties to any officer of a corporation.
Senator GOLDSBOROUGH. I t is too broad, you mean?
Mr. WHITNEY. Yes, sir; because in the future some one might,
under this act, sue and prove, perhaps conclusively, that a statement was misleading as a result of what had happened since the
time of the issuance of the statement, but at the time it would be
very difficult on the part of the officer to prove that he had not
intended to make it misleading.
Mr. PECORA. Conceivably a half truth is a more subtle form of
falsity than an outright lie. I t is also conceivable that only a part
of the truth might be given in a statement which would make that
statement perhaps not false in terms, but would make it misleading
to the person who it was hoped would rely upon it. I think that is
what that language is aimed at.
Mr. WHITNEY. Perhaps it is, sir; but I take it we are trying to
deal with honest men as well as with crooks.
Mr. PECORA. We are trying to deal with all men; and those who
are not honest we are trying to punish in the hope that the fear
of punishment will be a deterrent to their dishonesty.
Mr. WHITNEY. I t is my opinion, and merely my opinion, that the
breadth of these provisions and the wording could make it a very
grave position for a perfectly honest man inadvertently to have
violated some of the provisions of this act.
Mr. PECORA. I t is always open to a law-making body, where
injustice develops in the operation of a statute, to modify the
statute.
Senator KEAN. We are calling here in the bill, as it now stands,
for an audit every quarter. Suppose that you get an audit for a
quarter and that shows that the company has earned a great deal
for that quarter. Is not that misleading to the people that expected
it to earn the same amount for the other three quarters ?
Mr. WHITNEY. I don't know, sir.
The CHAIRMAN. It is misleading, as was said in the English case,
where the whole truth was not given. What was stated was true,
but they failed to state that the dividends paid were not paid out
of earnings, but out of surplus and reserve.
Mr. WHITNEY. Section 18 of the bill grants special powers to the
Federal Trade Commission. Some of them are in regard to stock
exchanges and members of exchanges, and others refer to authority
over corporations who list on such exchanges. Again, as Senator
Goldsborough said, the latter are very broad.
Senator GOLDSBOROUGH. YOU mean, the power goes beyond supervision and regulation?
Mr. WHITNEY. Yes, sir; in my opinion it does, far beyond.
Mr. PECORA. What is the language in that section that, in your
opinion, has that effect?
Mr. WHITNEY. The specific language with respect to corporations
as to the information that they shall file—
the items or details to be shown in the balance sheet and earning statement,
and the methods to be followed in the preparation of accounts, in the appraisal
175541—34—PT 15
20
6720
STOCK EXCHANGE PRACTICES
or valuation of assets and liabilities, in the detei mi nation of depreciation and
depletion, in the differentiation of recurring and nonrecurring income, in the
differentiation of investment and operating income, and in the preparation,
where the commission deems it necessary or desirable, of consolidated balance
sheets or income accounts of any person directly or indirectly controlling or
controlled by the issuer >
Mr. PECORA. Pardon me; I cannot find that language in the bill.
Mr. WHITNEY. Section 18 (b). I am reading from S. 2693.
Mr. PECORA.
Yes.
the authority above given the commission shall include, among other things,
authority to prescribe the form or forms in which required information shall
be set forth, the items or details to be shown in the balance sheet and earning
statement, and 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 so forth. Yes.
Does not that power relate principally to the matter of prescribing
uniform systems of methods of accounting, and isn't that the very
thing you say the stock exchange may be unable to effectuate ?
Mr. WHITNEY. I t may, sir. It may. But I think it goes far beyond
that, as well.
Mr. PEOORA. I do not see where.
Senator GOUJSBOROTJGH. DO you mean that because it includes substitution of the commission for the governing bodies of the security
exchanges ?
Mr. WHITNEY. NO. We have no power over any corporation, sir,
unless they freely come to us and desire to list on our exchange. Then
they have to meet our requirements. Here the commission is given
power on all corporations now listed or that may seek to list, not
only the power designated, but, as I see it, further power as the commission may itself in the future prescribe.
Mr. PECORA. Which all relates to the power to make rules and
.regulations and modify them from time to time with respect to the
form of information and other data which under this section must
be filed with the Commission ?
Mr. WHITNEY. Yes, sir. It all refers to that.
Mr. PECORA. I take it that this section is the basis for the contention that I see has been advanced by you in some of the printed
material that has bee^i submitted to this committee and to the House
committee also, and in which you say, in effect, that this gives to
the Commission the power to control and manage all business corporations ?
Mr. WHITNEY. This and other parts of the bill.
Mr. PECORA. Well, I do not see how the power to manage and
control and operate companies whose securities are listed is conferred upon the Commission merely by this provision of the act
which gives them the power to prescribe the form m which information shall be given to the Commission for the purposes of enforcing
this act.
Mr. WHITNEY. May I read *
Mr. PECORA. And carry out its purposes and provisions.
Mr. WHITNEY (reading):
SEC 18 (a) The Commission shall have authority from time to time to make,
amend, and rescind such rules and regulations as it may deem necessary or
appropriate to carry out and implement, administer, and enforce the provisions of this act, including rules and regulations governing the form and content
STOCK EXCHANGE PRACTICES
6721
of registration statements [to which we are leferring] and reports for various
classes of exchanges, members, securities, and issuers [they being the corporations], and define the accounting, technical, and trade terms used in this act.
To my mind, Mr. Pecora, that is so all-embracing and could be so
onerous as to give the Federal Trade Commission absolute control
of a corporation.
Mr. PECORA. I wish you would be specific about that and show how
the exercise of that power would operate in that fashion.
Mr. WHITNEY. By the imposition of forms of accounting, the
frequency of reports and all of the things that are stated clearly
here in the provisions of the bill upon corporations.
Mr. PECORA. YOU think that the power to impose forms of accounting is equivalent to the power to step m and run the business of a
corporation?
Mr. WHITNEY. I have said I think that I am referring to section
18 and the other provisions affecting corporations in the act.
Mr. PECORA. But I would like to see what the other provisions are.
Mr. WHITNEY. I think we have covered a great many of them,
sir.
Mr. PECORA. That you regard as affording a basis for your contention in that respect. The word has gone forth in printed documents that I understand were prepared by you to the executives of
business corporations all over the country that this act
Mr. WHITNEY (interposing). Listed corporations.
Mr. PECORA. Listed corporations—that this bill if enacted would
put the Federal Trade Commission in the saddle of management and
operation and control of every such corporation.
Mr. WHITNEY. If they choose.
Mr. PECORA. And I seriously and emphatically challenge that
statement or that contention.
(Mr. Whitney conferred with Mr. Redmond.)
Mr. WHITNEY. If the chairman would allow, I would like Mr.
Redmond to answer from the more technical point of view.
The CHAIRMAN. Yes; he may do so if necessary.
Mr. REDMOND. I ask the permission only because Mr. Whitney's
statement is based on my interpretation of the act.
If you will turn to section 18 (a), it gives the Commission not
only power to regulate the form of the information, Mr. Pecora,
but also the content thereof.
Mr. PECORA. Yes.
Mr. REDMOND. And
having the power both to regulate the form
and the content of registration statements, the Federal Trade Qommission could require as a condition of registration the including
of anything it wanted in those statements. The right to include
anything, to force a corporation to include anything, in effect* is a
club over management which would allow it to control management.
And that is the basis of my opinion.
Mr. PECORA. Well, I think that is the most
The CHAIRMAN (interposing). Specifying the content of a statement does not seem to me to control the management.
Mr. PECORA. I think that is the most fantastic kind of ghost to
conjure.
Senator BUCKLEY. I would like to clear this up.
Mr. REDMOND. Yes.
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STOCK EXCHANGE PEACTICES
Senator BULKLEY. DO you contend that the control over the corporation is by any direct words in the act, or is it by the Commission having the power to make itself such a burden and a nuisance
that it can indirectly control where it does not directly have the right
to do it?
Mr. REDMOND. Exactly, Senator.
Senator BULKLEY. I t is the latter?
Mr. REDMOND. It is the latter.
Senator BULKLEY. YOU do not base it on the former at all ?
Mr. REDMOND. Not on the former.
Senator BULKLEY. IS that your view, Mr. Whitney ?
Mr. WHITNEY. Yes, sir. I tried to express it before.
Mr. REDMOND. It even goes to the extent that the Commission
could demand a corporation to make daily reports, on condition that
if those reports are inaccurate in the least degree the directors and
officers who would be required to file them would be liable both
criminally and civilly. Now, you could imagine that if you face the
board of directors with the alternative of certain action or having
to file daily reports, the only action that that board could take would
be to comply with the wish of the Commission. In effect it is a
weapon that would allow the control of corporations.
Mr. PECORA. Mr. Redmond's statement in effect is saying that because a person is appointed to the Federal Trade Commission, in the
event of the enactment of this bill, he would automatically be deprived of all sense of reasonableness and of mentality and that he
would seek to discharge duties in the most vicious fashion possible.
Mr. REDMOND. NO, Mr. Pecora.
Mr. PECORA. And with a view designed not to carry out the wellrecognized purposes and provisions of this act, but simply to impede
and hamper business corporations in the conduct of their business.
Mr. REDMOND. NO, Mr. Pecora. My opinion is
Mr. PECORA (interposing). You can make that argument with regard to any public officer who is given any discretionary power at
all, as an argument why there should be no such public office.
Mr. REDMOND. NO. My opinion, Mr. Pecora, is simply limited to
this, that this bill gives that power. Whether that power in fact
would be abused is an entirely different question.
Mr. PECORA. There are many laws which give the executive head
of the Government a power that is capable of abuse, as for instance
the power to pardon. He could make a general jail delivery of
every Federal jail in the Country under that power. Would you
think that because it is possible under the executive power of pardoning that the President should be deprived of all such power ?
Mr. REDMOND. NO. That is an act of clemency, Mr. Pecora.
Mr. PECORA. Oh—it is a legal provision. I t is an act that is vested
in the Executive by the statutory authority, and it is capable of
abuse.
Senator KEAN. Hasn't it been abused, Mr. Pecora ?
Mr. PECORA. A S I recall it, a Mr. Morse once was pardoned.
Senator KEAN. Don't you recall that in cases in South Carolina a
Governor let out everybody in jail ?
Mr. PECORA. N O ; I do
Senator KEAN. Don't
not.
you recall that in California a Governor
pardoned everybody almost?
STOCK EXCHANGE PRACTICES
6723
Mr. PECORA. I don't recall that; no, sir.
The CHAIRMAN. We are getting outside of the subject matter, now.
Senator GORE. Mr. Eedmond, in that connection, this may be more
or less academic, but if you had a man that is chairman
of the Federal Trade Commission or a member of the Federal1 Trade Commission, or members who are really opposed to the existing system,
sometimes called the " capitalistic " system, who wanted to bring
about a situation where you could not sell securities in this country,
where you could not finance new enterprise, where you could not refinance an old enterprise, wanted to bring about a situation where
all industry would be driven to the Government as the only lender
of money, so as to bring industry into the lap of the Government,
subject to Government control—do you think that this legislation
would lend itself to that sort of an operation?
Mr. EEDMOND. Senator Gore, I think the power exists, and it is
only on the basis that the bill vests such a power that I gave my
opinion to Mr. Whitney and the exchange.
Senator GORE. I might say that I have heard such fantastic fears
expressed as that something of that sort might be latent in somebody's
breast.
The CHAIRMAN. Let us go on.
Mr. WHITNEY. That is section
18. It also gives infinite power
with regard to exchanges and their members, as I stated.
Section 19 imposes liability upon persons controlling any other
person liable under the provisions of the bill.
That was gone into at some length by Mr. Corcoran.
Section 20 authorizes the Federal Trade Commission to investigate for the purpose of determining whether a person has violated
or is about to violate any provision of the bill.
Sections 21 and 22 refer to hearings before the Commission. They
shall be public.
Section 28 refers to the review in the courts, this section having
been covered at some length by Mr. Corcoran
Senator GOLDSBOROUGH. Let me ask you about 23, about brokers
and dealers. Does section 23 (a) modify the sentence or finding of
the Commission as to the facts " if supported by evidence shall be
conclusive " ?
Mr. WHITNEY. I do not think it does modify.
Mr. PECORA. YOU do not think it modifies ?
Mr. WHITNEY. I t says, "the findings of the Commission as to
the facts, if supported by the evidence, shall be conclusive." To my
mind the review allowed is not what I would think was a thorough
review. I am speaking as an individual, sir, and not as a lawyer. I
don't know.
Mr. PECORA. Frankly, you do not know really what is within the
purview of this kind of a provision ?
Mr. WHITNEY. Yes; but I am a business man, and it would
frighten me dreadfully if I had no chance except as against the facts
presented by the Federal Trade Commission.
Mr. PECORA. Well, don't you realize that on those hearings before
the Federal Trade Commission you would have a right to present
evidence, too?
Mr. WHITNEY. I would have the right to present evidence; yes.
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STOCK EXCHANGE PRACTICES
Mr. PECORA. And the determination would be based upon all the
evidence ?
Mr. WHITNEY. AS I understand it, however, if the finding of the
Commission as to the facts, if supported by fair evidence, they shall
be conclusive.
Mr. PECORA. Supported by the evidence before them, not the evidence which the Commission procures, but all of the evidence in the
hearing. This says "if supported by evidence", and the evidence
might be found in the testimony introduced in behalf of not the
Commission but the persons brought in for hearing before them.
Senator BULKLEY. I S it " evidence " or " the evidence "?
Mr. PECORA. " If supported by evidence."
Senator GOLDSBOROTJGH. I t means the weight of evidence, doesn't it?
Mr. PECORA. I think it would be so construed by any court.
Senator KEAN. Would it be so construed as the weight of evidence?
Mr. PECORA. I think so; yes.
Senator KEAN. YOU think it would be the weight
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