in any event, a body which will include men of experience and responsibility who will command the confidence and respect not only of exchanges and their members but the executives of State and Federal banks, industrial corporations, and insurance companies, and through them, the confidence of the investing public whose welfare in the last analysis is what we all desire, and that this body be provided opportunity to study and authority to devise an adequate means of controlling such unfair market practices and abuses as impair the maintenance of a free and fair market for securities.

With respect to these suggestions, in order that the committee may have the benefit of our own considerations, if it is so desired by the committee, we should like to file our brief and later, with the consent of the committee, submit more detailed suggestions for such proposed legislation.

The CHAIRMAN. You have that privilege. You may file your brief. It would be better if you incorporated it following your remarks.

Mr. COLLINS. Thank you.

The CHAIRMAN. We are very much obliged to you, Mr. Collins. (The brief referred to is as follows:)

BRIEF IN BEHALF OF SECURITY DEALERS IN NEW ENGLAND

The main purpose of the proposed act is to maintain a fair and free market for securities, the importance of which is expressly acknowledged by section 2 to be of national public interest. It proposes to do this

(1) By curbing "excessive speculation" through the control of credit, sections 6 and 7, and

(2) By preventing certain "inequitable and unfair practices."
The accomplishment of the latter it is suggested can be obtained-

(a) By the enforced registration of all "exchanges" and their "securities" with the Federal Trade Commission, sections 4, 5, 14;

(b) By the denial of credit to the holders of securities not registered and the limitation of credit to exchanges and holders of registered securities, sections 6, 7; (c) By the prohibition by heavy fine and/or imprisonment and civil penalties of the use of the mails or interstate facilities to effect certain enumerated acts declared to be manipulative devices, sections 8, 9, 10, 15, 17, 19; and

(d) By providing an official source of information as to securities traded upon the exchanges, section 5, 11, 12, 13, 15, 16.

There can be no criticism of the main purposes of the bill. There can be no denial that the maintenance of a fair and and free market is of the utmost importance not only to traders but, because of the effects which an obstruction of such market has, upon industry and commerce in general.

Nor can it be argued that mischiefs have not existed which warrant the careful consideration of Congress to determine whether further regulation by legislation is needed even though it may be argued that exchanges are themselves striving to develop a self discipline which might more effectively prevent recurrences than any control by public authority.

However, regulation of either sort must be considered with relation to the main purpose sought to be achieved, for if that regulation itself, in an effort to prevent unfair practices, should destroy or unduly restrict the fair and free market which it is sought to maintain, it defeats itself.

AS TO CURBING SPECULATION

Ostensibly the bill seeks to limit the amount that brokers and dealers may lend upon securities and to limit the places and the amount the broker may borrow on those same securities. In truth, the effect of the bill is to limit the power of individual owners of securities, most of whom are not speculators, to borrow on their securities in any event in excess of 40 percent of their current price as against the limit of 80 percent allowed Federal Reserve banks on loans secured by stocks, bonds, or debentures, and 90 percent on loans secured by obligations of any State or political subdivision thereof. Obviously, the result of

this is to limit greatly the marketability not only of existing securities but of those hereafter to be issued. In a time when we are making every human endeavor to reopen the avenues of credit, it would make the marketing and distribution of both industrial securities and State and municipal obligations at a reasonable cost difficult, if not impossible.

We fear the passage of the bill would of necessity drive securities from listed exchanges into bootleg markets and stop the desirable trend of State banks into the Federal Reserve System, as otherwise they could not lend money on values generally considered safe from the banks' standpoint, values without which no individual could be induced to invest his money except at an exorbitant cost to industry and governmental agencies.

We believe, and are advised, that the Banking Act of 1933, which was expressly directed to "prevent the undue diversion of funds into speculative operations" already provides ample power and machinery to protect against excessive loans for speculative purposes; but if further power is needed, it should be through the amendment or amplification of the banking iaws and not through the extreme and inflexible limitations of this bill which confers to the Federal Trade Commission power to even further curtail that credit.

AS TO THE PROHIBITION OF ACTS DECLARED TO BE "MANIPULATIVE DEVICES" Sections 8 and 9 of this bill forbid, under penalty of heavy fine, imprisonment, and civil damages, the use of the mails or facilities of interstate commerce in connection with certain "effects" and "devices" which are alleged to be wrongful. In effect, these sections are extensions of the act forbidding the use of the mails to defraud. There can be no criticism of such extensions if the conduct or acts forbidden are universally or even generally admitted to be of greater public harm than public good. Many of the things aimed at are already declared to be illegal, either by common law or by State statutes, as, for instance, illegal pools and unlawful manipulation by false representation and corners, or the express statutory prohibition of the New York statute.

U.S. vs. Brown (5 Fed. Supp. 81). N.Y. Penal Law, sec. 953.

In such cases there can be no just objection to legislation extending the prohibition to instrumentalities of interstate commerce as well as the mails.

There is just objection, however, to the imposition of additional and unwarranted civil damages in the determination of which there is absolutely no causal connection between the act and the penalty provided. Nor should the statute extend its prohibitions to those things as to which the general good may greatly outweigh the harm, e.g., in such cases, until the balance is decided, other means should earnestly be sought which reduce the harm and preserve the good.

But in any event it must be borne in mind that unless the prohibitions are reasonable and directed to practices generally condemned, the risks of business are increased and the cost of this increased risk must eventually be passed on directly in the cost of money to industry and indirectly to the value of the security in the hands of the investor.

AS TO SEGREGATION OF THE DEALER-BROKER ACTIVITIES

The evident purpose of this provision is to protect the purchaser of securities from possible unfair practices on the part of the seller.

The fundamental argument against the broker's occupying this dual position rests on the fact that as a broker, he is occupying a fiduciary position and as such is under certain affirmative duties which disappear when he becomes, a seller, a principal charged only with an affirmative duty of refraining from actual misrepresentations of fact.

It is urged that a customer coming to a broker as confidential advisor and agent is lulled into a sense of security which makes him easy prey for that same broker, who, acting as a dealer, sells his own securities to that customer; that the broker cannot fairly deal with the customer as an agent and fiduciary and at the same time be fair to him as a dealer, discharged of any fiduciary obligations, in selling his own securities.

If this were the real situation, even though most brokers honestly and scrupulously avoided any possible advantage over the buyer in the desire to retain the good will of their customers, there would be much to commend it if it really protected the buyer from unscrupulous brokers. However, as the law has been developed, the duties of the broker have been so increased that there is really little distinction in his obligations in the two capacities. Indeed, at the present

time his obligations as a dealer are even greater than as a broker and there is little danger to the seller in the broker's acting in these different capacities.

Generally throughout New England a broker cannot buy from or sell to his customer securities without full disclosure of the fact that he is selling his own securities. If that fact is not disclosed, the customer may repudiate the transaction and recover what he has paid, with interest.

McNulty v. Whitney (273 Mass. 494).

Hall v. Paine (224 Mass. 62; 230 Mass. 62).

Under our State blue-sky laws a broker cannot sell a security to a customer that has not met the requirements of that law, and if he violates this prohibition, the customer can rescind and recover back the purchase price. If the dealer in the sale of a security is guilty of misrepresentation, bad faith, or gains, an exorbitant or unconscionable profit, his license may be suspended.

Finally, and conclusively, however, the Federal Securities Act itself eliminates any improper advantage on the part of a dealer. Under section 12 of that act, the seller of a security is not only responsible for any misstatement of a material fact but an affirmative duty has been imposed upon him to state all material facts omitting none which would make the dealer's statement misleading, in the light of the circumstances.

Under section 11 of the same act, as an underwriter the dealer is also liable in a civil action for any untrue statement of fact or omission of a material fact contained in the registration statement over which he has little or no control.

Perhaps no more forcible statement of the effect of this act can be found than that made by Professor Frankfurther of the Harvard Law School, in reply to the criticism that it placed too great a responsibility upon the dealer that "he who is unwilling to assume the responsibility of a fiduciary has no business to be a fiduciary."

It is significant that although there are blue sky-laws in every New England State that not a single State has found it necessary to segregate the brokerage and dealer activities of New England firms dealing in securities.

It is suggested that even if as "an abstract matter, the segregation of these various activities has much to commend it", New England has not found abuses which warrant segregation, or that if abuses have existed, they are minor compared to the cost and repercussions which the Roper committee admitted must be calculated (Roper Committee Report, p. 24) before final decision.

We are convinced that in New England the enforced segregation of these activities would result in the further withdrawal of the more responsible financial houses from activity in the very necessary function of financing our industries and local governments, with the consequence that it will be sought at a greater cost in other markets, or if they are unavailable, of necessity, from the Federal Government itself.

AS TO THE REQUIREMENTS OF REGISTERING AND COMPLYING WITH INFORMATION REQUIREMENTS AND THE SUBMISSION TO THE RULES AND REGULATIONS OF THE FEDERAL TRADE COMMISSION

As we view it, in this aspect of the bill it is sought by discrimination against unregistered exchanges and unlisted securities to force their registration and compliance with the information requirements of the act.

Unfortunately in this respect the bill is so drafted that the disadvantages of registration are even greater than the hardship imposed upon the unregistered. The cost and the extensive nature of the information required will drive securities from the exchanges with the consequent impairment of that fair and free market for which the bill is intended. Then again, while there is today a general tendency for publicity, the requirement in this case will not always prove beneficial to the holders of securities, who are the ones intended to be benefited. Indeed, while the bill makes the information filed with the Commission available to the public, there is ground for the belief that in many aspects this will have an undesirable effect.

The filing of the information will not result in its being brought to the attention of investors except by dissemination through private channels, newspapers, and financial services.

Already many corporations refuse to permit their securities to be listed because it is honestly believed that it places in the hands of operators and gamblers, and even competitors, the opportunity to create a misleading inference by the simple expedient of manipulating facts and figures revealed by such reports, and unless the corporation jumps into the breach and by way of defensive explanation

interprets the facts back of the apparent result shown by the figures, serious damage may be done to investors. The directors of such corporations believe honestly and sincerely that it is better to let their stockholders rely upon the reputation of the concern and the integrity of its management, with only yearly reports, than to become involved in the complexities of market manipulation. Furthermore, the requirements of the bill would tend to drive from the directorship of registered corporations many able and responsible men who would prefer not to serve than to make their personal holdings a matter of public comment and speculation.

In short, the matter of listing requirements and the matter of publicity of information is so complex and so far from abstract decision and rigid legislation, that even a cursory consideration must result in the conclusion that as to such matters, just as with credit matters, if legislation is needed, it should provide an elasticity in the determination of what best suits the needs of the particular community and the protection of its investing public. Such power should only be given to a body made up not only of men of experience in market and industrial matters but, indeed, with the operations and demands of the financial machinery of the nation and its political subdivisions.

For these reasons we believe that (1) legislation with regard to the prohibition of the use of the mails or instrumentalities of interstate commerce should be confined to those things which are by the preponderance of opinion wrongful or harmful (a supplementary memorandum describing in detail such legislation is being prepared and will be submitted later).

(2) That regulation of credit to prevent excessive speculation should be left to the control of the Federal Reserve System under the National Banking Act (a supplementary memorandum describing in detail such legislation is being prepared and will be submitted later) and, finally,

(3) That with respect to the regulation of exchanges, their rules and practices, and the requirement for information from corporations, there should be created a body such as is suggested in the Roper Report or as suggested by the New York Stock Exchange, but in any event, a body which will include men of experience and responsibility who will command the confidence and respect not only of exchanges and their members but the executives of State and Federal banks, industrial corporations and insurance companies, and through them, the confidence of the investing public whose welfare in the last analysis is what we all desire, and that this body be provided opportunity to study and authority to devise an adequate means of controlling such unfair market practices and abuses as impair the maintenance of a free and fair market for securities.

The CHAIRMAN. The next is the Chicago Stock Exchange.

STATEMENT OF MICHAEL J. O'BRIEN, PRESIDENT OF THE CHICAGO STOCK EXCHANGE, CHICAGO, ILL.

The CHAIRMAN. Will you give your full name and business, and I wish you would qualify so the members of the committee may hear

you.

Mr. O'BRIEN. My name is Michael J. O'Brien, president Chicago Stock Exchange, and I am speaking on their behalf.

As I have sat through these hearings, I have been impressed with the earnest desire of members of the committee for suggestions as to how the problem in which we are both so viatlly interested can be solved. My associates and I, representing the third largest exchange in the country, do not come here to oppose legislation which may be needed in the public interest. We are here to cooperate; to explain our viewpoint and offer you our experience in the hope that it may be helpful in arriving at a solution that will be fair to business and in the best interests of all of us.

I believe I can best assist this committee by telling concretely and in simple narrative style the progress the Chicago Stock Exchange has made, of its own volition, in preventing many of the abuses outlawed by this bill.

Constantly changing social and economic forces make ours an ever'changing business. To be workable, any legislation to regulate the exchanges and our business must be flexible enough to be almost instantaneously responsive to the forces that operate in times of crisis. Legislation should not discourage nor render ineffective the efforts of men who desire honestly to regulate themselves.

Since its organization in 1882 the Chicago Stock Exchange has been a definite factor in the financing and development of industry in the Middle West. In the 50 years of our existence, this country has gone through wars and panics. Such events have altered methods and actices in all lines of business. We have sought to have our rules keep pace with our experience.

I wish to outline to you briefly how far we have gone, so that you may judge how best to encourage self-regulation and impose the minimum of restraint upon individual initiative.

First, as to listings. The securities of 397 corporations are listed on the Chicago Stock Exchange. Each corporation has entered into a contract with the exchange. Experience has taught us many things in the years that these securities have one by one been admitted to the list, and those lessons have been incorporated in subsequent revisions of our listing contract. We have strengthened existing provisions

and added new ones.

More than a year ago the Chicago Stock Exchange undertook a special study and survey of listing problems. Abuses had crept in which we realized should and must be eliminated. On March 21, 1933, the governing committee promulgated a statement of 10 simple principles which were incorporated in our listing contract. Some of these requirements were new, some a strengthening of old rules. For the past 11 months all new applicants for listing have signed this new contract. All corporations listed under the old contracts have been advised that the Chicago Stock Exchange is guided by those principles and that all listed corporations are expected to abide by them. The 10 principles are:

1. No security can be bought or sold on the Chicago Stock Exchange unless and until its listing shall have been accepted by the governing committee upon an application signed and sworn to by a duly authorized officer of the corporation issuing the security. The Chicago Stock Exchange for many years has had no so-called unlisted department, nor does it list securities upon data or application filed by its own members or any persons other than the company itself.

2. The application shall contain a full statement of the experience and reputation of the management as well as a description and history of the applicant company.

3. Clear and informative financial statements, including a balance sheet, profit and loss statement, and an analysis of surplus, shall be submitted as part of each application. Such financial statements shall truly disclose the past operations and present condition of the company and shall be certified to the Chicago Stock Exchange by duly qualified independent public accountants, whose certificate shall be set forth in full as a part of the application.

4. The securities themselves shall be as proof against forgery or fraudulent alteration as it is possible to prepare them. They shall be fully steel engraved, unless they are to be outstanding only temporarily.

5. The applicant company shall maintain a transfer agency and a registrar in the City of Chicago. To safeguard against the issuance of unauthorized stock, the registrar shall be an independent, responsible trust company. Only independent, responsible trust companies may act as trustees for listed bond issues.

6. The validity and legality of the securities listed shall be approved by competent legal counsel, who shall not be an officer or director of the applicant com

pany.