By accident, we can give you a concrete example of very recent date. Last Friday, at the very moment that section 10 of this bill was being discussed in this room, four of the very firms I am speaking for today, purchased from the R.F.C. a million municipal bonds of a large western city which the R.F.C. had taken some months before when conditions were such that the city could not sell elsewhere. In the past 4 days these 4 firms, through their combined distributing organizations with their knowledge of markets and of likely buyers for these bonds, have placed a portion of them, and are in process of placing the balance, in permanent hands.

I speak of that, because I happen to be a partner of one of those houses that bought those bounds, and when I left New York last night I think about $400,000 of them had been sold. They had been sold to individuals and insurance companies. To this extent they have lightened the load of the R.F.C. and made funds again available for some similar constructive purpose. Under clause 10 of this bill, this operation would not be possible for any member of any registered exchange. This is only an isolated case of which we happen to have personal knowledge, but transactions of this nature must be taking place almost every day.

With the elimination of the distributing machinery of bank affiliates, the dealers today provide the only remaining vehicle of distribution. To illustrate the importance of this business, during 1933 when volume was at an absolute minimum, the record shows that the volume of dealer business in bonds alone, exclusive of any business on any exchange, because we have had a very few days to collect this information and it has been rather difficult even among friendly competitors to have each one disclose what his volume was; but I think that I am understating it rather than overstating itMr. MERRITT. Those are sales and purchases.

Mr. KINNICUTT. Those are sales and purchases; yes, sir. And, for the group I am speaking, it was over $1,250,000,000.

Now, please do not send me to jail if those figures are not right to a dollar. This is a substantial sum, yet obviously it is but a fraction of the business done by the several thousand dealers from Portland, Oreg., to Portland, Maine. During the same period the business on the exchanges was probably greater than the volume above. By far the largest part of this amount was not in new issues but in the important and necessary readjustment of portfolios as a result of changing conditions. Furthermore, in our judgment, it could not have been done by a broker.

You may say, Why could this not be done on a brokerage basis? To answer this not in a theoretical way, but from practical experience over many years, I think we can definitely say that it could not. If a savings bank or a trust company or an individual (if there are any such fortunate ones left) for sound reasons wants to sell, say, $200,000 of bonds of some issue, the very worst thing he can do is to go to a broker.

We are not criticizing the broker and he has a tremendously important function, but in a case like this he is legitimately keen to make his commission and so he offers the bonds wherever he has any chance of selling them and to many a place where has has no chance, and before you know it these two hundred thousand bonds appear to be two millions, and obviously no one will buy.

I think I can speak from pretty firm ground there, because I have seen it happen so often. Obviously under those conditions no one will buy. Many and many a time when I knew less than I now know, we have had our own bonds offered to us at a price less than we had offered them at. The second or third or fourth broker believed, perhaps naturally, that the unknown seller would lower his price. As a matter of fact we once bought our own bonds in this way.

Except in very few and very active issues, the sound way to sell any sizeable block of bonds is through a dealer and not a broker.

We believe there is a further definite advantage in preserving the present method of operation. Investors rightly should have from their financial advisers information regarding all types of securitiesboth listed and unlisted-and get the best possible service, both as to values and prices.

It is definitely to the advantage of the investor to have his individual business in securities in the hands of relatively few people, which creates a greater sense of responsibility in the firm he is dealing with.

It is the part of wisdom for an investor to seek advice and service in security matters from some one person or firm, as he would from his doctor or lawyer on problems of health or law. Even with your groceries-if you buy your vegetables and fruit and milk from one man, your chances of getting fresh eggs from him are better than from another.

Furthermore, it is only in the broker and dealer combined that you can get the necessary and essential statistical information in any comprehensive way. A man acting only as a broker, neither will nor can support the very great expense of an efficient service of this kind, and will be helpless, even with the best of intent, to give adequate information on most securities. The service and statistical departments of our group alone cost many thousands of dollars annually.

I am sorry time does not permit giving those figures but they would run, I think, into several hundred thousand dollars a year, in this group alone.

Turning to the function of the dealer in his capacity as an underwriter, we believe it is an equally necessary work in the public interest. Little financing of any size for refunding purposes or for the capital requirements of expanding business can be accomplished without the aid of underwriting. As an example, let us assume that a railroad finds it economically wise to electrify its lines from Chicago to St. Louis. Let us assume the completed cost will be $50,000,000. At first blush, it might be assumed that the railroad corporation could offer its issue direct to the public without the need of an underwriting to guarantee the sale, or could employ the broker to sell the bonds to the public for a commission. There are two fallacies in this:

First, the railroad is far more likely to make a mistake in the terms and price of its issue, and its reception by the public, than the dealer group with their combined knowledge and long experience of market conditions and the public demand of the moment, and also for the very good reason that the dealer is backing his judgment by his own money and commitment; secondly, though the railroad may not make this mistake and the security may be attractive to the public, both from the point of view of safety and yield, it can only be so, provided

the railroad gets its full requirements and is not left with an uncompleted program and the electrification completed only half the distance between Chicago and St. Louis. Under these circumstances, the road would have an uncompleted project and an unprofitable capital investment. In other words, the public will not supply the necessary capital without the assurance created by an underwriting of the full financial needs. Lastly, the dealer will not underwrite unless he also has available the means of distribution.

It is our judgment for these reasons that the dealer organizations throughout the country must be preserved for the public interest, both in their capacity as distributors and as underwriters.

Section 10 of this bill, coupled with section 19, will bring about a complete divorcement of the commission business from the dealer and underwriter business. The danger to the financial structure of the country of this segregation was clearly recognized by the Dickinson committee, from which we quote as follows:

The distributor and dealer business are closely intertwined in our financial structure

and no segregation should

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be accomplished before we are in a position to calculate its cost and foresee its repercussions there is not yet available sufficient information to enable it (the committee) to recommend such a far-reaching decision.

There is little danger to the investor in placing his money through a person acting both as dealer and broker in securities, a part of which such person as agent buys for, and a part of which he owns and sells to, his customers. But right here I would emphasize as strongly as possible that there must be the fullest disclosure to the customer in what capacity such person in each instance is acting, in order that the customer may have complete knowledge and give it due weight.

It seems to us obvious that where a broker-acting as a dealer-has a customer, he is going to get some income at least whether he acts in one capacity or the other. Where he is a dealer alone, his only profit can come from selling from his own inventory and the temptation to yield to the deplored high-pressure practices, irrespective of the needs of the individual customer, will be aggrevated. We do believe there is much mistaken criticism of a dealer in selling from his own inventory because it is approached from the false premise that an inventory presupposes something the dealer is "hung up" with. As a matter of fact, in the great majority of cases, his inventory is acquired because the dealer believes, like the corner grocer, it fits the needs of his customer as to quality and as to price. Call the dealer a knave if he deserves it, but for heaven's sake don't think that the dealers of this country are so stupid as to believe they can have success in the long run unless they make money for their customers instead of out of their customers. It is a truism that "good will" is the biggest single asset in any concern or industry.

The smallness of the investor's risk through carrying his account with a broker who at the same time is taking commitments for his own account is perhaps best answered by the yardstick of experience. The record for the years 1930, 1931, 1932, and 1933 are illuminating in the comparison of failures of members of the New York Stock Exchange, who to date are unregulated except by the rules of the exchange, with industries that are regulated. All the banks of the country including the national banks are under either Federal or

State regulation. The percentage of failures of all banks was over seven times that of the members of the New York Stock Exchange in relation to their number, and in national banks over five times. We are not referring to losses to the members or their firms but the loss to their customers.

Mr. WOLVERTON. Mr. Chairman.

The CHAIRMAN. Mr. Wolverton.

Mr. WOLVERTON. Are we to infer from the statement you have just made that you consider it preferable that there should be no regulation of the stock exchange?

Mr. KINNICUTT. No; I do not, and I am coming to that a little bit later if I may.

Mr. WOLVERTON. I would like to hear what you have to say about it. Mr. KINNICUTT. I will come to that later.

This may be partly due, so far as members of the New York Stock Exchange are concerned, to its own regulation that every 6 months every member must answer a questionnaire. Have you ever studied one of these? I do not know whether you have ever seen that questionnaire or not, but it requires a detailed statement of pretty nearly everything under the sun, and if every last thing is no in order, the exchange takes immediate action. Right here we would recommend that every exchange should demand from its members some similar requirement.

The record of the five biggest security exchanges in the United States over the past 4 years shows a percentage of failures to total memberships of only 12 percent, or less than one half of 1 percent per annum, and many of these were in no way due to causes that segregation of the borker from the dealer business would have prevented.

This is the record by which to measure the danger to the investor from a combination of commission and dealer business in the same firm.

Now as to the results that would come from complete segregation. Mr. WOLVERTON. Mr. Chairman.

The CHAIRMAN. Mr. Wolverton.

Mr. WOLVERTON. I assume from what you have said that you are in hearty accord with the provision of the stock exchange rule that requires members to make reports to the stock exchange as to their financial standing.

Mr. KINNICUTT. Very definitely; very definitely.

Mr. WOLVERTON. If you have definitely committed yourself to that policy, then why should not that plicy be made effective by a Federal regulatory body?

Mr. KINNICUTT. I think it should be and that I will arrive at later. Mr. WOLVERTON. You are in full accord then with regulation to the extent that financial stability should be a subject of examination by a Federal regulatory body?

Mr. KINNICUTT. Supervisory body, may I say, because I believe in the voluntary regulation which already exists in certain exchanges, and I think should be enforced in all exchanges.

Mr. WOLVERTON. Do you feel that there should be a Federal supervisory or regulatory power to pass on the listing of stocks to be sold on the exchange?

Mr. KINNICUTT. That comes a little without my providence, if I may say so, because I am speaking here primarily for bond houses

and frankly, neither I nor most of our group feel competent to pass on stocks.

Mr. WOLVERTON. What I have in mind is this: You have very definitely committed yourself to approval of a Federal body to examine the financial stability of the individual members of the Exchange. Now, I am wondering why the same reasoning that led you to that conclusion would not also carry you to the conclusion that stocks to be sold on the stock exchange should also be subject to some examination, to determine whether they were good, or whether they were bad. I have in mind the Insull stocks and the Krueger stocks, and stocks of that character that appeared on exchanges. Why shouldn't they have been subject to examination by a Federal body instead of a stock exchange committee?

Mr. KINNICUTT. What I am speaking more of now, and what I was trying to prove here, relates to the segregation of the commission business from the dealer business, and why, in our judgment, this is not necessary. I am not speaking beyond that of the different aspects of the bill, because as I said in the premise we want to talk about something we know more about than the other phases.

Mr. WOLVERTON. You do not feel that you are qualified to express an opinion on that subject?

Mr. KINNICUTT. Yes.

Mr. WOLVERTON. You do not think you can do so?

Mr. KINNICUTT. I do not think so.

Mr. WOLVERTON. How long have you been in the business?

Mr. KINNICUTT. Thirty years.

Mr. WOLVERTON. Thirty years?

Mr. KINNICUTT. Yes.

Mr. WOLVERTON. During that time you have certainly had knowledge of losses incurred by individuals who have dealt in stocks which should not have been listed. Are you not able to express an opinion now as to whether such listings should or should not have been the subject of Federal regulation or supervision?

Mr. KINNICUTT. I am referring to a regulatory body very shortly, which I think will answer your question, if I may go on with the

statement.

Mr. WOLVERTON. Do you approve of Federal supervision of the financial standing of companies whose stocks are listed on the stock exchange?

Mr. KINNICUTT. It depends very much upon the regulations, I should say.

Mr. WOLVERTON. Do you feel that there should be any regulation? Mr. KINNICUTT. Yes, I do.

The CHAIRMAN. Are you through, Mr. Wolverton?

Mr. WOLVERTON. Yes.

The CHAIRMAN. We are going to have to adjourn. I am very sorry to have to cut you off in the middle of your statement. If you have a further statement or further information, you can submit it for the record. We have given you all of the time that was allotted to you. Mr. MERRITT. Could we not let the gentleman finish his statement? The CHAIRMAN. You may go on Friday morning if you wish. will now have to adjourn.

We

(Thereupon, at 11:48 a.m., the committee adjourned to meet the following morning, Wednesday, Feb. 28, 1934, at 10 a.m.)

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