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Section 14 regulating. "over-the-market” market, enforces a particular hardship on outlying territories as there are a multitude of unlisted bonds and preferred stocks trade in which are in most cases obligations of companies so small that their size will preclude compliance with any extensive listing requirements. That pertains to bonds of small municipalities, for which the country markets are the best markets, and I think that many municipalities could not be financed if the provisions of the present bill were retained.
The Dickson report to the Secretary of Commerce recommended control by a “Federal stock exchange authority” and through a flexible mechanism to further study the means of regulating the stock exchanges and advised against placing stock exchanges in a straitjacket. It urged that the law be limited to minimum requirements and that broad discretionary power be given the authorities.
Regarding the segregation of brokerage and dealer businesses, it said:
Any such proposed segregation should not be accomplished before we are in a position to calculate its cost and to foresee its repercussions.
I think that the authority designated to exercise control of stockexchange firms should be authorized to extend the segregation of the two businesses as far as its further study indicates it to be necessary in the interest of the public.
I can amplify any of those comments, sir, and I would be glad to answer any questions I could. I do not think it would serve a useful purpose to cover it in greater detail.
The CHAIRMAN. We would like to have you recommendations in your extended statement if you can give them. Like practically all of our witnesses, you say you are in favor of regulation.
Mr. WITTER. Yes, sir.
The CHAIRMAN. And we would like to have your suggestions as to what sort of regulation. I mean, in your extended statement. Of course, you would not have time to do it this morning. We would like very much to have that, because it will be helpful to us when we go to write this bill to know what your constructive suggestions are.
Mr. WITTER. My thoughts as to regulation and control sir, are practically embodied in the Dickinson Report, which has given that matter careful study, of which I heartily approve, and which I think provides for flexible control of the stock exchanges, on the one hand, without limitation imposed by a fixed statute, to draft a bill in fixed terms which would regulate the stock exchanges, which would, in my opinion, require several hundred pages in the bill to cover all of the numerous contingencies, and would leave us with certain arbitrary laws to govern matters which at times there must be justifiable exceptions.
I would recommend, and I would be glad
The ChairMAN. We would like for you to state in your memorandum what practices that are now indulged in on exchanges you think ought to be prohibited by law.
Mr. WITTER. Yes, sir.
Mr. COOPER. Mr. Witter, most of the testimony we are getting at the present time is merely on the regulation of stock exchanges.
Mr. WITTER. Yes, sir.
Mr. COOPER. There is another part of this bill in which we are very intensely interested. Now, I think probably it is just as important, if not more important, than the regulation of stock exchanges, and that is what effect this measure would have if it became a law on industry, banks, and so forth. Now, I do not know whether you people intend to touch on that or not. It seems as if we are just forgetting, to a great extent, that important part of this measure. Probably you do not want to touch on that.
Mr. WITTER. I will be very glad to.
Mr. WITTER. The bill is not a bill to regulate stock exchanges, as I read it, and I am not an attorney. The bill is to regulate all banks, all credit, all corporations, all officers and directors of all corporations and all stockholders. It gives the so-called authority, of the Federal Trade Commission, or whatever authority may be finally incorporated as the administrative authority of the bill, power to so hamper and restrict the development, the financing of new industries, and providing of the capital of this country, that it is easily conceivable that it would put an entire estoppel to the capital market for new construction, which I think would be very disastrous, have a very disastrous effect upon the country as a whole.
I may say, if this bill is made effective, only on the New York Stock Exchange, although my firm is a member or upon the brokers of the country, and that if I thought that the bill could be made effective without crippling the country, my objections would be much less strenuous than they are, when I think that the bill provides for such a comprehensive governmental control of industry as to virtually destroy the initiative and independence of American business.
Mr. Cooper. I just wanted to get your views on that.
Mr. LEA. Mr. Witter, in looking for the causes that have led to losses to purchasers of stock in recent years, to what extent would you say that the irresponsibility of dealers and underwriters has been responsible for those losses?
Mr. WITTER. Well, that is a very difficult question to answer. I would say that bad judgement has been exercised by all dealers, and by all bankers, and by all business men. To try to analyze the particular effects of it, which could be directly attributed to dealers, would be, in my opinion, an almost impossible problem.
This bill, again, does not really deal with dealers except to the extent that it proposes the complete separation of dealers from brokers, and I can say that very little losses, comparatively, have come to investors as a result of the functioning of some firms in a dual capacity. I know of only 3 or 4 big firms that went broke as a result of that dual capacity There are thousands who remained solvent.
I would get considerably off of my subject, I think, if I spoke on the subject of dealers, which I think has been already covered. Is that what you had reference to, Mr. Lea?
Mr. LEA. Yes. This bill picks out the dual capacity as an evil to be eliminated under the provisions of section 10.
Now, what I had in mind is, how great an evil is involved in a firm acting in that dual capacity, based on your experience, of recent years?
Mr. WITTER. Well, I think there is none, sir. If someone wants to state, and I have heard it stated, that certain firms—Prince & Whitely and Pynchon are two that have been mentioned, and West, which are the only ones that I know of that went broke as the result of doing both types of business. I will agree with that; but I only say they did both types of business wrong. They would have gone broke, anyway. So, it was not dual capacity that bankrupted them. It was the fact that their policies were fundamentally unsound. They did not know what it was all about.
Mr. LEA. I suppose that dual capacity is under suspicion from the standpoint of financial responsibility and also the temptation of the man who finds himself the owner of poor stocks, to dump them on his customers to save a loss to himself.
Mr. WITTER. Well, there is no way by which a small dealer may operate without being a broker. If he is going to give any sort of service to his customers, he must be a broker also, so if you are discussing the matter of the small dealer, this is a bill which will destroy the small dealer, because I do not think they can survive. They will not have enough business to survive as a dealer and limit their business. They have to operate as brokers, and also this bill says that they cannot do that.
If you are discussing the large firms, there are various ways by which the matter of segregation could be accomplished. It could be accomplished by a segregation within a partnership in which the premises and the capital and the books, and the accounts and the personnel were entirely separated, so that the business would be as distinct as the business of two separate firms.
It could be provided that there could not be any interlending.
I have heard the theory discussed, that some brokerage-department customers might suffer because of the liability attached to the underwriting department. You could go further on and organize a corporation which would be owned by the partnership, which would carry on the dealer and the underwriter business, which would eliminate that evil. If you provide that the brokerage department customer's men should not be allowed to sell underwritten securities, or securities owned by the partnership, or by the bond department, which, as you say, are hooked up, you entirely prevent the evil of having the firm unload its frozen underwriting upon some unsuspecting customer, by the means of so-called “customer's men.”
The ChairMAN. We are very much obliged to you, Mr. Witter. We would like to hear you longer, but time will not permit.
You may file the telegram and the memorandum you referred to as a part of the record.
(The telegram and the statement above referred to are as follows:)
SEATTLE WASH., February 28, 1934. DEAN WITTER,
Carlton Hotel, Washington, D.C.: The Washington State Securities Dealers Association, a voluntary association composed of all dealers in securities in the State of Washington, at a meeting yesterday unanimously authorized you to represent their association before the Senate Banking Committee and the House Interstate and Foreign Commerce
Committee in connection with the Fletcher-Rayburn bill. While all members of our group are in accord that some regulation is desirable, they believe the bill in its present form will be detrimental not only to their own business but to industry in general and hence detrimental to the best interests of the public. Our members believe the following section will work an undue hardship upon their operations. Section 6 (a) would prohibit banks from extending credit on unlisted securities in the regular course of business, thus depriving dealers of the credit they now receive on bank drafts as well as on inventory, except in the case of listed securities. Section 10 prohibits a dealer from acting as both dealer and broker. All dealers in this State have found it necessary to act both as principal and agent in order to render a complete investment service.
This would work a particular hardship on dealers in this State whose business are of course smaller than in larger financial centers. The same result could be accomplished by requiring the dealer to state at the time the transaction is made and to typewrite or stamp on his confirmation whether he acted as dealer or broker or both. Section 14, which purports to control over-the-counter transactions in unlisted, as well as listed securities, would completely destroy the market for such unlisted issues. The stock of only one corporation and the bonds of only one corporation incorporated under the laws of the State of Washington are listed on a recognized national exchange, the New York Curb. Practically all securities issued by Washington corporations are in amounts too small to comply with the listing requirements of national exchanges; destroying the market for such securities and taking away their collateral value would be detrimental not only to security dealers but to the entire community. Our group desires to make the following comment as to the effect of certain sections on general business and financial conditions: Under subsection 2 of section 6 the fixing of margin requirements should be left to the Federal Reserve Board inasmuch as that body is responsible for financial policies in the United States. Margin provisions as fixed under this subsection would force liquidation of listed and unlisted securities not only from brokers, but also from banks, which is most undesirable at this stage of our recovery. Inasmuch as all banks are subject to supervision and examination by National and/or State banking department they should be permitted some latitude in the making of collateral loans.
Not only is this denied them under subsection 3, but also they are deprived of a highly satisfactory safe and liquid type of loan. Section 22 provides that all information filed with the Federal Trade Commission shall be made available to the public, thus intimate details regarding the business of every corporation whose securities are traded in are made available to all competitors, whether domestic or foreign. The requirements for listing are so onerous that many small corporations may find it impossible to comply. Moreover, there are apparently no limitations as to the number and nature of reports to be required from time to time by the Federal Trade Commission. The provisions relating to the responsibility of officers filing reports and the provisions governing the actions of officers, directors, and stockholders owning or acquiring 5 percent or more of a single issue appear after careful consideration exceedingly dangerous to the interests of the public. Moreover, the penalties provided thereunder bear no relation to any losses incurred and place a premium upon the activities of a litigious chiseler. The Washington State Securities Dealers Association is composed of 48 investment bankers, all operating both as broker and dealer, within the State of Washington.
WASHINGTON STATE SECURITIES DEALERS ASSOCIATION,
STATEMENT OF DEAN WITTER OF SAN FRANCISCO IN REGARD TO H.R. 7852
KNOWN AS “NATIONAL SECURITIES ExcHANGE ACT OF 1934" I am authorized to speak for 204 dealers on the Pacific coast about 30 of whom have seats on some exchange and who do both a brokerage and dealers business, and the remainder of whom have no stock exchange seats. All of these dealers also operate as brokers. Attached to this statement are copies of wire providing this authority. I should like to read them into the record. I particularly represent small dealers rather far removed from the financial centers.
I am allowed only 15 minutes of your time and will try not to repeat testimony already given. May I complete my statement which is brief and then I shall be glad to answer questions.
I am in favor of Federal supervision and control of stock exchanges. I am in favor of complete and accurate reports to stockholders; I am in favor of punishing misrepresentation, fraud, and other acts by either brokers or dealers which are detrimental to the public interest. I am opposed to pools, corners, and manipulation of markets.
I have certain general objections to the regulation of stock exchanges by rigid and fixed statute. I do not think a fixed statute endeavoring to deal with all the complex and intricate problems of the brokerage business can be so drawn as to eliminate the possibility of abuses without at the same time destroying the functions of exchanges and the free and open market for securities to the great detri. ment of the public.
Time does not permit me to cover the entire subject matter of the bill and I will therefore confine my statement ot the effect of the first sentence of section 10 and section 19 (b) insofar as this section relates to this sentence and section 7 (c), which separate dealers and underwriters from brokers.
The presumed purpose of these sections which provide for the divorce of broker and dealer is (1) to insure that the customer knows whether he is dealing with a firm as a broker or a dealer and (2) to prevent the use of the same capital for the conduct of two businesses. I do not presume that the bill was intended to enforce a hardship upon the conduct of legitimate business nor to further reduce the already decimated ranks of the dealers although these sections would do both. I shall later suggest how the purposes of these sections can be fulfilled without damage to public interest.
As drawn these sections would destroy the business of many small firms in smaller communities as these firms depend for their livelihood and their usefulness upon providing both brokerage and investment service to their customers. This would injure the investor. There may be no legitimate firms left in many smaller towns. If this is the case, it would make investment difficult and precarious. If there are any left, they would be wholly separate firms, which would have difficulty earning a livelihood. The investor could not buy municipal bonds and listed common stocks from the same firm. Neither the broker nor the dealer could take a comprehensive and disinterested view of the investors' requirements. Pressure will be exerted on the dealer to recommend only unlisted securities to his clients in order to handle all of their business. A broker is likely to be prejudiecd in favor of listed common stocks only. I do not see how the public will be benefited by the proposed separation.
I believe the country as a whole will be injured. First, if I am correct in the assumption that many small dealers will be forced out of business or would become brokers only, then it will become even more difficult than it is at present for deserving local enterprises to be financed. Secondly, municipalities are largely financed by small dealers, who are also brokers and who purchase municipal obligations and redistribute them to the individual investor. Experience has shown that this type of financing cannot be handled on a brokerage basis. If an arbitrary separation is imposed, it would greatly curtail the market for municipal bonds and small local issues. I shall not go farther into this phase of the matter because of limitations of time.
It would not be constructive to object to the divorcement of the brokerage and dealer business without suggesting some means which would insure the public against confusion of functions. This can be done by the segregation of the two businesses under one ownership, and by having all letterheads printed either “Bond Department” or “Brokerage Department. All statements showing transactions with customers should be clearly phrased to indicate without possibility of misunderstanding whether the firm is acting as a broker or a principal in that particular transaction. This has been comprehensively provided for in the Investment Bankers Code recently adopted. Our bond department has eight separate forms showing purchase and sale of securities and clearly setting forth whether we are acting as a broker or a principal. In the event that we are selling securities in which we have a profit that fact is also stated. I attach hereto copies of the eight forms which we use and in which we say in so many words that “We act as principal,” if that is the case. If we act as principal in the sale of securities in which we have no profit or a loss we obviously omit the phrase "which includes a profit to us," and unfortunately we have had much use for this particular form.
In the conduct of my firm and many others, we have scrupulously segregated our brokerage department premises, books, accounts, organization, capital, personnel, and functions. In general, our brokerage departments and bond departments are as separate as though they were two different firms except for