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Mr. NEWBOLD. Yes.
Mr. PETTENGILL. But when the relationship of broker and customer, principal, and agent lasting over a period of months or years is established
Mr. NEWBOLD. Yes.
Mr. PETTENGILL. Then, there is a fiduciary relationship that creeps in between the two.
Mr. NEWBOLD. Yes.
Mr. PETTENGILL. A trust relationship, and it seems to me then that the situation is a little different than it would be in the case of a man who has something to sell like a hardware merchant and his customer.
Now, when people go to banks, and they have got a little money to invest, they are not dealing at arm's length. They think that the bank is giving them disinterested advice, in a quasi-fiduciary capacity.
Mr. NEWBOLD. Could I ask you a question?
Mr. NEWBOLD. What could be done in a situation of this kind: A man telephones, a regular customer, an individual, telephones and says, “I have got some money to invest and want you to make some suggestions." I get out his list and look over it and find that possibly at this juncture, in view of his list, that he ought to buy, we will say, a second-class railroad bond, or high-grade railroad bonds, which are going up:
I find he has got enough of them. I think, and I hope you believe it, that it is not until then that I do look over my list as to what we have to sell, and to find out whether we happen to have anything of what I think that he should have. We will say, suppose, we have.
So then I will call him up and say, "I will come to see you, and talk to you about an investment." I take up two descriptions, two lots of bonds of which I have five each, you see, and we talk it over, and he says, “Well, I like that. I like that.” “I think that that is a very wise thing for me to have.” “I do not like this other one at all. We will throw it out." I say, “All right."
And then he says, "I have got $9,000. I would like to buy nine of these bonds." And then I say, "Oh, I am sorry. We can sell you five, but that is all we can do. That is all we have." Then he says, “Won't you go out and buy me four more?” I say, “Oh, no; I cannot do that. I am not allowed to do that, on commission."
Now, I think that does not seem to me quite a reasonable way of conducting a business. It gets even worse if we say that he has $6,750. He says, "I will take those five", and then I find I have", he will say, "37 shares of General Motors. Now, supposing you buy some of those. I want to build that up to 50 shares.” And I say, "No." I say, "I cannot invest your $1,750 in General Motors, because I am not allowed to do that. You will have to go to a broker."
And then I let the customer go to a man who has got very little investment interest, who is interested in trading.
I think that that presents a difficulty in keeping your customers, and if your customers slip away, they will not give the same confidence to several people that they will to one.
Mr. WOLVERTON. Mr. Chairman.
Mr. WOLVERTON. If I understand your position correctly, Mr. Newbold, it is this, that you are not objecting to regulation as pro
vided for, or suggested in the Dickinson report, but you do object to a segregation of the business activities of a broker and a dealer.
Mr. NEWBOLD. I do; yes, sir. I am not, may I say, I am not certain that ways cannot be found to accomplish the purpose; but it will take a great deal of study. We have had it before us in our minds for a long time. It will take a great deal of study to do that. To do it with one blow, I think will produce chaos.
Mr. WOLVERTON. So your remarks are not directed to an objection to regulation, but to segregation.
Mr. NEWBOLD. Yes, sir; that is the thing. We have other individual objections. I have other objections to the bill, and I think that all of us have, but that is not the subject. We did not feel that we knew enough about it to tell you anything about that.
Mr. WOLVERTON. What would be the effect of this section, so far as dealing in municipal bonds is concerned?
Mr. NEWBOLD. If—I do not know how to put that under segregation it were possible to continue with the active lists of the customers that they have, at present under the dual arrangement, I think it would be possible for dealers to buy all of the municipal bonds as they have in the past, but most of us feel it would be just a question of a little time, perhaps 2 or 3 years, if the dealers stood on their own feet entirely when they would begin to disappear and they are the only people who could really handle municipal bond issues, if we are right in considering that the broker is not investment-minded and, nobody buys municipal bonds who are not genuine investors, because the rate of return is so low, you see.
Mr. WOLVERTON. Of course, those of us who live in the vicinity of Philadelphia and know the high class of firms that have been joined together in the brief that you have presented, can appreciate somewhat your position in the matter, but what this bill is seeking to do is to deal with the situation, that exists where the business is not conducted by people as high minded and honorable and whose integrity is as unquestioned as the firms who are represented in your brief.
Now, what do you feel could or should be done with respect to that situation?
Mr. NEWBOLD. Well, it is difficult to say. I think that the more support and help the investment dealers who have high ideals receive, the more they are strengthened, the more they can bring about any reform that you might seek in their own lines, rather than being punished, innocent and guilty alike, by a legislative fiat.
This code to which reference has been made, which will probably come before the President very shortly, is a source of the deepest gratification to those of us who have been in the business longer, because it gives an opportunity of enforcing standards of performance that we have sought for years, by persuasion and blacklisting of people, if you want to call it that. I mean, refusing to deal with certain people because we did not think that they were straight. That code, I think, will accomplish more good by strengthening the hands of the honorable dealers than you could accomplish by, as I say, a legislative fiat, wiping all out, good and bad alike.
Mr. WOLVERTON. Are you prepared to say on behalf of those for whom you are speaking, whether you approve in a general way, the recommendations and suggestions made in the Roper-Dickinson report?
Mr. NEWBOLD. I think the fact-I have not had an opportunity of reading to you the last part of my memorandum—the fact that we again quote from the Dickinson report in reference to section 14 indicates that we are for it as a group.
I may say that I personally, and Mr. Cheston, who represents Edward B. Smith & Co., and my nephew, a partner of mine, Mr. Taylor, we all are for it enthusiastically, and I doubt if any of the others feel differently; but it was not discussed. In fact, we all agreed when we produced this thing and quoted the Roper report twice, and nobody said that is the only part of the Roper report I stand for, that we did agree.
Mr. WOLVERTON. I was prompted to ask the question because you rely on the suggestions of the Roper report so far as sections 10 and 14 are concerned and I was, therefore, interested in knowing whether you had the same feeling with respect to the balance of the report.
Mr. NewBOLD. I think we three may say that individually. Mr. Cheston can speak for himself.
Mr. Cheston. I would say that the rest of the group, speaking for the rest of the group, we are very strongly in favor of the RoperDickinson report.
Mr. WOLFENDEN. May I ask a question?
Mr. WOLFENDEN. Should section 10 be omitted from the bill, should not the customer know in what capacity you were acting, namely, as a broker or a dealer?
Mr. NEWBOLD. Should not the customer know? Mr. WOLFENDEN. Yes. Mr. NEWBOLD. Why, yes, sir. Of course he ought to know. He ought to know the moment he gives you an order, whether he is going to buy it from you directly, or you are going to buy it for him. Of course, I think that every bill of confirmation states that. I know it has ever since I used to make them out myself; that you are to sell to so-and-so; you buy from so-and-so and you are acting then as dealer, or else you sell for so-and-so, and you are acting then as a seller selling for so-and-so's account.
Now, I think that it would be very helpful if that were insisted upon, and I think the code does insist upon it. I would go further myself and make it necessary to establish that fact when the order is given rather than wait until the order is consummated. Is that an answer to your question?
Mr. WOLFENDEN. Yes.
The CHAIRMAN. Mr. Lea would like to ask a question, and then we are going to have to close with your statement. You have gone over your time now.
Mr. LEA. Would you agree that one of the greatest, if not the greatest, evils in reference to stock sales in recent years has been the dumping of poor stocks on the uninformed?
Mr. NEWBOLD. That is a difficult question to answer.
Mr. NEWBOLD. I do not know. I would be inclined to think that very closely is balanced by the informed willfully buying too many of the things than they thought were good, more than they probably were justified in buying.
Mr. LEA. Then, passing that, let us go to the motive leading to the sale of poor stocks to the uninformed.
That is, so far as the owner of the stocks are concerned he has a motive which serves this own purpose, and that may not serve the purposes of the customer. That is manifest, is it not?
Mr. NEWBOLD. Yes.
Mr. LEA. And that is a very great temptation for the average man?
Mr. NEWBOLD. Yes.
Mr. LEA. Now, as to the agent, what motive has he to sell his customers poor stocks instead of good stocks?
Mr. NEWBOLD. Well, Mr. Lea, did you give as an alternative there the prohibition entirely of the dealer selling the bad stocks that he has bought? If you can achieve that, why, I would say that it is worth while going into, but I do not think that you can. I do not think that is quite really the alternative that you have presented to me.
Mr. LEA. I do not want to argue that. I am just after information on the point as to what is the motive back of this dumping of poor stocks on the uninformed.
Mr. NEWBOLD. Trying to make money out of other people.
Mr. LEA. Why would not an agent sell his customer good stock instead of poor?
Mr. NEWBOLD. Why does not the agent? Mr. LEA. Yes. Mr. NEWBOLD. You mean if he is making the sale on commission why does he select the poor stock?
Mr. LEA. Yes; why does the broker pass over this poor stock on the customer, when they have good stock that they could sell to the customer, and in the end produce better results? What is the motive back of the broker doing that?
Mr. NEWBOLD. Well, a broker can have no motive because the commission he makes out of the transaction is the same, whether he sells good stocks or bad.
Mr. LEA. Does the exchange tolerate any differential in regard to the broker's commission?
Mr. NEWBOLD. You mean
Mr. LEA. Does he get more; does the exchange permit the broker to charge more or does he receive more for selling one stock than another?
Mr. NEWBOLD. I am a little hazy about that, because I am not very close to the actual mechanics, but I understand that recently, there is a different commission for stocks selling in different grades of prices; but, of course, not between two stocks selling between 15 and 25. The commission would be identically the same on the stock exchange.
Mr. LEA. How about the ordinary brokerage firms over the country; is there a privilege of taking larger awards for selling one class of stocks than another?
Mr. NEWBOLD. Oh, I should think so. I should think probably so.
Mr. LEA. Well, is that not one of the responsible motives for so much poor stock being sold to the uninformed?
Mr. NEWBOLD. Why, yes, sir; there is no doubt about that.
My colleague tells me just now that question is covered in the code. I have read the code only hastily, because I have been engaged so much on this; but it is covered in the code; that question, I understand, of getting larger commissions.
Mr. LEA. But, up to this time there has been nothing that prevented an ordinary stockbroker from favoring one particular stock because he got a larger reward for selling it; is that true?
Mr. NEWBOLD. I want to get that clear. Do you mean stocks that are listed?
Mr. LEA. No; I was not confining it to that. I was trying to get at the reasons for a broker being interested in selling poor stocks instead of good stocks.
Mr. NEWBOLD. Well, I do not think that I can help you very much there, except in the sense that if you get a man who is crooked, he will advocate the thing on which he makes the most money, that is true, and try to sell it.
The CHAIRMAN. Mr. Newbold, you are making a very interesting statement, but your time has expired. You will be allowed to print your whole statement in the record.
Mr. NEWBOLD. May I just say that we are also opposed to section 14.
The CHAIRMAN. You may print the rest of your statement in the record.
Mr. NEWBOLD. Thank you. (The remainder of the statement above referred to is as follows:)
MEMORANDUM IN RELATION TO SECTION 14
The provisions of section 14 prohibit the making of over-the-counter markets for unregistered securities unless such market is made in accordance with rules and regulations promulgated by the Federal Trade Commission. The passage of this section in its present form would mean the delegation by Congress of power to the Federal Trade Commission, if it were so inclined, to prevent any market whatever for such securities by imposing drastic conditions which might be even more severe than the regulations applicable to registered securities traded in upon national exchanges. If the purpose of this section is to prevent speculation in unregistered securities, consideration should be given to the character of securities now commonly sold in the over-the-counter markets. This class of securities are dealt in largely by investors and not by speculators. They do not lend themselves easily to speculation, as may be realized when it is known that they consist largely of Federal Land Bank bonds, Home Owners' Loan Corporation bonds, other Government securities, State, county, school district, and municipal obligations, bank and insurance company stocks, railroad equipment trust certificates, and bonds secured by trust mortgages upon real estate. In addition to such unlisted securities, the over-the-counter markets afford an opportunity for transactions in large blocks of listed securities primarily for the benefit of institutional investors. The over-the-counter markets afford little opportunity for uncontrolled speculation, not only because of the character of the securities traded in and the transactions occurring there, but because of the type of customer with whom the investment dealer has the majority by volume of such transactions. These customers are such as insurance companies, savings banks, National and State banks and trust companies, educational and charitable institutions, and corporate trustees.
These customers are advised by persons of long and extensive experience in the purchase and sale of such securities who are frequently as familiar with the market values as the representatives of the investment dealers trading with them. The purchases made are for investment and not for speculative profit, and almost invariably are cash transactions and not on marginal accounts. The problems arising out of such transactions are clearly not comparable to those which trading upon the national stock exchanges present, and a totally different treatment is required to control such practices, if any, that may have been indulged in by a