I am just speaking about what seems to me to be the inadvisability of separating the regulatory powers of the Federal Government in the two cases, so closely connected so far as results are concerned.

Mr. KINNICUTT. Of course, what I would like to see would be the operations of the securities act under the supervision of the Federal Securities Commission, rather than under the Federal Trade Commission.

The CHAIRMAN. Well, suppose that the securities administration is going to be left where it is and suppose we are not going to form a new commission in the matter. Then, where would you want the administration of this act placed?

Mr. KINNICUTT. I would still want it under a securities commission.
The CHAIRMAN. I say, if we do not create a new commission.
Mr. KINNICUTT. I beg your pardon.

The CHAIRMAN. I say, suppose that the securities act is going to remain under the administration of the Federal Trade Commission and we are not going to have a new commission, then where do you think the administration of this act should be placed?

Mr. KINNICUTT. Well, I should think, obviously, then it would have to come under the Federal Trade Commission, because they already have one function.

The CHAIRMAN. I think we might just as well go along with that theory.

Mr. COLE. Mr. Chairman, one other question of the witness.
The CHAIRMAN. Mr. Cole.

Mr. COLE. I understood you in the early part of your statement, this morning, to say that you favored the Roper report.

Mr. KINNICUTT. Yes.

Mr. COLE. The commission you advocate would have representation from the stock exchange?

Mr. KINNICUTT. Yes.

Mr. COLE. The Roper report on page 7 recommends very definitely against that at bottom of page 7, it says that the holder of any position connected with such agency be required to disassociate himself from all business connections engaged directly or indirectly with market transactions, just as the Secretary of the Treasury is required to disassociate himself from any private business.

Then, you approve of the Roper report, or approve of the recommendations of Mr. Whitney?

Mr. KINNICUTT. Well, I do not think in our recommendations we made any recommendation except only that there should be a commission, made up of men who served in the securities business. Mr. COLE. Oh, yes.

Mr. KINNICUTT. Does that not conform to the Roper report?

Mr. COLE. I understood your recommendation to be that there be a member from the stock exchange.

Mr. KINNICUTT. No; I did not say that. Personally I think it might be wise, but the primary thing is that he should have had practical experience in the securities business.

Mr. BULWINKLE. Mr. Chairman.

The CHAIRMAN. Are you through, Mr. Cole?
Mr. COLE. Yes.

The CHAIRMAN. Mr. Bulwinkle.

Mr. BULWINKLE. Mr. Chairman, practically every person who is opposed to this bill, representing the various exchanges, have come before this committee and have admitted that there were bad practices in each exchange and, I think that that is practically so, without an exception.

What are those bad practices?

Mr. KINNICUTT. Bad pools, washed sales, of course, fraud, which always happens in every industry; manipulations and, of course, false statements or misleading statements.

Mr. BULWINKLE. Now, that being so and that condition having existed for some time, and assuming, and knowing that the greater part of the members of each of these exchanges are honest men, why have you not done something to remedy that condition yourselves?

Mr. KINNICUTT. I think there has been a great deal done and I do not mean since this hearing started, but I could go back a good many years, and every year we feel it, because we are constantly coming under tighter and tighter rules and regulations from the exchanges of which we are members. I think there is a definite progression being made every year.

Mr. BULWINKLE. But, these five bad practices that you have mentioned to me just now have been existing all of the time, have they not? Pools, manipulations, and so forth.

Mr. KINNICUTT. Yes.

Mr. BULWINKLE. And, the others. Well, now, what have you done to remedy those?

Mr. KINNICUTT. I would have to take all of the different regulations in the exchanges in detail to answer that question.

Mr. BULWINKLE. Well, notwithstanding those regulations, you have passed from the statement which you have made to the committee there, you have not stopped them, have you?

Mr. KINNICUTT. On the other hand, my recommendations that such a commission should have in it, in the first instance, supervisory power to make their own recommendations, in the event the exchanges have not done what we all think they ought to do, and over and above that, if the suggestions of the commission are not put into effect by the exchanges, and the evil continues, our recommendation is, back of all of that, that such a commission should have mandatory powers.

Mr. BULWINKLE. Does it not seem to you, with the statement that each of you gentlemen have made, that you are asking the Congress in effect to protect you from yourselves?

Mr. KINNICUTT. I think we want protection just as much as the protection we want to give.

Mr. BULWINKLE. Protect you from your own membership and from your own bad practices.

Mr. KINNICUTT. Largely, is that not a protection against dishonesty or temptations?

Mr. BULWINKLE. Well, your States have various statutes covering, largely, dishonesty, do they not, and fraud?

Mr. KINNICUTT. Well, I think myself that legislation against temptation is almost an impossible feat. I think we are a little late on that. It should, I think, have begun in the Garden of Eden, perhaps.

Mr. BULWINKLE. Yes; I think so, too, but I am trying to find out, sitting here in the committee, not knowing anything about stock exchanges, but with every one of you gentlemen admitting that there are bad practices which have continued, and still continue, and that you want the help of Congress to eliminate these bad practices. That is all, sir.

Mr. PETTENGILL. Mr. Chairman

The CHAIRMAN. Mr. Pettengill, and then we must close with this witness.

Mr. PETTENGILL. You made one statement, Mr. Kinnicutt, inadvertently, I am sure, that I do not believe you want to stand. You said that the Federal Securities Commission passed upon the soundness of the securities.

Mr. KINNICUTT. I want to correct myself there.
Mr. PETTENGILL. They do not do that?

Mr. KINNICUTT. They make no observations, if that is a better phrase.

Mr. PETTENGILL. It is purely a matter that these securities are honestly represented to the public and not that the commission makes any recommendations as to their soundness.

The CHAIRMAN. We are very much obliged to you, Mr. Kinnicutt.

STATEMENT OF CLAUDE FOLLETTE, REPRESENTING THE COMMITTEE OF PUT AND CALL BROKERS AND DEALERS IN THE CITY OF NEW YORK, 120 BROADWAY, NEW YORK, N.Y.

Mr. FOLLETTE. My name is Claude Follette. I represent the committee of put and call brokers and dealers in the city of New York. The CHAIRMAN. We will have to ask you to speak a little louder. Mr. FOLLETTE. In setting forth the economic importance of puts. and calls in the securities markets, we wish to emphasize three major elements: First, their value for insurance against loss; second, their stabilizing quality; third, the opportunity afforded the operator of moderate means to protect a position in the market at minimum risk.

In appendix no. 1 will be found specimens of standard forms for put and call contracts employed by brokers and dealers in these contracts.

We wish to make it clear that this presentation refers entirely to privileges-puts and calls-sold on a competitive basis at a fixed premium and publicly offered, as distinguished from so-called "corporation or company options" frequently privately offered in large blocks for manipulative purposes.

Possibly it would be in the interest of clarity if a brief historical summary of puts and calls were presented to the committee. These contracts have been developed and sanctioned by business practice over a period of two to three centuries. Undoubtedly, they had their origin in transactions involving the merchandising of commodities, and in this respect are closely akin to the future contract system now in vogue and such an indispensible part of the marketing of all great staple commodities. As a matter of fact, the future contract system was devised entirely for the purpose of insurance against injurious price changes. The put and call system is in the same category, for

it insures the investor in securities against violent fluctuations due to unexpected developments.

Another instance of the use of the option contract in a business that probably is familiar to every member of your committee is its protective use in real-estate transactions. A man may own, let us say a corner-lot building in a district that is attracting the constructive attention of realtors. He is offered a good price for his holdings, and inasmuch as this shows him a handsome profit, he sells. However, his business judgment tells him that there are possibilities of a further advance in realty values in that neighborhood. He, therefore, is wise enough to take an option or options on other parcels in the vicinity, and if his vision is corroborated he has an opportunity to make a substantial profit on his option contract. On the other hand, if values do not advance, he has the satisfaction of knowing that he has sold his property to good advantage.

In connection with put and call contracts it might be pointed out that John Houghton, in 1694, described how puts and calls were used in connection with dealings on the London Stock Exchange. In 1816, the transactions in puts and calls already had reached considerable volume on the Berlin Stock Exchange. Today there is no important financial center where puts and calls are not dealt in and where they are not known as an important adjunct to security dealings. At present, New York has developed into a large market for puts and calls, and financial interests all over the world are buyers of these contracts in New York.

Probably the best method of illustrating the insurance feature of puts and calls would be to employ specific samples. Let us take the case of U.S. Steel selling, say, at 55. An investor may have bought the stock at 53. He feels reasonably confident that his judgment has been sound, but he wishes to guard against any unforeseen contingencies. He consequently pays $137.50 for a put-this charge being in the nature of an insurance premium. The put price is 51. If, during the 30-day period, a break comes in the market, and Steel, let us say, breaks to 45 at the end of the 30-day period, he will deliver 100 shares to the writer of the put at 51. In other words, while the best price he can obtain on the stock exchange is 45, he has been able to dispose of his stock at 51 through the medium of the protection of his put contract.

In the case of a call, let us say that the same holder is long of Steel at 53.

Mr. PETTENGILL. Mr. Follette, in the second paragraph on page 3, line 2, should that word be "long" or "short"?

Mr. FOLLETTE. In the case of a call, let us say that the same holder is long of Steel at 53.

Mr. PETTENGILL. The previous paragraph deals with a man who is long.

Mr. FOLLETTE. You say the second paragraph, page 3, line 2?
Mr. PETTENGILL. Yes. [Reading:]

"In the case of a call, let us say that the same holder is long of Steel at 53." Should that not be "short"?

Mr. FOLLETTE. No.

Mr. PETTENGILL. You have just been dealing with the case of a man who is long of Steel in the preceding paragraph.

Mr. FOLLETTE. Well, the ramifications of these things and trading position of any individual person is so great that it is almost impossible to put all of those things in here. However, I will be glad to answer any specific questions, if I can, which you may care to ask. He buys a call 4 points up at 57 which gives him the right to demand the stock from the writer of the contract at 57. This enables him to sell his stock at 57 and through the medium of his call contract for which he has paid the insurance premium, he is able to participate in any rise above 57 until the end of the 30-day period.

Mr. PETTENGILL. If a man is long on Steel at 53, why make somebody else deliver him Steel at 57?

Mr. FOLLETTE. He makes the difference between 53 and 57 as a profit, and besides he has $137.50 to his credit, which he received for that call.

Mr. PETTENGILL. Now, when you say that he is long on stock already delivered to his broker, for his account?

An investor holds 100 shares of Steel, which he purchased at 53 and he believes that on account of the increased earnings and improved general conditions Steel will advance very sharply.

However, it often happens that sudden, unforeseen developments arouse fear that the stock market might be affected adversely.

The reaction might either be of short duration, it might develop into a sustained downward tendency, or it might not come to pass at all.

If the investor sells his stock he might lose an excellent investment; if he holds on to it, he might sustain a heavy loss.

The purchase of a 30-day call on 100 steel at 57 will solve his problem.

He can sell the 100 shares, which he owns, at the prevailing market price.

If Steel declines, afterwards he, of course, is able, if he so desires, to buy back at a lower price the 100 shares which he sold previously. If Steel advances, he is enabled through the medium of the call, which he exercises on expiration date, to recapture the 100 shares at 57.

I do not know of a more perfect form of insurance.

Mr. PETTENGILL. Well, go ahead. I will not interrupt you any further.

Mr. FOLLETTE. Thus far this memorandum has referred entirely to the buyer of these contracts. It should be interesting to describe the position of the seller of these contracts. The maker of the put in the case of Steel is willing to take the stock at 51, the contract price. In the event that the stock is put to him by reason of the premium of $137.50, less the commission charge, which he has received, the cost to him is reduced to that extent. In case the put is not exercised the maker of the contract has received substantial compensation for the insurance contract.

As the seller of the call is usually the owner of the stock, he is perfectly willing to sell the amount of shares represented by the call contract at the advance plus the premium he receives.

It can be seen that in both the cases of the buyer of the put or call and the maker of these contracts there may be in the majority of cases a mutual advantage.