more liberal borrowing on new securities than you are going to have on old seasoned securities.

The CHAIRMAN. Do you think that we should in an act here fix the margin requirements, or leave that entirely to the stock exchange? Mr. HANCOCK. Well, you have asked me a pretty hard one, Mr. Rayburn. I believe that you will have to recognize the vice that some people find their way made easy to go into the market, and I believe you have to find some way to keep out of the market those who do not understand the risk of the market.

The CHAIRMAN. Well, that is our problem, and that is the reason why we are asking about it.

Mr. HANCOCK. You have got a curious proposition there, the 80percent provision as to new securities.

Now, I am in accord with a high margin requirement. I do not see anything to be gained by putting it in the law as against having it in the control of the exchange, or controlled by the Federal Trade Commission.

The CHAIRMAN. Now that is

Mr. HANCOCK (continuing). I do not see how you will gain anything by putting it in the law as against having it either in the control of the exchange or the control of the Federal Trade Commission.

The CHAIRMAN. Do you think that there should be, as I think that somebody said, a "bright line" here the other day. Do you think that there should be any line around which the commission and the exchange should understand that they should not get away from, or that they should swing pretty close to it?

Mr. HANCOCK. I do not quite get your meaning, sir. I am sorry, but I do not know anything about a bright line.

The CHAIRMAN. Yes, Mr. Corcoran referred to something like a bright line, or some guide, in other words, leaving discretion with the Commission, after consultation with the officers, which presumably the members of the Commission would do.

Mr. HANCOCK. I think, gentlemen, you would be surprised to find, outside of those men who are here, and have to defend their positions, you would be surprised how many men recognize the good that has been done by the investigation. There is a quickened conscience today, which you may not appreciate, and a lot of the troubles that have been turned up-not by the investigation alone-but over the last 4 or 5 years are going to cure themselves, so far as honest men are concerned, and I believe that the best plan, beyond that, is a prohibition of specific abuses by law, adding only penal provisions.

The CHAIRMAN. Of course, that is always a problem in connection with criminal statutes. It is not the good fellow, but it is the fellow who will violate the laws, and so forth, and I presume that that is the reason why we are here, not to legislate against everybody that has anything to do with a stock exchange, or deals on one, but to attempt to eliminate the bad practices that are possible under the present conditions.

Mr. HANCOCK. That is right.

The CHAIRMAN. And everybody knows that if the stock exchange makes a rule, they can change it tomorrow if they so desire.

Mr. HANCOCK. They are going to respond to public opinion with a

great deal more alacrity than they have in the past.

The CHAIRMAN. But, they nearly ruined the public, before.

Mr. HANCOCK. They were not the only factor in that, sir.

The CHAIRMAN. I know that. We cannot legislate either to protect a man against his own folly, because there are a lot of people in America who are not willing to invest in stocks paying 6 percent. They want to put $10 into an oil well and take out $100 in 90 days. We are going to have to close. We are very much obliged to you. And, you can expand on any answers to the questions that the members have asked, and we will appreciate your getting your statement back as early as possible. We would like to print these hearings pretty soon.

Mr. HANCOCK. I have printed copies of my memorandum, if you want them.

The CHAIRMAN. We will be very glad to have them. You can put all of that statement in the record.

(A memorandum previously referred to and the statement above referred to follow:)

MARCH 3, 1934.

This is the memorandum I referred to in the hearing on March 2. I prepared it on January 24 before I knew of the present bill. On account of the exact reference I made to this memorandum I have not felt at liberty to modify it.

MEMORANDUM

JOHN M. HANCOCK.

Having in mind the legislation already passed and proposed, it still seems that the attack on the problem of protecting the investor has become largely an attack upon the bankers and brokers. Nothing has been done to provide current facts to the investor after the filing of the registration statement. Nothing has been done to establish better corporate practices. After all has been done that can be done in giving the investor the facts about the business it still remains impossible to appraise the management from time to time, and it is impossible to apprize the investor in advance of new developments which may affect his security.

Recognizing all of the difficulties there are in the way of a Federal corporation law it is believed that nothing effective can be done until the passage of such a law. It might be possible to embody many provisions in codes under N.R.A. The development of these practices might well be undertaken by a committee appointed by the President and composed of men of recognized public standing and from the several professions most directly concerned.

Many of these provisions, it would appear, could be included in a code for auditing firms which would make it an unfair trade practice for them to submit a report not complying with these and other acceptable provisions. If the corporations themselves are required to have audited reports, and then the auditor's conduct is governed by the code, it will be effective against the corporation. Not only that, but uniformity of practice among auditors would make it impossible for any corporation to discharge one firm of auditors in order to get more favorable treatment at the hands of another firm of auditors.

While accounting practice probably cannot be absolutely standardized, undoubtedly leading accountants will agree as to many things which should not under any circumstances be permitted. The building up of such standards over a time through the operation of codes ought to lay the foundation for subsequent permanent legislation.

In developing a standard of accounting procedure consideration should be given to revealing more of the facts of the business to the stockholders and any gain in this direction will be helpful.

The query naturally arises as to whether the present laws dealing with these problems are being enforced, and if not being enforced, what is to be gained by adding more laws. A study of this might well be undertaken.

It will probably be admitted that no law will enforce morality, and it is quite certain that no honest man can provide provisions for a law that will be truly effective against a crook.

It is urged that an attempt be not made to arrive at perfection in these matters in one effort. The developments which have taken place have been material over the years. Progress is being made, undoubtedly too slowly, but there is

still need for a vigorous educational campaign so that any law will become in large measure self-enforcing.

There are other problems involved which require further consideration. No adequate provision has been thought of to cover oral "tips." It has been suggested that written advice to buy or sell should be required to be on a sheet of paper with the words "Tipster Sheet" at the head.

Several suggestions are added as an appendix and relating particularly to those items which should be considered in connection with corporate reports. These suggestions are drawn from experience without an effort to cover all such experiences. They can readily be added to and should be added to before the formulation of any legislation is attempted. Those ills mentioned would appear clearly to require reform. Additions to the list would only further demonstrate the need of reform.

APPENDIX

The selection of auditors should be left to the stockholders and not to the management upon whom they are reporting and to whom they must look for their employment. As a practical matter corporations whose securities are widely held are in the hands of the management as long as the management is successful, and in such cases the selection of the auditing firm by the management will always be ratified by the stockholders. If the auditors preparing the report were required to attend the stockholders' meeting and to be prepared to answer all questions that might be asked at that time, this might afford some small measure of protection.

It would seem only fair and reasonable to provide that if a corporation has over 10 stockholders (or some arbitrarily chosen small number) all plans involving extra compensation such as stock options, stock purchase plans, bonus plans, profit-sharing plans, should be approved by the stockholders in advance of any payment, and that the allocation of the benefits under such plan to any individuals in the management should be approved by a committee of directors not participating in any such plans, such committee to be chosen by the stockholders of the parent corporation, and their compensation, if any, to be fixed by such stockholders.

The salaries of officers should be fixed by such committee and should not be left to the board of directors, many of whom would also be employees of the corporation and in a position to approve a salary scale for others conditional upon their receiving a salary satisfactory for themselves.

The compensation of officers and directors of the corporation and subsidiaries, in any form and in all forms, should be reported at least yearly to stockholders, covering the corporation and all its subsidiaries under the following general headings:

1. As to officers of the parent corporation who are also members of the board of directors of the parent corporation, their number and their total compensation. 2. As to all other officers of the parent corporation and all officers of the subsidiaries, the number of officers and their total compensation.

3. As to disinterested directors of the parent corporation chosen by stockholders, their number and total compensation.

The registration statement under the Securities Act will not provide current information as to the company, even as to the character of facts embodied in the registration statement. There should be a positive requirement for at least annual reports made by public auditors, to be sent to all stockholders, and interim reports might well be allowed to be audited or not as the management might wish. Corporations having over 10 stockholders should be required to submit consolidated balance sheets and operating statements, or if they desire to carry the item of the investments in any subsidiary and not consolidate the balance sheets, the gain or loss for the period covered by the report, together with the accrued gain or loss since incorporation, must be separately shown.

The transferring of reserves to the income account, or the application of operating expenses against reserves, directly or indirectly, should be prohibited unless the transfers are set forth.

Any hidden unrealized profit in the inventory should be required to be covered by a note on the report. All inventories are to be stated on the basis of cost or market, whichever is lower, even to the extent that finished goods may not be carried at cost if the raw materials going into them have declined as against the purchase price at which they entered into costs.

While it will be difficult to set up an exact definition of terms, a corporation should be required to set forth any income derived during the period outside of

the normal course of its business and of a character not reasonably to be expected to be recurring.

If marketable securities are carried on the balance sheet, a separate list must be embodied in the report and no securities of a subsidary or affiliate shall ever be carried as current assets.

There have been false earning statements published by corporations. I do not know what the present laws provide as to the officers and directors having guilty knowledge of such statements, but if this is not now provided for by present laws it should be covered.

The minutes of all meetings of the board of directors of the parent corporation, its executive committee, or other standing committees, its subsidiary corporations and their standing committees, should be sent to all members of the board of the parent corporation in order to place upon them the responsibility of knowing in definite form what is done by the corporation and in order to give them no excuse for failing to exercise their own independent judgment.

Corporations should be required to furnish to their directors a summary of the operating figures covering the results of all transactions currently reported upon to the management, and at as frequent intervals as such figures are supplied to the management and not less frequently than once a month.

There have been evils in connection with accounts receivable, particularly of concerns engaged in installment selling and in connection with inventories in many different kinds of concerns. There is often no aging of accounts receivable and no basis given for the investor to determine whether or not the reserves are adequate. As to inventories, obviously the items should include only merchantable stock and in an amount likely to be sold over a reasonable period. Some general provisions could undoubtedly be drafted by accountants in these respects.

Loans and advances to officers and to employees should be stated separately and not as current assets.

If a parent corporation chooses not to consolidate its balance sheet it must show under the heading "Investment in Subsidiary Corporations" any intangible items (including goodwill particularly) and their amounts pertaining to any and all subsidiaries.

It would be better if the items of land, buildings, and equipment were separately stated instead of being combined under the heading of "Fixed Assets." In any event, such of these items as are not used in the business should be separately stated as idle plant.

The purpose for which treasury stock is acquired in the market and held as shown by the balance sheet might well be also shown on the balance sheet. The stock exchange is giving consideration to this problem with reference to the corporate securities listee on the exchange.

In order to meet the needs of the small investor who has not ready access to financial manuals it would seem desirable to require any funded debt liabilities to be separated by the issues and under each issue by the amount and the maturity. The practice of carrying funded debt, or sinking funds thereunder, due within a year as a current liability should be made a requirement of law.

Under the heading of contingent liabilities specific mention should be made of lease or rental obligations by year and amount for each year. Where due to the nature of the obligation the exact amount may not be stated with certainty, an estimated figure might be used.

Not all of the bad practices in this respect are known, nor their extent, but it would seem quite necessary to require that any items of intercompany profits should be revealed as to their amounts and their nature.

STATEMENT SUBMITTED BY JOHN M. HANCOCK, A MEMBER OF THE BANKING FIRM OF LEHMAN BROS., NEW YORK CITY

The announced objective of the national securities exchange bill is the protection of the investing public from manipulative or dishonest practices by persons dealing on securities exchanges. With this objective I am in hearty accord. I am sure that provision for such public protection can be made by legislation, in the formulation of which I should be happy to assist, in a spirit of constructive effort.

After careful study of the bill as now written, however, I believe that certain substantial amendments are necessary, in order that this legislation may not have results disastrous to the economic prosperity of the country. I believe that such amendments can be made while preserving the purpose of the bill, and that the

resulting legislation will be the sounder for such amendments; since I am convinced that the bill, as now written, contains provisions, unnecessary to its real purpose, which:

First. Will have a drastically deflationary effect on banks, investors, and consequently, industry;

Second. Will do away with most of the responsible machinery whereby essential long-term private capital may flow into industry, leaving the burden of providing such capital chiefly on the Federal Government;

Third. Will tend to deprive the investor of responsible sources of financial information and advice;

Fourth. Will through excessive penalties, tend to drive conscientious management out of industry; and

Fifth. Will place an unprecedented absolute and arbitrary power over industry and finance in the hands of a governmental bureau-a kind of power unknown in any other country where private enterprise is still permitted.

The following memorandum and its appendices amplify the views stated above. JOHN M. HANCOCK.

MARCH 2, 1934.

MARCH 2, 1934.

After an intensive study of the national securities exchange bill I find myself almost 100 percent in accord with the goal sought to be attained by this legislation. That there have been vices concerning transactions in securities every fairminded man is willing to concede. In giving unreserved approval to the bill's purposes of eliminating bad practices, I am not taking into account any question of the constitutionality of the bill, or any essentially legal question. Nor am I giving approval to the wording of the paragraphs as they now are written in the bill. A tremendous amount of work has been done in bringing the bill to its present form. There still remains much to be done to prevent only those things which should be prevented and to stop short of preventing those things which should not be prevented.

By way of illustration may I refer to section 8 (a), article 9, wherein the apparent intention was to prevent transactions in puts and calls and the kind of option which is used for market manipulation. I doubt that it was the intention of the committee (1) to outlaw options given to executives, in connection with their employment, as a reward for good work or as an inducement for better work, or, (2) to outlaw options given to bankers or others for the purpose of procuring additional working capital for a company, or in connection with the purchase of stock for the same purpose, or, (3) for services whose value is difficult of ascertainment in advance and wherein the benefit to be received by the optionee will be proportionate to the benefit secured by the company.

The need of a more careful study, and perhaps redrafting, is emphasized by the character of the penalty provisions. If unprecedented penalities are to be provided the provisions covering abuses must be very definitely drawn so as not to go beyond the desired intention.

May I cite as an illustration section 8 (a), paragraph 5, providing that it is unlawful to give out false or misleading information if the giver has reason to believe that his action may induce the purchase or sale of a security. There is almost no way in which the giver may ordinarily know or form any belief as to the action likely to be taken by the receiver of the information. Most givers of information are not in a position to determine whether the information given is sufficiently important to influence the judgment of the average investor. A man might come to my office and ask for my comment about any company whose secur ities my firm had issued, and I would feel bound to give him the facts available in as exact form as possible. I might report the fact that a certain business showed sales in December of 1933 which were 15 percent in excess of the sales in December 1932. I might also report that the sales in January 1934, were 25 percent in excess of the sales in January 1933. These facts would be absolutely true and yet might give a thoroughly wrong impression to a man who did not know how to interpret them. The first impression the receiver would have regarding the meaning of such a statement would be that the business of the company concerned was showing a marked improvement. This might not be at all the fact, for, while the January percentage increase was accurately reported, the truth is that the increase for January over January a year ago resulted from the fact that business in January a year ago was extremely bad and that the apparent increase in sales between December 1933, and January 1934, did not exist.