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Now, the question is whether I am going to be able to give the facts with any assurance that they will be accurately interpreted. Even if I take particular care to interpret the facts accurately, what assurance have I that the man receiving the information will understand what I say, or will act upon it? In most cases I am bound to comment upon certain aspects of a company's business which appear favorable and some aspects which appear unfavorable.

MARGIN PROVISIONS The margin requirements of the present bill are presumably based upon the belief that they will keep out of the market those people who cannot safely afford to incur the risk of the market, despite the regulations embodied in the other provisions of the bill. I assume that this provision will be modified so as not to force the liquidation of securities under present loans, thus bringing on a generally lower level of security prices, undermining confidence, and perhaps delaying recovery: A mere postponement of the effective date of this margin provision will not be sufficient. While I favor more flexible provisions than those embodied in the bill, so as to take into account the inherent differences between classes of securities, I do not wish to stress this point, for I am sure it will be carefully considered by Congress and that all the factors will be weighed before a final conclusion is reached as to the social desirability of, or need for, this particular regulation.

GOVERNMENTAL SUPERVISION The provisions relating to supervision by the Federal Trade Commission present the question as to whether the desired flexibility cannot be obtained without building up a bureaucracy with its attendant expense, probable inefficiency and possession of extreme powers capable of arbitrary use. The general provisions as to the Commission's discretionary powers are very broad. This question is one which has been before Congress many times and concerning which it is thoroughly informed. It seems to me impossible for the Government to avoid responsibility for security values if it should place in a Government agency the tremendous responsibility given to the Federal Trade Commission under this bill. It is my deliberate judgment that no amount of supervision will eliminate fluctuations in security values; but the grant of this extreme power to a Government agency is going to give uninformed people the belief that the Government will prevent these fluctuations.

May I suggest that you seriously consider the wisdom of enacting into law those desirable provisions of the bill wbich permit of definite drafting at the present time. If there is not enough factual information available to this committee now, machinery should be set up so that the committee shall secure the information upon which a statute might be based. It is suggested that two means of getting the information are readily available if the committee has not the time to do the work itself. The development of codes under the N.R.A. offers one avenue. The Federal Trade Commission, as an investigating body, or a committee like the Dickinson committee might be used as an alternative.

I cannot subscribe to any measure whereby the Congress delegates its legislative authority to the Federal Trade Commission or any other executive bureau. Surely the least desirable form of supervision is the managerial type set up by the present bill, and, rather than establish this, would it not be wiser to allow the Federal Trade Commission a limited supervision over security exchanges, giving it the right to investigate, imposing upon it the obligation to press for voluntary reforms which it deems advisable, and allowing it to sit somewhat as an appeal court with regard to grievances which the exchange itself cannot or will not rectify-thus leading to a body of law with suitable penalties when experience has found the wise form for such laws to take?

Further detailed comment upon the powers granted by the bill to the Federal Trade Commission is embodied in appendix B.

GOVERNMENTAL RESPONSIBILITY

Even if both the Securities Act and the proposed national securities exchange bill were in full operation, I believe that a false hope, with inevitably serious consequences, would be raised in the minds of innocent people, for only a modicum of protection is afforded. It is claimed by the proponents of the bill that the people need protection on account of their ignorance. I fear they are going to believe that the protection given by law and this bill in its present form, or as modified, will be full protection. Such a belief is unjustified.

There will remain untouched by the law, and untouchable by any law, or by an act of any person or organization, short of God himself, those major considerations and factors in human nature which govern security values and the rise and fall in security prices. If every holder of every security on the market knew all of the facts called for in the voluminous registrations and current reports by corporations, and if he had the best judgment in the world, he still could not know the trend of security prices and he could not know how to appraise the value of any individual security.

Without laboring the point may I emphasize that the strength of the management, the position of a company in an industry, the trend of developments in the industry, the whole trend of developments in the nation, and in the world, for that matter, are factors outside the control of any provision of any present law or proposed law.

THE SEGREGATION PROVISION Section 10, as now written, would prevent an underwriter or dealer from being a broker or member of an exchange. (The section also relates to specialists.) Let us examine only the provision that prohibits the underwriter or dealer from doing business also as a broker on an exchange.

Outside of a few large centers the distribution of securities is handled by small firms combining all or two at least of the functions listed. These small firms cannot live on their volume of business in any one line. The bill, as written, would put many of these concerns out of business and would reduce employment.

The trend of the financing business under this provision would be towards a monopoly of the issue business. A few extremely rich banking firms might survive, but except for them the financing business would be left to irresponsible concerns. The reasons for this will appear from a consideration of the facts. Quite obviously, the issuing of new securities is a sporadic business; it does not exist in times like those we have gone through in the past four years. During such times the smaller houses of issue in the large cities and the houses of issue and dealers in the smaller cities remained in business only through the volume of their brokerage or stock exchange business. If their income from the brokerage business is removed, such concerns have not the financial strength to survive a long period of depression and to maintain the staffs required to help companies needing financial help and advice. This removal of the only bread and butter business during a depression will force the house of issue either (1) to give up business or fail, or (2) to discharge its staff in order to survive a depression period. Even though a house of issue may desire to maintain its staff in order to carry out its obligations to its companies and their security owners it will be prevented from doing so because of lack of income. If it should decide to maintain its staff, even with difficulty, the inevitable result is that when new financing can be done the pressure to pay the overhead will be a very dangerous factor as it will tend to create a poorer grade of securities. If the issuing house goes to the other extreme and discharges its staff, it will not be able to make the proper investigations to insure having only good securities issued.

I feel that the desire is to eliminate abuses without going any further toward the destruction of legitimate, honest businesses than is absolutely necessary to insure the elimination of these abuses. No one has given any indication of any desire to do more than this. I feel sure that a reading of section 10 will convince anyone that the bill goes far beyond the cure sought to be effected by this provision.

The two problems which have arisen and which the bill is aimed to solve may be treated under two headings: First, financial, and second, ethical. Some few banking houses of issue have furnished false reports to the exchange authorities and have used securities belonging to their customers as a basis for borrowing in order to carry new issues which were going badly in the market. Now, quite obviously, if a firm carries no margin accounts there should be no such financial risk to its brokerage customers. If the firm carries margin accounts, however, it should be easily possible to separate the capital of the firm doing the combined business so as to have one portion of the capital applicable to the brokerage business only and to prohibit loans from the brokerage portion to the issuing portion of the business. This would be as effective as actual segregation.

Now as to the ethical problem involved. It has been claimed that a banking firm of issue is able to push its slow-moving issues upon its brokerage customers. I have no information that this has been a serious evil, but it assuredly has been an evil.

A simple remedy, but an effective one, would be to require the banking house of issue to inform its brokerage customer on the confirmation of the sale or purchase of stock on brokerage orders to the effect that the house had been the bank of issue for the security within the previous 6 months, or even a year if a longer period is preferred.

No reason is seen why the customer should not be free to place his business where he chooses, provided only he is not put at a disadvantage. If the broker to day under present law sells his own stock to the customer he is required to inform the customer. The customer might prefer to deal with the house of issue and no reason is seen why he should not be free to do so if he is in possession of the facts.

The other aspect of the ethical problem is that a banking or brokerage firm holding securities or options in its own account may attempt to push the sale of the securities in which it has an interest to customers on brokerage orders. This could be met by a requirement for publicity on the confirmation slip which would reveal the character of the interest on the part of the banking or brokerage firm. If the banker had an interest and did not reveal it he should be held liable under a suit for damages or in rescission. The practical working out of such a provision would be that the banking firm would endeavor to notify the brokerage customer of its interest at the time it received the order and before it executed it. If it did not do so it would lose its customers when they were first apprised of the banking firm's interest through receiving the confirmation slip. The record on the confirmation slip would be a definite proof that the banker had revealed his interest and this should avoid subsequent disputes.

PENALTIES

While it is readily admitted that the penalty provisions for violation should be severe, they should not be so severe as to prevent enforcement, or to punish honest business or honest management. The inherent difficulty arises from the fact that a vicious intent is not a part of the act covered by the penalty, and that the penalties prescribed are such that they should be applicable to vicious acts alone.

Section 15 requires every director, officer, or owner of 5 percent of any class of security to inform the Federal Trade Commission of his holdings, and within 10 days after the close of each calendar month to report changes in ownership. Aside from the fact that this might seem to me an intrustion into personal affairs, the provision will create many curious conditions. If any such person is forced to sell any security for any reason quite unrelated to the business or his own desires, and if the fact of his sale becomes known, as it doubtless will, he will feel he has to explain his personal condition which made the sale necessary, and no matter what he says, and no matter what the facts are, the popular impression is going to be that he has lost faith in the security. This perfectly honest action on his part will constitute the most vicious kind of a “tip.'

This is not a new problem. During past years many corporations have had options on their stock granted to their executives and to many of their employees. Very few of these options have been availed of and their purpose has been defeated. It is human nature not to avail one's self of an option as long as a stock is rising in the market. It is likewise not human nature to avail one's self of an option when the stock has gone down from its high point. If a senior executive having the confidence of his associates in the business should exercise his option in part even and sell the stock in order to make the profit desired to be given to him, or if he should advise others to do so, then he is, in fact, saying to his staff that he believes that the highest reasonable price in the market has been attained, or that the price is going to go lower. When it becomes known that insiders are selling-as they often must sell—the facts are misinterpreted and misunderstood. This whole provision is likely to create far more harm than the most viscious form of tip included in the general provisions of the act.

While there have been officers and directors and large owners who have taken advantage of inside information, the great percentage of corporation officers do not do such things. Even the small minority who do are as likely not to profit as to profit. There are not many companies whose securities advance when the general market declines, or decline when the general market advances. The vital factors affecting the market price of a security have not been those relating to the company. They have been those relating primarily to Government policy. The man who knows in advance, or can estimate by any possible means, psychological or otherwise, the probable policy of the Government on major matters, really has far more inside information which he may use to his own profit

causes.

than any corporation executive immersed in the affairs of his business and depending only on his knowledge of the facts as to his particular company.

The provision that the director who buys shall turn over his profits to his company and accept his own losses, provided he sells within six months of his purchase, seems unreasonably harsh, but this unfortunately is not the only pound of flesh this provision exacts. In addition, his profit has to be calculated as the difference between the lowest cost to him and the highest selling price secured by him during the six months period. This provision would effectively prevent corporation officers, anxious to prevent a decline in the market price of their stock, from buying in the market and providing the market support needed in a declining market for the benefit of all the stockholders. These men who might be trying to do a constructive act would be thus prevented from selling within six months and gaining any benefit therefrom. It seems to me that a mere statement of these obvious facts shows the unnecessarily harsh character of the provision.

Section 17 embodies a rigorous provision against any misleading statement in any report. Surely the honest person who discovered a mistake, reported it to the Commission and to the public so that the market price would reflect the true facts and not the erroneous first statement, it would seem, should not be liable to people who buy or sell after the correction.

Paragraphs b and c of section 17 set up penalties following the general idea of the securities act. A misleading statement might affect the value of a security to the extent of $1 and the market on the security might drop $50, due to other

The man who caused the loss of the dollar might fairly be held to pay that loss but to hold him accountable for the whole fluctuation of the market seems fantastic. It is the same measure of liability imposed upon issuing bankers. in the securities act. There is no reason known why this measure of libaility should be imposed upon corporation officers and directors.

All of the comment under the heading of “Penalties" takes into account the provisions of the bill that I will not be held liable if I maintain the burden of proof that I “acted in good faith and in the exercise of reasonable care and had no grounds to believe that the statement was false or misleading”.

The final determination as to what these provisions mean will be the result of jury findings and court decisions in several States, lasting over a period of many years. So far as the “tipping” provisions are concerned most of the evidence will of necessity be oral testimony. The jury will have to weigh one man's word as against another without having, in the normal case, any character of supporting evidence on either side. This introduces a hazard on account of the length of time for which the liability lasts, as well as the dangers of connivance of others with the plaintiffs and the introduction of false substantiating oral testimony.

Let us assume that these provisions are drawn as carefully as language permits. If by any stretch of the imagination successful litigation results in one case, the unsuccessful defandant is liable to all the purchasers or sellers of any given security for an unlimited period of time, the measure of the damage being the fluctuation of the security for a period of 180 days. The measure of damage, therefore, spells financial ruin to the unsuccessful defendant. No careful, prudent business man would undertake the possibility of financial ruin under such circumstances and the inevitable result would be that the honest, careful person could not afford to have even a single discussion with anybody on any security. He would have to make it an inflexible rule of his conduct never to speak, thus becoming a mere automaton; otherwise he would have no means of controverting individual claims made long after the event. Whether or not the principle of agency applies in this case, we face the dilemma, first, if the principal is liable on account of the act of the employee his only recourse is to have no employees, since he cannot with certainty control what they may say or do-particularly if they have been discharged or have left the principal's employ during the period for which liability runs; second, if the principal is not liable for the act of the employee, then there is created the vicious situation in which the principal will not talk but will permit and encourage the employee to talk freely. Under either condition or rule a a vicious result follows. The door will be laid wide open to collusion and fraud. This bill by its terms would supersede any State statute of frauds in conflict with it and would almost certainly prevent any security business, even the taking of orders, for the mere fact of doing business with a person would lay the only necessary foundation for a fraudulent suit. The liabilities upon all of the partners of a firm from what one person may say or do are already severe enough without expanding the doctrine to apply to the acts of the firm's employees.

My honest belief is that many of the evils complained of have already been cured in substantial measure through their exposure to public opinion which, after all, is the great antidote for many of the distempers that have flowed from the abuse of trusteeships. While there is much that can be accomplished by law, greater things can be accomplished by helping to create in business at this moment, by a spirit of legislative tolerance, a new atmosphere, a new deal, fair alike to existing business, the investing public, the corporations needing capital, and the Government itself.

There is attached as appendix C a memorandum covering other points in the bill meriting consideration, though they are not as vital as the parts previously discussed.

course.

APPENDIX A-SUPPLEMENTARY AND SUPPORTING CONSIDERATIONS The bill is entitled National Securities Exchange Act of 1934. This title is something of a misnomer. The bill regulates not only the securities exchanges but a number of incidental and related business activities.

Section 6 relates primarily to the use of credit. In an attempt to regulate margin requirements and to cover possible evils the bill establishes maximum loan values of listed securities and, as written, nullifies the value of unlisted securities for collateral purposes. Testimony before the House committee indicates one of the purposes of the bill is to regulate the amount of credit flowing into the securities market. It would seem that this is a proper discretionary function of the Federal Reserve authorities and not something to be crystallized in a law based on recent experiences which may or may not include problems that are to be encountered in the future.

Sections 11, 12, and 15 have to do with the obligations of officers, directors, and principal stockholders, a group which might be labeled under the single term of management. The duties are in part spelled out and in part left to the discretion of the Trade Commission. The penalties for violation are so severe that it would be dangerous for any management to deviate from the prescribed

Admitting that there are vices in connection with security trading, is it the part of wisdom to destroy a whole house in order to rid it of rats?

This legislation contemplates jumping away from known evils, but will it not involve jumping into unknown evils?

Aside from the question as to whether there isn't an attempt being made by the authors of this bill to effect a Federal Trade Commission control of all business and as to whether such control is desirable, would not this legislation hobble business instead of putting it into harness so that it can pull?

An effect of the stock exchange act would be to concentrate business in the hands of the strong national companies now adequately financed. New business initiative would be stifled since the small man would be unable to find capital through formerly available sources, and the aiready existing small company unable to increase its business by public financing would be likely to fall into the hands of larger competitors.

The destruction of credit for small businesses is not likely to be presented by many witnesses at the hearings, but it must not be lost sight of.

Has not the recent experience of prohibition demonstrated that human nature does not readily yield to the cold mandate of the statute? When one calmly considers some of the provisions of this bill, which pretend to be regulatory, he soon sees they are prohibitory.

It has been suggested that the way to attack the problem of speculation by those who should not engage in it, is to start at the other end, not with the seller of the security but with the buyer of the security, and to handle this through a system of registration and license for individual investors or speculators. The cost of administration would be no greater than that of the system proposed by the bill. The present bill gives protection to the sophisticated investor who will study and understand all the provisions of the Securities Act and the national securities exchange bill. But this man presumably does not need the protection which these laws would attempt to furnish. The small individual who buys 10 shares of stock will not secure any effective remedy under these laws, owing, first, to his probable ignorance of his rights under the law and, second, to the difficulty of finding counsel to take his case.

Has consideration been given to the thought that in order to avoid the responsibilities under the law corporation officers might withdraw securities from an exchange? Such action would work serious injury to the stockholders. The management determined to do this would be able to do it without the consent of

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