Quotation Bureau, L. E. Walker, 48 Front Street, New York, N.Y.; C. E. Unterberg & Co., Chas. E. Unterberg, 48 Wall Street, New York City; Ward & Co., Bertram A. Seligman, 120 Broadway, New York, N.Y.

MEMORANDUM OF

PROPOSED NATIONAL SECURITIES EXCHANGE ACT OF 1934.
NEW YORK SECURITY DEALERS ASSOCIATION REGARDING UNLISTED TRADING
ON EXCHANGES

S. 2693-H.R. 7852

There has been submitted a statement of president of the New York Curb Exchange dated February 23, 1934, in respect to exchange trading in unlisted securities as affected by S. 2693 and H.R. 7852 which says, among other things: "The New York Curb Exchange believes, moreover, that all trading should take place upon the floor of an exchange where it will always be subject to proper regulation and control."

It contains, moreover, numerous remarks and statements to which we must take exception because of their inaccuracy.

The matter of investigation by Government authorities of trading in unlisted securities on an exchange is not a new one. This was done a quarter of a century ago by the present Chief Justice of the Supreme Court, Charles Evans Hughes, in connection with the investigation of the insurance scandals in New York City. As a result of this, there came out the so-called "Hughes Report" which, in speaking of dealing in unlisted securities on the New York Stock Exchange, among other things recommended that "the unlisted department, except for temporary issues, should be abolished." As a result of this, the previously existing unlisted department of the New York Stock Exchange was voluntarily abolished in 1909. We propose in the main to refer to the text of the statement of E. Burd Grubb, president of the New York Curb Exchange, and make comment next to each quotation.

Mr. Grubb says, on page 5:

"The so-called 'unlisted securities' with which this review deals primarily are admitted upon an entirely different theory and fulfill a somewhat different economic need. Such securities are never those of new or newly formed companies, but are of companies which have been in existence for a substantial number of years and with respect to which there exists a public record of their history and financial condition and a public market."

This may be the current policy of the New York Curb Exchange regarding dealing in securities of new or newly formed companies, but is not, we believe, the policy of other exchanges in New York dealing in unlisted securities, particularly the securities divisions of the New York Produce Exchange.

On page 9 he says:

"Quite naturally, the Exchange made mistakes both of commission and of omission. In the speculative period immediately approaching 1929, many securities were admitted to trading where an actual market in New York did not exist but where it was hoped that a market would develop. The Exchange now appreciates that the existence of an active market here is fundamental and should in all cases be a prerequisite for admission of a security to unlisted trading. This requirement is now among those firmly insisted upon.'

Again, on page 16, Mr. Grubb says:

"In the past the Exchange has itself too freely admitted securities to unlisted trading, particularly in cases where, at the time of admission, no active market in the security existed in the East of in New York. The Exchange has recognized these mistakes, and on its own volition, since January 2, 1933, has removed from dealing by reason of inactivity 696 issues of stock and 247 issues of bonds."

These two statements recognize the principle that there must be a dividing line from the standpoint of activity and distribution, between securities that are properly susceptible to being traded in on an exchange and those which are not. We cannot reconcile them, however, with the following pronouncement which Mr. Grubb makes on page 24:

"The New York Curb Exchange believes, moreover, that all trading should take place upon the floor of an exchange where it will always be subject to proper regulation and control."

Mr. Grubb, on page 13, says:

"The theory of the exchange in the maintenance of its unlisted department may be stated as follows: When an active market in a security, which meets the qualifications, exists in New York, the public is better served by having that security dealt in on an exchange. The purchaser or seller on an exchange deals through a broker member acting as agent who makes contracts for his customer with other members, likewise acting as agents. A specified commission only is

charged; the transaction is immediately made public by means of the ticker; purchases and sales appear throughout the country in the daily papers; each transaction is open to investigation and verification; each member is subject to the rules and discipline embodied in the constitution and rules of the exchange." This is what we would term the simon-pure theory of an exchange with which we would be the last ones to quarrel. This picture does not take into consideration the activities of the specialist who buys and sells for his own account and whose activities notoriously can become pernicious and contrary to public policy when applied to inactive securities.

When an order is put on the telephone through the machinery of an exchange, the buyer or the seller loses all power of direct negotiation. If he gets back more than he gives up in terms of an equitable execution at a fixed commission rate, the public good is served. But, if he gives up his power of negotiation and does not get back the benefits of an execution by the matching up of buying and selling orders that are extant, but is subject only to the good nature of the specialist, it would seem that he is worse off.

On page 13 Mr. Grubb says:

"By way of contrast to transactions taking place on an organized exchange, a transaction outside of the Exchange is generally conducted between the customer and one acting as a dealer or principal; i.e., for himself. There is no specified rate of commission. Indeed, the dealer pays what he feels inclined to pay and sells for what he can get. The spread is often notoriously wide. opportunity of verifying the transaction is not comparable to that on an exchange where the officers or a committee may call upon members to produce all records and to explain any transaction."

The

He neglects to point out that under the conditions pictured the purchaser or seller retains the important power of negotiation. It may be suggested that the power of negotiation by an individual investor is more theoretical than real; but experience shows that it is a common thing for the investor to reject a bid or offering, or for his banker or broker (who is acting for him) to do so.

As to the spread being notoriously wide over the counter, we submit that the spread between the bid and asked prices of any security is based on the nature of the particular security rather than upon the market in which it is traded. In general, securities fully listed on, say, the New York Stock Exchange have a . better market than unlisted securities. On the other side of the picture, there are securities in the over-the-counter market that day in and day out have a ready market.

Putting it a different way, the listing of a security does not necessarily make a better market. The market is determined by characteristics of the particular security listed; that is, distribution, speculative interest, and so forth. The inference that listed securities uniformly have good markets and those dealt in over-the-counter have poor markets is not in accord with the facts. Looking at yesterday morning's New York Times in the column recording bid and asked prices of stocks not traded in the day before on the New York Stock Exchange, we find 39 which have either no bid or no offering and 211 which have a spread between bid and asked prices of 2 points or more and run as high as 262 points. For example:

Mr. Grubb says on page 13: "Moreover, quotations of the outside market are not as accurate and complete as those on an exchange and are given very little publicity. Indeed, outside of the great cities, it is doubted if the price range in securities other than those dealt in on the New York Stock Exchange or the New York Curb Exchange is given any notice whatsoever. Most newspapers carry

transactions on these two exchanges, but no reports of outside markets."

This completely overlooks the fact that the newspapers in the smaller cities invariably carry the quotations of the unlisted local securities and, indeed, in many cases, carry the quotation of some of the New York securities.

45381-34- --40

On page 14 Mr. Grubb says: "The interest of the dealer is in the profit he may make for himself acting as a principal; the interest of an agent or broker buying and selling securities for his customer on an exchange is in his commission, fixed by the exchange."

Here again Mr. Grubb is painting the simon-pure theory of an exchange without referring to the incidence on the exchange of the specialist who buys and sells for his own account.

On the same page Mr. Grubb says: "The outside dealer answers to no one other than his customer."

This definitely does not portray the picture in New York and, we believe, in many other sections of the country. Our association was formed in 1926 and from the constitution we have submitted to you, you will see that we have various standing committees, such as the business-conduct committee, the committee on securities, the arbitration committee, etc., to safeguard the public interest. In addition the forthcoming Investment Bankers' Association Code of Fair Practice will regulate dealers, whether they sign the code or not. We have advised our members to sign this code.

Mr. Grubb, on pages 14 and 15, says: "Moreover, as frequently happens, the customer has little or no means of ascertaining the standing of the outside dealer and takes a very wide chance when he forwards his securities for sale or his money for purchase to one whom he may know only through advertisement.

The

The implications in this sentence are distinctly unfair and misleading. majority of dealers are very jealous of their reputations for honesty and fair dealing. Moreover, as we know from experience, the occasional investor is well able to make his choice by reference to his local bank.

On page 15 Mr. Grubb says: "It has sometimes been claimed that the public is deceived, when it reads the record of transactions on the Curb Exchange, into believing that all securities named are fully listed. As a matter of actual fact,

as has been said above, and this is deemed of great importance, no security is dealt in on the Curb Exchange today which is not officially listed; that is to say, listed upon the official action of the exchange itself.

"The exchange has urged that a clear demarcation be made in the press between these securities. Many newspapers distinguish in their reports between 'fully listed' and 'admitted to unlisted trading'."

Again by a manipulation of words Mr. Grubb is attempting to make unlisted and listed securities one and the same thing on the ground that they are both "officially" listed. The history of the differentiation in the newspapers and on the ticker between these two groups is that differentiation was urged by the National Association of Securities Commissioners a number of years back, as follows:

"Your committee suggested that the New York Curb Exchange work out some plan with the various newspapers and financial publications which carry daily stock quotations, whereby the listed and unlisted securities might be distinguished by any reader of such publications. The officials of the New York Curb Exchange stated that an effort would be made to comply with this suggestion."

And again, about a year ago, when Attorney General John J. Bennett of the State of New York investigated unlisted trading on the New York Curb Exchange, one of the regulations that the Curb Exchange promulgated as a result was:

"Resolved further, That newspapers in market reports shall be urged to make a clear differentiation between listed and unlisted securities.

"Resolved further, That Fitch's sheets shall be requested to group separately sales of fully listed and of securities admitted to unlisted trading.

"Resolved further, That the bulletin of the exchange shall differentiate between fully listed and securities admitted to unlisted trading."

Here we see that two important sources maintain that the public interest requires that the real distinction between "fully listed" and "unlisted" securities be continuously established.

On page 16 Mr. Grubb says:

"In cases where substantial and adequate reasons for removing a security from unlisted trading were presented, the exchange was glad to drop the security from the list."

Why should the officials of a company be compelled to submit any reason to the Curb Exchange authorities for compliance with the company's request that a security be not dealt in on that exchange? It is being recognized more and more that the executives of a company occupy a semifiduciary position in relationship to the owners of their securities. In effect, in the case of stocks the executives of a company are investing and managing the funds of their stockholders. In

the case of bonds they are actively supervising the property against which the bondholders are creditors. It seems thoroughly consistent that both of these groups of security holders would follow the recommendation of the management of the company on this additional item of where the securities are to be traded in. On page 17 Mr. Grubb says:

"It is a market which does not 'fold up' when the pressure on dealers becomes too heavy, creating thereby a moratorium on the security with the resulting embarrassment to an owner who has to realize on his security."

Experience of professionals in that over-the-counter activity is augmented when exchange facilities "fold up" under stress. On this point we refer you to the testimony recently presented to you by six of the biggest investment banking houses in the country, Salomon Bros. & Hutzler; Wood, Struthers & Co., etc. On page 18 Mr. Grubb says:

"In an outside market a few purchases may lift the level 25 points."

Here again professional experience proves the reverse, particularly in regard to institutions and others buying "en bloc", and again we refer you to the report of the six investment banking houses which speaks of the liquidation of securities under stress. It says: "This was successfully accomplished because the liquidating banks and other institutions who were able to help, were willing to rely where necessary upon the knowledge and fairness of our firms in arranging the transactions and setting prices to both sides in spite of the market chaos that then existed."

On page 19 Mr. Grubb says:

"It is for these reasons that the exchange is not necessarily led to remove a security because the company objects."

Here again, the question comes up, who should be the judge of where the security should be dealt in, the exchange or the issuing corporation?

It is interesting to know the attitude of the president of another exchange on this matter of admitting securities by application of a member of an exchange rather than by the corporation. Mr. Michael J. O'Brien, president of the Chicago Stock Exchange, recently stated in these hearings:

"No security can be bought or sold on the Chicago Stock Exchange unless and until its listing shall have been accepted by the governing committee upon an application signed and sworn to by a duly authorized officer of the corporation issuing the security. The Chicago Stock Exchange for many years has had no so-called "unlisted" department, nor does it list securities upon data or application filed by its own members or any persons other than the company itself." On page 19 Mr. Grubb says:

"It must be remembered in this connection that the exchange does not admit securities to unlisted dealing when primary distribution is taking place."

This may be the new policy of the New York Curb Exchange since the investigation by Attorney General Bennett, but can hardly be said to be the policy of the various other exchanges which follow the practice of admitting securities to "unlisted trading privileges.'

On page 23, Mr. Grubb says:

"It becomes a nationally known stock such as several now on the exchange. Would it be in the public interest for the Curb to be compelled to cease trading in this stock because the company, perhaps for selfish reasons, listed the stock on an exchange, say for illustration, in Arizona?"

This brings out again the question of who ought to be the judge of where the security should be traded, the exchange or the issuing corporation.

In conclusion, permit us to say that we introduce this brief not for the sake of complicating your deliberations but because we feel compelled to do so to clear the record of the brief submitted by Mr. Grubb, president of the New York Curb Exchange, on the same subject. Respectfully submitted.

MARCH 6, 1934.

MARK A. NOBLE,

OLIVER J. TROSTER,
MEYER WILLETT,

Members of the Board of Governors of the
New York Security Dealers Association.

The CHAIRMAN. We will now have to adjourn until 10 o'clock Tuesday morning.

(Thereupon, at 11:48 a.m., the committee adjourned until 10 a.m., Tuesday, Mar. 13, 1934.)