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(1) They provide the ready resale market for those investors in the securities in question who had occasion to dispose of those investments:
(2) They tend to prevent the market price from sagging under the influence of the addition to the supply, because this added demand by the Securities Co. competes with the public demand as expressed in purchases on the curb exchange and appears or is augmented in volume just before and during the period in which a new block of original issue is being offered to the investing public. This supplement to such public demand may even cause the market quotations for the security in question to advance.
(3) They induce investment confidence in the security in question and also speculative cupidity. The latter is stimulated especially when the Securities Co.'s activities result in successive advances in the market price, which advances offer the speculator the prospect of reaping a profit by purchasing the security and reselling it later at a higher price.
Basis of market purchases and sources of funds.—These “market purchases' tend rapidly to deplete the Securities Co.'s cash funds; and it could not long continue to make them if it did not have means of replenishing its funds. They are provided or replenished, and the Securities Co. obtains a basis on which to determine the volume of its market purchases, by the following means. In addition to their sales offices in New York City, Henry L. Doherty & Co. had, in May 1929, district offices 25 cities of th United States; and 802 securities salesmen reporting to these offices operated not only in those cities and adjacent communities but in 28 others also. Those salesmen were continuously active in obtaining from their acquaintances and other sources the names of likely individual and institutional prospects, and in following up such leads, soliciting and obtaining orders for the securities. Telegraphic reports followed by daily transmission of copies of the sales confirmations kept the New York office continuously informed as to the details and volume of orders so obtained. The volume of sales orders so obtained and of sales effected “over the counter” constituted a basis of the volume of “market purchases” made by the Securities Co. “over the counter" and on the organized exchange; and the down payments of cash by the customers and the later collections of cash from them constituted an important source from which were replenished the cash funds that were depleted through the aforesaid market purchases. To some extent these sales orders and funds were supplemented for this purpose by orders and funds obtained from or through investment retailers who participated in special offerings and even in syndicate-distributing groups.
Thus, the Securities Co., through Henry L. Doherty & Co. as agent, functioned, to the extent of its market purchases, very much like a broker who received from customers orders to purchase certain designated securities in specified quantities and then purchased on the exchange or over the counter the securities with which to fill the orders. However, it differed from an ordinary broker in the following respects:
(1) The customer investor did not give an order to purchase the securities for him, but he contracted to purchase them from Henry L. Doherty & Co.
(2) The securities salesmen of Henry L. Doherty & Co. took the initiative in soliciting the orders rather than waiting for orders to come.
(3) Neither the Securities Co. nor Henry L. Doherty & Co. is a member of the exchange, but the purchases on the exchange were executed through broker members.
(4) The purchases of securities with which to fill the customers' orders did not necessarily have to be made immediately after receipt of the orders, because of the fact that a large portion of the orders was made on account or on 10-months installments, thereby affording the Doherty management leeway as to the time at which to provide the securities. According to the company's representatives, the shares sold on the installment plan during the period under review averaged something less than 15 percent of the Securities Co.'s total sales of this stock. The securities so sold were not deliverable until paid for in full; and, according to the terms of the installment contract used in 1929, those sold on such contracts were not deliverable until the expiration of the contract period even though the customer completed his payments before that expiration. Also securities needed for delivery to customers, particularly Cities Service Co. common stock, could be and were provided temporarily by borrowing them from large holders. This made it possible to build up sales balances to cover which securites of new original issue were disposed of to the lenders or to the ultimate investors. The last step accomplished the ultimate purpose of the whole process—the acquisition of new capital.
Secondary function.-—The Securities Co. is also a convenient instrument through which gradually to buy in those securities that are to be retired, or that are to be tendered to sinking-fund trustees, or that are to be taken out of the market temporarily, or that are to be modified.
For example, Public Service Co., of Colorado, an indirect subsidiary of Cities Service Co., found it advantageous to issue 6 percent rather than 7-percent preferred stock, and later to issue 5-percent rather than 6-percent preferred stock. Up to January 29, 1931, the Securities Co., and Henry L. Doherty & Co., who functioned before the Securities Co. was formed, purchased $3,939, 215.12 par value of the 7-percent preferred stock at a cost of $4,287,062.17, exchanged $895,000 par value of it for $966,800 par value of the 6 percent preferred at an annual dividend saving of $4,634, exchanged $300,000 par value for $375,000 par value of the 5 percent preferred at an annual dividend saving of $2,250, and sold $2,690,000 par value of it to Cities Service Co. Also after the marketing of 5-percent preferred stock was commenced, the Securities Co. gathered in 6-percent preferred stock, and, on August 2, 1929, sold $535,700 par value of it to Cities Service Power & Light Co. at cost $547,500.94. The Securities Co. also marketed $4,112,700 par value of the 6-percent preferred stock, for $4,046,921, and, during the process, spent $991,348.34 making market purchases to the extent of $977,000
Again in March 1927, Cities Service Co. sold $15,000,000 face amount of 3percent debentures maturing in 1966 to A. B. Leach & Co.; and the Securities Co. participated in the distribution as a member of the distributing group. The issuing company had outstanding at the time 6-percent debentures maturing in the same year; and the Securities Co. purchased these in considerable quantities in the market. It continued these purchases up to the end of 1928, both in the market and from European bankers, while two other debenture issues bearing 5percent interest were being marketed. More than $17,000,000 face amount of these were sold to Cities Service Co.
Examples of buying in securities and modifying them previous to resale are the following: On November 1, 1928, when the market price of Cities Service Co. common stock was about $70 per share, that company sold to Harris, Forbes & Co. and Halsey, Stuart & Co., who marketed them through a distributing group of retailers, $30,000,000 face amount of 5-percent debentures maturing in 1963 at 9242 and interest. These debentures bore nondetachable option warrants conferring upon the holder of each 1,000-dollar debenture the right to purchase 15 shares of Cities Service Co. common stock at prices which, commencing at $72 per share, advanced $2 per share each 6 months. Again, in March 1929, when the market price of this stock was about $120 per share, that company sold to the same wholesale investment bankers at 92%, and interest, $50,000,000 face amount of 5percent debentures maturing in 1969; and these debentures bore nondetachable option warrants whereby the holder of each 1,000-dollar debenture had the right to purchase 10 shares of Cities Service Co. common stock at prices which increased at half-yearly intervals commencing with $122 per share if the option were esercised within the first months. Subsequent to the issuance of these debentures, the market quotations for the stock rose to such heights that sale of it at the debenture warrant prices was not advantageous to the issuing company, but at the same time the differences between the market prices of the debentures with warrants and ex-warrants were so narrow that more proceeds could be realized by purchasing the debentures with warrants, exercising the warrants and reselling them ex-warrants. The Securities Co. purchased these debentures in large volume paying high premiums. It exercised the warrant options on $10,818,000 face amount of the debenture 5's of 1963 and on $18,328,000 face amount of the debenture 5's of 1969, thereby making them available for resale as debentures ex-warrants. Of their total cost, $20,996,193.19, representing the difference between their cost and their market value ex-warrants, was treated as a part of the cost to the Securities Co., of the common shares obrained in the exercise of the warrants. Some of the ex-warrants debentures were resold, some were transferred to Cities Service Co., and, at last accounts, some were still being held by the Securities Co.
Importance of the securities company's chief function. The chief function of Cities Service Securities Co. was variously designated as "providing a ready resale market for securities”, “facilitating the marketing of securities”, “supervising the market”, and “sole handling of the market” for securities. Another name commonly applied to this function is "sponsoring.
Inasmuch as the securities company is wholly owned by Cities Service Co., its performance of this function with reference to the parent company's stock virtually amounts to Cities Service Co.'s trading in its own stock. Such activity
is regarded with disfavor by the governing body of the New York Stock Exchange. However, the securities of Cities Service Co. are dealt in not on the New York Stock Exchange but on the New York Curb Exchange. Even in the case of many companies whose securities are listed on the New York Stock Exchange, however, the trading is nevertheless carried on by the company's financial agent, or by pools gotten together by the financial agent, or by a securities company owned by the financial agent.
These trading activities are not of mere minor and incidental importance in modern finance. They are of major importance, because of their volume and of the effects produced through their volume. While the practice of “sponsoring" stocks has been a matter of common report over several decades, the volume of trading involved in it, the great proportion of the demand for securities on the organized exchanges that is provided by these company purchases, the extent to which funds supplied by the investing public are used for this purpose, and the extent and public importance of the effects are probably little realized. The description in this report of the activities of Cities Service Securities Co. in connection with campaigns to market common stock of Cities Service Co. and class A common stock of Arkansas Natural Gas Corporation furnishes outstanding illustrations that may convey such realization.
When the securities company took over this function from Henry L. Doherty & Co. on April 1, 1927, an operation to distribute Cities Service Co. common stock was drawing to a close, and the sale of another 250,000 shares under a special offering to dealers was under way. In the performance of its function during the remaining 9 months of 1927, the securities company spent nearly $45,851,000 in market purchases of 936,104 shares of this stock, its sales during the same period amounting to 938,910 shares for $45,880,759.38. By “market purchases ” is meant not only purchases on the New York Curb Exchange but also purchases “over the counter. The latter did not, on the whole, exceed one sixth of the total. These market purchases amounted to 92.4 percent of the total number of Cities Service Co. common shares traded on the New York Curb Exchange during the same period and they exceeded the number traded on the curb in 4 of the 9 months. During that period, the closing curb price of this stock, after sagging from $51% to $44 in April, followed a fluctuating rise to $557 at the vear end.
On March 9, 1928, when the market price was about $58 per share, Cities Service Co. offered its common stockholders a 10 percent pro rata subscription for additional shares at $45 per share. In the process of supervising the market for the stock and the rights during this operation, the securities company and Pearsons-Taft Co. formed a syndicate distributing group for the purpose of effecting sales of 300,000 shares at current closing curb prices plus one-eighth point; and the syndicate participants sold 466,755% shares for $27,327,762.25. The purpose of this distributing group was to provide a channel through which to sell such shares as the stockholders failed to take; but, the stockholders having taken the entire 10 percent offering, the syndicate sales were utilized along with sales effected by Henry L. Doherty & Co.'s organization as channels through which to dispose of the shares obtained by the securities company in its market purchases to dispose of 100,000 additional shares of original issue and to dispose of approximately 51,892 shares held by Gas Securities Co. Preparatory to making voluminous market purchases in its process of supervising the market, the securities company guarded agaiust excessive loss in the resale of such shares by forming a put syndicate and paying it a commission of $300,000 for the privilege of selling to the put syndicate not to exceed 200,000 shares obtained in such market purchases and in the exercise of rights purchased in the market, the "put” price to be $50 per share or cost, whichever should be the lower. The privilege was exercised to the extent of 55,000 shares, of which 29,300 shares were repurchased. The securities company also purchased at a cost of $2,220,219.55 the rights to subscribe for 210,8972 shares and exercised most of the rights. Also during the 9 months, January to September, 1928, the securities company's market purchases of this stock totalled 1,451,890 shares, which fell short of the total number of shares of this stock traded on the curb exchange by only 18,810 shares or by less than 1.3 percent; the securities company's market purchases exceeded the number traded on the curb in 5 of the 9 months. During these 9 months, the securities company's sales amounted to 1,867,254 shares. And the closing curb quotations for this stock continued their upward progress from $55% on January 1 to $6836 on September 30, 1928.
Up to September 30, 1928, the securities company's market purchases of Cities Service Co. common stock frequently exceeded the total number of shares of that
stock traded on the exchange, indeed exceeded the totals in 9 out of the 18 months. Thereafter the proportion of the securities company's market purchases to the total trading on the exchange was less than 100 percent and, with exceptions, grew progressively less---not, however, through diminished volume of the market purchases (which increased, instead) but through a greater increase in the volume of purchases on the curb exchange by the investing and speculating public. It is probable that the spectacle of the continuous and rapid rise in the market quotations for this stock attracted speculators who purchased in larger and larger volumes, doubtless on margins to a large extent, for the purpose of reaping large profits in the resale.
On December 17, 1928, Cities Service Co. announced to its common stockholders another offer of common stock for pro-rata subscription at $65 per share to the extent of 10 percent of their record holdings on January 8, 1929. The securities company undertook supervision of the market for the rights and for the stock during this operation. It formed another Put Syndicate and paid it a fee for the privilege of putting to it not to exceed 200,000 “market shares" at $75 per share or cost, whichever should be the less. In order to provide channels through which to dispose of any shares that should not be taken by the stockholders, it joined with Pearsons-Taft Co. in the formation of another syndicate distribution group, which was to obtain orders at retail for 300,000 shares at the current closing cu price plus Y6 point. In its market “supervising” activities the securities company purchased in the market at a cost of nearly $2,489,000, rights to subscribe for 110,880%10 shares. Also, during December 1928 and January 1929, it spent over $56,900,000 in market purchases of approximately 649,087 shares. Its sales during the same 2 months amounted to 890,068 shares with contractual proceeds of $75,079,805.64. The closing Curb quotations rose from $73 on December 1, 1928 to $8942 by January 10, 1929, and to $91 by February 1. The number of shares offered to and subscribed by the stockholders was 522,84242.
Although, including the securities company's subscriptions, the pro-rata subscription offer to the stockholders was a complete success, extensive sales had been effected by the syndicate distributing group and by Henry L. Doherty & Co.'s organization. These sales were sufficient not only to cover the securities company's market purchases but to leave a margin to which could be applied more shares. With market quotations approaching and attaining $120 per share, the Doherty management continued the marketing campaign; also Mr. Doherty decided to sell 200,000 shares of his personal holdings. Steps were also taken whereby he reinvested $1,000,000 in Cities Service Co.'s newly created noncumulative stock in such manner as to increase his voting power from 144,813 votes or 6.19 percent of the total voting power to 1,104,813 votes or 33.11 percent of the total. The company's representatives averred that there was no connection between these two transactions. With such high prices for a 20-dollar par stock, steps were also taken to change the common stock to the non-par variety and split it 4 shares for 1, which became effective on May 2, 1929. A new selling campaign was launched in April 1929 and was carried on through a dealers' special offering and through the Doherty organization until the end of September. While the market quotations held at about $120 per share from about March 19 to the date of the split-up, their upward movement resumed after the split-up and continued to a maximum of $6848 for the new non-par stock (equivalent to $272.50 per share of the 20-dollar par stock) which was attained on October 15, 1929.
In this connection the company's representatives urged that the advance in market price of this stock during 1927 and the greater part of 1928 lagged noticeably behind the upward trend of the general market for stocks. They also point out that on December 4, 1928, one of the Cities Service Co. subsidiaries brought in the discovery well in the now famous Oklahoma City oil pool; and they claim that this discovery attracted public interest and focused attention of investors and speculators upon Cities Service common stock, that this interest was stimulated as other wells in this pool came in later; and they point out that it was during this period from November 1928 to October 1929—particularly from July to October 1929—that the market price of Cities Service common stock had its spectacular rise. They point out that during this period the management was engaged in raising a large amount of new capital with which to develop its holdings in this oil field. However, that may be, it is a fact that during the 11 months and 6 days from October 31, 1928, to October 5, 1929, during which large additional amounts of new capital were sought, the management spent nearly $389,250,000 in the purchase of the equivalent of nearly 12,072,000 non-par shares
of Cities Service Co. common stock over the counter and on the curb exchange, with which to fill sales orders from customers.
The extent to which the securities company's market activities influenced and contributed to that spectacular elevation of the market quotation for Cities Service Co. common stock and to the general market condition that was attained by the beginning of October 1929, and that culminated in the stock-market. crash of that month, may be judged from the following summary of significant facts. The records of Cities Service Co. show that, from November 1, 1928, to October 5, 1929, that company issued, exclusive of stock dividends, new original issues of common stock to the extent equivalent to 5,763,850 shares of the present non-par variety, for proceeds amounting to $86,789,125. During identically the same period, the Doherty management, as agent for the securities company, spent $389,248,248.77 in the purchase, mostly on the curb exchange, of the equivalent of 12,071,692.812 non-par shares of Cities Service Co. common stock. Of course, all of the shares so purchased and several millions more were resold over the counter by Henry L. Doherty & Co.'s stock salesmen and through other channels. During that period the market quotations for the stock rose from the equivalent of about $17.69 to $61.75 per share. The contribution of those market activities to that price elevation may be inferred from the fact that those purchases amounted to 73.5 percent of the entire reported demand on the Curb Exchange. Any percentages are subject to qualification because not all transactions on the Curb Exchange may have been reporting-in fact, particularly in the early years (1927 and 1928) numerous discrepancies occurred between quantities reported by different agencies.
Prior to September 30, 1928, the securities company's market purchases of Cities Service Co. common stock frequently exceeded the total number traded on the Curb Exchange. The last statement in the preceding paragraph shows the proportion from November 1, 1928, to October 5, 1929, at 73.5 percent. The proportion from October 1, 1928, to October 5, 1929, was about 74.4 percent. Even this is a very large proportion, and indicates that the public market demand of investors and speculators for this stock was a very small proportion of the total market demand expressed on the Curb Exchange. It also indicates, however, that the general public had been attracted to this stock. Probably these purchases by the general public consisted in large part of margin purchases by speculators for the purpose of reaping large profits on the resale at still higher prices.
In September 1929 the Doherty management planned another 10 percent prorata suh'scription offer to Cities Service Co. common-stock holders of record November 7, 1929. In order to provide an alternative channel in case the stockholders did not respond fully, another syndicate distributing group was arranged, and marketing commenced on October 1. The securities company undertook supervision of the market.
The market condition was exceedingly precarious, however. Doubtless stimulated by the sustained upward trends of market prices of stocks which in turn were doubtless stimulated by the large and sustained volumes of market purchases by "sponsors” such as Cities Service Securities Co., there was a very large volume of margin holdings of stocks-10 to 12 billions of dollars—as was evidenced by brokers' loans which stood on Octobr 3, 1929, at the stupendous total of $8,549,383,979 and which had increased during the preceding 4 months to the extent of nearly $1,868,000,000. Call loan rates were high. The prices of many stocks were so high that the income accruing to them represented yields of 2 percent or less on those prices, a fact that would naturally precipitate investment selling. Specu-lators would have to sell in order to realize their paper profits in cash. These facts invited short selling raids by "bear” cliques in the hope of producing sufficient drops in market quotations to precipitate a large amount of forced selling by the margin speculators, which would enable the “bear" operators to cover their short sales at a profit. Once such forced selling was commenced there was not necessarily any stopping point until the last speculator was squeezed out.
During the first half of October 1929 the securities company spent vast sums. of money in withstanding the selling pressure on Cities Service Co. common stock; and it was so successful that the market quotations actually advanced from a closing $6044 on September 30 to a high of $68% on October 15. However, on Monday, October 21, in a panic that was precipitated on the preceding Saturday, 936,500 shares of Cities Service Co. common stock, were hurled onto the market. The securities company, in an endeavor to allay the panic, spent more than $48,886,000 in the purchase of 784,644 of those shares. It was only partially