5. Plainly the marketability, and hence the market value, of any bond will be greatly influenced by the circumstances whether or not the bond is eligible for purchase and sale on the exchanges. Section 11 makes it unlawful for any person to effect any transaction in an unregistered security on a registered securities exchange. By The registration requirements entail expenditure of time and trouble. statutory provision the issuer must furnish information as to the issuer and its affiliates in respect of numerous specified matters concerning organization, financial structure, security provisions and miscellaneous information regarding directors, officers and principal security holders and underwriters, and their remuneration and relationship with the issuer and its affiliates; bonus and profitsharing arrangements must be described; managements and service contracts and options on securities set out; contracts not made in the ordinary course of business must be described; and other information must be listed. The commission may make additional rules and regulations as to the information to be furnished in connection with the registration of securities, and as to the undertakings to be entered into by the issuer, but such rules and regulations shall require, among other things, an undertaking by the issuer to comply with the provisions of the bill and with the commission's rules and regulations. In many cases the issuer of a bond may have little or nothing to gain from registration of the security. The securities are already in the hands of the public, and whether or not they are readily realized upon may be a matter of little or no concern to the issuer. On the other hand, registration subjects the issuer to trouble and expense, to an extent undetermined and subject to further enlargement by the cominission. Registration subjects the officers of the issuer, and other agents, to dangers of personal financial liability, or at least to annoying attempts to fasten such liability upon them. We may confidently anticipate, therefore, that many outstanding issues will not be registered. It will be the holders of the securities, and not the issuers, who will pay the penalty of impaired marketability. The mutual savings banks own municipal bonds to the value of several hundred millions of dollars. It is doubtful if many municipal bonds now outstanding will be registered. The same thing is true of the bond issues of States, counties, school districts, improvement districts, and other obligations of like nature. To a somewhat less extent, it is true of equipment trust obligations. The savings banks urge that consideration be given to this effect of the bill of visiting the penalty of nonregistration upon those who are unable to control the issuer in this respect. Here we have an additional illustration of the inapplicability of the principles of the bill to bonds. The holders of the outstanding stock of an issuer cannot be said to be without an opportunity of influencing the course of the issuing corporation with regard to registration. The holders of outstanding bonds certainly are afforded no such opportunity to influence the action of the issuing corporation. It is conceivable that the requirements concerning registration before bonds are eligible for sale on the exchange might afford openings for abuses by issuers with nothing to gain from enhanced marketability. For example, an issuer might decline to make the registration statement and to enter into requisite undertakings for the very purpose of depreciating the market value and enabling the issuer to buy in its outstanding bonds at a substantial discount from par. This would penalize the owners of the bonds, and not the issuer. We ask the committee not to of the general policy of the bill. CONCLUSION construe this expression as voicing disapproval We have purposely and carefully confined ourselves to an attempt to point out particulars in which the bill appears to threaten the direct and proper interests of savings banks, chiefly by impairing the marketability of the bonds which they held. Respectfully submitted. PHILIP A. BENSON, President, COVINGTON, BURLING, RUBLEE, ACHESON & SHORB, Hon. SAM RAYBURN, House of Representatives, Washington, D.C. DEAR SIR: Incident to the hearings on the bill H.R. 7852, proposing to enact the National Securities Exchange Act of 1934, the American Institute of Accountants herewith presents a memorandum brief which it requests to be incorporated in the hearings. This brief sets forth the views of the public accountants respecting certain changes in the bill which are believed to be essential for reasonable and effective administration, and properly to limit the responsibility of the public accountants. Sincerely yours, J. HARRY COVINGTON, Counsel for American Institute of Accountants. Before the Committee on Interstate and Foreign Commerce of the House of Representatives, Hearing on H.R. 7852. Memorandum on the National Securities Exchange Act of 1934, Submitted by American Institute of Accountants] This memorandum is respectfully submitted to the congressional committees which have under consideration the so-called national securities exchange bill of 1934, on behalf of the American Institute of Accountants, national professional accountancy organization. ANNUAL AND QUARTERLY AUDITS Section 12 (a) (2) of the bill would require every issuer of a security registered on a national securities exchange to file with the Federal Trade Commission annual and quarterly reports, including among other things a balance-sheet and profit-and-loss statement certified by an independent public accountant. We approve the requirement of at least one report each year certified by independent public accountants. This is in accord with what is commonly regarded as good practice. It is preferable that the certified report be rendered as of a date marking the end of the natural business year of the company concerned (which is not necessarily December 31) i.e., the date most closely coinciding with the termination of the annual business cycle, which is also usually the date at which inventories are at their minimum. The work of the regulatory body would be facilitated by spreading the closing dates of various industries in accord with their natural fiscal periods, and resulting financial statements would be more valuable for comparative purposes. It is suggested that there be inserted in section 12 (a) (2) a provision making it clear that annual reports are to be filed as of the date marking the end of the natural business year of the company concerned. However, there is serious question in our minds whether the requirement of quarterly reports certified by independent public accountants is desirable in all cases. Accounts are essentially continuous historical records and accounting statements for brief periods of time are less significant and valuable than for longer periods of time. On the basis of personal judgment and convention certain charges and credits must be assigned more or less arbitrarily to one period or another and when the period is as short as 3 months it is very difficult to prepare accounting statements which are not open to the danger of misleading the uninformed reader. Items of income or expense, which are extraordinary or unusual in either nature of amount influence the net result shown for a given quarter to a greater disproportionate extent than they would influence the net result shown by an annual statement which includes the same items. Many businesses are of a highly seasonal nature, e.g., automobile, department stores (with Easter and Christmas seasons), flour milling and other industries related in one way or another to agriculture, and the real result of the operations is not dependent on a few months-as quarterlybut on at least the full annual cycle. It must therefore be recognized that the results shown by quarterly statements cannot be stated with the same degree of accuracy as statements for a longer period, such as annual statements. It is not intended to be argued that corporations generally should not inform their stockholders quarterly of the corporation's progress, but it should be recognized that such quarterly statements are to a greater extent dependent upon estimates than needs to be the case with statements for longer periods. Neither is it argued that more frequent than annual examinations of corporate accounts are not desirable, but to require that quarterly statements must be certified would tend to give them a weight and authority beyond that which they inherently possess, and might well lead investors to place an undue reliance thereon. In view of the foregoing, it would be unreasonable, and indeed improper, to place upon public accountants, with respect to quarterly statements, the heavy burden of responsibility set forth in section 17 of the bill. If it is considered essential that independently audited statements be submitted more often than once a year, there would be less objection to semiannual reports than to those covering only three months. LIABILITY Section 17 (a) of the bill provides that accountants may be sued for damages if they have made any statement which is false or misleading in respect to any matter sufficiently important to influence the judgment of an average investor. It will, of course, become the duty of the courts to determine what might influence the judgment of an "average investor," as the courts have had for many years the duty fo determining what might be the actions or the judgment of a "reasonable man. The term "average investor" has had no judicial determination. It is, in fact, novel to the law, and the type of person who is an "average investor" may vary greatly in different parts of the country. We suggest, therefore, that the phrase 'an averge investor" appearing in section 17, page 32, line 2, be changed to "a reasonable man. The action and the judgment of " a reasonable man", and consequently matters which would influence that action or judgment, can in harmony with the existing general law be readily determined by the courts. It is necessary for us to object most strenuously to the measure of damages outlined in section 17 (b) and (c). Under these provisions it is possible that an accountant who had made an honest error might be held liable for an amount which would have no relation whatever to the amount of damage occasioned by his error. The accountant is an expert exercising his professional skill and judgment for a fee. It seems to us that there is no precedent in law or equity on the basis of which such an expert should be exposed to immeasurable liability in the absence of fraud. It seems perfectly possible that under section 17 (b) and (c) an investor who had sustained loss might, if he discovered an error in the statement certified by an independent accountant, sue that accountant for a sum much greater than the amount of the damage occasioned by the accountant's error. Such a provision would be likely to encourage unwarranted suits against accountants and would impose upon the profession the heavy financial burden of defending such suits even though the courts found the accountants blameless. No reputable accountant has any desire to deny or ignore his responsibility to those who rely upon statements which he certifies. The courts under existing law have already imposed upon accountants a financial liability quite sufficient to deter any accountant from deliberate fraud or deceit. A public accountant's reputation for probity is his chief asset and no one would be willing to risk the professional destruction which certainly follows discovery of a dishonest or a careless act. It seems to us that the measure of damages imposed upon accountants by section 17 (a) and (c) is of a punitive character which is unreasonable and unwarranted by the record of the accountancy profession in the United States, and we respectfully request that it be modified. UNIFORM ACCOUNTING Under section 18 (b) of the bill the Federal Trade Commission would have power to prescribe uniform accounting for industry. This provision we believe does not belong in a bill designed to regulate national securities exchanges. It is a matter of such great importance that it should be considered as a separate problem. We understand that a committee on uniform accounting and statistical reporting for industry appointed by the Secretary of Commerce is now giving thought and study to the matter. The application of attempted uniformity in the keeping of the accounts of public utilities and railroads has not, it is believed, tended toward the presentation of more dependable financial statements by companies in those fields than has been the case with industrial companies. On the contrary, it is believed that there has been a greater advance in the accounting practices and in the recognition and treatment of such problems as those arising with respect to allowances for depreciation of plant and property, etc., in the case of representative industrial companies then in the fields subject to governmental regulation 45381-34-42 of accounting. Uniformity of principles is vastly more important than superficial uniformity of form. It should also be observed that, if public accountants are to have imposed upon them the heavy burden of responsibility set forth in section 17, there is a gross inequity in having a body which obviously does not, and cannot, have the background of professional training and experience in accounting essential to enable it to speak the last word on such a subject and the immediate first hand contact with new problems constantly arising, empowered to prescribe the form or manner in which the financial statements to be certified by the public accountant shall be prepared. Rigidity of form may be dangerous because it cannot in the very nature of the case forsee and prepare for the disclosure required with respect to new developments or situations having an important bearing upon the statement of the results of a company's operations or of its financial position. A sufficient, and at the same time more reasonable, requirement is that the Federal Trade Commission may call for the disclosure in the financial statements of any information which it deems essential to the completeness or clear understanding thereof. In the final analysis, the problem of disseminating reliable financial information to investors is not dependent upon the application of uniform accounting methods or upon a rigid uniformity in form of the statements to be submitted to investors. Further, the introduction of uniform accounting methods or of uniform forms of financial statements will not solve the problem. Accordingly, we believe it inappropriate and undesirable from the point of view of the investor that there be included in this bill a provision authorizing the Trade Commission to prescribe accounting forms and methods. We respectfully recommend the elimination of section 18 (b). Representatives of the institute would be glad to enter into discussion of any of the questions raised herein. Respectfully submitted. NEW YORK. March 6, 1934. Hon. SAM RAYBURN, JOHN L. CAREY, Secretary American Institute of Accountants. CONTROLLERS INSTITUE OF AMERICA, New York City, March 8, 1934. Chairman Committee on Interstate and Foreign Commerce, Washington, D.C. DEAR MR. RAYBURN: The enclosed statement presents the views of the Controllers Institute of America, with respect to the proposed measure known as "National Securities Exchange Act of 1934", and it is respectfully requested that this statement be entered in the record of your committee's hearings on this measure. Very truly yours, D. J. HENNESY, President. STATEMENT OF Comment anD SUGGESTION TO THE SENATE OF THE UNITED STATES COMMITTEE ON BANKING AND CURRENCY IN THE MATTER OF "NATIONAL SECURITIES EXCHANGE ACT OF 1934", S-2693, FOR CONTROLLERS INSTITUTE OF AMERICA BY EDWIN F. CHINLUND COMMITTEE ON BANKING AND CURRENCY, United States Senate, Washington, D.C.: NEW YORK, N.Y., March 5, 1934. The Controllers Institute of America has considered the provisions of S. 2693 and H.R. 7852, to be known as the National Securities Exchange Act of 1934, and has requested me to submit this statement and to appear before you to present the views of the Controllers Institute on the bill. The Controllers Institute is in sympathy with necessary actions taken to protect the investing public by the elimination of abuses in the security business, and to prevent abuses of credit caused by the diversion of credit into speculative channels to the injury of general business. This statement is principally confined to the accounting and financial aspects of the bill since those aspects are the ones in which our membership is primarily interested. The membership of the Controllers Institute of America consists of over 300 controllers and other executives who are responsible for the accounting and finan cial policies of many of the corporations whose securities are listed on exchanges. This statement has the approval of our board of directors and based upon that approval and the many communications received from members, we feel safe in stating that it represents the opinion of the majority of our members even though we have not had time to obtain their vote. In this connection it is appropriate to refer to the declaration of principles of the Controllers Institute of America, adopted shortly after foundation of the institute, which expresses our point of view on this subject and which, as will be seen, harmonizes with the avowed purposes of the bill. "The Controllers Institute of America stands for the observance of the highest ethical standards in corporate accounting practice and in the preparation of reports of financial and operating conditions of corporations to their directiors, stockholders and other parties at interest, in such manner that all concerned may know the actual conditions insofar as such reports may assist in the determination thereof. To that end, the Controllers Institute of America offers its advice and assistance in connection with any movement which has for its purpose the establishment of better safeguards for the protection of the investor.' We submit the following as to the accounting and financial features of the bill: The provision of section 12, which provides for the filing of quarterly balance sheets and income accounts, and further provides that such balance sheets and income accounts shall be certified by independent auditors, is, in our opinion, too burdensome to business and is unnecessary to secure the protection to investors for which the law is intended. The present listing requirements of the New York Stock Exchange provide that corporations shall publish an annual balance sheet and income account, and quarterly income accounts. The variation of balance sheet items during a quarter is usually not great enough to justify spending the investors' money to set up the elaborate accounting machinery necessary to prepare a balance sheet sufficiently accurate to permit the officers of the corporation to assume responsibility for its correctness. Furthermore, quarterly audits would multiply the cost of the present annual audits and would be too heavy a burden for the corporation to bear. It is well recognized in accounting and business circles that quarterly statements of many corporations, although reasonably correct, are based upon estimates to a larger degree than annual statements, and therefore without greatly elaborating the present accounting methods they cannot be as accurate as the annual statements. Furthermore, if a corporation were to publish a certified quarterly balance sheet, it would be necessary in many cases to take physical inventories quarterly whereas now physical inventories are, in most cases, only taken once a year. What the investor requires mainly to pass judgment on his investment, is the trend of earnings, and most corporations whose securities are listed on the New York Stock Exchange are meeting this requirement by issuing quarterly income accounts. It is true that some corporations are not submitting quarterly reports because their agreements with the exchange were made before the exchange instituted the provision making this a requirement for new listings. However, the efforts of the exchange through its committee on stock list have been devoted for a long time to having corporations agree voluntarily to modifications of their listing agreements, so as to provide for quarterly earnings reports. In this connection it should be pointed out that when the New York Stock Exchange made the publication of quarterly earnings statements a listing requirement, it was found that in certain industries quarterly statements were wholly misleading by reason of wide seasonal variations. Furthermore, in some cases it was found to be impossible to ascertain with any reasonable degree of accuracy certain basic data necessary for the preparation of such statements. In such cases, the stock exchange decided to permit the publication quarterly of earnings statements covering the 12 months' period immediately preceding such publication, instead of 3 months' figures, thus eliminating the seasonal factor. We suggest, therefore, that 12 months' earnings statements, published four times yearly, be permitted in place of quarterly statements where the latter would be misleading to the investing public. We suggest also that permission be granted to publish semiannual earnings statements in cases where it appears that such statements present the picture more fairly than quarterly statements. Furthermore, in cases where it is obvious that an investment policy can be determined most satisfactorily from annual statements, such annual statements should be permitted. The point we wish to make is that greater flexibility should be permitted, to conform to the diversity of conditions found in the various industries. It is our |