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The originating house makes the contract with the issuer, and signs the papers committing itself and its associates in that piece of business, to purchase from the corporation issuing the securities and to accept delivery of them, and to make payment for them at a certain time. The CHAIRMAN. Then, under this bill the issuing corporation would have to come here to the Federal Trade Commission, file its statement, and have the securities registered. Mr. HARVEY. Presumbaly that is it, or I would think so. From my reading of the bill, and Senator Kean by his questions of another witness has convinced me further along that line, that all that should be done before any of these negotiations can go on. But I want to say to you gentlemen that I do not see how that is possible. Senator ADAMs. Well, as I understand the bill, before you sell a .# all you have to do is to file this information, just before they are SOIOI. Mr. HARVEY. All right. And I should like to say to you gentlemen before I go further with my remarks, that I have not prepared myself to discuss the merits or demerits of the bill you have under consideration. And I think I would have to be a great deal better prepared before I would even attempt to do so. The CHAIRMAN. You are simply trying to give us the mechanics of the origination and distribution of investment securities. Mr. HARVEY. Yes, sir. But I will try at least to answer any questions you may ask. The CHAIRMAN. You may proceed. Mr. HARVEY. Now, I should like to make one point here which I think is the most misunderstood part of investment banking, of the functions of investment banking. It is because of the improper use of the term that has sprung up in America, particularly in the trade, and that is the term “underwriting.” The word underwriting as it is commonly used in connection with investment banking in America is a misnomer. True underwriting is an operation of this kind: let us suppose that the American Telephone & Telegraph Co. desires to raise some additional capital by the sale of additional stock. They, ordinarily as you know, would give, first, the right to their common stockholders to purchase that additional stock. They would set up that right by saying to the outstanding stock, “You have the right to purchase additional stock at a certain fixed price.” Now, let us assume that the American one & Telegraph Co. wishes to put out $50,000,000 of additional stock. It needs $50,000,000 of new capital. It knows that that represents its requirements, and it wants to be perfectly sure of getting $50,000,000. They may be reasonably certain that their present stockholders will subscribe, will take advantage of the right offered to buy the new stock at the price fixed. It is usually made quite attractive, as it should be, but they want to be absolutely sure they will get the $50,000,000 out of that issue of new stock. They want to protect themselves against any failure, of their present stockholders to take up all of that additional stock. In order to accomplish that purpose, to insure themselves that they will get the $50,000,000 in its entirety, they might approach their own bankers, or a group of bankers, . say §§ you underwrite this issue of new stock?” That simply means, will you guarantee that we will sell the $50,000,000 of stock to our stockholders, or you will take over any unsubscribed portion of that stock. Senator ADAMs. Is that the common understanding of the term? Mr. HARVEY. That is the correct understanding of it. But that is not the common understanding of the term in America. Senator ADAMs. I think it is the common understanding of it. Mr. HARVEY. No, sir; because we talk of it in the trade, or I think the general public takes this view I spoke of: at the moment that we make the commitment it is called “underwriting.” Senator ADAMs. I do not think I ever heard any other use of it than the correct use. Mr. HARVEY. I think that is a quite commonly misused term. Senator Adams, are you familiar with the operation of underwriting in the English market? Senator ADAMs. No. Mr. HARVEY. In England, and I should like to say this to you if I may digress that far for I think you would be interested: in England an underwriting group is an entirely separate group from the banking group. The people who come in and underwrite are the same as Lloyds who underwrites insurance risks. They insure the success of the issue. They are called underwriters. And they are perfectly willing to take any unsubscribed securities for their own investment. It is like the so-called big trust companies, I mean in the English system. They buy the unsold securities. They are underwriters. Over here we use that term but it does not mean the same thing for us. Over here the underwriter buys the securities himself, and pays his money for the entire amount of the issue before he sells it. In other words, he makes a commitment. Do I make myself clear on that? It is difficult to do so. Do I make myself clear to you, Senator Adams? Senator ADAMs. I have never found any confusion about it at all. Mr. HARVEY. I thank you. I thought I had not made myself clear. When this group has been formed, and the liability has been distributed in the original banking group, and the purchase of the securities has been made, and the securities are ready for sale to the general public—and that is where the public sale of the thing would come in—a so-called selling group is organized. The originating house, the house I have defined as the originating house, will be the manager of this whole business, and these other people will be the partners and advisors in it. The managing member of the group will send out notice to its so-called syndicate list, or dealers' list, in various parts of the country, like local dealers here in Washington, or in Denver, or in other parts of the country; and will invite them to participate in the sale of it. They will describe the issue, and say that the issue has been purchased by this group, and that they are going to offer it for sale to the public at a certain time and at a certain price; and that there is, we will say, a wholesale commission of one percent, or one and a half percent, to dealers, and they will be given the right to enter subscriptions for the new issue on those terms. The CHAIRMAN. And that is all consigned to dealers, is not to banks or individuals? Mr. HARVEY. Well, the bond departments of banks are included. Banks with security affiliates have been a part of the whole distributing system, and I am including them now.

Senator ADAMs. If they are bonds, of course the banks are among the larger purchasers. Mr. HARVEY. Yes, they might be purchasers of them for their own account. Senator KEAN. So that you distribute them as well. Mr. HARVEY. They have done both. The CHAIRMAN. All right. Go ahead. Mr. HARVEY. Well, now, you will read in the newspapers that the issue is floated, that the issue has all been sold. That means only that it has been distributed to the trade, that the merchants who are in the business have taken the issue. Senator ADAMs. It means that the wholesaling is over and that the retailing is about to begin. Mr. HARVEY. Yes. Or the retailing might have been going along with it but has not been completed. The issue has been taken out of the account. We call the department in which it is kept before being distributed as the account. It means the account has distributed the issue of securities to the merchants of securities all over the country. Those merchants of securities are proceeding then to effect the ultimate distribution of the bond, I mean to the ultimate consumer or the final investor in them, to institutions, banks, educational foundations, and individual investors of all kinds. And the issue has not been completely sold until the final bond has reached the ultimate investor. The CHAIRMAN. What is the usual spread there between what the originator gets and what the buyer pays? Mr. HARVEY. There is no fixed amount. But it would run something like this in general: If it were an issue of American Telephone & Telegraph Co. bonds, for instance, J. P. Morgan & Co. are their bankers, the Telephone Co. would have all of its original discussions with J. P. Morgan & Co. J. P. Morgan & Co. might ask in some of their closest friends in the banking business, to discuss the preliminaries, but they might not. They might make all arrangements with the Telephone Co. to purchase the issue, and have it all fixed before they invite or discuss the matter with other people that they expect to take into partnership with them in the particular deal. Well, we will say that they make the purchase themselves from the Telephone Co. They buy the issue of bonds, and then they pass them on to a group of fellow bankers that they form. And they say to them, in the contract between them, we have made a profit ourselves—and this is the first step to effectuate the issue, for all of the original investigation, for carrying on the negotiations with the company, and for the risk that they take in making a commitment of 50 or 100 million dollars by purchase of bonds—and they take, we will say, a quarter of one percent for that step-up. Then they join in the next group, which is called the purchase group or banking group. They become members of that particular group, and take part with them. They start off with the $50,000,000 issue, as owners of the whole issue. And if I may misuse the term, they underwrite the whole issue themselves, take the whole $50,000,000 and they are very anxious to immediately distribute that risk that they have assumed, and they get 10 or 12 other houses to assume a proportionate part of that risk with them, to carry it along and take some of the risk themselves.

Then they form a selling group, and pass the securities out to retail merchants of the country. J. P. Morgan & Co. does not happen to be a retail house, but they pass the issue along to houses such as I have been associated with. We do both an originating and a distributing business, and were for many years one of the biggest distributors for J. P. Morgan & Co. issues. We would put our sales organization to work in distributing the particular issue to the extent that we had taken a commitment in it. If we happened to sell all of our commitments and there were still bonds left in the account we would go back to J. P. Morgan & Co., perhaps, and buy some more. Now, as to the profit in each step: When it comes to the second step, after you pass the originating house and come into the banking group, which is the purchase group, there is probably a step-up in there of a quarter or half percent, and sometimes it may be as much as 1 percent, if it is an issue a great deal harder to sell. But the Telephone issue is one of the easiest to sell. If there is more risk involved, if it is a harder job, quite naturally the compensation would be larger. Senator ADAMs. The compensation bears somewhat on the marketability of the issue? Mr. HARVEY. Yes; and on the risks involved, and the difficulties of distributing it. It would go up there. Then when it comes to the compensation of the final merchant who distributes the issue to the public, we call that the selling commission, and that runs ordinarily from 1 to as high as 2% percent. I should say that the average would be about 1% percent or 1% percent on the ordinary general oins of a corporation bond. Is that about correct, Senator ean? Senator KEAN. Yes; I think so. Mr. HARVEY. And that is the commission earned by the man for his efforts in distributing the issue at retail. Senator KEAN. That is to cover also the commission to the salesmen? Mr. HARVEY. Yes, sir. Ordinarily, in the case of institutions, such as banks, insurance companies, sometimes charitable institutions are allowed to purchase bonds at a quarter percent down from the price to the general public, because they usually purchase large amounts. It is easier to distribute 100 bonds to 1 of them than to distribute 5 bonds each to 20 purchasers. Senator BULKLEY. Is it customary for wholesale distributors to buy outright? Mr. HARVEY. Yes, sir. Whenever our house has been an originator we have always participated to a large extent in that part of the business. Senator BULKLEY. Do others who participate buy outright from you? Mr. HARVEY. Yes, sir; just as though they were one of the distributors. Each group as it comes along participates. They participate as you go along the line. Senator ADAMs. I understand that Harris, Forbes & Co. did not do this, but some of the big originators would send out wires to their country correspondents the substance of which was: We have allotted to you so much of a certain issue. In other words, if you do not take these we won't let you in on the next good thing we have. Therefore, there was a sort of moral obligation imposed upon them, that if they did not go right along with that house, they would not be let in on another good thing. *. HARVEY. We do not offer to them definite amounts to be taken. Senator ADAMs. I understand, but a good many houses will say: We have allotted to you so much of this issue. Mr. HARVEY. Yes. And I want to be perfectly frank with you and say, that we would not expect a dealer to just take the very choicest of our issues and not take some others, too. And that is business. We would expect them to be fair about it. But we do not put it in just that way to them, I mean in the way you mentioned it. Senator ADAMs. I mean that that goes with the business. Mr. HARVEY. Yes, sir. I will answer that that is not unusual, I understand. Senator KEAN. While talking along this line let me ask you a few questions that I should like to get into our record: You have mentioned the American Telephone & Telegraph Co. And you have a great many smaller issues, I take it. Mr. HARVEY. Yes, sir. Senator KEAN. And you have engineers and you have accountants, and you have various people looking over issues all the time. Mr. HARVEY. Yes, sir. Senator KEAN. What do you have to load an issue with in order to cover that expense? Mr. HARVEY. To cover the expense of looking for business? Senator KEAN. Yes. Mr. HARVEY. We do not have any Senator KEAN (interposing). Well, when you get an issue if you make 1 percent on that issue that will not cover your expense, will it? Mr. HARVEY. No, sir. We would lose money I think on that. Senator KEAN. What do you claim that you have to load an issue in order to get out even? Mr. HARVEY. Well, Senator Adams has gotten at the root of that in his questions. It all depends upon the trouble of selling an issue. Take the State of New York bonds, and they are the least costly issue to sell that you can probably find. The expense of originating and selling such an issue would probably not be greater than a quarter of 1 percent. But if you take an issue, say, of Iowa Railway & Light Co. bonds, you probably run your expense up to 2% or 3 percent. You have to do a great deal more investigating in such a case and therefore have to go to a good deal more expense. Senator KEAN. Would you say about 2 percent? Mr. HARVEY. Yes. It would go up that. Senator KEAN. Then if you should buy them at 90 you would have to sell them at 92 before you would get out even? Mr. HARVEY. Yes, sir; before we would cover the cost. And those costs amount to a good deal. I think you would be surprised at the various costs involved. The less you know about an issue the more you have to pay in order to find out if it is all right and good before you can put your name to it. You must understand, in spite of the general and popular opinion to the contrary, that there are a great many honest men in the investment banking business, men whose desire is as great as anybody's to

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