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The CHAIRMAN. I say, not many suggestions that you are proposing will come of the proposal we have on our desks, this bill?

Mr. WHITNEY. How many are?

The CHAIRMAN. No; I did not ask you that. I said that there would not be many of your suggestions that would be taken from this bill that you are discussing.

Mr. WHITNEY. It is on a different basis, Mr. Chairman. There are a good many of certain phases and definitions in the bill that we do endorse quite heartily.

We were at subdivision (f), which deals with the lending of customer's securities without consent, makes effective another ruling of the New York Stock Exchange. The final part of this paragraph, however, provides that the account of the customers whose securities are loaned must be credited with "the interest received on account of such lending”. This provision, quite frankly, is meaningless. The lender of securities does not receive interest but pays interest.

Mr. Mapes. May I ask a question?
The CHAIRMAN. Yes, Mr. Mapes.

Mr. Mapes. Is it the practice of brokers to require the customers to sign a statement consenting to the loaning of their securities?

Mr. WHITNEY. It is customary for brokers to ask their customers to sign; yes, sir.

Mr. Mapes. So that if they do sign, as I suppose most of them do, this provision here is of no effect, insofar as changing present practices of the exchange is concerned?

Mr. WHITNEY. That is the same as subdivision (e); yes; but subdivision (f) requires the giving of the interest received by the lender of the securities. He does not receive interest. He pays interest. It is only when stocks are lending at a premium that the lender of securities receives any direct compensation for the loan. It has frequently been urged that brokers should account to their customers for any premiums so received but the practical difficulties of doing so are almost insuperable. If the committee is interested in this subject, I can readily give them an example of how impossible it is for a broker who receives a premium on a loan of stock to apportion it among the persons who might theoretically be entitled to a part of it.

Section 8 of the bill deals with certain prohibitions against the manipulation of security prices. Subdivision (a) contains nine specific subsections which I will refer to as briefly as possible.

The first prohibits fictitious transactions which, of course, include "wash" sales. That is already the penal law of the State of New York and is, likewise, prohibited by the rules of the New York Stock Exchange

Mr. PETTENGILL. If I may interrupt you there, please. You say section 8 (a) (1) is covered by the penal laws of the State of New York, or your own rules?

Mr. WHITNEY. Yes, sir.

Mr. PETTENGILL. Is it covered by the penal laws or by rules of various other exchanges all over the United States?

Mr. WHITNEY. I cannot speak as to the other exchanges. It is not covered in all of the law statutes of all of the States.

Mr. PETTENGILL. Well, then to the extent that it may not be covered in the penal statutes, in States where there are other stock exchanges, this might be a good thing?

Mr. WHITNEY. Absolutely.

Mr. COOPER. Mr. Chairman, may I ask what the procedure for the rest of the afternoon is?

The CHAIRMAN. I am hoping to adjourn about a quarter to 5.

Mr. COOPER. I am very much interested in that part of this bill which provides for registration requirements of securities, which affects the general public and industries and business, and I am wondering if Mr. Whitney will have a chance tomorrow to explain that?

The CHAIRMAN. I think that we will have to go on with Mr. Whitney tomorrow morning for awhile.

Mr. COOPER. I was wondering if he would be here tomorrow. Will you, Mr. Whitney?

Mr. WHITNEY. Oh, sir, I am at your disposal as long as you want me.

Mr. COOPER. That is all. Thank you.
Mr. WHITNEY. Shall I proceed, sir?
The CHAIRMAN. Yes.

Mr. WHITNEY. Subsection 2 prohibits the purchase and sale on an exchange of a listed security at substantially the same time and substantially the same price, unless the transaction is made only as a matter of record and is reported in a specified manner. It is not quite clear whether this section is intended to prohibit more than "matched orders”, which, in effect, are a form of fictitious transaction whereby two or more persons, by prearrangement, enter orders at about the same time to buy and sell a certain security with the intention or design that these orders will meet and be executed one against the other. This practice we consider is a violation of our rule prohibiting transactions which do not involve a real change of ownership. If, on the other hand, this section is given a broader interpretation and will operate to prevent a man in the course of a single day buying and selling the same security at about the same price, it will prevent perfectly legitimate and honest transactions. Many purchases are made with the idea of selling again as soon as market conditions change and it frequently happens that in the course of a single day a man who has bought in the morning may deem it advisable to sell in the afternoon. There is no good reason why he should not do so.

Subsection 3 deals with transactions made for the purpose of raising or depressing the price of securities or for the purpose of creating a false or misleading appearance of activity. I think we will all agree that such practices should be forbidden when they involve an intentional effort to unfairly influence the price of securities for the purpose of making a profit. The rule adopted by the New York Stock Exchange on February 13 not only forbids members from participating in transactions of this kind but, likewise, prevents them from either managing or financing such activities for others.

Subsection 4 deals with the dissemination of rumors as a means of stimulating market activity. Such acts are already prohibited by the rules of the exchange.

Subsection 5 seems to prohibit false or misleading statements, but the definition is so general that it is difficult if not impossible to say what statements would fall within the scope of this prohibition. We all agree, I am sure, that the dissemination of false information to induce the purchase or sale of securities is fraudulent The difficulty

with this subsection, however, is that it may cover perfectly honest statements as well as fraudulent ones. In effect, it may mean that no person--and I ask you to note that it is not only members of exchanges and brokers who are subject to this provision but every citizen of the United States no person can make any statement in regard to any listed security unless he shall have first made an investigation and exercised reasonable care to determine that what he says is entirely accurate.

Subsection 6 prohibits any payment being made to any person for the purpose of procuring the dissemination of information to the effect that the price of any security is likely to rise or fall because of the activity in the market of any one or more persons. The New York Stock Exchange has a rule prohibiting its members making any payment to secure inspired publicity. This section, which accomplishes substantially the same result, would simply carry into the criminal law and make general a rule which the exchange has already put in force in regard to its own members. I hesitate to express any opinion in regard to the feasibility of enforcing this provision.

Subsection 7 prohibits any person engaging in a series of transactions intended to peg or stabilize the price of any listed security, unless the details of such operation shall have first been reported to the Federal Trade Commission and, presumably, approved by it. Transactions aimed at maintaining a certain price or at stabilizing the price of a security have heretofore been considered legitimate when connected with the distribution of securities and the maintenance of a fair market for securities. This subsection would apparently make such operations illegal unless they were first submitted to and approved by the Federal Trade Commission.

In spite of the critical comments that have been made about stabilizing security prices, no one can doubt that such practices have been considered legitimate in the past. They were generally indulged in by our own Government when the Liberty bonds were being sold during the war and, more recently, it has been the custom of our Federal Reserve banks to intervene in the Government bond market to maintain and stabilize prices in anticipation of new Treasury issues. The ethical character of such operations cannot, therefore, be questioned.

It is, at least, doubtful whether any restriction should be placed upon purchases and sales made to support a market in connection with the distribution of securities. The maintenance of a price having some reasonable relation to the offering price through the medium of actual purchases and sales in the market, really operates to the benefit of investors in that it allows them to freely buy and sell while the process of distribution is still in progress. Many people believe that when such operations terminate, the market necessarily recedes and that the existence of such stabilizing orders must operate to mislead the public. These people overlook the fact that a distributor of securities, who undertakes to stabilize the market price of the security he is selling, is backing his judgment with his money that the price at which he is offering the security to the public is a fair one. If he is mistaken and the security has been offered at too high a price, the net result of the stabilizing operation will be an accumulation of securities by the issuer and this may, in some instances,

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result in his repurchasing the entire issue which he has offered to the public. If, on the other hand, his judgment is justified and the public is willing to pay the price at which the security is offered, the only result of the stabilizing operation will be the maintenance of a fair market while distribution is being effected. Certainly, this question is one which deserves greater study before it is condemned by being included among the criminal provisions of the bill.

There is one other normal and useful practice which would seem to be within the scope of this subsection. I refer to arbitrage transactions which frequently play an important part in the market. Arbitrage is possible between different markets and, likewise, between different securities. For example, a security like the stock of the American Telephone & Telegraph Co. is dealt in in Boston as well as in New York. If there should be more buyers than sellers for this stock in the Boston market there would be a tendency for the price of this stock to rise on that exchange. At the same moment, however, there might be more sellers of this stock than buyers on the New York Stock Exchange, so that, in effect, the price of the same stock might be rising in Boston at the very moment that it was declining in New York. The function of the arbitrageur is to bring the two markets into relation with each other and, in the example which I have cited, he would buy in New York and sell in Boston, with the result that the price in New York would not decline and the price in Boston would not rise. This, as I see it, is a beneficial service which creates a better market for the public on both exchanges. The example which I have cited between two exchanges in this country is commonly called "domestic arbitrage.” Similar transactions frequently take place between our markets in this country and the great European financial centers, and these international transactions are usually called “foreign arbitrage.” Of the two different types, the latter is infinitely more important, because it brings together the supply and demand of international centers and, at the same time, plays a stabilizing role in foreign exchange rates. I appreciate that this subject is a highly technical one and will not elaborate upon it unless the committee desires me to do so. Foreign arbitrage is, however, generally recognized as a legitimate and useful activity, and even during the last year, when restrictions were placed upon foreignexchange transactions, every means was used to facilitate the business of foreign arbitrageurs.

Arbitrage takes place not only between markets but also between securities. For example, a corporation like the American Telephone & Telegraph Co. may offer its stockholders rights to subscribe to additional stock. These rights may be valuable and some stockholders may wish to exercise their rights while others may decide to sell them. It is obvious that the value of the rights should bear a very direct relation to the price of the stock in connection with which they were issued, but at any given moment there may be more people who wish to sell rights than there are buyers of rights and therefore the price of the rights might decline even if the price of the stock should remain stable. The arbitrageur by buying the rights and selling the stock keeps an equilibrium between these two securities, just as the domestic arbitrageur maintains an equilibrium between markets within this country. This is an important function and there are many instances where arbitrage is necessary to prevent unfair markets. I have used as an example a case involving rights to subscribe, but arbitrage applies also when stock dividends are declared or stocks are split up, in cases of merger and consolidation and also when part-paid certificates are issued at a time when full-paid certificates are already being traded in.

There is no evidence that the different types of transactions falling under the ban of this subsection 7 have operated to the disadvantage of the public. On the contrary, we know that they have been of real benefit to investors. Certainly, it would be most unwise to outlaw such useful practices.

Section 8 prohibits any person acquiring substantial control of the floating supply of any listed security for the purpose of increasing the price by means of such control. There is no definition of what constitutes the "floating supply" of a security. If the real intention of this subsection is to prohibit corners, I would like to point out that the best means in our opinion of preventing a corner is not to make it a criminal act but to provide that contracts in the security which has been cornered may be settled by the payment of a fair cash value rather than by actual delivery of the security. Such a provision makes corners unprofitable and prevents them more effectively than any criminal penalty. The stock exchange adopted such a rule in the general revision of its constitution in 1925.

Subsection 9 prohibits all forms of option contracts. The purpose of including such a sweeping prohibition was undoubtedly the prevalent belief that options have customarily been used as a means of unfairly influencing market prices in connection with manipulative pools. This does not justify, however, an arbitrary prohibition of all forms of option contracts. Options which are used for manipulation might well be prohibited, without preventing the use of options for legitimate and proper purposes.

The balance of section 8, subdivisions (b), (c), (d), and (e), contain provisions imposing severe civil penalties upon persons who violate the specific prohibitions which I have just discussed. I am advised that these civil penalties introduce a new and vicious principle into our law. While the enforcement of the criminal law has sometimes been made more effective by granting to persons who have been injured by the criminal act a right to recover penal damages, there is not, I am told, any known case in which civil penalties of a punitive nature have been granted to persons who have not suffered direct injury from the criminal act.

In substance, these provisions allow any purchaser or seller of a security, the price of which may have been affected by any one of the prohibited transactions, to bring suit to recover the difference between the price at which he bought his security and the lowest price at which the security sells during 90 days before and 90 days after the date of purchase, or, in the case of a sale, the difference between the sales price and the highest price at which the security sells during 90 days preceding and 90 days following the sale. These amounts can apparently be recovered irrespective of whether the person has suffered actual damage or not, and it is obvious that these sections will result in allowing any purchaser or seller of a security, the price of which may have been affected by a prohibited transaction, to recover vastly greater damages than he could have suffered. In fact, it is even conceivable that a person might buy a security and sell it

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