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NATIONAL SECURITIES EXCHANGES-H.R. 7852

FRIDAY, MARCH 2, 1934

HOUSE OF REPRESENTATIVES,

COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE,

Washington, D.C.

The committee met, pursuant to adjournment, at 10 a.m., in the committee room, New House Office Building, Hon. Sam Rayburn (chairman) presiding.

The CHAIRMAN. The committee will come to order.

STATEMENT OF G. HERMAN KINNICUTT, REPRESENTING THE INVESTMENT HOUSE GROUP, DEALERS, BROKERS, AND UNDERWRITERS, NEW YORK, N.Y.-Resumed

Mr. KINNICUTT. When my time expired on Tuesday morning, we were about to indicate to you what in our belief the results of complete segregation would be.

Section 10 of the bill makes it unlawful for any member of a national-securities exchange or any person who, as a broker, transacts a business in securities through a member, to act as a dealer or underwriter in securities, whether listed or unlisted. This in effect means that all security dealers, whether members of an exchange or not, who now act as brokers, will be prohibited from continuing to act as dealers if they continue to act as brokers.

You have already heard much testimony that the registration requirements of the bill, to obtain listing, unquestionably means that many of the securities now listed on different exchanges will no longer be listed. Another great mass of securities such as the whole list of State obligations, municipal bonds, and equipment trusts, for practical purposes cannot be listed. Almost all State and municipal bonds and equipment trusts are issued in serial maturities. You can readily see that for practical purposes you could not list, say, an equipment trust having a relatively small amount maturing every 6 months for 10 or 15 years, or 20 or 30 different maturities.

As a matter of public policy, bank stocks and insurance company stocks should not be listed. Another great class of perfectly sound small issues of local securities from every substantial community in the country obviously will not be listed because, aside from the cost of the audits, they are only of local interest.

If we have demonstrated the value to the country of the dealerwe feel he is an economic necessity-we have next to see if he can survive if this bill becomes law.

During the past 4 years the dealer organizations which have taken. years to create-at an infinite cost of effort, labor, and money, and employing many thousands of people from the "white-collar" class

of labor, which is finding it possibly harder than any other to get work-have with difficulty kept alive. In many cases they have greatly shrunken or disappeared. Those who have survived have done so primarily because of the combination of earnings from their brokerage and dealer business. This refers to both large and small organizations in the big cities as well as in small cities.

The result to the dealers throughout the country is self-evident when they no longer have any income from the commission business. The great majority could not survive solely as brokers or solely as dealers.

It is undisputed that there are isolated cases of unsound practices and high-pressure methods among dealers. So there are in every profession and industry, but such bad practices and high-pressure methods are far more likely to increase than to diminish under the economic pressure to keep alive.

Perhaps the most dangerous result of all will be that if every member of every exchange is barred from acting as a dealer in investment securities, the business will be thrown into the hands of persons subject to no control by any exchange, and extremely difficult of any control by any body, governmental or otherwise. A big, uncontrolled "bootleg" market will rapidly develop, with great danger to the public welfare, and the danger to the investor will be greatly increased rather than diminished. It is a rather delicate subject even among friendly competitors such as we all are, and I have not cared to ask the information, but it would be a safe guess that on their commission business alone, or on their dealer business alone, or on their underwriting business alone, every firm in this group-and they are a pretty good cross section of the industry-would show a loss rather than a profit.

We submit that the dealer and underwriter performs a necessary and essential function as the intermediary between private capital and industry; that there is no other machinery to perform this vitally important function; that he performs an essential service to the investor; that the segregation clauses of this bill will largely cripple or destroy him, and that such clauses, therefore, should be stricken from the bill We think the whole argument as to segregation can be thus summarized briefly.

I would like to amplify the recommendations which we were unable to make at our last appearance.

We think we have shown that the dealer, as dealer, is a very definite benefit to the investor and to the public. We believe we have proved that the dealer is an absolute necessity. We think we have also shown that the underwriter performs an equally necessary function.

You have heard testimony to the effect that there was too much underwriting of new securities in 1928 and 1929. Perhaps there was. There was too much of many other things for the good of all of us. This, however, does not answer the question as to the necessity of underwriting for refunding purposes and the legitimate capital requirements of expanding business.

The reasons advanced for segregation at the hearings before this committee and before the Banking and Currency Committee of the Senate are two:

First, the temptation said to be inherent in the combination of the broker-dealer functions on the part of the dealer to sell securities to

his customer rather than to buy securities for his customer on a commission basis. Secondly, the danger to the brokerage customer from excessive commitments of the dealer on the underwriting or dealer side of his business.

As to the first, I think that we have shown that this temptation is greatly exaggerated and that as a matter of fact if the dealer is permitted to act only as a dealer the temptation increases rather than decreases. As to the second, we showed by actual record of the five biggest security exchanges in the United States over the past 4 years that the percentage of failures to the total membership was only three eighths of 1 percent per annum.

I want to correct the statement there that I made in our statement before, where I said one half of 1 percent. I want to be fair. It is only three eightns of 1 percent per annum and many of these failures were in no way due to causes that segregation would have prevented. This is an extraordinary record. These failures, small in number as they are, are greatly to be deplored, but from the point of view of the public interest they are prefereable to the crippling and destruction of the responsible dealer which in my judgment would occur if segregation is compelled by statute.

There should be no provision such as section 10 and section 19 of the bill which would, to my mind, destroy the successful operation of the dealer, underwriter-broker functions of our financial machinery.

I wish now to amplify our constructive recommendations. There are today three commissions in specific charge of specific activities and a fourth has just been recommended by the President. By this I mean the Federal Reserve Board, the Interstate Commerce Commission, the Federal Trade Commission and the proposed communications commission.

The securities business of the country today is a national function and we recommend that a fifth commission, namely, a Federal securities commission, be appointed by the President to be in specific charge of the whole field of securities exchanges. We do not undertake to outline from whence the membership of this commission should be drawn except to say it should have definite representation by those who are particularly familiar, by experience, with the securities business. In other words, the only definite recommendation here is that the boys who know the job should have representation.

The CHAIRMAN. Let me ask, have we been held to that in any board? Has the President been held to a specific group from which he should select people to fill places on the Interstate Commerce Commission, Federal Trade Commission or the Federal Reserve Board, or the Radio Commission, which we propose to abolish?

Mr. KINNICUTT. I do not quite get your query. You mean should

The CHAIRMAN. What I am asking you is following up some of the questions I asked the gentleman the other day about this commission which Mr. Whitney, for instance, suggests, to have two men, one recommended by the New York Stock Exchange and the other recommended by the associated exchanges.

Do you think that Congress should pass a bill tying the President to a group?

Mr. KINNICUTT. We are not making specific recommendations as to from whence that group should be drawn.

The CHAIRMAN. Yes.

Mr. KINNICUTT. I do not do that, except along the lines of reason. Except that it seems to me, that any commission should have representation on it, of a very intricate nature, such as this is, of people, "top sergeants" in the trenches, who know the business from experience and not from theory.

The CHAIRMAN. Of course, if we are going to trust the President at all, we have got to trust his discretion and his fairness to name commissioners. That is all there is to it.

Mr. KINNICUTT. Well, if that is your pleasure, I think that we would be quite ready to trust ourselves to the discretion of the President as to the appointment of that commission. This is only our personal idea about it.

The CHAIRMAN. That is where it would be, without anything being said about it.

Mr. KINNICUTT. In connection with the appointment of this Commission there is one thing we would stress as of the greatest importance and that is that it should be left free to operate with great flexibility. The securities business operates under constantly changing conditions which from time to time call for different treatment. Regulations which today are wise and necessary may be most unfortunate under the differing conditions which are bound to occur. What are wise regulations on some exchanges may be quite inappropriate under different operating conditions on other exchanges. What may apply in San Francisco, New Orleans, or Toledo might not apply in Boston or New York.

We think that such a Federal Securities Commission, in addition to being elastic should be primarily supervisory, but we recommend that it should also be clothed with mandatory power. We believe that in the vast majority of cases this supervisory power will bring about any changes that may seem wise to the Commission, for we are of the definite opinion that all of the exchanges will cooperate to the greatest degree. Obviously it is their desire to eliminate all bad practices for their own preservation.

In the rare instances where experience shows that a definite evil has not been cured the Federal Securities Commission could then invoke its mandatory powers.

While we believe in a minimum of statutory provisions there should be a differentiation between the treatment of business in senior securities such as bonds or preferred stocks, from common stocks or more speculative securities.

We believe as to margin requirements that a greater margin should be required on the highly volatile or more speculative securities than on governments, municipals, or high-grade investment securities which have a far less fluctuating market.

There should be no provision in the statute giving control over Commission charges or control over the closing out of margin accounts. These must be left as matters of self preservation to the exchanges themselves.

We recommend that all exchanges be registered.

We recommend that securities listed at the time of registration should continue to be listed provided the listing requirements are, taking into account varying local conditions, as full as those now required by the New York Exchange.

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