still need for a vigorous educational campaign so that any law will become in large measure self-enforcing.

No

There are other problems involved which require further consideration. adequate provision has been thought of to cover oral "tips." It has been suggested that written advice to buy or sell should be required to be on a sheet of paper with the words "Tipster Sheet" at the head.

Several suggestions are added as an appendix and relating particularly to those items which should be considered in connection with corporate reports. These suggestions are drawn from experience without an effort to cover all such experiences. They can readily be added to and should be added to before the formulation of any legislation is attempted. Those ills mentioned would appear clearly to require reform. Additions to the list would only further demonstrate the need of reform.

APPENDIX

The selection of auditors should be left to the stockholders and not to the management upon whom they are reporting and to whom they must look for their employment. As a practical matter corporations whose securities are widely held are in the hands of the management as long as the management is successful, and in such cases the selection of the auditing firm by the management will always be ratified by the stockholders. If the auditors preparing the report were required to attend the stockholders' meeting and to be prepared to answer all questions that might be asked at that time, this might afford some small measure of protection.

It would seem only fair and reasonable to provide that if a corporation has over 10 stockholders (or some arbitrarily chosen small number) all plans involving extra compensation such as stock options, stock purchase plans, bonus plans, profit-sharing plans, should be approved by the stockholders in advance of any payment, and that the allocation of the benefits under such plan to any individuals in the management should be approved by a committee of directors not participating in any such plans, such committee to be chosen by the stockholders of the parent corporation, and their compensation, if any, to be fixed by such stockholders.

The salaries of officers should be fixed by such committee and should not be left to the board of directors, many of whom would also be employees of the corporation and in a position to approve a salary scale for others conditional upon their receiving a salary satisfactory for themselves.

The compensation of officers and directors of the corporation and subsidiaries, in any form and in all forms, should be reported at least yearly to stockholders, covering the corporation and all its subsidiaries under the following general headings:

1. As to officers of the parent corporation who are also members of the board of directors of the parent corporation, their number and their total compensation. 2. As to all other officers of the parent corporation and all officers of the subsidiaries, the number of officers and their total compensation.

3. As to disinterested directors of the parent corporation chosen by stockholders, their number and total compensation.

The registration statement under the Securities Act will not provide current information as to the company, even as to the character of facts embodied in the registration statement. There should be a positive requirement for at least annual reports made by public auditors, to be sent to all stockholders, and interim reports might well be allowed to be audited or not as the management might wish. Corporations having over 10 stockholders should be required to submit consolidated balance sheets and operating statements, or if they desire to carry the item of the investments in any subsidiary and not consolidate the balance sheets, the gain or loss for the period covered by the report, together with the accrued gain or loss since incorporation, must be separately shown.

The transferring of reserves to the income account, or the application of operating expenses against reserves, directly or indirectly, should be prohibited unless the transfers are set forth.

Any hidden unrealized profit in the inventory should be required to be covered by a note on the report. All inventories are to be stated on the basis of cost or market, whichever is lower, even to the extent that finished goods may not be carried at cost if the raw materials going into them have declined as against the purchase price at which they entered into costs.

While it will be difficult to set up an exact definition of terms, a corporation should be required to set forth any income derived during the period outside of

the normal course of its business and of a character not reasonably to be expected to be recurring.

If marketable securities are carried on the balance sheet, a separate list must be embodied in the report and no securities of a subsidary or affiliate shall ever be carried as current assets.

There have been false earning statements published by corporations. I do not know what the present laws provide as to the officers and directors having guilty knowledge of such statements, but if this is not now provided for by present laws it should be covered.

The minutes of all meetings of the board of directors of the parent corporation, its executive committee, or other standing committees, its subsidiary corporations and their standing committees, should be sent to all members of the board of the parent corporation in order to place upon them the responsibility of knowing in definite form what is done by the corporation and in order to give them no excuse for failing to exercise their own independent judgment.

Corporations should be required to furnish to their directors a summary of the operating figures covering the results of all transactions currently reported upon to the management, and at as frequent intervals as such figures are supplied to the management and not less frequently than once a month.

There have been evils in connection with accounts receivable, particularly of concerns engaged in installment selling and in connection with inventories in many different kinds of concerns. There is often no aging of accounts receivable and no basis given for the investor to determine whether or not the reserves are adequate. As to inventories, obviously the items should include only merchantable stock and in an amount likely to be sold over a reasonable period. Some general pro

visions could undoubtedly be drafted by accountants in these respects. Loans and advances to officers and to employees should be stated separately and not as current assets.

If a parent corporation chooses not to consolidate its balance sheet it must show under the heading "Investment in Subsidiary Corporations" any intangible items (including goodwill particularly) and their amounts pertaining to any and all subsidiaries.

It would be better if the items of land, buildings, and equipment were separately stated instead of being combined under the heading of "Fixed Assets." In any event, such of these items as are not used in the business should be separately stated as idle plant.

The purpose for which treasury stock is acquired in the market and held as shown by the balance sheet might well be also shown on the balance sheet. The stock exchange is giving consideration to this problem with reference to the corporate securities listee on the exchange.

In order to meet the needs of the small investor who has not ready access to financial manuals it would seem desirable to require any funded debt liabilities to be separated by the issues and under each issue by the amount and the maturity. The practice of carrying funded debt, or sinking funds thereunder, due within a year as a current liability should be made a requirement of law.

Under the heading of contingent liabilities specific mention should be made of lease or rental obligations by year and amount for each year. Where due to the nature of the obligation the exact amount may not be stated with certainty, an estimated figure might be used.

Not all of the bad practices in this respect are known, nor their extent, but it would seem quite necessary to require that any items of intercompany profits should be revealed as to their amounts and their nature.

STATEMENT SUBMITTED BY JOHN M. HANCOCK, A MEMBER OF THE BANKING FIRM OF LEHMAN BROS., NEW YORK CITY

The announced objective of the national securities exchange bill is the protection of the investing public from manipulative or dishonest practices by persons dealing on securities exchanges. With this objective I am in hearty accord. I am sure that provision for such public protection can be made by legislation, in the formulation of which I should be happy to assist, in a spirit of constructive effort.

After careful study of the bill as now written, however, I believe that certain substantial amendments are necessary, in order that this legislation may not have results disastrous to the economic prosperity of the country. I believe that such amendments can be made while preserving the purpose of the bill, and that the

resulting legislation will be the sounder for such amendments; since I am convinced that the bill, as now written, contains provisions, unnecessary to its real purpose, which:

First. Will have a drastically deflationary effect on banks, investors, and consequently, industry;

Second. Will do away with most of the responsible machinery whereby essential long-term private capital may flow into industry, leaving the burden of providing such capital chiefly on the Federal Government;

Third. Will tend to deprive the investor of responsible sources of financial information and advice;

Fourth. Will through excessive penalties, tend to drive conscientious management out of industry; and

Fifth. Will place an unprecedented absolute and arbitrary power over industry and finance in the hands of a governmental bureau-a kind of power unknown in any other country where private enterprise is still permitted.

The following memorandum and its appendices amplify the views stated above. JOHN M. HANCOCK.

MARCH 2, 1934.

MARCH 2, 1934.

After an intensive study of the national securities exchange bill I find myself almost 100 percent in accord with the goal sought to be attained by this legislation. That there have been vices concerning transactions in securities every fairminded man is willing to concede. In giving unreserved approval to the bill's purposes of eliminating bad practices, I am not taking into account any question of the constitutionality of the bill, or any essentially legal question. Nor am I giving approval to the wording of the paragraphs as they now are written in the bill. A tremendous amount of work has been done in bringing the bill to its present form. There still remains much to be done to prevent only those things which should be prevented and to stop short of preventing those things which should not be prevented.

By way of illustration may I refer to section 8 (a), article 9, wherein the apparent intention was to prevent transactions in puts and calls and the kind of option which is used for market manipulation. I doubt that it was the intention of the committee (1) to outlaw options given to executives, in connection with their employment, as a reward for good work or as an inducement for better work, or, (2) to outlaw options given to bankers or others for the purpose of procuring additional working capital for a company, or in connection with the purchase of stock for the same purpose, or, (3) for services whose value is difficult of ascertainment in advance and wherein the benefit to be received by the optionee will be proportionate to the benefit secured by the company.

The need of a more careful study, and perhaps redrafting, is emphasized by the character of the penalty provisions. If unprecedented penalities are to be provided the provisions covering abuses must be very definitely drawn so as not to go beyond the desired intention.

May I cite as an illustration section 8 (a), paragraph 5, providing that it is unlawful to give out false or misleading information if the giver has reason to believe that his action may induce the purchase or sale of a security. There is almost no way in which the giver may ordinarily know or form any belief as to the action likely to be taken by the receiver of the information. Most givers of information are not in a position to determine whether the information given is sufficiently important to influence the judgment of the average investor. A man might come to my office and ask for my comment about any company whose securities my firm had issued, and I would feel bound to give him the facts available in as exact form as possible. I might report the fact that a certain business showed sales in December of 1933 which were 15 percent in excess of the sales in December 1932. I might also report that the sales in January 1934, were 25 percent in excess of the sales in January 1933. These facts would be absolutely true and yet might give a thoroughly wrong impression to a man who did not know how to interpret them. The first impression the receiver would have regarding the meaning of such a statement would be that the business of the company concerned was showing a marked improvement. This might not be at all the fact, for, while the January percentage increase was accurately reported, the truth is that the increase for January over January a year ago resulted from the fact that business in January a year ago was extremely bad and that the apparent increase in sales between December 1933, and January 1934, did not exist.

Now, the question is whether I am going to be able to give the facts with any assurance that they will be accurately interpreted. Even if I take particular care to interpret the facts accurately, what assurance have I that the man receiving the information will understand what I say, or will act upon it? In most cases I am bound to comment upon certain aspects of a company's business which appear favorable and some aspects which appear unfavorable.

MARGIN PROVISIONS

The margin requirements of the present bill are presumably based upon the belief that they will keep out of the market those people who cannot safely afford to incur the risk of the market, despite the regulations embodied in the other provisions of the bill. I assume that this provision will be modified so as not to force the liquidation of securities under present loans, thus bringing on a generally lower level of security prices, undermining confidence, and perhaps delaying recovery. A mere postponement of the effective date of this margin provision will not be sufficient. While I favor more flexible provisions than those embodied in the bill, so as to take into account the inherent differences between classes of securities, I do not wish to stress this point, for I am sure it will be carefully considered by Congress and that all the factors will be weighed before a final conclusion is reached as to the social desirability of, or need for, this particular regulation.

GOVERNMENTAL SUPERVISION

The provisions relating to supervision by the Federal Trade Commission present the question as to whether the desired flexibility cannot be obtained without building up a bureaucracy with its attendant expense, probable inefficiency and possession of extreme powers capable of arbitrary use. The general provisions as to the Commission's discretionary powers are very broad. This question is one which has been before Congress many times and concerning which it is thoroughly informed. It seems to me impossible for the Government to avoid responsibility for security values if it should place in a Government agency the tremendous responsibility given to the Federal Trade Commission under this bill. It is my deliberate judgment that no amount of supervision will eliminate fluctuations in security values; but the grant of this extreme power to a Government agency is going to give uninformed people the belief that the Government will prevent these fluctuations.

May I suggest that you seriously consider the wisdom of enacting into law those desirable provisions of the bill which permit of definite drafting at the present time. If there is not enough factual information available to this committee now, machinery should be set up so that the committee shall secure the information upon which a statute might be based. It is suggested that two means of getting the information are readily available if the committee has not the time to do the work itself. The development of codes under the N.R.A. offers one avenue. The Federal Trade Commission, as an investigating body, or a committee like the Dickinson committee might be used as an alternative. I cannot subscribe to any measure whereby the Congress delegates its legislative authority to the Federal Trade Commission or any other executive bureau. Surely the least desirable form of supervision is the managerial type set up by the present bill, and, rather than establish this, would it not be wiser to allow the Federal Trade Commission a limited supervision over security exchanges, giving it the right to investigate, imposing upon it the obligation to press for voluntary reforms which it deems advisable, and allowing it to sit somewhat as an appeal court with regard to grievances which the exchange itself cannot or will not rectify-thus leading to a body of law with suitable penalties when experience has found the wise form for such laws to take?

Further detailed comment upon the powers granted by the bill to the Federal Trade Commission is embodied in appendix B.

GOVERNMENTAL RESPONSIBILITY

Even if both the Securities Act and the proposed national securities exchange bill were in full operation, I believe that a false hope, with inevitably serious consequences, would be raised in the minds of innocent people, for only a modicum of protection is afforded. It is claimed by the proponents of the bill that the people need protection on account of their ignorance. I fear they are going to believe that the protection given by law and this bill in its present form, or as modified, will be full protection. Such a belief is unjustified.

There will remain untouched by the law, and untouchable by any law, or by an act of any person or organization, short of God himself, those major considerations and factors in human nature which govern security values and the rise and fall in security prices. If every holder of every security on the market knew all of the facts called for in the voluminous registrations and current reports by corporations, and if he had the best judgment in the world, he still could not know the trend of security prices and he could not know how to appraise the value of any individual security.

Without laboring the point may I emphasize that the strength of the management, the position of a company in an industry, the trend of developments in the industry, the whole trend of developments in the nation, and in the world,. for that matter, are factors outside the control of any provision of any present law or proposed law.

THE SEGREGATION PROVISION

Section 10, as now written, would prevent an underwriter or dealer from being a broker or member of an exchange. (The section also relates to specialists.) Let us examine only the provision that prohibits the underwriter or dealer from doing business also as a broker on an exchange.

Outside of a few large centers the distribution of securities is handled by small firms combining all or two at least of the functions listed. These small firms cannot live on their volume of business in any one line. The bill, as written, would put many of these concerns out of business and would reduce employment.

The trend of the financing business under this provision would be towards a monopoly of the issue business. A few extremely rich banking firms might survive, but except for them the financing business would be left to irresponsible concerns. The reasons for this will appear from a consideration of the facts. Quite obviously, the issuing of new securities is a sporadic business; it does not exist in times like those we have gone through in the past four years. During such times the smaller houses of issue in the large cities and the houses of issue and dealers in the smaller cities remained in business only through the volume of their brokerage or stock exchange business. If their income from the brokerage business is removed, such concerns have not the financial strength to survive a long period of depression and to maintain the staffs required to help companies needing financial help and advice. This removal of the only bread and butter business during a depression will force the house of issue either (1) to give up business or fail, or (2) to discharge its staff in order to survive a depression period. Even though a house of issue may desire to maintain its staff in order to carry out its obligations to its companies and their security owners it will be prevented from doing so because of lack of income. If it should decide to maintain its staff, even with difficulty, the inevitable result is that when new financing can be done the pressure to pay the overhead will be a very dangerous factor as it will tend to create a poorer grade of securities. If the issuing house goes to the other extreme and discharges its staff, it will not be able to make the proper investigations to insure having only good securities issued.

I feel that the desire is to eliminate abuses without going any further toward the destruction of legitimate, honest businesses than is absolutely necessary to insure the elimination of these abuses. No one has given any indication of any desire to do more than this. I feel sure that a reading of section 10 will convince anyone that the bill goes far beyond the cure sought to be effected by this provision.

The two problems which have arisen and which the bill is aimed to solve may be treated under two headings: First, financial, and second, ethical. Some few banking houses of issue have furnished false reports to the exchange authorities and have used securities belonging to their customers as a basis for borrowing in order to carry new issues which were going badly in the market. Now, quite obviously, if a firm carries no margin accounts there should be no such financial risk to its brokerage customers. If the firm carries margin accounts, however, it should be easily possible to separate the capital of the firm doing the combined business so as to have one portion of the capital applicable to the brokerage business only and to prohibit loans from the brokerage portion to the issuing portion of the business. This would be as effective as actual segregation.

Now as to the ethical problem involved. It has been claimed that a banking firm of issue is able to push its slow-moving issues upon its brokerage customers. I have no information that this has been a serious evil, but it assuredly has been an evil.