A simple remedy, but an effective one, would be to require the banking house of issue to inform its brokerage customer on the confirmation of the sale or purchase of stock on brokerage orders to the effect that the house had been the bank of issue for the security within the previous 6 months, or even a year if a longer period is preferred.

No reason is seen why the customer should not be free to place his business where he chooses, provided only he is not put at a disadvantage. If the broker to day under present law sells his own stock to the customer he is required to inform the customer. The customer might prefer to deal with the house of issue and no reason is seen why he should not be free to do so if he is in possession of the facts.

The other aspect of the ethical problem is that a banking or brokerage firm holding securities or options in its own account may attempt to push the sale of. the securities in which it has an interest to customers on brokerage orders. This could be met by a requirement for publicity on the confirmation slip which would reveal the character of the interest on the part of the banking or brokerage firm. If the banker had an interest and did not reveal it he should be held liable under a suit for damages or in rescission. The practical working out of such a provision would be that the banking firm would endeavor to notify the brokerage customer of its interest at the time it received the order and before it executed it. If it did not do so it would lose its customers when they were first apprised of the banking firm's interest through receiving the confirmation slip. The record on the confirmation slip would be a definite proof that the banker had revealed his interest and this should avoid subsequent disputes.

PENALTIES

While it is readily admitted that the penalty provisions for violation should be severe, they should not be so severe as to prevent enforcement, or to punish honest business or honest management. The inherent difficulty arises from the fact that a vicious intent is not a part of the act covered by the penalty, and that the penalties prescribed are such that they should be applicable to vicious acts alone.

Section 15 requires every director, officer, or owner of 5 percent of any class of security to inform the Federal Trade Commission of his holdings, and within 10 days after the close of each calendar month to report changes in ownership. Aside from the fact that this might seem to me an intrustion into personal affairs, the provision will create many curious conditions. If any such person is forced to sell any security for any reason quite unrelated to the business or his own desires, and if the fact of his sale becomes known, as it doubtless will, he will feel he has to explain his personal condition which made the sale necessary, and no matter what he says, and no matter what the facts are, the popular impression is going to be that he has lost faith in the security. This perfectly honest action on his part will constitute the most vicious kind of a "tip.'

This is not a new problem. During past years many corporations have had options on their stock granted to their executives and to many of their employees. Very few of these options have been availed of and their purpose has been defeated. It is human nature not to avail one's self of an option as long as a stock is rising in the market. It is likewise not human nature to avail one's self of an option when the stock has gone down from its high point. If a senior executive having the confidence of his associates in the business should exercise his option in part even and sell the stock in order to make the profit desired to be given to him, or if he should advise others to do so, then he is, in fact, saying to his staff that he believes that the highest reasonable price in the market has been attained, or that the price is going to go lower. When it becomes known that insiders are selling as they often must sell-the facts are misinterpreted and misunderstood. This whole provision is likely to create far more harm than the most viscious form of tip included in the general provisions of the act.

While there have been officers and directors and large owners who have taken advantage of inside information, the great percentage of corporation officers do not do such things. Even the small minority who do are as likely not to profit as to profit. There are not many companies whose securities advance when the general market declines, or decline when the general market advances. The vital factors affecting the market price of a security have not been those relating to the company. They have been those relating primarily to Government policy. The man who knows in advance, or can estimate by any possible means, psychological or otherwise, the probable policy of the Government on major matters, really has far more inside information which he may use to his own profit

than any corporation executive immersed in the affairs of his business and depending only on his knowledge of the facts as to his particular company.

The provision that the director who buys shall turn over his profits to his company and accept his own losses, provided he sells within six months of his purchase, seems unreasonably harsh, but this unfortunately is not the only pound of flesh this provision exacts. In addition, his profit has to be calculated as the difference between the lowest cost to him and the highest selling price secured by him during the six months period. This provision would effectively prevent corporation officers, anxious to prevent a decline in the market price of their stock, from buying in the market and providing the market support needed in a declining market for the benefit of all the stockholders. These men who

might be trying to do a constructive act would be thus prevented from selling within six months and gaining any benefit therefrom. It seems to me that a mere statement of these obvious facts shows the unnecessarily harsh character of the provision.

Section 17 embodies a rigorous provision against any misleading statement in any report. Surely the honest person who discovered a mistake, reported it to the Commission and to the public so that the market price would reflect the true facts and not the erroneous first statement, it would seem, should not be liable to people who buy or sell after the correction.

Paragraphs b and c of section 17 set up penalties following the general idea of the securities act. A misleading statement might affect the value of a security to the extent of $1 and the market on the security might drop $50, due to other causes. The man who caused the loss of the dollar might fairly be held to pay that loss but to hold him accountable for the whole fluctuation of the market seems fantastic. It is the same measure of liability imposed upon issuing bankers in the securities act. There is no reason known why this measure of libaility should be imposed upon corporation officers and directors.

All of the comment under the heading of "Penalties" takes into account the provisions of the bill that I will not be held liable if I maintain the burden of proof that I "acted in good faith and in the exercise of reasonable care and had no grounds to believe that the statement was false or misleading".

The final determination as to what these provisions mean will be the result of jury findings and court decisions in several States, lasting over a period of many years. So far as the "tipping" provisions are concerned most of the evidence will of necessity be oral testimony. The jury will have to weigh one man's word as against another without having, in the normal case, any character of supporting evidence on either side. This introduces a hazard on account of the length of time for which the liability lasts, as well as the dangers of connivance of others with the plaintiffs and the introduction of false substantiating oral testimony.

Let us assume that these provisions are drawn as carefully as language permits. If by any stretch of the imagination successful litigation results in one case, the unsuccessful defandant is liable to all the purchasers or sellers of any given security for an unlimited period of time, the measure of the damage being the fluctuation of the security for a period of 180 days. The measure of damage, therefore, spells financial ruin to the unsuccessful defendant. No careful, prudent business man would undertake the possibility of financial ruin under such circumstances and the inevitable result would be that the honest, careful person could not afford to have even a single discussion with anybody on any security. He would have to make it an inflexible rule of his conduct never to speak, thus becoming a mere automaton; otherwise he would have no means of controverting individual claims made long after the event. Whether or not the principle of agency applies in this case, we face the dilemma, first, if the principal is liable on account of the act of the employee his only recourse is to have no employees, since he cannot with certainty control what they may say or do-particularly if they have been discharged or have left the principal's employ during the period for which liability runs; second, if the principal is not liable for the act of the employee, then there is created the vicious situation in which the principal will not talk but will permit and encourage the employee to talk freely. Under either condition or rule a a vicious result follows. The door will be laid wide open to collusion and fraud. This bill by its terms would supersede any State statute of frauds in conflict with it and would almost certainly prevent any security business, even the taking of orders, for the mere fact of doing business with a person would lay the only necessary foundation for a fraudulent suit. The liabilities upon all of the partners of a firm from what one person may say or do are already severe enough without expanding the doctrine to apply to the acts of the firm's employees.

My honest belief is that many of the evils complained of have already been cured in substantial measure through their exposure to public opinion which, after all, is the great antidote for many of the distempers that have flowed from the abuse of trusteeships. While there is much that can be accomplished by law, greater things can be accomplished by helping to create in business at this moment, by a spirit of legislative tolerance, a new atmosphere, a new deal, fair alike to existing business, the investing public, the corporations needing capital, and the Government itself.

There is attached as appendix C a memorandum covering other points in the bill meriting consideration, though they are not as vital as the parts previously discussed.

This title is

APPENDIX A-SUPPLEMENTARY AND SUPPORTING CONSIDERATIONS The bill is entitled National Securities Exchange Act of 1934. something of a misnomer. The bill regulates not only the securities exchanges but a number of incidental and related business activities.

Section 6 relates primarily to the use of credit. In an attempt to regulate margin requirements and to cover possible evils the bill establishes maximum loan values of listed securities and, as written, nullifies the value of unlisted securities for collateral purposes. Testimony before the House committee indicates one of the purposes of the bill is to regulate the amount of credit flowing into the securities market. It would seem that this is a proper discretionary function of the Federal Reserve authorities and not something to be crystallized in a law based on recent experiences which may or may not include problems that are to be encountered in the future.

Sections 11, 12, and 15 have to do with the obligations of officers, directors, and principal stockholders, a group which might be labeled under the single term of management. The duties are in part spelled out and in part left to the discretion of the Trade Commission. The penalties for violation are so severe that it would be dangerous for any management to deviate from the prescribed

course.

Admitting that there are vices in connection with security trading, is it the part of wisdom to destroy a whole house in order to rid it of rats?

This legislation contemplates jumping away from known evils, but will it not involve jumping into unknown evils?

Aside from the question as to whether there isn't an attempt being made by the authors of this bill to effect a Federal Trade Commission control of all business and as to whether such control is desirable, would not this legislation hobble business instead of putting it into harness so that it can pull?

An effect of the stock exchange act would be to concentrate business in the hands of the strong national companies now adequately financed. New business initiative would be stifled since the small man would be unable to find capital through formerly available sources, and the already existing small company unable to increase its business by public financing would be likely to fall into the hands of larger competitors.

The destruction of credit for small businesses is not likely to be presented by many witnesses at the hearings, but it must not be lost sight of.

Has not the recent experience of prohibition demonstrated that human nature does not readily yield to the cold mandate of the statute? When one calmly considers some of the provisions of this bill, which pretend to be regulatory, he soon sees they are prohibitory.

It has been suggested that the way to attack the problem of speculation by those who should not engage in it, is to start at the other end, not with the seller of the security but with the buyer of the security, and to handle this through a system of registration and license for individual investors or speculators. The cost of administration would be no greater than that of the system proposed by the bill. The present bill gives protection to the sophisticated investor who will study and understand all the provisions of the Securities Act and the national securities exchange bill. But this man presumably does not need the protection which these laws would attempt to furnish. The small individual who buys 10 shares of stock will not secure any effective remedy under these laws, owing, first, to his probable ignorance of his rights under the law and, second, to the difficulty of finding counsel to take his case.

Has consideration been given to the thought that in order to avoid the responsibilities under the law corporation officers might withdraw securities from an exchange? Such action would work serious injury to the stockholders. The management determined to do this would be able to do it without the consent of

the stockholders and their only recourse would be to change the management. If no better management could be secured the only result would be to injure the stockholder.

There is certainly a need for the flow of private capital into capital goods industries. The Government can keep up its expenditures in this field for only a limited time. I feel sure that Congress will consider all of the suggestions made for the improvement of this legislation. If it is to be enacted into law, nothing must be done that will delay recovery. Rather, everything should be done to hasten it.

It is generally recognized that the return on a fixed interest security includes two elements: first, pure interest, and second, compensation for the risk. Naturally, the risk in any industrial situation changes from time to time and fluctuations in securities are certain to develop as long as this is so. If the public could be made to understand this a great part of the demand for this regulation would cease. In the end no cure other than public education is going to be effective.

There seems to be an idea inherent in the bill that, if sufficient information regarding the affairs of any corporation is given to an investor, the latter will be able to determine the value of a security. This same idea seems to have been predominant in Mr. Pecora's questioning of Mr. Frank Altschul in regard to the activities of the committee on stock list. Mr. Pecora came back time and again to whether the committee had looked into the value of the properties being acquired by the issuance of additional shares. Mr. Altschul made the point that the committee did not attempt to go beyond the judgment of the directors of the corporation seeking listing.

So far as I am aware no student of securities, however well informed, has been able accurately to determine values. This is perfectly clear in the case of intangibles. What is the actual value of goodwill; the accumulated effect of advertising; the worth of patents or formulae? How much is a plant worth? Of course, it is possible to determine the original cost but this cost figure becomes meaningless and depends for its informative worth upon a disclosure as to when the plant was constructed, 1913, 1919, 1921, 1929, 1933. Officials within a company will spend hours arguing as to the proper basis of valuing receivables or inventory. Accountants have labored for years in the attempt to create the understanding that a certified audit, except in a few minor particulars, is not a statement of fact, but a statement of opinion.

A sidelight might be thrown on this whole question of valuation by the very certificate of the accountants. A sophisticated person accustomed to reading balance sheets is much more apt to look, not at the careful working of the accountant's certificate, but at the name of the accountant who made the certificate. An appraisal of the carefulness of the audit is usually based not on a careful reading of the words but on the reputation of the accounting firm making the audit.

The penalties for willful violation set forth in section 24 are much smaller than the civil liabilities set forth primarily in sections 9-b and c, and section 17. The magnitude of the penlaties for violations not willful is so great that in order to make a workable law extreme care in drafting is called for. Interpretation of many sections is left to the discretion of the Federal Trade Commission, and in many other sections the language is so broad that the full effect will not be determined for years through the medium of jury trials and court decisions. Under these circumstances it is probable that the prudent will allow the law to be determined by the courageous or foolhardy as defendants in litigation. The alternatives proposed are (1) either that the bill be so carefully drawn as to cover possible violations with such clarity that any business man can understand them in the daily conduct of his business, or (2) that, if a rule of reason is to be applied the unprecedented penalty provisions be excluded from the bill and the courts allowed to determine damages under this rule of reason as is presently done in practically all damage suits. In a complex situation of this character which is subject to organic growth it would seem that the latter course is the most sensible. I am wondering whether the extreme character of the penlaties carried under the law would not open new fields of conscienceless persons to take unfair advantage of honest men employed in a legitimate business. Have not the reactions to legislation of the past containing extreme penalties convinced us that unusual penalties are ineffective in preventing criminal acts?

APPENDIX B.-REGULATORY POWERS OF THE FEDERAL TRADE COMMISSION

The question as to whether governmental supervision should be established is certainly an open one, far from conclusive in favor of governmental regulation and supervision, when one considers the full sweep of regulation and its inevitable

results. I doubt that the staff required by the Federal Trade Commission or any other new supervisory organization can be mobilized by October. It would have to be hastily mobilized and there would be no assurance that the new personnel would be either honest or efficient. If additional statutes will not solve the problem surely more supervision is not the answer but rather better supervision.

If the Federal Trade Commission were an appeal board to which complaints could be made about practices in the exchanges or among their members, or on the part of corporations whose securities were listed, there would be a tremendous pressure put upon all parties to follow sound and fair methods of procedure. The mere fact that corporation officers were subjected to an inquiry regarding the accuracy of the financial statements given out by a corporation, for example, would bring bad practices sharply to the attention of all other corporate officials. In this way moral standards would be developed.

The Federal Trade Commission is given power by the bill to ruin any security dealer or broker (1) through the operation of the provision allowing the Commission to investigate the firm, to fix the cost of the investigation, and to make the investigated firm pay such cost, and (2) through the power to fix brokerage charges. These two provisions would permit the Federal Trade Commission effectively to wreck any part of the security distribution system.

The special powers of the Federal Trade Commission outlined in section 18 are so arbitrary that, if they were exercised, businesses might be seriously embarrassed or even destroyed and all without recourse. There is almost no limitation upon the acts of the Commission.

There might well be included in these rigorous provisions a requirement that members and employees of the Federal Trade Commission should be required to reveal their interests in securities.

Paragraph (e), last sentence, goes so far as to make it a misdemeanor for a witness before the Commission to tell his wife or his personal counsel that he was a witness.

Section 20, paragraph (b), subsection (iii), permits the Commission to order the expulsion of an exchange member for effecting "any transaction for any other person who he has reason to believe is violating" either the act or the Commission's rules. The query naturally arises as to whether the Commission would have this right, even though the other party were not violating the act, but the member of the exchange had reason to suppose that he was.

In addition to the specific sections outlining the powers of the Federal Trade Commission there are references throughout the bill to the discretionary powers of the Commission. For example, section 13, dealing with proxies, and section 14, dealing with over-the-counter market, are practically meaningless as they stand. A blank check is being drawn in favor of Federal Trade Commissioners yet to be named by many future administrations yet to be elected.

Leaving aside all questions of personalities and outside pressure, the amount of responsibility to be assumed by an official will be difficult of determination. People with a sense of responsibility may very well hesitate to make decisions under the various ramifications of the bill.

The problems confronting the insurance commissioner of New York State are in point. From the record it would seem that a company selling mortgages in New York State broke the law and the insurance commissioner, by strict interpretation, undoubtedly should have closed that mortgage company; yet in the exercise of discretion the commissioner apparently took a chance in the hope that the panic would not be increased and financial distress augmented. If by keeping the institution alive he had prevented the collapse he could have had the innate satisfaction of having done a socially desirable thing, even though the law might have been transgressed. If his judgment was wrong and the depression continued and the mortgage company collapsed anyway, as it did, then the commissioner violated the law and did not fulfill his duties. There had to be a determination between social responsibility and personal responsibility. I do not know whether the insurance commissioner was able or not (but I think he was able). I do know that he was appointed to office by the now President of the United States.

It is argued that all forms of regulation have been opposed, and that that is the reason this form of regulation is being opposed. While the argument is certainly pertinent, it is far from conclusive. The Federal Trade Commission is known, and its makeup since its creation has probably been as good as it will be in the future. It is still discussing matters of fair business practice which it was created some 20 years ago to settle. These questions of fair business practice did