The CHAIRMAN. Mr. Lea.

Mr. LEA. I wish you would simplify your statement in reference to short selling. I think it would be useful if you would briefly describe how short-selling operations are conducted for the information of those who are unskilled in these questions.

Mr. PRESLEY. I am not a broker and only in a general way do I know the technic of the brokerage business, and the operation of the organized exchanges. Therefore, I think I am probably not competent to explain clearly the technical operations of short selling beyond the bare statement that it is, of course, a ficticious transaction.

Mr. LEA. Would you amplify that by a concrete illustration? Mr. PRESLEY. I am reluctant to undertake to explain something which I am not completely certain of the technique of, but in principle. You give your broker an order to sell 100 shares of a stock short. The broker, according to my understanding, takes this stock from a customer account or borrows it from some other broker and sells it in the open market. When you decide to cover your position, that is complete the transaction, the broker buys 100 shares of the stock in the open market and returns it either to the account from which it was taken or to the broker from whom it was borrowed.

Mr. LEA. Is that sale ordinarliy made with the consent of the man who really purchased the stock?

Mr. PRESLEY. I am not competent to answer that question; as I said, I am not a broker and do not know; but I think, without being certain, that he is not consulted.

Mr. LEA. That he is not consulted?

Mr. PRESLEY. That he is not consulted.

Mr. LEA. What do you take to be the effect upon the market of such transactions?

Mr. PRESLEY. The answer to that question depends upon the phase through which the market is moving. In the early stages of a business depression short selling usually is heavy and contributes to the intensity of the decline in general prices. And I disagree with those who contend that short selling is a stabilizing influence, because speculators who operate on the short side of the market usually cover their position on the way down and without any real effect on the general behavior of prices. There are exceptions, naturally, and that is where the short seller is caught unawares overnight or over the weekend, by significant news.

Mr. LEA. Now, does the short seller profit by his transactions? Mr. PRESLEY. Of course, when he sells short he is forecasting a decline in prices. Short selling operates to accelerate the decline. If he covers his position at a lower price level, he makes a profit, but if he closes out his position at a higher price level, he incurs a loss.

Mr. LEA. Is the short seller transaction commonly made for the purpose of reducing the price of stock; the ordinary short seller transaction?

It is

Mr. PRESLEY. I do not think that that can be demonstrated. purely conjectural. In all probability in the early stages of a decline in stock prices there will be junctures where the decline will be intensified by short selling; but on the whole I do not regard short selling as an important influence one way or the other on stock prices, and no influence whatever on the major movement of stock prices.

Mr. LEA. Well, what, then, is the main evil of it?

Mr. PRESLEY. As I previously stated, I think it is a matter of pretty small consequence insofar as the fluctuations or movements in prices are concerned. It is, in my opinion, however, a destructive rather then a constructive operation.

Mr. LEA. Is it a method commonly used to get the control of any particular stock?

Mr. PRESLEY. I had not thought of it in that light.

Mr. LEA. At favorable prices?

Mr. PRESLEY. I had not thought of it in that light. I know of no examples in my experience.

Mr. LEA. This bill, as I understand it, prevents the use of unlisted stock as security or collateral.

What is your opinion as to the necessity of provisions of that character?

Mr. PRESLEY. I have not thought out that aspect of the bill any too carefully. Of course, unlisted securities, generally speaking, and with exceptions, do not enjoy as good a market as securities listed on organized exchanges.

I can see no particularly good reason, subject to further study as to this aspect of the bill, for unlisted securities not enjoying the same position as listed securities, provided the companies come within the scope of this act in their reporting.

The CHAIRMAN. Are there any other questions?

Mr. PRESLEY. Otherwise, I do not think they enjoy the same position.

Mr. LEA. That is all.

The CHAIRMAN. Mr. Mapes.

Mr. MAFES. In view of the fact, as you say, that to fail to make a full and complete report has the effect largely of deceiving the stockholders and no one else, and that the managers of the big corporations are simply representatives of the stockholders and are not to any great extent the owners of the corporation, what, in your opinion, is the motive or the purpose in putting out reports that do not mean much or anything?

Mr. PRESLEY. I am very glad you asked that question. I do not think that in a very high percentage of the cases there is any motive to deceive or mislead. It is simply a custom that has been handed down for generation after generation, to tell as little as possible.

Mr. MAPES. Referring to the questions that Mr. Marland asked about the managers of the corporations anticipating unfavorable reports. Is there any difference in principle between that and their anticipating favorable reports, and purchasing stocks?

Mr. PRESLEY. No, sir; no difference whatsoever, and that is why I suggested that quarterly reports be put in the hands of the stockholders promptly at the end of each period.

Mr. MAPES. In your judgment, would it be feasible to put any limitation upon the right of managers of corporations to invest or speculate in stocks of their own companies?

Mr. PRESLEY. I will answer that in the way that I answered my position toward short selling. It should be legislated out of existence as a practice. Insofar as an officer or director buying the stock and selling it later at a higher price is concerned, I do not think that that freedom should be removed.

Mr. MAPES. Well, those two statements seem to be inconsistent. Mr. PRESLEY. They sound inconsistent.

Mr. MAPES. If that should be legislated out of existence, then their right to buy and sell at higher prices is interfered with. How would you reconcile those two statements?

Mr. PRESLEY. I qualify that this way: Directors or officers of corporations, for some personal reason wholly aside from the rise in the market, or realization of a profit, may be required to dispose of a part of their holdings in the company, but as a matter of practice, directors and officers buying or selling their own stock in anticipation of favorable or unfavorable current earnings is a pretty common practice.

Mr. MAPES. Your position, then, as I understand it, is you think this right should be denied except in certain cases of necessity or with certain exceptions?

Mr. PRESLEY. I would not take precisely that position for the simple reason that I do not believe a high percentage of officers or directors of responsible companies operate on their own stocks for current turn-over profits, but the suggestion that the holdings of officers and directors be published quarterly could go far toward taking care of the small percentage which do.

Mr. MAPES. Of course, your remarks, as I understand them, are directed to corporations only whose stocks are listed upon the stock exchanges.

Mr. PRESLEY. Any corporations with stock outstanding that can be reached by this or any other legislation.

Mr. MAPES. That would take in the small corporation that might not have a very large list of stockholders.

Mr. PRESLEY. That is correct, yes.

The CHAIRMAN. If there are no further questions, we are very much obliged to you, Mr. Presley.

Mr. MARLAND. Mr. Chairman, I would like to clarify a point I made a while ago, and that Mr. Mapes has asked about.

A director of a corporation possessed of quarterly information unfavorable to the company, not known generally to the stockholders, and he sells his stock in that company in advance of the publication of such a report. Frequently is that not the case?

Mr. PRESLEY. Yes, sir.

Mr. MARLAND. Now, should not the fact that he had diminished his holdings in that company be made known to his stockholders so that they could know that he had sold his shares in anticipation of an unfavorable report? That is one of the things.

Mr. PRESLEY. I think that that is a very excellent point, which I have not given real, careful consideration to, but which certainly should be taken under consideration.

Mr. MARLAND. He is a paid servant of the stockholders, and as a paid servant, he is possessed of information, and he sells his stocks, possibly, to a stockholder, and that stockholder would not have bought, if he had had the information. I am simply asking whether it would not be proper to obtain a statement of his stock holdings at the end of each period.

Mr. PRESLEY. I think it is a very excellent point, and I can see no good reason why the report should not include such information.

The CHAIRMAN. All right, Mr. Presley, we are very much obliged to you.

Is Mr. Thomas in the room?

STATEMENT OF WOODLIEF THOMAS, OF THE RESEARCH STAFF OF THE FEDERAL RESERVE BOARD

The CHAIRMAN. Mr. Thomas, will you qualify by telling us what your full name is, what you have been, and what you are?

Mr. THOMAS. My name is Woodlief Thomas. I am on the research staff of the Federal Reserve Board at the present time, having been here since September on leave of absence from the Federal Reserve Bank of New York. I was there for 3 years, and in that time, among other things, I attempted to make a careful study of the question of brokers' loans, and the use of credit in stock-market speculation.

In connection with that study, while I happened to be in Europe for another purpose, I also made a short and more or less superficial inquiry into the ways in which stock market speculation is financed abroad-in London, Paris, Berlin, and Amsterdam.

Before being with the Federal Reserve Bank in New York, I was for a year and a half in Berlin with the economic service of the transfer committee, connected with the Office of the Agent General for Reparations Payments. Before that I was for 6 years in Washington with the Division of Research and Statistics of the Federal Reserve Board. I should like to limit my statement here to a description of the credit aspect of the stock markets; how speculation, or stock trading, if you prefer, is financed; what credit is obtained; how it is obtained; through what sources, and where the money comes from.

All stock speculation, or practically all, is financed by the use of credit. It is, of course, entirely possible for someone to buy stock and pay for it in full, with the idea of selling it a short time later at a profit. If that were done, however, the amount of speculation would be relatively small, because it would be limited to supply of savings and would not incur the expansion of speculative activities on the basis of credit.

Now, the types of credit that are used in the stock market can be roughly classified, very roughly, in three general forms or stages. (1) An individual trader can go to his bank and arrange to purchase securities and borrow on them part of the purchase price.

(2) An individual trader can open an account with a brokerage commission house. By that process he has an open account and he can readily buy or sell, as the case may be, and the broker will arrange the necessary financing, except for a certain margin which the trader will put up.

(3) The third form of stock market credit, represented by the socalled "broker's loans", involves the relationship between a broker on the one hand and a banker or some other lender on the other hand. A broker, in order to finance transactions for his customers must go out and borrow from other lenders, generally from banks.

In regard to the first two types of credit, which involve the relations of the individual trader to a borrower, there are certain differences. that might be pointed out between a stock trader, operating on the basis of bank loans and one operating on the basis of an account with a brokerage commission house.

In the case of a bank loan, the trader gives a note for certain specified amount. He signs the note. It is turned over to the bank. If he increases his commitments, he signs another note. As he makes payments on these loans, his note is credited by corresponding amounts and the debt is reduced. In the case of a trader operating through the brokerage house, all debits and credits are made on an open book account, under certain agreed upon provisions, or rather certain requirements by the brokerage house as to what the customer shall do.

The customer may sign a slip covering these requirements but he signs nothing showing the size of monetary obligation.

There is also a difference between a bank loan and a brokerage account in respect to title of the securities. In the case of a bank loan, the individual borrower generally retains title in the security and simply pledges it as collateral for the note. In the case of a brokerage account, the broker generally holds title to the security and has the right to hypothecate it in turn as security for his own loans at a bank. Generally, that right is given expressly by a little statement, which the customer must sign and which also appears in the broker's monthly statement, to the effect that the broker retains that right to hypothecate securities held on margin.

There is another distinction between bank loans and brokerage accounts, one which is rather important. In general, it may be stated that banks are a little more particular about whom they make loans to than a brokerage house. A bank will ordinarily make some credit investigation and find out about the credit standing of the individual. As a matter of fact, a bank will generally not make a loan to anyone who is not a customer of the bank, maintaining a deposit.

In the past, certainly in case of some brokerage houses and perhaps to a certain extent at present, it has been relatively simple to open up an account with a broker. The chief requirement was that the account should be adequately margined. If a man came in with $10,000 worth of securities and an order to buy, or to sell, he generally found it relatively easy to open up an account. That is not the case in the market in London, for example. One has to be a gentleman to have an account with a broker in London. He has to have a credit reference from his bank. He has to show ability to meet his obligations in case there should be any difficulty. Altogether it is a difficult process to open such an account. Partly for that reason they do not have much margin trading in London.

I understand that many of the more reputable brokerage houses in this country recently have made it more difficult to open up accounts; they require credit references and make some sort of an investigation.

Another difference between banks and brokerage houses in respect to credit for stock-market purposes, is the matter of margin requirements. I think it is customary for a bank to require a little larger margin than would be true with a broker. But, also, the banker has an additional margin which a broker does not have in that the borrower maintains a deposit balance with the bank against which the bank has always a claim in case of difficulty.

A very important difference from the standpoint of the stability of the stock market is that the broker feels a little freer about selling out his clients in case of an under-margined loan, although a bank