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I have no difficulty in my own mind about the constitutionality of Federal regulation through the medium of the postal power and the power to regulate interstate commerce, in general in the manner which is followed in the bill which we have before us, although I would not care to underwrite the constitutionality of each and every detailed provision of that bill.
I have read the bill and I interpret it as having, among its purposes, those which I have mentioned and with which I heartily agree, namely, the protection of the public against unfair practices in the sale of securities and the trading in securities, and the protection of the national economic health against undue and unwholesome speculation.
Principles and purposes may be approached in many different ways and, from a practical standpoint, in any given instance, the application of a principle, or an attempt to achieve a purpose, has to be judged in the form or the complete detailed provisions in which they are embodied in that particular instance.
In such study as I have been able to give to the bill before you, I have therefore sought to get a picture in my own mind of what it does concretely, and I would like to mention a few of the details to you here, as I interpret them:
Section 6 (a) of the bill makes it unlawful for a broker or a dealer who operates on or through a licensed exchange to lend on securities which are not listed on any licensed exchange. At the present time, unlisted securities include State and municipal securities, the stocks and bonds of most banks and insurance companies, and some sound industrial and a great many local securities.
Under section 6 (a) securities will have to be listed on a licensed exchange in order to become eligible as collateral for loans to or by brokers.
No doubt this provision was inserted to force trading on to the regulated exchanges, but the bill goes on to provide that in order to be listed, a security must be registered with the Federal Trade Commission, and if a company or any other issuer, municipalities, or otherwise, desires to so regulate its securities with the Federal Trade Commission in order that they may have the position and the privilege of listed securities, then, I want to point out some of the consequences to that issuing company, or municipality, which follow from the provisions of the bill.
In section 18 (b), it gives to the Federal Trade Commission as a condition of registration, the power to prescribe and supervise the accounting system of the registrants, including the valuation of property, the determination of operating income, depreciation and the like, and hence, at a good many vital points the determination of factors that affect very closely the financial policy of that issuing company:
Now, if we read those provisions together, with the earlier provisions of the bill to which I have referred, it follows that in order to list its securities and have them eligible as collateral, the insurance companies and the banks and the municipalities whose securities are not now listed, as well as the public utilities, will become subject to the financial control of the Federal Trade Commission in respect to these accounting practices and the financial questions which depend upon them and the regulations of the Federal Trade Commission are
made by section 26 (a) to supersede all State laws and, accordingly, as I read these provisions, they mean that the regulation and authority of State insurance commissioners and banking commissioners, and public utility commissioners, at least insofar as they affect the accounting and financial practices of the companies, are superseded bt the regulatory power of the Federal Trade Commission.
The only regulatory power in these fields which is not overridden by the powers conferred on the Federal Trade Commission is that of the Interstate Commerce Commission, which is expressly excepted by the proviso of section 18 (b), to the effect that as to carriers subject to the Interstate Commerce Commission, the rules and regulations of the Federal Trade Commission, as to accounting matters, shall not be inconsistent with the requirements imposed by the Interstate Commerce Commission.
As a condition of the registration and listing of the securities of any issuer, the Federal Trade Commission is given power to demand any information which it may deem appropriate in the public interest, and is given power to make such information public.
Let me turn from these general powers over listers given to the Federal Trade Commission and refer to certain provisions of the bill connected with banking and credit. By sections 6 (b) and 6 (c), the Federal Trade Commission is given power to fix the loan value of securities, and these loan values so fixed will apply by section 6 (c) to loans from banks as well as loans by brokers, where the security is carried on credit.
By section 7 brokers and dealers who operate on or through a licensed exchange are forbidden to borrow on any security from anyone at all, except a member bank of the Federal Reserve System.
By section 7 the Federal Trade Commission is authorized to limit the aggregate indebtedness of every broker or dealer who operates on or through exchanges in relation to the net assets, subject to a maximum percentage which is fixed by the act itself.
By section 11 the Federal Trade Commission is authorized to regulate the lending of funds by any registrant or lister to or for any broker or dealer, and this applies where the registrant is a bank, unless, it is a member bank of the Federal Reserve System.
It is thus apparent that the provisions of this bill touch a good many more matters than the direct registration of stock-exchange practices, and give to the Federal Trade Commission a very considerable range of power over banking and credit matters, on the one hand, as well as over industrial management, in the financial field, on the other hand.
Turning to those provisions of the bill which deal immediately and directly with stock exchanges, the bill contains a number of specific prohibitions to which I would invite your attention. First, there is, of course, the well-known flat 60-percent margin provision, which is tempered, of course, by the permission to loan up to 80 percent of the lowest price of the security during the preceding 3 years.
Secondly, there are the provisions of section 8 (a), subdivision 9, regarding puts, calls, and options, which in their present form are so expressed as in effect to prohibit trading on an exchange in convertible bonds and stock-purchase warrants.
Section 10 prohibits members of licensed exchanges or brokers who operate through such members, to act as dealers or underwriters in securities, and thus squarely segregates and divorces the two, requiring a segregation between the business of dealing as a broker on a commission, on the one hand, and the business of buying and selling securities, on the other hand.
This same section, by its various provisions, prohibits specialists from executing market orders, and when you read that provision in conjunction with the provision which prohibits the specialist from trading on his own account as a dealer, the substance of it is to eliminate the so-called "specialist” from the exchanges.
I have referred to these particular provisions of the bill because they constitute—these last ones that I have been referring to express statutory prohibitions on a point where there is some room for a difference of opinion as to the desirability of a flat statutory prohibition in contrast with some discretionary authority to forbid the abuse of a useful practice for improper purposes.
The bill contains a number of prohibitions of practices as to which it is entirely clear that the practice should be absolutely prohibited and which are properly prohibited by its provisions, namely, wash sales and fictious transactions of that kind, matched orders, pools for rigging the market, dissemination of false information, rumors concerning the market, and other practices which are wholly bad and which are properly covered by absolute prohibitions.
I have signaled out for mention these particular provisions of the bill that I have referred to in order to indicate the type of regulation that it applies directly to stock-exchange practices, and also the extent to which it is apparently thought necessary that it should go beyond the regulation of stock-exchange practices, by establishing some control through the Federal Trade Commission over the flow of credit into the security market and over the corporate financial practices of those companies whose securities are traded in.
In these two fields of control over credit and control over the corporate financial practices of the corporations whose securities are traded in, the ball relies on very wide discretionary powers to be exercised by the Federal Trade Commission, while within the field of stock-market practices it relies more directly on flat prohibitions.
I want to refer in a little more detail to the apparent object of the bill and what seem to me to be its probable results in the field of credit control. Here it confers on the Federal Trade Commission a considerable degree of authority in a field which has hitherto been wholly within the regulatory power of the Federal Reserve Board and the banking authorities of the Government, and in which the recent legislation has sought to follow the line leaving that control to the Federal Reserve Board and the banking authorities.
I refer to section 3 of the Glass-Steagall Act of June 15, last, which gives to the Federal Reserve Board power to suspend the use of the credit facilities of the Federal Reserve System by any bank which makes an excessive use of its credit for speculative trading in the security markets, and also to section 7 of the Glass-Steagall Act, which again authorizes the Federal Reserve Board to exercise power in this field by fixing the amount of bank funds which may be represented by loans on stock or bond collateral.
The Federal Trade Commission has not hitherto operated within this field of credit control, and in spite of the very wide range and scope of the present functions of the Federal Trade Commission, none of these have yet brought within its practice the field of control over credit to the extent that is involved in the provisions of the present till.
While it might be desirable, and is desirable, in my opinion, to strengthen the control over credit for stock market purposes which now exists in the Federal Reserve Board, there is at least a question whether or not such control would be strengthened by setting up a divided authority and granting a portion of control in that field to the Federal Trade Commission, or to any agency in which the Federal Reserve Board is not represented.
For this reason, the report of the Roper committee suggested that when the stock exchange authority, as there proposed, was taking action in a field which involved credit problems, such as the matter of margins, it should do so in conjunction with the Federal Reserve Bank of the district in which the particular exchange affected was located, and I now want to come to this margin provision of the bill and say just a little more about that in detail.
The objective of this provision is apparently to cut down very greatly the amount of the available funds of the country which flow into the security markets, with the idea that that will prevent the degree of speculation that causes violent oscillations, or such a violent oscillation as we experienced 4 years ago.
To accomplish this purpose, the bill would require at all times the maintenance of a margin of 60 percent, except so far as this might be tempered by the 80-percent loan provision.
This flat requirement, of a fixed margin, I think, ought to be considered from at least two points of view: First, its immediate prospective effect; and secondly, its long run desirability. The bill, as it now stands, call for the margin provision to go into effect along with the other provisions by October 1, next.
The gentlemen who, I believe, have drafted the bill, Messrs. Cohen and Cochran, have informed me that they have made a change in this provision, but as that has not yet been embodied in the bill as it stands before the committee, I believe, I want to speak to what seems to me to be the possible results of attempting to put the present margin provisions of the bill into effect by next October 1. Of course, it is difficult to reduce these things to figures, and they cannot be reduced to absolute statistical accuracy; but still, in order to get some conception of what is likely to happen, I believe that we can rely roughly on some of the figures that have been put in evidence here before you gentlemen of the committee.
For example, I notice a statement in the testimony of one of your witnesses, Mr. E. A. Pierce, that in order to bring the margin accounts of his firm into line with the margin provisions of the bill as they at present stand would require that securities now in those accounts should be liquidated to the extent of approximately one third of the total value of the securities now in the accounts, or an equivalent amount of cash must be put in. That, of course, is the experience of only one firm; but in the absence of any better evidence, I think it might supply us with a clue as to what might be expected all along the line. Assuming the total market value of the securities in the accounts of all of the members of the New York Stock Exchange is somewhere around $2,000,000,000, which I believe is the generally
accepted figure, and that somewhere in the neighborhood of 17 percent of that $2,000,000,000, or in other words $350,000,000 of those securities, are unlisted securities, which under section 6 (a) of the bill would be ineligible to remain in the accounts, there would remain in those accounts approximately $1,650,000,000 of listed securities. Applying to these the 3372-percent experience of E. A. Pierce & Co., it would mean that approximately $550,000,000 of these securities would have to be sold out, or an equal amount of cash put up, in order to bring those accounts into line with the margin requirements of the bill by October 1, and, in addition to that, we have to take into account the $350,000,000 of unlisted stocks and securities which would no longer be available for margin purposes, and would, to a greater or lesser extent, have to be sold out.
So that we see the apparent extent of the liquidation which would have to follow within the next few months if we were to get around by October 1 to meeting the margin requirements of this bill.
The liquidation in so short a period of such a volume of securities would have a natural tendency to depress the market, and, as the liquidation continued, there would be a progressive necessity of liquidating more securities than would be necessary if values remained at the point where they would stand in the absence of such liquidation.
Whatever might be the desirable thing, therefore, from a long-run standpoint of reducing the amount of funds in the stock market, it is at least a question whether it would be sound economic policy to effect this reduction in so short a period at the present time when the efforts of the Government are in the direction of increasing or at least sustaining values.
Assuming, however, that the bill would be so amended as Mr. Cohen and Mr. Cochran have suggested to me, that the proposed flat requirement, the 60 percent margin requirement would not go into effect for a considerable time, perhaps not until the expiration of a number of years, the question still remains whether the fixing of a flat arbitrary margin for all stocks under all circumstances is an advisable method of protecting the economic structure of the country against the disastrous consequences of excessive speculation. The very simplicity of that method proposed for the solution of a highly complicated problem might raise some question as to its effectiveness or its wisdom. The danger of overspeculation consists, after all, not so much in the total amount of funds in the stock market at any one time as in the excessive expansion and contraction of those funds, and you do not get any control over expansion and contraction by a flat margin which applies equally under all circumstances, no less when the market is bare of funds, on the one hand, than when it is tremendously active and flushed with funds, on the other hand. It is a flat provision which does not operate to check when speculation occurs, and which is just as rigid when there is no expansion.
The control over margin trading would seem to require the application of different standards at a time when speculative practices become excessive, from those which are applied when there is only a small amount of speculation. In the words of the Roper report, liquidity as affected by margin requirements changes in importance from time to time, and it seems hardly desirable to freeze requirements into the provisions of a statute.