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It is in the above order that we shall discuss our objections to the bill.

1. We take it that in large part the bill is the outgrowth of disclosures during the recent and continuing stock-exchange investigation. So far as we have observed, that investigation accorded very little or no attention to the characteristics of transactions in bonds of the type required by savings banks and trustees institutions, or to the practices of those who specialize in transactions in high grade investment bonds. It seems plain that the principal evils to which the bill is directed have to do with corporation control, or are associated with the practice of conducting transactions in stocks on margin.

Throughout the bill there are provisions which in terms include bonds and bond dealers and brokers but which the policy of the bill makes applicable only to stock and stock-handling houses. Consider section 15 (a), it is difficult to perceive the justification for requiring tedious reports, with monthly supplements of reflect changes, from owners of 5 percent or more of a company's bonds. Bondholders as such exercise no control over the management of the issuer and its policies. In fact, that it was the holders of the stock and not of the bonds who are in contemplation is suggested by the fact that the title of the section reads "Transactions by directors, officers and principal stockholders.”

That proper differentiation be made in this respect between bonds and stock is a matter of material importance to the savings banks. It is by no means unusual for a savings bank to hold in excess of 5 percent of a particular class of securities of a particular issuer.

The burdensome provisions in other sections of the bill looking to the furnishing by issuers of voluminous data as a condition to listing securities for trading on exchanges in most instances plainly reflect the desire that complete information regarding corporation control be disclosed to the public. Bond ownership does not ordinarily mean an opportunity to participate in management.

Section 6 (b), dealing with margin requirements is also plainly aimed at stocks, as there can be no sound reason to require margins such as are there specified to carry high-grade bonds.

2." As stated above, purchases of securities by members of this association are almost wholly limited to those of the soundest and most conservative investment type. The same thing is true of all institutions of a like fiduciary type. Chiefly because of the low yield which goes hand in hand with their high degree of stability, such securities are often, perhaps usually, held in comparatively large blocks by investment institutions, and change hands so seldom that there is no active market for them. Consequently when an institution, such as a savings bank, desires to sell or buy a large block of such securities, there may not be bids to buy, or offers to sell, in quantities sufficient to complete the transaction without undue delay.

Investment houses handling high-grade bonds have therefore developed and have acquainted themselves with the selling and the buying needs of institutional investors of the kind mentioned. Th must be prepared to purchase large blocks of these securities with the view of disposing of them to other investors, perhaps a number. Taking the other side of a transaction, it is often necessary for an institutional investor desiring to purchase a block of seasoned securities to depend upon a security house which had acquired the securities previously, perhaps by gradual accumulation.

A dealer in bonds cannot carry in his inventory all issues of the kind of bonds in which he deals, and cannot carry issues which he possesses in quantities sufficient to satisfy every demand of his customers. Consequently, it is desirable for the customer that the dealer be permitted to handle some transactions in part or in whole on a brokerage basis, going in behalf of his customer to the exchanges, or, as it usually is done, to over-the-counter markets to complete or to effect the transaction. The alternative to either to force the customer to resort to other sources of supply, or to compel the dealer to endeavor to sell the customer "something just as good. A situation similar in principle is presented where the customer desires to sell an issue which a security house is not in a position to acquire on its own account, or to acquire in the quantity in which offered.

In short, the savings banks have found that they require the services of dealers in high-grade securities who are also empowered to act as brokers. This combination service will be denied to them if the provisions of section 10 of the bill become law. The restrictions there proposed should be removed as to security houses dealing in bonds of the type held by savings banks. It may well be that such dealer-brokers should be subjected to some regulation by the Federal Trade Commission, including perhaps a requirement that they make known to their customers instances in which they are exercising a combination function. But it seems plain that to forbid such houses to provide the valuable services which have heretofore been availed of by institutional investors, such as savings banks, would be highly unsatisfactory, and might have the effect of preventing the savings banks from realizing quickly on their assets in time of emergency.

Many savings banks, as well as other institutions of somewhat like fiduciary character, have rules which in practice postpone, sometimes for considerable periods, the final consummation of transactions in bonds, pending formal approval or ratification.

During the intervening time, it is necessary that the bonds which have been contracted for be carried by the investment house. The investment house, in turn, must arrange for credit in order to carry the securities. The provisons regarding extent of margin contained in section 7 (b) would severely limit the continuance of this service which the investment houses have furnished the savings banks, and other like investors. It is plain that such requirements are not apt when the security is a high-class bond.

Investment houses handling high-grade bonds are usually found among the subscribers to issues of state and municipal bonds, and bonds of like character, all involving purchases in large amounts. It is plain that if it is necessary for the investment house to possess such bonds in its own name for a period of inore than 30 days before a loan can be had thereon, as contemplated in section 6 (c), the ability of investment houses to finance such issues, and to provide them for savings banks or the like, will be drastically curtailed.

3. The bill proposes what in effect approached the retroactive application of the Securities Act of 1933 in that it applies the substance of certain provisions of the earlier act referring to registration and its consequences to seasoned investment securities tested by the experience of years. It is with surprise, therefore, that we find that it fails to exempt from its requirements as to registration municipal bonds, bonds of States and political subşdivision, and railroad bonds, all exempted in the Securities Act.

The ground for exemption in the Securities Act is plainly because obligations of the classes specified possess guaranties not found in securities generally. As to governmental issues of the several orders, there is a presumption in favor of soundness and against deception in the nature of their issuers. Railroad bonds must pass the scrutiny and obtain the approval of the Interstate Commerce Commission. It is difficult to conceive of justification for a refusal to accept like guaranties in connection with the acceptance of those already outstanding bonds for trading on the exchanges.

4. At the time of the adoption of the Banking Act of 1933, and throughout the administration of the provisions of that and associated laws, constant reassurances have been made that there is no intention to discriminate against or in any way injure banks which are not members of the Federal Reserve System Subsection (y) of section 8 of the Banking Act of 1933 expressly incorporates that policy.

Adherence to that policy would be abandoned at least in some measure if the provisions of section 1 (a) become law. To forbid a bank which is not a member bank of the Federal Reserve System to lend on any registered security would be to deprive such a nonmember bank of a very important and legitimate part of the business in which it is in justice entitled to participate.

It is the practice of mutual savings banks in certain localities, particularly Massachusetts and Connecticut, to make loans to brokers secured by high-grade securities as collateral. We can hardly believe that it was the intention of the framers of the bill to prohibit mutual savings banks from participating in such legitimate financing of securities as the banking laws of the several Sates provide. It has been demonstrated that they prove to be a strong secondary reserve and with proper arrangement of maturities provide an unfailing source of available money received regularly. Mutual savings banks should not be prevented, where other conditions are proper, from making such loans secured by safe and sound securities.

It would also seem unwise to fix by legislation rigid margin requirements with no differentiation whatever as to the classes of securities on which loans may be made under the banking legislation of the several States. These severe restrictive provisions would limit unduly the amount which savings banks might loan on high-grade securities. These provisions would also apparently limit the borrowing capacity of mutual savings banks on securities which they own in the case of sudden temporary emergency where money might be needed to pay their depositors.

5. Plainly the marketability, and hence the market value, of any bond will be greatly influenced by the circumstances whether or not the bond is eligible for purchase and sale on the exchanges. Section 11 makes it unlawful for any person to effect any transaction in an unregistered security on a registered securities exchange.

The registration requirements entail expenditure of time and trouble. By statutory provision the issuer must furnish information as to the issuer and its affiliates in respect of numerous specified matters concerning organization, financial structure, security provisions and miscellaneous information regarding directors, officers and principal security holders and underwriters, and their remuneration and relationship with the issuer and its affiliates; bonus and profitsharing arrangements must be described; managements and service contracts and options on securities set out; contracts not made in the ordinary course of business must be described; and other information must be listed.

The commission may make additional rules and regulations as to the information to be furnished in connection with the registration of securities, and as to the undertakings to be entered into by the issuer, but such rules and regulations shall require, among other things, an undertaking by the issuer to comply with the provisions of the bill and with the commission's rules and regulations.

In many cases the issuer of a bond may have little or nothing to gain from registration of the security. The securities are already in the hands of the public, and whether or not they are readily realized upon may be a matter of little or no concern to the issuer. On the other hand, registration subjects the issuer to trouble and expense, to an extent undetermined and subject to further enlargement by the cominission. Registration subjects the officers of the issuer, and other agents, to dangers of personal financial liability, or at least to annoying attempts to fasten such liability upon them.

We may confidently anticipate, therefore, that many outstanding issues will not be registered. It will be the holders of the securities, and not the issuers, who will pay the penalty of impaired marketability.

The mutual savings banks own municipal bonds to the value of several hundred millions of dollars. It is doubtful if many municipal bonds now outstanding will be registered. The same thing is true of the bond issues of States, counties, school districts, improvement districts, and other obligations of like, nature. To a somewhat less extent, it is true of equipment trust obligations.

The savings banks urge that consideration be given to this effect of the bill of visiting the penalty of nonregistration upon those who are unable to control the issuer in this respect. Here we have an additional illustration of the inapplicability of the principles of the bill to bonds. The holders of the outstanding stock of an issuer cannot be said to be without an opportunity of influencing the course of the issuing corporation with regard to registration. The holders of outstanding bonds certainly are afforded no such opportunity to influence the action of the issuing corporation.

It is conceivable that the requirements concerning registration before bonds. are eligible for sale on the exchange might afford openings for abuses by issuers with nothing to gain from enhanced marketability. For example, an issuer might decline to make the registration statement and to enter into requisite undertakings for the very purpose of depreciating the market value and enabling the issuer to buy in its outstanding bonds at a substantial discount from par. This would penalize the owners of the bonds, and not the issuer.

CONCLUSION

We ask the committee not to construe this expression as voicing disapproval of the general policy of the bill. We have purposely and carefully confined ourselves to an attempt to point out particulars in which the bill appears to threaten the direct and proper interests of savings banks, chiefly by impairing the marketability of the bonds which they held. Respectfully submitted.

Philip A. BENSON, President,

BENNETT, Chairman, Committee on Federal Legislation.

COVINGTON, BURLING, RUBLEE, ACHESON & SHORB,

Washington, D.C., March 8, 1934. Hon. SAM RAYBURN, Chairman of Committee on Interstate and Foreign Commerce,

House of Representatives, Washington, D.C. DEAR SIR: Incident to the hearings on the bill H.R. 7852, proposing to enact the National Securities Exchange Act of 1934, the American Institute of Accountants herewith presents a memorandum brief which it requests to be incorporated in the hearings.

This brief sets forth the views of the public accountants respecting certain changes in the bill which are believed to be essential for reasonable and effective administration, and properly to limit the responsibility of the public accountants. Sincerely yours,

J. HARRY Covington,

Counsel for American Institute of Accountants. Before the Committee on Interstate and Foreign Commerce of the House of Representatives, Hearing on H.R. 7852. Memorandum on the National Securities Exchange Act of 1934, Submitted by American Institute of Accountants]

This memorandum is respectfully submitted to the congressional committees which have under consideration the so-called national securities exchange bill of 1934, on behalf of the American Institute of Accountants, national professional accountancy organization.

ANNUAL AND QUARTERLY AUDITS

Section 12 (a) (2) of the bill would require every issuer of a security registered on a national securities exchange to file with the Federal Trade Commission annual and quarterly reports, including among other things a balance-sheet and profit-and-loss statement certified by an independent public accountant.

We approve the requirement of at least one report each year certified by independent public accountants. This is in accord with what is commonly regarded as good practice.

It is preferable that the certified report be rendered as of a date marking the end of the natural business year of the company concerned (which is not necessarily December 31) i.e., the date most closely coinciding with the termination of the annual business cycle, which is also usually the date at which inventories are at their minimum. The work of the regulatory body would be facilitated by spreading the closing dates of various industries in accord with their natural fiscal periods, and resulting financial statements would be more valuable for comparative purposes. It is suggested that there be inserted in section 12 (a) (2) a provision making it clear that annual reports are to be filed as of the date marking the end of the natural business year of the company concerned.

cases.

However, there is serious question in our minds whether the requirement of qu erly reports certified by independent public accountants is desirable in all

Accounts are essentially continuous historical records and accounting statements for brief periods of time are less significant and valuable than for longer periods of time. On the basis of personal judgment and convention certain charges and credits must be assigned more or less arbitrarily to one period or another and when the period is as short as 3 months it is very difficult to prepare accounting statements which are not open to the danger of misleading the uninformed reader. Items of income or expense, which are extraordinary or unusual in either nature of amount influence the net result shown for a given quarter to a greater disproportionate extent than they would influence the net result shown by an annual statement which includes the same items. Many businesses are of a highly seasonal nature, e.g., automobile, department stores (with Easter and Christmas seasons), flour milling and other industries related in one way or another

to agriculture, and the real result of the operations is not dependent on a few months—as quarterlybut on at least the full annual cycle. It must therefore be recognized that the results shown by quarterly statements cannot be stated with the same degree of accuracy as statements for a longer period, such as annual statements.

It is not intended to be argued that corporations generally should not inform their stockholders quarterly of the corporation's progress, but it should be recog. nized that such quarterly statements are to a greater extent dependent upon estimates than needs to be the case with statements for longer periods. Neither is it argued that more frequent than annual examinations of corporate accounts are not desirable, but to require that quarterly statements must be certified would

tend to give them a weight and authority beyond that which they inherently possess, and might well lead investors to place an undue reliance thereon.

In view of the foregoing, it would be unreasonable, and indeed improper, to place upon public accountants, with respect to quarterly statements, the heavy burden of responsibility set forth in section 17 of the bill.

If it is considered essential that independently audited statements be submitted more often than once a year, there would be less objection to semiannual reports than to those covering only three months.

LIABILITY

Section 17 (a) of the bill provides that accountants may be sued for damages if they have made any statement which is false or misleading in respect to any matter sufficiently important to influence the judgment of an average investor. It will, of course, become the duty of the courts to determine what might influence the judgment of an “average investor," as the courts have had for many years the duty fo determining what might be the actions or the judgment of a "reasonable man." The term “average investor" has had no judicial determination. It is, in fact, novel to the law, and the type of person who is an "average investor" may vary greatly in different parts of the country. We suggest, therefore, that the phrase "an averge investor" appearing in section 17, page 32, line 2, be changed to "a reasonable man. The action and the judgment of “a reasonable man", and consequently matters which would influence that action or judgment, can in harmony with the existing general law be readily determined by the courts.

It is necessary for us to object most strenuously to the measure of damages outlined in section 17 (b) and (c). Under these provisions it is possible that an accountant who had made an honest error might be held liable for an amount which would have no relation whatever to the amount of damage occasioned by his error. The accountant is an expert exercising his professional skill and judgment for a fee. It seems to us that there is no precedent in law or equity on the basis of which such an expert should be exposed to immeasurable liability in the absence of fraud.

It seems perfectly possible that under section 17 (b) and (c) an investor who had sustained loss might, if he discovered an error in the statement certified by an independent accountant, sue that accountant for a sum much greater than the amount of the damage occasioned by the accountant's error. vision would be likely to encourage unwarranted suits against accountants and would impose upon the profession the heavy financial burden of defending such suits even though the courts found the accountants blameless.

No reputable accountant has any desire to deny or ignore his responsibility to those who rely upon statements which he certifies. The courts under existing law have already imposed upon accountants a financial liability quite sufficient to deter any accountant from deliberate fraud or deceit. A public accountant's reputation for probity is his chief asset and no one would be willing to risk the professional destruction which certainly follows discovery of a dishonest or a careless act.

It seems to us that the measure of damages imposed upon accountants by section 17 (a) and (c) is of a punitive character which is unreasonable and unwarranted by the record of the accountancy profession in the United States, and we respectfully request that it be modified.

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UNIFORM ACCOUNTING

Under section 18 (b) of the bill the Federal Trade Commission would have power to prescribe uniform accounting for industry. This provision we believe does not belong in a bill designed to regulate national securities exchanges. It is a matter of such great importance that it should be considered as a separate problem. We understand that a committee on uniform accounting and statistical reporting for industry appointed by the Secretary of Commerce is now giving thought and study to the matter.

The application of attempted uniformity in the keeping of the accounts of public utilities and railroads has not, it is believed, tended toward the presentation of more dependable financial statements by companies in those fields than has been the case with industrial companies. On the contrary, it is believed that there has been a greater advance in the accounting practices and in the recognition and treatment of such problems as those arising with respect to allowances for depreciation of plant and property, etc., in the case of representative industrial companies then in the fields subject to governmental regulation

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