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abling another to make or create, a market for any security, whether or not registered on a national securities exchange, without complying with such rules and regulations as the Commission may prescribe as appropriate in the public interest or for the protection of investors.
It will be noticed first of all that this provision is not a limitation upon persons engaged in the business of buying and selling securities, but is a restriction upon any person. There is probably some question as to whether the provision is constitutional inasmuch as there is at least a possibility that it may be construed as an unwarranted interference with the rights of an indiviqual to hold and dispose of property. Aside from that question it appears that if the language is construed literally, every person offering a security for sale through the mails or fn interstate commerce must inake such offer in accordance with rules and regulations prescribed by the Commission. Undoubtedly many uninformed persons not in any way engaged in the securities business would expose themselves to liability through ignorance of the existence and content of rules and regulations.
If the rules and regulations adopted by the commission with reference to overcounter markets were construed as exclusive regulation thereof, the rights of the States to regulate such markets would be eliminated and the public interest would be seriously impaired. At the present time there is in the city of Milwaukee particularly a rather broad market on building and loan stocks, baby bonds issued by the city of Milwaukee, real estate bonds (including those in default and those not in default), and preferred stocks of certain Wisconsin utilities. The practices of dealers and brokers in connection with the sale of such securities may be controlled by the Public Service Commission of Wisconsin through the licensing provisions of the Wisconsin Securities Law. In the event that unfair or inequitable practices are disclosed, the person who indulges in said practices may have his license revoked and thus be removed from the securities business. It is unnecessary for the Wisconsin Commission to adopt general rules and regulations relating to said business or said practices, but each case may be examined and the determination based upon the facts of the particular case. It is submitted that such regulation by a local commission familiar with local conditions, local securities, and local brokers and dealers, would be more effective than regulation by a central body located at Washington. There can be no objection to such a situation as a supplement to State regulation providing the language of the section under consideration is amended to clearly indicate that it applies only to persons engaged in the business of buying and selling securities, but if such Federal regulation through prescription of general rules and regulations is to be continued as in any sense exclusive regulation, it is highly objectionable as an invasion of State rights generally, and particularly as pairing the State's right to protect its local investors.
The first sentence of paragraph (c) of section 18 of the act contains this language:
"The authority above given the Commission shall include, among other things, authority to prescribe such rules and regulations for national securities exchanges, their members and persons transacting a business in securities through such members, in addition to those specifically provided in this act, as it may deem necessary or approrpiate in the public interest or for the protection of investors, and may by its rules and regulations more specifically define the form and procedure to be followed in carrying the provisions of this act into
It appears that under the language above referred to a person engaged in the business of buying and selling securities exclusively for his own account may be subject to Federal regulation under the provisions of this section. There can be no objection to imposing the provisions of the act upon persons engaged in the business of buying and selling securities so far as their dealings with the public are concerned, but it is doubtful if the act should go so far as to regulate every individual who may buy and sell for his own account. This is particularly true in view of the other provisions of the act specifically regulating dealings by persons having interest in the issuer or having access to information not available to the public generally.
The balance of paragraph (c) of section 18 deals with regulation of many practices of dealers, and again it may be stated that there is no objection of such regulation, does not impair the rights of the States to regulate licensed dealers and brokers with reference to the fairness, honesty, legality, and equity of their practices, but that if said provision for Federal regulation contemplates
exclusive regulation, it is highly objectionable. For instance, in lines 14 to 18 on page 35 of the printed bill, this language appears:
"The commission may fix or prescribe the method of fixing uniform rates of commission, interests and other charges, may prescribe minimum units of trading, rules limiting the manner, method, and place of soliciting business'
And so forth. It is submitted that the italicized portion of the above language deals with a matter which is particularly of local interest and should be subject to supervision and regulation by local authorities. To deprive local authorities of such authority again constitutes an invasion of State rights generally and particularly impairs the State rights to use its agencies for the protection of its investors. Sec. 16 of the act contains this language:
‘Every national securities exchange, every' member thereof, every person transacting a business in securities through the medium of such member, every dealer making or creating a market for securities through the mails or the use of any means or instrumentality of interstate commerce, shall make, keep, and preserve such accounts, correspondence, memoranda, papers, books, and other records and make such reports as the Commission by its rules and regulations may prescribe. The accounts, correspondence, memoranda, papers, books, and other records of such persons shall be subject at any time or from time to time to such periodic, special, or other examinations by examiners or other representatives of the Commission as the Commission may deem necessary or appropriate, and the cost of such examinations, including the compensation of the examiners, shall be fixed by the Commission and paid by the person examined. Any representatives of the Commission designated by it shall have access to the premises or any part thereof of any national securities exchange and the right to attend any meeting or proceeding of the exchange or any committee thereof."
The first conclusion which may justifiably be reached with reference to the above language is that it imposes an impossible administrative burden upon the Federal Trade Commission with reference to effective examination of books and accounts of the persons referred to in the section. However, from the standpoint of regulation it appears that this provision, if it is exclusive, takes away from the State all right to regulate persons engaged in the securities business within its borders. It will be noted that the section is not applicable only to securities exchanges and members thereof. It applies to every person transacting a business in securities through the medium of such members. Thus, it is applicable to every person who buys and sells securities for his own account for the purpose of making a profit even though he does not deal with the public. It also applies to every dealer making or creating a market for securities through the mails or the use of any instrumentality of interstate commerce. Thus, if a dealer in Milwaukee underwrites an issue of securities and attempts any solicitation of orders for the purchase of said securities through the mails, even though it is done exclusively in intrastate commerce, he is subject to the provisions oi this section. Even though the distribution of the securities was completed long before the act takes effect, if said dealer attempts to maintain a secondary market in such securities and receives inquiries by mail and replies to inquiries by mail in intrastate commerce, he is subject to the provisions of the section. There may be some question as to the propriety of the Federal Government attempting such detailed regulation with reference to purely intrastate business. However, if said policy contemplates an exclusive regulation thereof so that the State is left without authority to regulate in accordance with its laws the practices of persons engaged in strictly intrastate business within its borders, the provision has no justification.
It is submitted that section 26 (a) of the act referred to above should be amended, and that there should be incorporated in the act a provision substantially similar to section 18 of the Securities Act of 1933, which contains this language:
"Nothing in this title shall affect the jurisdiction of the securities commission (or any agency or office performing like functions) of any State or territory of the United States, or the District of Columbia, over any security or any person."
It is further submitted that the provisions of the act should be clarified to establish clearly that the regulation provided shall affect persons and companies engaged in the business of buying and selling securities to and from or for members of the public and not to a person who is not engaged in the securities business except as he buys and sells securities for his own account.
ADOLPH JOHNSON, Chief Counsel. MARCH 6, 1934:
STATEMENT OF George H. HOUSTON, VICE PRESIDENT OF THE NATIONAL Asso
CIATION OF MANUFACTURERS, PRESENTED ON BEHALF OF THE BOARD OF DIRECTORS, IN REGARD TO SENATE Bill No. 2693, THE SHORT TITLE OF WHICH IS NATIONAL SECURITIES EXCHANGE ACT OF 1934"
Mr. Chairman and gentlemen of the committee: I appear before you in opposition to Senate bill no. 2693, entitled "A bill to provide for the registration of national securities exchanges operating in interstate and foreign commerce and through the mails and to prevent inequitable and unfair practices on such exchanges and for other purposes.'
Previous witnesses before your committee have testified at length with respect to the detailed provisions of this bill. I shall not attempt to duplicate this presentation but wish to submit for your consideration the viewpoint of industry as a user of capital and a seller of securities.
The greater portion of all existing unemployment in industry is traceable in large part to the reduced volume of private capital flowing into private enterprise, and to the enormous losses sustained by business since 1929. Employment in industry will not again he restored to normal until these conditions are corrected.
Of the 49 million persons normally gainfully employed in this country as shown by the Census of 1930 about 23 million are engaged normally in the rendering of services and about 26 million in the production of goods. Of the latter group about 1072 millions are engaged normally in agriculture, about 472 millions in the production of manufactured consumption goods and about 10 millions in the production of durable goods. Col. Leonard P. Ayres of Cleveland has estimated that in December about 20 percent, or somewhat less than 10 million, of this employable personnel were unemployed. A little more than one half of these unemployed persons would be employed normally in the production of durable goods; about 1 million in the production of manufactured consumption goods other than agricultural products, and the remainder in the rendering of service. There has been no appreciable unemployment in agriculture. Unemployment in the service industries is almost directly attributable to unemployment in the production industries. As the production of goods is increased, the rendering of services in connection with them, such as transportation, communications, aid wholesale and retail trade will be increased. It may be said, therefore, that the restoration of normal employment is dependent upon the restoration of normal activity in the durable-goods industries.
Durable goods are purchased largely with individual and corporate savings and through the use of credit. These resources are made available through the sale of securities. In the 10 years ended with 1930 American business was supplied with new capital, through the sale of sacurities, other than for refundings, to the amount of about 4 billion dollars average per annum. In 1931 this volume of new capital supplied to private enterprise dropped to $1,551,000,000; in 1932 to $325,000,000; in 1933 to $160,000,000, or 4 percent of the previous 10 years average. In general deficiency has been accumulated since 1929 in the normal supply of private capital to private enterprise of about 9 billion dollars. A comparison of this situation with the volume of private capital flowing into private enterprise in the United Kingdom during 1933 of about 56 percent of normal indicates the presence of certain vital interferences with the normal supply of capital and credit to American business.
In many instances, corporate resources have been so diminished that normal operation is out of the question without replenishment of capital. This condition is indicated in the report issued recently by the National Bureau of Economic Research covering a study of the national income made by it in cooperation with the Department of Commerce in response to a request from the United States Senate. This report shows that the national income paid out in 1929 was about 2 billion dollars less than the national income produced, this difference representing largely an increase in the resources of American business. Since then, however, the national income paid out each year has been much greater than the national income produced, the difference representing a shrinkage in business resources.
In 1930 this shrinkage amounted to $4,954,000,000; in 1931 to $8,637,000,000; in 1932 to $10,603,000,000; in 1933 it is reasonable to assume that it was not less than 1932, or about $11,000,000,000; or an aggregate shrinkage in business resources since 1929 of about $35,194,000,000.
Normal employment in private enterprise will not be restored until the flow of new capital into business is again resumed. Business needs not only its normal supply of new capital but, over a period of years, it will require an additional supply to replenish the enormous shrinkage of recent years in its resources. This
supply of capital can be obtained only by drawing upon the savings and credit resources of the country through the sale of securities.
The Securities Act of 1933 created a serious obstacle to recovery through its drastic regulation of the issuance of new securities by private enterprise. The Banking Act of 1933 created an additional impediment through the provisions of section 16 prohibiting national banks from participating in underwritings in securities after June 16, 1934. The National Securities Exchange Act of 1934, as proposed, would interfere in a vital way with the essential supply of capital to business for the following reasons:
(1) It attempts drastic regulation of the financial policies and accounting procedures of private business as well as the form of its financial reports. It also burdens business unnecessarily with expensive and intricate reports and records.
(2) It burdens officers, directors, and stockholders of private enterprises with such personal liability as effectually to discourage responsible men from undertaking corporate direction and supervision. It penalizes the holders of substantial blocks of any one security so greatly as to discourage the individual of large resources from using corporate securities as a medium for investment or from acquiring a sufficient amount of the securities of a company to warrant him in taking an active interest in its operations.
(3) It fixes rigidly by statutory provision the use of corporate securities as collateral, including use in marginal trading, thereby depriving the owner of a legitimate and proper enjoyment of his property, and to a large extent prevents the lender from the legitimate exercise of his own judgment in the carrying out of a purely private transaction. This provision would have a seriously deflationary influence during the period of its application and subsequently would retard the issuance of new securities.
(4) It so restricts and regulates the investment dealer and broker in the creation, initial distribution, and subsequent exchange of corporate securities as to interfere seriously with the availability of credit resources and savings to the capital needs of private enterprise. In effect it prevents a free market for securities of business.
The ostensible purpose of this bill is to regulate the national securities exchanges with which purpose, properly undertaken and administered, there can be no dispute. It goes far beyond this purpose, however, in the regulation of business and the personal affairs of the investor. Taken together with the Securities Act of 1933 it will effectually bar the flow of private capital into American business. Regulation of the national securities exchanges should be undertaken under a statute giving a properly constituted regulatory body wide administrative latitude and flexibility. Such a regulatory body and possibly the directing boards of the exchanges themselves, might well be so constituted as to represent the various parties at interest, namely, the broker, the buying public, and the corporations whose securities are traded in. This bill should be rewritten to restrict its scope and alter its character in this manner, without permitting it in any way to hamper or discourage the flow of private capital into business.
The provisions which subject corporations to the control of the Federal Trade Commission and which increase the burdens of corporate financing to the point of prohibition are unsatisfactory for reasons similar to those which have been presented from time to time for liberalizing certain provisions of the Securities Act of 1933. All such provisions should be stricken out or modified to make them applicable only to the regulation of national securities exchanges and to transactions in securities.
The requirements that directors, officers, and large stockholders be required to disclose their holdings of securities and be prohibited from disposing of them in the manner and under the circumstances provided for, may be justified in principle but the extent to which such information is made public and the drastic penalties imposed for violations would result in discouraging many desirable men from accepting the position of director or executive officer of any corporation. It would seem sufficient for the purpose if the information were lodged in proper form with the controlling officers of the exchanges upon which the securities of the corporation in question may be listed and/or with the Government agency having jurisdiction over such exchange, but without the publicity now attaching to such reports.
It is in the interest of permanent stability in business and sound management to have individuals continue to own substantial blocks of the securities of a given corporation. One of the greatest dangers facing business management today is that no one person will have a sufficiently large interest in any one enterprise to make it worth while to give an adequate amount of his time and attention to its direction and management, resulting in a form of absentee management that is most undesirable.
The many provisions of the bill fixing penalties and personal liability should be made less drastic and the basis for such liability should be modified. This bill carries the same objectionable provisions imposing the burden of proof upon the defendant in civil litigation and upon the accused in criminal prosecution which have been criticized in the Securities Act of 1933. There is no justification for them and the existing rule of law should be maintained. Consideration should be given also to the impropriety of imposing any such liability upon individuals ior misstatements unless made willfully.
The prohibition against the use of unlisted securities as collateral and fixing by statute or by arbitrary action of the Federal Trade Commission of the collateral value of listed securities for bank purposes would prove an unjustifiable hardship upon the owner of such securities and a serious interference with their distribution and subsequent market value.
The seriously inflationary effect of the application of this provision to loans then outstanding and secured by listed and unlisted securities would be sufficient in itself to check recovery during the resulting liquidation, but when coupled with the practical prohibition that such liquidation would have upon the issuance and distribution of new securities, it may be anticipated that no progress toward recovery would be possible during this period. Mr. Dickinson has brought out forcibly in his testimony on this bill before the Committee on Interstate and Foreign Commerce of the House of Representatives that the rigidity of this flat margin provision would check the desirable expansion of security issues during periods of depression just as it would probably check the undesirable expansion speculation in boom periods.
If business needs capital for prosperity, it is in the public interest to not burden the securities issued by business for the procurement of such capital with such stringent regulations with respect to their use as collateral as to interfere with their free issuance, distribution, and retention. The present method of fixing the collateral availability of such securities by the Federal Reserve System appears to be entirely adequate for the protection of the public interest.
The Banking Act of 1933 required the separation of investment banking from commercial banking. This bill proposes to separate brokerage from security distribution. The first step—that is, the separation of investment banking from commercial banking-has forced a reorganization of the largest channels in the country for the distribution of the securities of private enterprise. This second proposed step-that is, the separation of brokerage from security distributionwould force a further reorganization and rearrangement of such facilities. One of the serious obstacles to the marketing of corporate securities is the existing general disruption of the organizations previously engaged in the underwriting and distribution of such securities. Any further disruption of this character would further retard the essential distribution of such securities.
The provisions of this bill which have been criticized are calculated to reform past abuses without consideration of their effect upon present recovery. The abuses sought to be corrected are largely those of uncontrolled speculation upon the securities exchanges. The need for regulation of such speculation is well recognized, but it should be noted that speculation of this character occurs generally after a long period of prosperity and not at the bottom of a great depression or in the early stages of recovery. More than everything else, this country needs encouragement to recovery and to a return to the initiation by private enterprise of new ventures which will restore employment. This cannot be accomplished with enterprise in the strait-jacket created by the Securities Act of 1933 and tightened by this bill.
It is held that adequate regulation of the national securities exchanges can be obtained without interference with industrial recovery, and it is recommended that the scope of this bill be limited strictly to that objective.
George H. Houston,