STATEMENT OF GEORGE H. HOUSTON, VICE PREsident of the NATIONAL ASSOCIATION 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 be 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 10%1⁄2 millions are engaged normally in agriculture, about 41⁄2 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, a d 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. 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.

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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 sup ply 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 sccepting 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 for 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,

Vice President.

STATEMENT OF THOMAS GARNER CORCORAN, COUNSEL WITH THE RECONSTRUCTION FINANCE CORPORATION, WASHINGTON, D.C.

The CHAIRMAN. Mr. Corcoran is here, who has been interested in the drafting, with a group of gentlemen from the Treasury, the Federal Reserve Board, the Federal Trade Commission, and other interested people, and I have asked Mr. Corcoran to come here this morning and tell us the differences between this bill before us and the original bill. Tomorrow we hope to have the representatives of the Federal Reserve Board and the Treasury here to tell us what effect they think this bill will have on banks and bank credits, and matters of that sort. Mr. Corcoran, you may proceed.

Mr. CORCORAN. Mr. Chairman and gentlemen of the committee: This draft, as I understand it, represents a bill on which the staff of the Treasury and the staff of the Federal Reserve Board can agree. It is the result of an attempt to take into consideration every criticism, whether it seemed fair or unfair, of the original bill.

Mr. MAPES. Mr. Corcoran, I did not hear your first statement. Mr. CORCORAN. Oh, I am sorry. This bill, this draft, represents something on which the staff of the Treasury, the draftsmen of the original bill and members of the staff of the Federal Reserve Board, have sat around the table with Mr. Pecora's group and some others and been able to agree. It represents an effort to take every criticism

Mr. MAPES. You mean by that that the Treasury Department and the Federal Reserve Board endorse this draft?

Mr. CORCORAN. They worked this draft out with us. I am not going to put words in anyone's mouth. They will be before you tomorrow, I understand, to tell you their position on this bill. We have worked on this bill for 8 days and nights. Mr. Rayburn stepped in on the final conference.

I understand that Mr. Tom Smith, representing the Treasury, and Governor Black, of the Federal Reserve Board, will appear before you on this draft. I understand that the staff of the Treasury and the staff of the Federal Reserve Board feel they can recommend this bill.

As I say, every criticism of the first bill, both those that seemed fair and those that seemed unfair, have been honestly weighed by a group that has sat around a table in the Federal Reserve Board room for over 8 days, trying to evaluate those criticisms and trying to fit them into the frame of a bill.

We have also had, of course, the benefit of two additional bills that have been floating around town, particularly a draft written, as I understand, by Mr. Desvernine, counsel of the Association of Stock Exchange Firms, which follows the original bill in skeleton and in chapter headings.

The principal changes made in this bill have been outlined for you very carefully in a mimeographed statement distributed to you last evening.

If we should try to pick out the two features most important in the light that they have been changed the most, they would be the margin provisions and the provisions relating to the segregation of brokers and dealers.

I think we would probably best start with an explanation of the changes made in the margin provisions to show you how carefully the attempt has been made to work out all of the difficulties that were represented to be inherent in the first bill.

You will remember that one of the things most worried about in the margin provisions by those who opposed the first bill, was the possibility that it would bear down unduly on the banks, and that it would force the banks to liquidate loans that were already under water by the test of the new margin requirements.

To consider that problem, first, I would suggest that you turn to page 18 (f) in the new bill:

(f) The provisions of this section shall not apply on or before January 31, 1939, to any loan, renewal, or extension thereof made on any security or securities prior to the enactment of this Act, or on any exempted securities and/or securities registered on a national securities exchange substituted therefor: Provided, That at no time shall the amount by which the loan exceeds the maximum loan which may be maintained under subsection (c) or (e) of this section VI be increased by any substitution or withdrawal: And provided further, That when, and after the market value of securities registered on a national securities exchange securing any such loan, extension, or renewal, would permit an initial extension under this section VI of the amount of credit represented by such loan, extension, or renewal, the provisions of this section VI shall apply to the maintenance of such credit.

The margin provisions have now been divided so that different percentage requirements are made for the initial opening of a margin account and for its maintenance. On the initial opening of the account, the broker can lend only 40 percent of the market value of a speculative security; but he can carry that security down to the point where he is lending 60 percent before he has to close the security

out.

Now, this subsection (f) fixes a deadline date at January 31, 1939. That deadline was fixed as the result of consultation between representatives of the Federal Reserve Board and representatives of the Comptroller of the Currency to warn banks that at some definite time they will have to have cleaned out these hangover accounts, so that the banking system will not be carrying over bad loans for 10 or 12 years. At the end of 5 years present loans have to meet the new margin requirements, but nothing happens to them for 5 years. Any charges therefore that any deflationary liquidation of accounts will be necessitated by the margin provisions of the bill are now I think thoroughly evaporated.

You will notice at the very end of that section a provision that if a loan now under margin gets above water to the extent where it could meet the 60 percent initial margin requirement, that is, gets to a point where the value of the securities is high enough so that the banks or brokers could initially open the account as it then stands, the margin requirements become applicable insofar as the maintenance of that loan is concerned. That is, the value of the securities have to get up to a 60 percent margin, but once they reach that 60 percent margin, the loan becomes subject to the margin rules of the bill insofar that the bank or the brokers cannot carry the account after it drops 20 points more. That avoids creating a situation where a bank will carry an undermargined account only up to the point where the account just gets its head above water and then clip it off. The bank is allowed to carry the account down another 20 points.