Senator ADAMS. If they are bonds, of course the banks are among the larger purchasers. Mr. HARVEY. Yes, they might be purchasers of them for their own account. Senator KEAN. So that you distribute them as well. Mr. HARVEY. They have done both. The CHAIRMAN. All right. Go ahead. Mr. HARVEY. Well, now, you will read in the newspapers that the issue is floated, that the issue has all been sold. That means only that it has been distributed to the trade, that the merchants who are in the business have taken the issue. Senator ADAMs. It means that the wholesaling is over and that the retailing is about to begin. Mr. HARVEY. Yes. Or the retailing might have been going along with it but has not been completed. The issue has been taken out of the account. We call the department in which it is kept before being distributed as the account. It means the account has distributed the issue of securities to the merchants of securities all over the country. Those merchants of securities are proceeding then to effect the ultimate distribution of the bond, I mean to the ultimate consumer or the final investor in them, to institutions, banks, educational foundations, and individual investors of all kinds. And the issue has not been completely sold until the final bond has reached the ultimate investor. The CHAIRMAN. What is the usual spread there between what the originator gets and what the buyer pays? Mr. HARVEY. There is no fixed amount. But it would run something like this in general: If it were an issue of American Telephone & Telegraph Co. bonds, for instance, J. P. Morgan & Co. are their bankers, the Telephone Co. would have all of its original discussions with J. P. Morgan & Co. J. P. Morgan & Co. might ask in some of their closest friends in the banking business, to discuss the preliminaries, but they might not. They might make all arrangements with the Telephone Co. to purchase the issue, and have it all fixed before they invite or discuss the matter with other people that they expect to take into partnership with them in the particular deal. Well, we will say that they make the purchase themselves from the Telephone Co. They buy the issue of bonds, and then they pass them on to a group of fellow bankers that they form. And they say to them, in the contract between them, we have made a profit ourselves and this is the first step to effectuate the issue, for all of the original investigation, for carrying on the negotiations with the company, and for the risk that they take in making a commitment of 50 or 100 million dollars by purchase of bonds-and they take, we will say, a quarter of one percent for that step-up. Then they join in the next group, which is called the purchase group or banking group. They become members of that particular group, and take part with them. They start off with the $50,000,000 issue, as owners of the whole issue. And if I may misuse the term, they underwrite the whole issue themselves, take the whole $50,000,000 and they are very anxious to immediately distribute that risk that they have assumed, and they get 10 or 12 other houses to assume a proportionate part of that risk with them, to carry it along and take some of the risk themselves. Then they form a selling group, and pass the securities out to retail merchants of the country. J. P. Morgan & Co. does not happen to be a retail house, but they pass the issue along to houses such as I have been associated with. We do both an originating and a distributing business, and were for many years one of the biggest distributors for J. P. Morgan & Co. issues. We would put our sales organization to work in distributing the particular issue to the extent that we had taken a commitment in it. If we happened to sell all of our commitments and there were still bonds left in the account we would go back to J. P. Morgan & Co., perhaps, and buy some more. Now, as to the profit in each step: When it comes to the second step, after you pass the originating house and come into the banking group, which is the purchase group, there is probably a step-up in there of a quarter or half percent, and sometimes it may be as much as 1 percent, if it is an issue a great deal harder to sell. But the Telephone issue is one of the easiest to sell. If there is more risk involved, if it is a harder job, quite naturally the compensation would be larger. Senator ADAMS. The compensation bears somewhat on the marketability of the issue? Mr. HARVEY. Yes; and on the risks involved, and the difficulties of distributing it. It would go up there. Then when it comes to the compensation of the final merchant who distributes the issue to the public, we call that the selling commission, and that runs ordinarily from 1 to as high as 21⁄2 percent. I should say that the average would be about 11⁄2 percent or 14 percent on the ordinary general marketing of a corporation bond. Is that about correct, Senator Kean? Senator KEAN. Yes; I think so. Mr. HARVEY. And that is the commission earned by the man for his efforts in distributing the issue at retail. Senator KEAN. That is to cover also the commission to the salesmen? Mr. HARVEY. Yes, sir. Ordinarily, in the case of institutions, such as banks, insurance companies, sometimes charitable institutions are allowed to purchase bonds at a quarter percent down from the price to the general public, because they usually purchase large amounts. It is easier to distribute 100 bonds to 1 of them than to distribute 5 bonds each to 20 purchasers. Senator BULKLEY. Is it customary for wholesale distributors to buy outright? Mr. HARVEY. Yes, sir. Whenever our house has been an originator we have always participated to a large extent in that part of the business. Senator BULKLEY. Do others who participate buy outright from you? Mr. HARVEY. Yes, sir; just as though they were one of the distributors. Each group as it comes along participates. They participate as you go along the line. Senator ADAMS. I understand that Harris, Forbes & Co. did not do this, but some of the big originators would send out wires to their country correspondents the substance of which was: We have allotted to you so much of a certain issue. In other words, if you do not take these we won't let you in on the next good thing we have. There fore, there was a sort of moral obligation imposed upon them, that if they did not go right along with that house, they would not be let in on another good thing. Mr. HARVEY. We do not offer to them definite amounts to be taken. Senator ADAMS. I understand, but a good many houses will say: We have allotted to you so much of this issue. Mr. HARVEY. Yes. And I want to be perfectly frank with you and say, that we would not expect a dealer to just take the very choicest of our issues and not take some others, too. And that is business. We would expect them to be fair about it. But we do not put it in just that way to them, I mean in the way you mentioned it. Senator ADAMS. I mean that that goes with the business. Mr. HARVEY. Yes, sir. I will answer that that is not unusual, I understand. Senator KEAN. While talking along this line let me ask you a few questions that I should like to get into our record: You have mentioned the American Telephone & Telegraph Co. And you have a great many smaller issues, I take it. Mr. HARVEY. Yes, sir. Senator KEAN. And you have engineers and you have accountants, and you have various people looking over issues all the time. Mr. HARVEY. Yes, sir. Senator KEAN. What do you have to load an issue with in order to cover that expense? Mr. HARVEY. To cover the expense of looking for business? Mr. HARVEY. We do not have any Senator KEAN (interposing). Well, when you get an issue if you make 1 percent on that issue that will not cover your expense, will it? Mr. HARVEY. No, sir. We would lose money I think on that. Senator KEAN. What do you claim that you have to load an issue in order to get out even? Mr. HARVEY. Well, Senator Adams has gotten at the root of that in his questions. It all depends upon the trouble of selling an issue. Take the State of New York bonds, and they are the least costly issue to sell that you can probably find. The expense of originating and selling such an issue would probably not be greater than a quarter of 1 percent. But if you take an issue, say, of Iowa Railway & Light Co. bonds, you probably run your expense up to 21⁄2 or 3 percent. You have to do a great deal more investigating in such a case and therefore have to go to a good deal more expense. Senator KEAN. Would you say about 2 percent? Mr. HARVEY. Yes. It would go up that. Senator KEAN. Then if you should buy them at 90 you would have to sell them at 92 before you would get out even? Mr. HARVEY. Yes, sir; before we would cover the cost. And those costs amount to a good deal. I think you would be surprised at the various costs involved. The less you know about an issue the more you have to pay in order to find out if it is all right and good before you can put your name to it. You must understand, in spite of the general and popular opinion to the contrary, that there are a great many honest men in the investment banking business, men whose desire is as great as anybody's to do right and to sell the right kind of bonds, and to have an honorable reputation. My house for many, many years was more jealous of its reputation always than it was interested in making profits, because we knew that without a fine reputation we could not command the confidence necessary to run a profitable business. It is good business to be honest in the investment banking business. It is good business to be perfectly fair with your customers, and to protect them to the fullest extent of your ability. If you do not do that you soon will drop down to a second-grade house, or a third-grade house, and then go out of the business. And I know what I am talking about. Senator ADAMS. Now that you speak of a second-grade house let me ask: A lot of things that a first-grade house does in order to insure the validity of an issue are not done by a second- or a third-grade house, are they? Mr. HARVEY. No. And they cannot afford to do it in many cases, because they cannot maintain the necessary highly specialized organization. Senator ADAMS. They also work for longer profits, isn't that so? Mr. HARVEY. Ordinarily that would be so. And of course the smaller houses depend a great deal on the larger houses for accuracy of information, and for careful consideration of issues, and for good faith in the purchase of them. Senator ADAMS. There are issues that are originated by secondand third-grade-and, I take it, using the term "third-grade" would be complimentary to some of them. Mr. HARVEY. Yes, sir. Senator ADAMS. They originate issues and put them out that are actually well, I was going to use the word "fraudulent", but perhaps the word "fraudulent" is not quite fair. Mr. HARVEY. Let us say, careless issues. Senator ADAMS. Well, they come out in that way at least. Mr. HARVEY. Yes, sir. You will find the majority of that kind of business is what we call local issues, issues that are not known outside of a comparatively small radius from where the company is. Senator ADAMS. When you get away from the big investment centers quite a large proportion of the so-called bond investments, security investments, is made in that kind of securities. Mr. HARVEY. Yes, sir; in local issues. Senator COUZENS. But that does not mean that they are always bad. Mr. HARVEY. No, sir; not at all. Senator COUZENS. Just because a house may be a small house and takes a local issue, it does not mean that it is any more dishonorable or disreputable than some big house. Mr. HARVEY. No, sir. There are some very excellent local issues put out by small houses that are all right. Senator COUZENS. Well, we do not want this to become a selfadulation meeting. I want the fact to go on our record that there small institutions that are all right. Mr. HARVEY. Certainly. And I should like very much to say that I know a great many very reputable small houses in New Orleans, in Birmingham, in Atlanta, and elsewhere, that have handled and been most careful to handle good securities, and where they afforded every necessary function in making it possible for a small corporation with perfectly good credit to do financing. Oh, yes, that has been done, sir. But when you came in the Senator from Colorado was asking me a little different question. Senator ADAMS. I did not mean to imply size in my question. I was talking about grade and not size. Mr. HARVEY. Yes. And I certainly do not want to put forth the idea that the big houses are the only righteous ones. There are plenty of others just as righteous and in my opinion just as good. But because of the fact that they cannot have trained experts, and cannot afford to keep an engineering staff, and all that kind of thing, they are not equipped to go into these matters in the way that some others do. Senator ADAMS. Senator Couzens knows that some of the big houses have the machinery to persuade us that some issues are good when they have not proven so, while some of the smaller issues may have been better. Senator COUZENS. I did not want to permit to go unchallenged on our record that just because a house was small it was not good. Mr. HARVEY. Oh, no. And I assure you that I had no such intention. Senator KEAN. Your house not only originates issues but also distributes them. Mr. HARVEY. Yes, sir. Senator KEAN. And you have, I take it, 60, 70, or 80 salesmen. Mr. HARVEY. Yes, sir; we have more than that. We have had about 120 salesmen. Senator KEAN. You have had 120 salesmen? Mr. HARVEY. Yes, sir. Senator KEAN. Now, those salesmen get a small salary and a commission? Mr. HARVEY. Yes, sir. Senator KEAN. And pressure is on you all the time to feed that number of salesmen? Mr. HARVEY. Well, I do not think a salesmen has any particular weight in what we must buy. In other words, our buying department is not going to listen to a salesman. They should be and are, I would say, in the main influenced by something else than a salesman's wishes to have more securities to sell. Senator KEAN. But the pressure is there all the time from your salesmen, who say: Give us something to sell? Mr. HARVEY. Yes, sir. Senator KEAN. That is correct, I take it? Mr. HARVEY. It is quite correct. But I do not believe that that has influenced a great deal bad financing. That is my personal opinion. The CHAIRMAN. Those 125 salesmen that you have, do they engage other salesmen to help them? Mr. HARVEY. No. They do not do anything but sell securities. The CHAIRMAN. Who is it that engages ex-school teachers, and ex-ministers sometimes, and other people of good reputation, to go about telling people: You sell your Liberty bonds; they only pay you 4 percent, and this security will pay you 8 percent? I know of instances where people have been persuaded to give up their Liberty |