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THE FEDERAL REGULATION OF SECURITY EXCHANGES.

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T H IS D IS S E R T A T IO N HAS BEEN M IC R O F IL M E D E X A C T L Y AS RE CE IVE D.
L ik rary
N. Y, UwivJ
THE FEDERAL REGULATION OF
SECURITIES EXCHANGES
by
F r e d e ric k W illiam H a rris o n
S u b m itted i n p a r t i a l f u l f i l l m e n t o f th e
re q u ire m e n ts f o r th e deg ree o f
D octor o f P h ilo so p h y
at
New York U n iv e rs ity
j u-
y '- f t . - A
\< \ A \
December, 1940
FOREWORD
In vievr o f th e im p o rta n t r o le played by s e c u r i t i e s ex­
changes in th e economic system o f th e U nited S ta te s , t h e
e f f e c t s o f t h e r e c e n t l e g i s l a t i o n r e g u la tin g exchange
p r a c t i c e s , and i n p a r t i c u l a r th e enactm ent
o f C ongress
known as th e S e c u r i t i e s Exchange A ct, w a rra n t c a r e f u l
o b s e rv a tio n .
I t i s th e purpose o f th e p r e s e n t s tu d y
( l ) t o rev iew th e f a c t o r s w hich le d to i n v e s tig a tio n o f
th e exohanges and th e f a o t s b ro u g h t o u t by th e i n v e s t i ­
g a tio n , ( 2 ) to a n a ly z e th e p r o v is io n s and scope o f th e
l e g i s l a t i o n i t s e l f , and (3) t o exam ine, and, as f a r a s i s
p o s s ib le a t t h e p r e s e n t tim e , to e v a lu a te th e r e s u l t s o f
th e l e g i s l a t i o n a s i t has been i n te r p r e te d and a d m in is te re d
by th e S e c u r i ti e s and Exohange Commission.
mm
CONTENTS
Chapter
Page
I . INTRODUCTION: THE DEVELOPMENT OF CAPITAL
MARKETS --------------------------------------------------O rig in s o f c a p i t a l m a rk e ts - - - - - - - - Groups i n t e r e s t e d i n o a p it a l m a rk e ts- - - M a rk e ts: o rg a n iz e d and u norganized - - - Economic im p o rtan ce o f c o rp o ra tio n s - - - F lo ta tio n of s e c u r itie s - - - - - - - - - Ownership o f s e c u r i t i e s - - - - - - - - - The r o l e o f s e c u r ity exch an g es- - - - - - The p la c e o f th e New York S tock Exchange- The fu n c tio n in g of' th e New York Stock Exchange
The exchanges and th e c ra s h o f 1929 - - - Demand f o r r e g u la tio n - - - - - - - - - - II.
THE CASE AGAINST THE STOCK EXCHANGESC o n c e n tra tio n o f pow er- Exchange d i s c i p l i n e - - L is tin g re q u ire m e n ts - - Exchange m achinery- - - E x te rn a l f a c t o r s - - - - M a n ip u la tiv e p r a c t i c e s - S m aller exchanges - - - Summary - - - - - - - - -
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1
3
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10
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14
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25
28
32
35
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I I I . THE DEFENSE OF THE STOCK EXCHANGES-------------S tate m en t o f f u n c tio n o f exchanges by d efe n se
D efense o f o r g a n iz a tio n a l s e t- u p and
g e n e ra l p r a c t i c e s - - - - - - - - - - - D efense o f s p e c i f i c p r a c ti c e s - - - - - - Summary o f d e fe n se o f s p e c i f i c p r a o tio e s - Small exchanges d efen d ed - - - - - - - - - C onclusions re g a rd in g th e oase a g a in s t th e
s to c k exchanges and t h e i r d e fe n s e s - - - IV. THE SECURITIES EXCHANGE ACT: CONTROL OF
EXCHANGES, BROKERS, AND SECURITIES ----------A n a ly s is o f th e A ct - - - - - - - - - - - R e g is tr a tio n o f exchanges - - - - - - - - R e g is tr a tio n o f s e c u r i t i e s on exohanges - U n lis te d t r a d in g p r iv i l e g e s - - - - - - - O v e r-th e -o o u n te f m a rk e ts - - - - ---- _ _ _ _ _
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37
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61
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64
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CONTENTS
C hapter
V. ORGANIZATION OF THE SECURITIES AND EXCHANGE
COMMISSION--------------------------------------------------The Commission: s e t- u p and p e r s o n n e l- - - Scope o f j u r i s d i c t i o n o f th e Commission- - A d m in is tra tiv e m achinery o f th e Commission Powers o f i n v e s t i g a t i o n and p r o s e c u tio n - - R ig h ts o f ap p e al to th e c o u r ts - - - - - - Power to p re v e n t f l i g h t o f s e c u r i t i e s - - - P e n a ltie s under th e S e c u r i t i e s Exchange Act
o f 1934 ---------------------------------------------------------
Page
132
133
135
137
144
149
150
151
V I. REGULATION OF CREDIT---------------------------------------------163
P ro v is io n s o f t h e A ct r e g u la tin g c r e d i t ex­
te n s io n - - - - - - - - - - - - - - - - - A n a ly sis o f R e g u la tio n "T "- - - - - - - - - Banking A cts o f 1933 and 1935 - - - - - - - R e g u la tio n "U11- - - - - - - - - - - - - - - Supplem ents to R e g u la tio n s ”T” and "U11- - - F u r th e r stu d y o f th e c r e d i t problem - - - - -
153
158
172
175
179
179
V II. SHORT SALES AND MANIPULATIVE DEVICES----------------- 182
A. SHORT SALES
D e s c rip tio n o f s h o r t s e l l i n g - - - - - - D e m o ra liz a tio n o f th e m arket th ro u g h s h o rt
s e llin g - - - - - - - - - - - - - - - - M isuse o f th e c u s to m e rs ' s to c k th ro u g h
le n d in g by b ro k e rs - - - - - - - - - - -
182
183
188
B. MANIPULATIVE DEVICES--------------------------------------191
M an ip u la tio n in g e n e r a l- - - - - - - - - 192
C o n tro l o f m a n ip u la tiv e p r a c tic e s by th e
New York S tock Exchange- - - - - - - - 194
P r o h ib itio n s a g a in s t m a n ip u la tio n under th e
S e c u r i ti e s Exchange A ct o f 1934- - - - - 197
The problem o f p r ic e s t a b i l i z a t i o n - - - - 198
R e g u la tio n o f th e use o f o p tio n s - - - - 201
F u r th e r sa fe g u a rd s a g a in s t m a n ip u la tiv e
p r a c t i c e s - - - - - - - - - - - - - - - - 202
j
CONTENTS
C hapter
Page
V I I I . THE SECURITIES EXCHANGE ACT IN OPERATION - A.
204
ROLE AND INSTRUMENTS OF THE COMMISSION - - 204
B. OPERATION OF PROVISIONS FOR BASIC CONTROL
OF EXCHANGES, SECURITIES, AND BROKERS R e g is tr a tio n o f e x c h a n g e s -----R e g is tr a tio n o f s e c u r i t i e s - - - - - - - U n lis te d t r a d in g p r i v i l e g e s - - - - - - - P ro x ie s
_ _ _ _ _ _ _ _
R e g is tr a tio n o f b ro k e rs and d e a le r s - - - -
211
211
211
216
220
226
C. OPERATION OF TRADING REGULATIONS------------------ 231
F u n c tio n s o f b ro k e rs and d e a le r s - - - - 231
S h o rt S a le s - - - - - - - - - - - - - - - 243
C o n tro l o f c r e d i t - - - - - - - - - - - - 244
D. ADMINISTRATION OF REGULATION CONCERNING
MANIPULATION AND FRAUD------------------------------- 245
M an ip u lativ e a c t i v i t y - - - - - - - - - - - 245
B roker S olvency- - - - - - - - - - - - - 261
IX. THE REFORM OF THE STOCK EXCHANGES--------------------- 270
Study o f th e exchange o r g a n iz a tio n by th e
Commission- - - - - - - - - - - - - - - - R eport o f th e "Conway Committee" - - - - - - R ev isio n o f th e New York S tock Exchange Con­
s t i t u t i o n and refo rm s i n o th e r exchanges- P ro v is io n s a g a in s t b ro k e ra g e f a i l u r e - - - - Study o f th e p ro p o sa l f o r a "b ro k e rag e bank" SUMMARY AND CONCLUSIONS'
270
280
286
287
290
292
CHAPTER I
INTRODUCTION: THE DEVELOPMENT OF CAPITAL MAMETS
O rdgine o f c a p i t a l m a rk e ts
The developm ent o f c a p i t a l and c a p i t a l m ark ets can n o t be s e p a ra te d
from th e grow th o f th e exchange economy, w hich i s commonly c h a r a c te r iz e d
b y (1) d i v i s i o n o f l a b o r , (2) exchange, (5) p r iv a te p r o p e r ty , and ( 4 )
freedom o f c o n tr a c t.
Through d iv is io n o f la b o r goods a r e produced f o r the m a rk e t, and
i t i s o n ly th ro u g h t h i s means t h a t exchangeable p ro d u c ts a r e produced
i n s u f f i c i e n t q u a n tity t o be o f consequence.
Through exchange, s u rp lu s
p ro d u c ts a r e d i s t r i b u t e d t o th o se who need o r d e s ir e them, and th e de­
g re e t o w hich exchange ta k e s p la c e d e te rm in e s th e l i m i t to w hich d iv is io n
o f la b o r may be c a r r i e d .
P r iv a te p r o p e r ty r i g h t s a re lik e w is e ch a ra c ­
t e r i s t i c o f th e exchange economy, s in c e p r iv a te c o n tr o l o v e r goods n o t
o n ly f u r n is h e s I n c e n tiv e t o p ro d u c tio n , b u t i s a n e c e s s a ry elem en t i n
th e p ro c e s s o f exchange.
F i n a l l y , freedom o f c o n tr a c t e x i s t s w herever
p ro d u c tio n p ro c e ss e s have been developed beyond th e s ta g e o f in d iv id u a l
h a n d i c r a f t , s in c e developm ent beyond t h i s s ta g e n e c e s s i t a t e s agreem ent
betw een in d iv id u a ls o r g ro u p s.
Such agreem ents o r d in a r i l y c o n ta in
s u f f i c i e n t f l e x i b i l i t y to m eet th e demands o f changing s i t u a t i o n s , and
y e t a r e r i g i d enough to form a b a s is f o r u n ite d a c tio n .
The mere e x is te n c e o f th e s e and o th e r c h a r a c t e r i s t i c s , how ever,
n o t synonymous w ith th e e x is te n c e o f
commonly u sed .
an exchange economy as th e
is
term i s
They must n o t o n ly e x i s t i n a s o c ie ty , b u t th e y m ust e x i s t
i n such a d eg ree and i n such r e l a t i o n s h i p to each o th e r as t o g iv e t h a t
s o c ie ty m o tiv a tio n and d i r e c t i o n .
-
2-
C o in cid en t w ith the development o f an exchange economy i s th e
developm ent o f c a p i t a l .
Adam S m ith p o in ts o u t t h a t b e fo re d i v i s i o n o f
la b o r can ta k e p la c e a su p p ly o f goods t o m a in ta in th e l a b o r e r w h ile he
1
i s m a n u fa c tu rin g a s p e c ia liz e d p ro d u c t i s an a b s o lu te n e c e s s i t y .
When t h i s p ro c e s s has s t a r t e d , th e e x te n t t o w hich th e exchange
economy may d ev elo p i s d eterm in e d by th e s v p p ly o f c a p i t a l w hich i s
a v a ila b le t o be employed i n p ro d u c tio n .
S in c e b u s in e s s and in d u s tr y d e riv e
t h e i r income from s a l e s , th e y m ust p o s se s s a su p p ly o f c a p i t a l to command
th e n e c e s s a ry in s tru m e n ts o f p ro d u c tio n and m eet o p e r a tin g ex p en ses b e fo re
t h e i r p ro d u c ts a re m ark eted .
p a r t o f exchange economy.
Hence, th e developm ent o f c a p i t a l i s a v i t a l
The grow th o f c a p i t a l m ark ets i s th e l o g i c a l
outcome o f th e n e c e s s ity f o r a l l o c a t i o n o f c a p i t a l to v a r io u s p ro d u c tiv e
uses.
The e x te n t t o w hich c a p i t a l m ark ets d e v e lo p , how ever, i s d eterm in ed
2
by th e m atu re o f th e c ir c u n s ta n c e s i n w hich an exchange economy o p e r a te s .
Under c ir c u n s ta n c e s where th e developm ent o f in d u s tr y and tr a d e i s slow ,
and where l a r g e s u rp lu s e s o f c a p i t a l have n o t a c c u n u la te d i n th e hands
o f p e rso n s who a re u n ab le o r u n w illin g to use them i n t h e i r own e n t e r p r i s e s ,
t h e r e i s l i t t l e o c c a s io n f o r th e t r a n s f e r o f c a p i t a l .
T h e re fo re , i t would
be e x p e c te d t h a t c a p i t a l would be a c c u n u la te d f o r th e m ost p a r t th ro u g h
sa v in g s by th o s e engaged i n p a r t i c u l a r k in d s o f a c t i v i t y , and used by them
f o r e x p a n sio n o f th e s e e n t e r p r i s e s w ith o u t r e s o r t to c a p i t a l m a rk e ts .
In th e economic developm ent o f W estern Europe and A m erica, s u rp lu s e s
1
Adam S m ith , An I n q u ir y i n t o th e N ature and C auses o f th e W ealth o f N a tio n s .
(Random H ouse, I n c . , New Y ork, 1957"), Edwin Cannan, E d ., Book I I , I n tr o d u c tio n
p p .259-260.
2
I b i d . , Ch.V, p p .541-547.
1
-5 -
a p p e ar to have d ev elo p ed a t an e a r l y d a te .
Duguld m entions th e f a c t
t h a t a s e a r l y a s th e r e ig n o f W illiam I I I th e r e were s u rp lu s e s which
3
sought an o u t l e t , and found i t i n th e nK ingf s D eb t". L ik e w ise , in th e
U nited S t a t e s , a f t e r th e a d o p tio n o f th e C o n s t itu t io n , R e v o lu tio n a ry War
d e b t f u rn is h e d an o u t l e t f o r s u rp lu s s a v in g s .
Under th e le a d e r s h ip o f
H am ilto n , th e F e d e r a l Government assumed r e s p o n s i b i l i t y f o r b o th i t s
own d e b ts and th o s e o f th e s t a t e s .
The combined d e b t was fu n d ed , w ith
th e r e s u l t t h a t th e i n v e s t i n g p u b lic was p ro v id e d w ith l e g a l claim s w hich
were r e a d i l y t r a n s f e r a b l e .
W hile th e fu n d in g o f th e d e b t i n i t s e l f r e ­
p r e s e n te d no p a r t i c u l a r change i n th e m ethods th e n g e n e r a lly used f o r
r a i s i n g c a p i t a l , th e s e c u r i t i e s is s u e d f o r t h i s p u rp o se gave r i s e to a
m arket i n w hich l e g a l c la im s i n c a p i t a l m ig h t be exchanged.
Groups i n t e r e s t e d i n c a p i t a l m arkets
T rade i n s e c u r i t i e s on such m ark ets gave r i s e to a system o f o p e r a tio n s
c a r r i e d on by v a r io u s i n d iv id u a ls who a re i n t e r e s t e d i n making a p r o f i t .
C o l l e c t i v e l y , th e y may be th o u g h t o f a s groups whose i n t e r e s t s a r e some­
tim e s i d e n t i c a l and som etim es opposed, depending upon c irc u m s ta n c e s .
The
b r o k e r s , i n th e n arrow se n se o f th e term , a r e i n t e r e s t e d in com m issions
o b ta in e d from th e p u rc h a se and th e s a le o f s e c u r i t i e s f o r o t h e r s .
They
may, how ever, and u s u a lly do o p e ra te f o r t h e i r own a c c o u n t a s w e ll; th e y
a r e , th e r e f o r e i n t e r e s t e d i n p r ic e changes o f which th e y may ta k e advan­
ta g e f o r t h e i r own b e n e f i t .
The i s s u e r s o f s e c u r i t i e s , w hether govern­
m e n tal u n i t s o r p r i v a t e c o r p o r a tio n s , a r e i n t e r e s t e d i n making s a le s a t
th e h ig h e s t p o s s ib le f i g u r e .
The in v e stm e n t b a n k e rs, who a c t a s in te rm e d i­
a r i e s betw een i s s u e r s o f s e c u r i t i e s and th e c a p i t a l m a rk e ts, a r e lik e w is e
i n t e r e s t e d i n o b ta in in g th e b e s t p r ic e s f o r th e s e c u r i t i e s w hich th e y s e l l .
3
C h a rle s Duguid, The S to ry o f th e S tock Exchange. (G ra n t R ic h a rd s , London,
1 9 0 1 ), Ch. 1 , p . 4 .
The le n d e r s o f money w ith which s e c u r i t i e s a re fin a n c e d a r e i n t e r e s t e d in
l a r g e lo a n s and h ig h i n t e r e s t r a t e s .
The in v e s to r s d e s ir e t o buy claim s
t o income a t th e lo w e s t p o s s ib le p r i c e .
There a re a ls o th e s p e c u la to r s ,
who o p e r a te f o r p r o f i t on p r ic e d if f e r e n c e s .
They d i f f e r from b ro k e rs
who tr a d e f o r t h e i r own a c c o u n t, i n t h a t th e y d e riv e income from p r o f i t s
o n ly , an d , e x c e p t p e rh ap s f o r a few who o p e r a te on a la r g e s c a l e , th e y
a r e n o t i n a p o s i t i o n to o b ta in th e n e c e s s a ry knowledge o f m arket condi­
t i o n s f o r s u c c e s s f u l o p e r a tio n .
F in a lly th e r e i s th e governm ent, which
o c c u p ie s a changing p o s i t i o n w ith r e l a t i o n t o th e o th e r groups in v o lv e d ,
a s i t i s co n cern ed w ith th e e f f i c i e n t o p e r a tio n and th e e f f e c t s on th e
p u b lic w e lf a re o f th e mechansim as a w hole.
M ark etsi o rg a n iz e d and u n o rg an ized
The m ark ets i n w hich s e c u r it y tr a d in g ta k e s p la c e a r e o f two kinds*
( l ) o rg a n iz e d , and (2 ) u n o rg an ized .
The o rg a n iz e d m ark et, o f which th e
New York S to ck Exchange i s th e most n o ta b le example i n th e U n ited S t a t e s ,
o p e r a te s under a h ig h ly developed s e t o f r u l e s , which f a c i l i t a t e th e tr a d in g
p ro c e s s and p r e s c r ib e th e co n d u ct o f th e p e rso n s in v o lv e d .
The member­
s h ip i s u s u a lly l i m i t e d , and o n ly members a re p e rm itte d to tr a d e th e r e .
T ra d in g i s done by o u t s i d e r s th ro u g h th e medium o f members, who charge a
com m ission and impose such c o n d itio n s upon t h e i r tr a n s a c tio n s as have been
a g re ed upon by th e g o v e rn in g o f f i c i a l s o f th e m ark et.
Not o f l e a s t im­
p o rta n c e among th e r u l e s o f o rg a n iz e d s e c u r it y m ark ets a re th e c o n d itio n s
p r e s c r ib e d f o r th e p u rp o se o f r e g u la tin g th e ty p e o f s e c u r i t y tra d e d i n .
These c o n d itio n s l i m i t exchange tr a d in g to th e is s u e s o f th e l a r g e r and
b e t t e r known c o r p o r a tio n s which e n jo y a broad p u b lic d i s t r i b u t i o n o f t h e i r
s e c u r i t i e s and w hich a r e a b le and w illin g to f u r n i s h r e q u ir e d in fo rm a tio n
-5 c o n c e rn in g t h e i r o p e r a tio n s and c o n d itio n .
I t i s on th e s e m ark ets t h a t a
g r e a t d e a l o f s p e c u la tio n ta k e s p la c e .
U norganized m ark ets a r e m ark ets which have l e s s co m p reh en siv ely worked
o u t s e t s o f r u l e s , and w hich do n o t p o s s e s s th e d eg ree o f fo rm al o r g a n iz a tio n
fo u n d i n o rg a n iz e d m a rk e ts.
W hile, s t r i c t l y sp eak in g th e term "u n o rg a n iz ed
m arket" m ust be b ro ad enough to in c lu d e a l l s e c u r ity s a le s o th e r th a n
th o s e w hich ta k e p la c e on o rg a n iz e d ex changes, i t d e r iv e s i t s m ajor im­
p o rta n c e th ro u g h i t s i n c lu s io n o f th e " o v e r -th e - c o u n te r" m a rk e ts.
O ver-
t h e - c o u n te r m ark ets a r e made up o f s e c u r ity b ro k e rs and d e a le r s who tra d e
d i r e c t l y w ith cu sto m ers and ea c h o th e r , e n t i r e l y a p a r t from th e ex ch an g es.
W hile t h e i r a c t i v i t i e s a r e l a r g e l y c o n c e n tra te d i n th e f i n a n c i a l c e n te r s ,
f ir m s o f t h i s c h a r a c te r may be found th ro u g h o u t th e c o u n try .
I n th e s e
m a rk e ts th e s e c u r i t i e s o f th e s m a lle r and l e s s w e ll known c o r p o ra tio n s
a r e tra d e d *
F u rth e rm o re , by f a r th e g r e a t e r p a r t o f bond t r a d in g i s done
" o v e r - th e - c o u n te r " .
I n s h o r t , th e o v e r -th e - c o u n te r m arkets p ro v id e f a c i l ­
i t i e s f o r d e a lin g i n a l l o f th o s e s e c u r i t i e s w hich, f o r one r e a s o n o r
a n o th e r a r e n o t o r can n o t be l i s t e d on th e o rg a n iz e d exch an g es.
I t is
d i f f i c u l t to a p p r a is e th e q u a l i t y o f o v e r -th e - c o u n te r is s u e s b ecau se
th e y ran g e from th e h ig h e s t grade bonds, such a s U nited S ta te s govern­
m ent b o n d s, to th e m ost s p e c u la tiv e s to c k s .
I n g e n e r a l, th e s e s e c u r i t i e s
p o s s e s s one o r more o f th e fo llo w in g c h a r a c t e r i s t i c s : lim ite d d i s t r i b u t i o n ,
4
h ig h p r i c e , o r d e s i r a b i l i t y f o r th e p o r t f o l i o s o f i n s t i t u t i o n a l b u y e rs .
O v e r-th e -c o u n te r m ark ets have p re s e n te d c o n s id e ra b le o p p o r tu n ity
4
T w e n tie th C en tu ry Fund, S to ck M arket C o n tro l. (D .A ppleton C en tu ry Company,
I n c . , New York and London, 1 9 5 4 ), C h .I I I , p p .£ 0-21.
I
-6 -
f o r abuse o f th e in v e s tin g p u b lic by d e a le r s .
Because o f th e la c k o f
c lo s e q u o ta tio n s on s e c u r i t i e s tra d e d i n th e s e m a rk e ts, i t i s
v e ry -
d i f f i c u l t f o r th e av erag e custom er to check th e p r ic e s which may be q u o ted
to him.
He i s th e r e f o r e more o r l e s s a t th e mercy o f th e d e a l e r , u n le s s
he engages a b ro k e r to t r a n s a c t h i s b u s in e s s f o r him .
Large i n s t i t u t i o n a l
b i^ re rs , on th e o th e r hand, a r e i n a much s tr o n g e r p o s it i o n , s in c e th e y
u s u a lly employe e x p e r ts who a r e f a m i l i a r w ith th e m a rk e ts.
W hile o rg a n iz e d
exchanges a r e e s s e n t i a l l y f r e e from t h i s ty p e o f a b u se , t h e i r f a c i l i t i e s
5
le n d th em se lv es t o s p e c u la tio n and p r ic e m a n ip u la tio n .
Economic im p o rtan ce o f c o r p o ra tio n s
The f l o t a t i o n o f c o r p o ra te s e c u r i t i e s i n th e c a p i t a l m ark ets h as
p e rm itte d th e b u s in e s s u n i t t o expand i n s i z e , and h as given r i s e t o a
h ig h d e g ree o f i n t e g r a t i o n i n th o s e a r e a s where such a co u rse i s p r a c t i ­
c a b le e i t h e r from th e p o in t o f view o f te c h n ic a l o r b u s in e s s e f f i c i e n c y .
The t r a n s i t i o n to la r g e s c a le e n t e r p r i s e was accom plished i n th e U n ited
S t a t e s a f t e r 1880, and betw een t h i s tim e and th e p r e s e n t th e vise o f th e
c o rp o ra te form has in c r e a s e d r a p i d l y .
F u rth e rm o re , th e s iz e o f c o rp o ra te
e n t e r p r i s e s has te n d e d to in c r e a s e t o keep s te p w ith th e n e c e s s i t i e s o f
te c h n ic a l and economic c o n d itio n s .
The f o llo w in g t a b l e sh ed s c o n s id e ra b le l i g h t on th e economic
s tr u c t u r e o f to d a y w ith re g a rd to th e s iz e o f p roducing u n i t s :
5
T w e n tie th C en tu ry Fund, The S e c u r ity M a rk e ts. (T w en tieth C en tu ry Fund,
I n c . , New Y ork, 1 9 5 5 ), C h .V III, pp.207suid 269.
i
-7 D i s tr i b u t l o n o f P ro d u cin g U n its
6
and t h e i r Employment by Number Employed, 1957
(ro u n d f ig u r e s )
Number
Employed
1
6
S00
1000
10000
No. o f P ro d u cin g
U n its
----------- 5
--------299
--------999
- - 9999
- -& o v e r
T o ta l
% o f T o ta l
Employed
9 ,3 6 6 ,0 0 0 - 1 0 ,8 6 8 ,0 0 0
696,564
11,762
3,549
246
30-35
28-35
9-12
12-16
11-14
1 0 , 0 0 0 ,0 0 0 - 1 2 , 0 0 0 ,0 0 0
100
I t sh o u ld be n o te d t h a t o v e r l / 5 o f th e man power engaged i n p ro d u c tio n
i n 1957 was a tta c h e d to u n i t s o f 300 p eo p le o r m ore, and t h a t ap p ro x i­
m a te ly 1 /8
was employed by u n its o f 1 0 ,0 0 0 p e o p le o r more.
Such u n its
demand la r g e q u a n t i t i e s o f c a p i t a l , w hich can s c a r c e ly be su p p lie d e x c e p t
th ro u g h c o r p o ra te o r g a n iz a tio n .
I n th e f i e l d o f m an u fa c tu rin g , 92% o f
a l l income i s d e riv e d from c o r p o r a tio n s .
T h is f ig u r e i s exceeded o n ly i n
th e case o f th e m ining and q u a rry in g i n d u s t r i e s , where c o r p o ra tio n s acco u n t
f o r 96% o f th e incom e; i t I s approached o n ly by th e t r a n s p o r t a t io n and
p u b lic u t i l i t i e s i n d u s t r i e s , i n w hich 86 % o f th e income I s a t t r i b u t a b l e
7
to c o r p o r a tio n s . I t does n o t fo llo w , how ever, t h a t th e f i e l d s i n which
th e c o r p o ra te form i s m ost p r e v a le n t c o n ta in th e l a r g e s t and m ost a l l
6
N a tio n a l R eso u rces C om m ittee, S tr u c tu r e o f th e American Economy. (U .S.
Government P r i n t i n g O f f i c e , W ashington, D .C ., 1 9 5 9 ), P a r t I , C h .V II, pp.
99-101.
7
T w e n tie th C en tu ry Fund, I n c . , B ig B u s in e s s : I t s Growth and i t s P la c e .
(New York, 1 9 5 7 ), C h .I , p . 17.
I
-8 em bracing c o rp o ra te o r g a n iz a tio n s , a lth o u g h th e r e a p p e a rs t o be a te n ­
dency i n t h i s d i r e c t i o n .
When s iz e o f b u s in e s s u n it i s c o n s id e re d in s t e a d o f p re v a le n c e o f
th e c o rp o ra te form , i t i s n o t i n m ining o r m a n u fa c tu rin g t h a t c o rp o ra te
im p o rtan ce i s g r e a t e s t .
A s tu d y ( a s o f 1955) s t a t e s t h a t 95 o u t o f thB
200 l a r g e s t c o r p o ra tio n s (b ased on v a lu e o f a s s e t s c o n tr o lle d ) a r e r a i l ­
ways o r u t i l i t i e s .
The r a i l r o a d s i n t h i s l i s t and t h e i r s u b s i d i a r i e s o p e ra te
o v er 90 p e r c e n t o f th e r a i l r o a d m ileag e i n th e c o u n try .
The u t i l i t i e s i n
th e l i s t a cc o u n t f o r o v e r 80 p e r c e n t o f th e power p ro d u c tio n , o v er 90
p e r c e n t o f th e te le p h o n e s e r v ic e , p r a c t i c a l l y a l l o f th e te le g r a p h s e r ­
v ic e , and a la r g e p a r t o f th e r a p id t r a n s i t s e r v ic e s i n New Yoric, C hicago,
P h ila d e lp h ia , B o sto n , and B a ltim o re .
Of th e rem ain in g 107 c o rp o ra tio n s
i n th e l i s t 84 a r e m a n u fa c tu rin g u n i t s , 10 m erch an d izin g u n i t s , 9 m ining
u n i t s , and 4 m is c e lla n e o u s .
M an u factu rin g com panies on t h i s l i s t com prise
a much s m a lle r p r o p o r tio n o f a l l m a n u fa c tu rin g a s s e t s th an i n th e case
8
o f th e ra ilw a y s and u t i l i t i e s . N e v e r th e le s s , th e 100 l a r g e s t m anufactur­
in g com panies i n 1955 employed 20.7 p e r c e n t o f a l l man power engaged in
m a n u fa c tu rin g , c o n tr ib u te d 24.7 p e r c e n t o f a l l th e v a lu e added i n manu­
f a c t u r i n g a c t i v i t y , and acco u n ted f o r 5 2 .4 p e r c e n t o f the v alu e o f
p ro d u c t o f a l l m a n u fa c tu rin g p l a n t s .
I t i s a ls o e s te ira a te d t h a t due to
th e f a c t t h a t th e l a r g e r c o r p o ra tio n s r e p r e s e n t a l a r g e r p r o p o rtio n a l
c a p i t a l in v e s tm e n t, more th a n
l / 5 o f th e m an u fa c tu rin g p la n ts I n th e
c o u n try a r e o p e ra te d by th e 100 l a r g e s t c o r p o r a tio n s , even though th e y
employ o n ly i / 5 o f th e man power.
L ik e w is e , i n th e f i e l d o f m ining
8
N a tio n a l R eso u rces Com m ittee, o p . c i t . . P a r t I , Ch. V II, p . 101.
-9 -
( i r o n and a n t h r a c i t e c o a l) a few la r g e c o r p o r a tio n s do a la r g e p r o p o rtio n
o f th e b u s in e s s .
T h ey
a l s o h an d le a s i g n i f i c a n t p a r t o f t h e n o n -fe rro u s
9
m e ta ls and p e tr o le tm .
The f i n a n c i a l f i e l d te n d s t o be c h a r a c te r iz e d by c o n s id e ra b le
c o n c e n tr a tio n a l s o .
T h ir ty banks h o ld 5 4 .5 p e r c e n t o f th e ban k in g a s s e t s
o f th e c o u n try (F e d e ra l R eserv e Banks e x c lu d e d ).
n e s s c o n c e n tr a tio n i s much more a p p a re n t.
I n th e l i f e in s u ra n c e b u s i­
S eventeen l i f e in s u ra n c e com­
p a n ie s c o n tr o l 8 1 .5 p e r c e n t o f th e a s s e t s o f a l l l i f e in s u ra n c e com panies.
The in v e stm e n t t r u s t b u s in e s s i s marked by th e im p o rtan ce o f th r e e la r g e
in v e stm e n t t r u s t s .
T his c o n c e n tra tio n i s n o t so e v id e n t i n w h o le sla e and r e t a i l tr a d e
where 10 m erch an d isin g houses I n th e l i s t o f th e 200
p la y a s i g n i f i c a n t b u t n o t a dom inating r o l e .
l a r g e s t c o rp o ra tio n s
These te n c o r p o ra tio n s
a c c o u n t f o r som ething below 8 p e r c e n t o f t o t a l r e t a i l s a l e s .
The same
s i t u a t i o n o b ta in s i n th e c a s e o f com panies, o th e r th a n p u b lic u t i l i t i e s ,
w hich s e l l s e r v ic e s r a t h e r th a n goods.
I n th s m otion p i c t u r e I n d u s tr y ,
t h e r e a r e th r e e im p o rta n t c o r p o ra tio n s b u t m ost com panies w hich s e l l
10
s e r v ic e s a re o f sm all o r medium s i z e .
A good g e n e ra l p i c t u r e o f th e s ig n if ic a n c e o f l a r g e c o rp o ra te
b u s in e s s may be o b ta in e d from th e fo llo w in g t a b l e , w hich I s b ased upon
c o rp o ra te r e tu r n s f i l e d w ith t h e B ureau o f I n t e r n a l Revenue i n 1955.
9
N a tio n a l R esources Com m ittee, o p . c l t . . P a r t I , Ch. V II, p p .102-103.
10
I b i d . . p . 105
- lo ­
ll
S iz e o f C o rp o ra tio n s b y A s se ts i n 1955
A sset c la s se s
by th o u sa n d s
o f d o lla rs
P e rc e n ta g e o f t o t a l
c o r p o ra tio n s su b m ittin g re tu rn s
Under 50
50100
250
100 500
250500- 1000
1 , 000 - 5000
5 ,0 0 0 - 10000
1 0 , 000 - 50000
50,000 and o ver
P e rc e n ta g e o f t o t a l
a s s e t s owned by c o r p o r a tio n s s u b m ittin g
54.7
1 4 .1
1 4 .0
6 .0
4 .4
4 .4
.7
.6
.2
r e tu r n s
1 .5
1 .4
3 .0
3 .3
4 .2
1 2 .6
6 .4
1 6 .2
51.5
I t i s e v id e n t from th e fo re g o in g t h a t th o s e c o r p o r a tio n s w hich must
r e s o r t t o b ro ad p u b lic m arkets f o r t h e i r c a p i t a l a r e o p e r a to r s o f r a i l r o a d s ,
p u b lic u t i l i t i e s , la r g e m an u fa c tu rin g e n t e r p r i s e s , f i n a n c i a l i n s t i t u t i o n s ,
and o th e r b u s in e s s e s o f a s im i l a r l y im p o rta n t c h a r a c t e r .
F u rth e rm o re , th e
c o r p o ra te form p r e v a i l s i n economic a r e a s where th e b u s in e s s u n i t i s r e l a ­
t i v e l y s m a lle r th a n ±n th o s e J u s t m en tio n ed , b u t i s n e v e r th e le s s la r g e
enough t o p ro v id e s e c u r i t i e s f o r p u b lic s a le b o th on exchanges and i n un­
o rg a n iz e d m a rk e ts.
F lo ta tio n o f s e c u ritie s
The f l o t a t i o n o f s e c u r i t i e s on p u b lic m ark ets has r e f l e c t e d th e grow th
o f c o r p o r a tio n s .
P r i o r t o 1890, e x c e p t f o r th e p e rio d o f governm ent f in a n ­
c in g d u rin g t h e C i v i l War, r a i l r o a d s e c u r i t i e s c o n s itu te d th e m ost im p o rta n t
medium o f in v e stm e n t.
By 1890 u t i l i t y com panies had become o f s u f f i c i e n t
im p o rtan c e t o a p p e a r on th e New York S to c k Exchange l i s t i n la r g e num bers.
7 5 th C o n g ., 3rd S e s s ., P u b . R es. N o.1 1 3 , H earin g s b e fo re th e Temporary
N a tio n a l Economic Com m ittee, e x h ib it n o . 57, ap p en d ix , p . 229
-li­
l t was n o t u n t i l 1900 t h a t I n d u s t r i a l s e c u r i t i e s were l i s t e d on th e Ex­
change t o any g r e a t e x t e n t , a lth o u g h a few of them had been a d m itte d to
u n l i s t e d tr a d in g s e v e r a l y e a r s b e f o r e .
N e v e r th e le s s , r a i l r o a d i s s u e s main­
t a i n e d a p o s it i o n o f prime im p o rta n c e , and betw een 1907 and 1914 r a i lr o a d s
is s u e d s e c u r i t i e s a t t h e r a t e o f a b o u t a b i l l i o n d o l l a r s a n n u a lly .
During
th e same p e rio d u t i l i t i e s and i n d u s t r i a l is s u e s combined av erag ed ab o u t
12
650 m i l l i o n s .
From 1915 to 1919 th e c h ie f o f f e r i n g o f s e c u r i t i e s c o n s is te d o f gov­
ernm ent bonds, which in c re a s e d i n amount o u ts ta n d in g betw een 1917 and 1919
by 24 b i l l i o n
d o lla rs .
I s s u e s o f r a i l r o a d s e c u r i t i e s d e c lin e d a f t e r
1914, re a c h in g a low p o in t o f 237 m illio n s I n 1918, w h ile th o s e o f u t i l i t i e s
and i n d u s t r i a l s in c re a s e d r a p i d l y , th e fo rm er f l o a t i n g new i s s u e s v alu ed
a t 547 m illio n s and th e l a t t e r is s u e s v a lu e d a t ab o u t 2 .1 b i l l i o n s i n 1919.
Between 1919 and 1939, p u b lic u t i l i t i e s and i n d u s t r i a l e n t e r p r i s e s
w ere th e m ost im p o rta n t i s s u e r s o f s e c u r i t i e s .
From 1924 t o 1929, p u b lic
u t i l i t i e s is s u e d s e c u r i t i e s a t a r a t * o f 1 .5 b i l l i o n s a n n u a lly , w h ile
i n d u s t r i a l s e c u r i t i e s were is s u e d a t an a n n u a l r a t e o f 1 .7 b i l l i o n s .
W hile is s u e s o f r a i l r o a d s e c u r i t i e s in c r e a s e d d u rin g th e s e y e a r s , c a p i t a l
i s s u e s av erag ed o n ly 499 m illio n s a n n u a lly between 1921 and 1929.
R eal
e s t a t e was th e m ost im p o rta n t o u t l e t f o r c a p i t a l d u rin g t h i s p e r io d ,
c a l l i n g on an av erag e f o r ab o u t 2 .6 b i l l i o n d o l l a r s p e r y e a r, b u t r e a l
e s t a t e s e c u r i t y i s s u e s av eraged a n n u a lly o n ly about 590 m i lli o n s .
S ta te
and l o c a l governm ents a ls o in c r e a s e d i n im p o rtan ce a s i s s u e r s o f s e c u r i t i e s
d u rin g th e s e y e a r s .
Between 1921 and 1929 th e s e s e c u r i t i e s in c r e a s e d
12
B i r l E. S h u ltz , S tock Exchange P ro c e d u re . (N.Y. S to ck Exchange I n s t i t u t e ,
1 9 3 6 ), p p .14 and 16} and M oulton, Edw ards, Magee, and L ew is, C a p ita l Expansion
Employment, and Economic S t a b i l i t y , (B rookings I n s t i t u t i o n , W ash in g to n ,1 9 4 0 ), *
p p .8 -9 .
13
C a p ita l E x p a n sio n .pp. 10-13
-1 2 i n o u ts ta n d in g amount from a b o u t 8 .5 b i l l i o n s to 1 6 .8 b i l l i o n s o f d o l l a r s .
Meanwhile th e f e d e r a l d e b t had been re d u c e d , re a c h in g a t o t a l o f a b o u t
16 b i l l i o n s o f d o l l a r s i n 1950, a d e c re a s e o f a b o u t 9 b i l l i o n s .
F o re ig n
in v e s tm e n ts in c r e a s e d i n an n u al amount d u rin g t h i s p e r io d ; betw een 1907 and
1914 th e av erag e an n u al f l o t a t i o n was a b o u t 35 m illio n s o f d o l l a r s , w h ile
betw een 1921 and 1928 th e av erag e an n u al f ig u r e was 800 m i l lio n s .
L ik e ­
w ise th e tw e n tie s e x p e rie n c e d a r a p id grow th i n in v e stm e n t t r u s t s , h o ld in g
and t r a d in g com panies.
S e c u r iti e s is s u e d by th e s e com panies in c r e a s e d
from a b o u t 15 m illio n s o f d o l l a r s i n 1925 t o s l i g h t l y o v er 2 b i l l i o n s i n
14
1929.
The d e p re s s io n y e a rs have been c h a r a c te r iz e d by a marked sh rin k a g e
i n new c o r p o ra te is s u e s o f th e ty p e s w hich were o f p rim ary im p o rtan ce i n
th e t w e n t i e s , and, a f t e r 1952, by a predom inance o f f e d e r a l f in a n c in g .
Some i d e a o f th e im p o rtan ce a t ta in e d by s e c u r i t y f l o t a t i o n i n r e c e n t
y e a rs can be g a in e d , however, from e s tim a te s o f th e t o t a l m arket v a lu e
o f o u ts ta n d in g s e c u r i t i e s i n 1932 and 1934; th e f ig u r e f o r th e form er
d a te , w hich r e p r e s e n ts th e lo w e st l e v e l o f th e d e p re s s io n and w hich p re ­
ceded th e g o v ern m en t's program o f e x p a n sio n , i s p la c e d a t a t l e a s t 100
b i l l i o n s o f d o l l a r s , w h ile th e f ig u r e f o r March 1934 i s e s tim a te d a t a t
15
l e a s t 160 b i l l i o n s o f d o l l a r s .
O w nership o f s e c u r i t i e s
S e c u r i t i e s w hich a re b o u th and s o ld i n p u b lic m arkets (o rg a n iz e d
and u n o rg a n iz e d ), have come to r e p r e s e n t n e a r l y h a l f o f our n a t i o n a l
w e a lth .
Many o f them , l a r g e l y bonds, a r e h e ld by banks and l i f e in su ra n c e
14
C a p ita l E x p a n sio n , p p .1 3 -16.
15
The S e c u rity M arkets, p.35
-1 5 -
com panies, th e r e b y r e p r e s e n tin g th e s a v in g s o f many in d i v i d u a l s .
The
m agnitude o f th e s e h o ld in g s a t t h e lo w e st p o i n t o f th e d e p re s s io n i s
shown i n th e f o llo w in g t a b l e :
16
S e c u r i t i e s H eld b y Banks and In s u ra n c e Companies
(1932)
Bonds
S to ck s
N a tio n a l Banks
$ 6 ,7 5 2 ,0 0 0 ,0 0 0
$ 2 0 5,000,000
S t a t e B anks, and
Loan and T r u s t Cos.
6 ,0 8 5 ,0 0 0 ,0 0 0
384,000,000
S av in g s Banks
4 ,4 0 0 ,0 0 0 ,0 0 0
1 4 5 ,0 0 0 ,0 0 0
L if e In s u ra n c e C os.
6 ,5 0 0 ,0 0 0 ,0 0 0
524,000,000
____________
F ed. R es. Banks
1 .8 6 0 .0 0 0 .0 0 0
$ 2 5 ,5 9 7 ,0 0 0 ,0 0 0
$ 1 ,2 6 8 ,0 0 0 ,0 0 0
C o lle g e s , h o s p i t a l s , and o th e r i n s t i t u t i o n s o f s im i l a r c h a r a c te r l i k e ­
w ise have l a r g e h o ld in g s o f s e c u r i t i e s .
I t has been e s tim a te d t h a t a t
l e a s t f i f t y m i llio n p eo p le a r e i n d i r e c t l y i n t e r e s t e d I n s e c u r i t y v a lu e s .
The number o f in d iv i d u a l s e c u r i t y h o ld e rs i s d i f f i c u l t to d e te rm in e .
I t h as heen e s tim a te d , i n a T w en tie th C entury Fund s tu d y , t h a t b o n d h o ld ers
i n th e U n ited S t a t e s i n 1932 were betw een s ix and t e n m il lio n .
S tock­
h o ld e rs i n th e U n ited S t a t e s were e s tim a te d a t betw een f iv e and s i x m illio n
17
i n 1927, and betw een n in e and e le v e n m illio n i n 1930.
W hile th e number o f s to c k h o ld e rs i s la r g b , th e g r e a t b u lk o f th e
s to c k i s i n th e hands o f th e w e a lth y .
Only tw e n ty p e r c e n t o f a l l sto c k
d iv id e n d s went to p eo p le w ith incom es o f under $ 5 ,0 0 0 betw een 1927 and
1930.
Not more th a n te n p e r c e n t o f th e e s tim a te d s to c k h o ld e r s owned
n o t l e s s th a n t h r e e - f o u r t h s o f th e t o t a l c o rp o ra te s to c k h e ld by i n d i v i d u a l s .
I n 1930 p e rso n s w ith incom es to o sm all t o f i l e an income t a x r e t u r n con­
s t i t u t e d s e v e n ty - f iv e p e r c e n t o f th e t o t a l s to c k h o ld e r s , b u t th e y h eld
16
S tock M arket C o n tr o l, p . 3
K e S e c u r ity M ark ets f p . 60
-1 4 -
l e a s th a n f i f t e e n p e r c e n t o f th e s to c k .
On th e o th e r hand, te n thousand
i n d i v i d u a l s , a b o u t one t e n t h o f one p e r c e n t o f th e w hole, r e c e iv e d tw en ty
p e r c e n t o f th e c o r p o ra te d iv id e n d s tls t y e a r .
When allo w an ce i s made,
how ever, f o r th e f a c t t h a t p eo p le i n m oderate c irc u m sta n c e s can l e s s
w e ll a f f o r d to lo s e money, t h i s
o f i t s s ig n i f i c a n c e .
c o n c e n tra tio n o f ow nership lo s e s some
I f we assume t h a t th e T w en tie th C en tu ry Fund f ig u r e s
a re a p p ro x im a te ly a c c u r a te , even though we a ls o assume t h a t th o s e who
own s to c k a ls o own b onds, i t i s a p p a re n t t h a t ev e ry n in th o r te n th man,
woman, and c h ild i n th e U n ited S ta te s has a d i r e c t i n t e r e s t i n th e s e c u r i ty
m a rk e ts.
18
th r e e .
T h is may be I n te r p r e t e d to mean a t l e a s t one f a m ily o u t o f ev e ry
The r o l e o f s e c u r i t y exchanges
O rg an ized exchanges have come to p la y a c e n t r a l r o l e i n th e s e c u r it y
m ark ets o f th e U nited S t a t e s .
I t has been e s tim a te d t h a t 64% o f th e
t o t a l v a lu e o f bonds and 70% o f t h a t o f a l l r a i l r o a d , p u b lic u t i l i t y , and
i n d u s t r i a l s to c k s were l i s t e d on o rg an ized exchanges i n 1930.
F u rth e rm o re ,
77% o f a l l l i s t e d bonds were l i s t e d on th e New York S tock Exchange a lo n e .
Of l i s t e d s to c k s , 41% were l i s t e d on th e New York S tock Exchange, and 84
19
% on th e New York S to ck Exchange and New York Curb Exchange com bined,
A Check o f th e two hundred l a r g e s t n o n - f in a n c ia l c o r p o r a tio n s a g a in s t th e
re c o rd o f s e c u r i t i e s l i s t e d on th e New York S tock Exchange shows t i n t ,
w ith few e x c e p tio n s , th o s e c o rp o ra tio n s w hich a re l a r g e s t and w hich p la y
a m ost v i t a l p a r t i n o u r economic l i f e a re l i s t e d on t h i s exchange.
From th e p o in t o f view o f b u s in e s s done, th e im p o rtan ce o f th e New
18
The S e c u r ity M a rk e ts, p p . 5 9 -6 1 , and S tock M arket C o n tr o l, p . 2 .
19
The S e c u rity M arkets, p p .59-60.
-1 5 York ex ch an g es, and p a r t i c u l a r l y o f th e New York S to c k Exchange, i s s t i l l
more s t r i k i n g : 85/6 o f a l l exchange tr a n s a c tio n s a r e conducted e i t h e r
th ro u g h th e New York S to ck Exchange o r th e New York Curb M arket; th e r e ­
m aining 15^ i s d iv id e d betw een th e o th e r exchanges i n v a r io u s s e c tio n s
o f th e c o u n try .
The New York S to ck Exchange a lo n e does betw een tw o - th ir d s
and t h r e e - f o u r t h s o f th e t o t a l s e c u r i t i e s b u s in e s s o f th e U nited S t a t e s ,
20
and does s i x tim e s a s much a s th e New York C urb.
The f u n c tio n o f th e exchanges i s n o t one o f f u r n is h in g c a p i t a l to
in d u s t r y i n a d i r e c t s e n s e .
I n th e is s u in g o f new s e c u r i t i e s exchanges us­
u a l l y p la y l i t t l e d i r e c t p a r t .
E x c e p tio n m ust be made o f th o s e c a s e s
where new s h a re s a r e is s u e d th ro u g h th e use o f s u b s c r ip tio n o p tio n s on
t r e a s u r y r i g h t s w hich a r e d e a l t i n on ex changes, o r th ro u g h o p tio n s on
t r e a s u r y s to c k .
s m a ll.
I n th e l a t t e r in s ta n c e s such i s s u e s a re u s u a lly r e l a t i v e l y
New is s u e s w hich a r e to be l i s t e d , how ever, r e p r e s e n t o n ly a sm all
p a r t o f th e t o t a l s e c u r i t i e s o u ts ta n d in g a t any one tim e , and t h e i r d i s ­
t r i b u t i o n r e p r e s e n t s an in c o n s e q u e n tia l p a r t o f t o t a l tr a d in g .
I t i s in
th e p ro c e s s o f r e v a l u a t i o n w hich ta k e s p la c e when s e c u r i t i e s a lr e a d y
is s u e d change hands t h a t th e o rg a n iz e d , and to a l e s s e r e x te n t th e unorgan­
i z e d m ark ets p la y a r o l e o f v i t a l im p o rta n c e .
Newly I s s u e d s e c u r i t i e s
f r e q u e n t l y change hands many tim es b e fo re th e y f i n a l l y re a c h owners who
a r e w i l l i n g to h o ld them more o r l e s s perm an en tly a s in v e s tm e n ts , a p ro c e ss
w hich I s c a l l e d se co n d a ry d i s t r i b t u i o n .
W hile i t I s tr u e t h a t , a f t e r t h i s
p r o c e s s h as ta k e n p l a c e , o n ly a sm a ll p a r t o f any is s u e changes hands o v er
a s h o r t p e r io d o f tim e , I t i s e q u a lly t r u e t h a t in v e stm e n t I h o n ly r e l a ­
t i v e l y p erm an en t.
T h e re fo re , n o t o n ly do new I s s u e s change h an d s, b u t o ld e r
20
Stock M arket C o n tro l, p . 19.
-1 6 i s s u e s a re c o n s ta n tly b e in g b ought and s o ld to m eet th e w ish es and n e c e s­
s i t i e s o f th e i n v e s tin g p u b lic .
The s e c u r i t y exchanges p ro v id e th e med-
l u a by means o f w hich th e s e t r a n s a c ti o n s ta k e p la c e , and i n so d o in g re n d e r
such s e c u r i t i e s l i q u i d .
S in c e l i q u i d i t y has meaning o n ly i n c o n ju n c tio n
w ith th e te rras on which l i q u i d a t i o n may ta k e p la c e , th e p r i c e s a t w hich
t r a n s f e r s a r e made a re o f fundam ental im p o rta n c e .
I n a c o n tin u o u s m ark et,
th e s e p r i c e s c o n s t i t u t e a c o n s ta n t r e —a p p r a i s a l , n o t o n ly o f th e s e c u r i t i e s
tra d e d , b u t
o f
th e o th e r s h a re s o f th e
I ssu b
o f w hich th e y a r e a p a r t .
By means o f m ark et q u o ta tio n s , th e owner o f s e c u r i t i e s e s tim a te s t h e i r
v a lu e , and th e le n d e r o f money a p p r a is e s them a s c o l l a t e r a l f o r a lo a n .
The f u n c tio n s o f exchanges have b een d e s c rib e d by s c h o la r s a s
f o llo w s : ( l ) exchanges f u r n i s h a c o n tin u o u s m ark et, w hich g iv e s m o b ility
t o p r o p e r ty ; (2 ) th e y d i r e c t c a p i t a l from u n p r o f ita b le to p r o f i t a b l e i n ­
d u s t r i e s ; (3 ) th e y harm onize p r ic e s w ith in v e stm e n t v a lu e s ; ( 4 ) th ro u g h
t h e i r e v a lu a tio n o f s e c u r i t i e s , which a r e o f te n used as c o l l a t e r a l , th e y
expand and c o n tr a c t c o l l a t e r a l v a lu e s a t p ro p e r tim e s ; (5 ) s h o r t s e l l i n g
te n d s t o s t a b i l i z e th e m a rk e t, and makeb hedging p o s s ib le ; and (6) specurl a t i o n on exchanges f a c i l i t a t e s a c o n tin u o u s m a rk e t, s t a b i l i z e d p r i c e s ,
and p ro v id e s a m arket f o r new and r i s k y s e c u r i t i e s , p ro v id e d th e specur21
l a t o r i s w e ll-in fo rm e d .
T h a t th e s e f u n c tio n s a r e o n ly im p e r f e c tly perform ed i s a d m itte d even
by d e fe n d e rs o f th e ex ch an g es, and under c e r t a i n c ir c u n s ta n c e s some o f
them a r e n o t perform ed a t a l l .
The l a t t e r s i t u a t i o n o b ta in e d d u rin g th e
b u l l m a rk e t o f t h e tw e n tie s , p a r t i c u l a r l y betw een 1925 and 1929, w hich w i l l
be d is c u s s e d below .
21
S .S . H uebner, The S tock M ark et. (D. A ppleton & C o ., New Y ork, and London,
1 9 2 2 ), Ch. I , p . 1 2 ; J . E . M eeker, The Work o f th e S to ck Exchange. (Ronald
P r e s s C o ., New Y ork, 1 9 3 0 ), Ch. V, p a ssim . See a ls o T w en tie th C en tu ry Fund,
I n c . , The S e c u r ity M ark ets. Ch. I I , p p .22-27.
-1 7 Tha p la c e o f th e New York S to c k Exchange
S in ce th e New York S to ck Exchange o c c u p ie s a p rim ary p o s it i o n in
th e s e c u r i t y m ark ets o f th e U n ited S t a t e s , th e grow th o f c o r p o ra tio n s
and th e co n se q u e n t d i s t r i b u t i o n o f t h s i r s e c u r i t i e s i s r e f l e c t e d i n i t s
developm ent.
The New York S tock Exchange was f i r s t o rg a n iz e d i n 1792, as a r e s u l t
o f th e s e c u r i t y tra d e w hich had grown up w ith th e fu n d in g o f th e F e d e ra l
d e b t.
Under fo rm al agreem ent tw e n ty -fo u r b ro k e rs pledged th em selv es to
g iv e p r e fe r e n c e t o each o th e r i n t h e i r t r a n s a c t i o n s , and th e y a g reed to
ch arg e n o t l e s s th a n a s t i p u l a t e d r a t e o f com m ission.
At t h i s tim e th e
number o f s e c u r i t i e s tra d e d i n was v e ry li m i t e d . On May 26, 1792, o n ly
22
seven d i f f e r e n t is s u e s were bought and s o ld . L i t t l e i s known c o n cern in g
th e e a r l y h i s t o r y o f th e Exchange.
A new c o n s ti t u t i o n was ad o p ted i n
1817} b u t i t i s th e r e v is e d c o n s t i t u t i o n o f 1820 w hich g iv e s th e f i r s t
com prehensive p i c t u r e o f i t s o r g a n iz a tio n and o f th e r u le s under w hich i t
o p e r a te d , a s th e 1817 c o n s t i t u t i o n was l o s t .
T here i s l i t t l e or n o th in g
i n t h i s c o n s t i t u t i o n o f th e Exchange t o in d i c a t e any concern a s t o th e
p u b lic i n t e r e s t , beyond bounds w hich c o u ld e a s i l y be a t t r i b u t e d t o a
d e s ir e to m a in ta in p u b lic c o n fid e n c e .
The b ro k e rs ap p ear t o have been
a group o f i n d i v i d u a l s who were e x c lu s iv e i n c h a r a c t e r , bound to g e th e r
by a common i n t e r e s t , o p e r a tin g under c o n d itio n s o f r e s t r i c t e d c o m p e titio n ,
and under a s e t o f e x a c tly s p e c i f i e d r e g u l a t io n s , w hich had been worked
25
o u t w ith a view t o f a c i l i t a t i n g t h e i r o p e r a tio n s .
22
. E .C . Stedman and A.N. Eastm an, The New York S tock Exchange: I t s H is to r v .
(New Y ork, 1 9 0 5 ), Ch. I I , p p .5 5-57.
----------------25
F .L . Eames, H is to r y o f th e New York S to ck Exchange (New Y ork, 1894) ,p p .
18—26*
-1 8 In the fin a n c ia l s e t t in g o f the f i r s t h a lf o f the n in etee n th
cen tu ry , th e Yew Tork Stock Xzehange was a very co n serv a tiv e organ i­
z a tio n , d e a lin g o n ly in the h ig h er grade is s u e s , and r ig id ly p r e s c r ib in g
the conduct o f i t s members and the p o lic y w ith regard to membership.
I t was so c o n s e r v a tiv e , In f a c t , th a t another exchange, c a lle d the Yew
Board, sprang up.
I t d id w e ll f o r a tim e, but i t c o lla p se d and became
r e l a t i v e l y unim portant w ith the f a ilu r e o f tw o -th ird s o f i t s members
In th e p an ic o f 1837.
lam es reproduces an a r t i c l e , published i n 1848,
whloh I n d ic a te s th a t more b u s in e s s was done In an unorganized way a t
24
t h is tim e than on the two exchanges combined.
IXirlng th e e a r l i e r e x is te n c e o f th e
Yew Yoxk Stock Ixoh m ge, in ­
d u s t r ia l s e c u r i t i e s were o f l i t t l e Importance; th ey made t h e ir f i r s t
appearance ln l8 3 1 , but th ey were an in s ig n if ic a n t fa c to r u n t i l a f t e r
28
th e O iv il Var. 9he c e n te r in g o f the ^ c a p ita l market11 f o r th ese se c u r i­
t i e s on the Yew Toric f inane Id. coumanlty took p la c e in th e la t e n in e­
te e n th and e a r ly tw e n tie th c e n tu r ie s; i t was co in cid en t w ith the r is e
o f la r g e corp orate b u sin e s s.
I s a p u b lic a tio n o f the Yew Toric Stock
Xxchange p u ts I t , "The Yew Tork Stock Ixchange continued alm ost to th e
end of th e p a st cen tu ry to be a market for government a id r a ilro a d
s e c u r it ie s , b u t I t a ls o welcomed a m u ltitu d e o f other I ss u e s by which
c a p it a l i s provid ed to b u ild f a c t o r ie s end p rovid e machinery f o r la r g e
26
s c a le p r o d u c tio n .**
24
Ysmes, o n . c l t . . pp. 34-36
25
Margaret II y e r s , 3ha Yew Toric Money Market. (Columbia U n iv e r s ity P r e ss ,
Yew Toric, 1 9 3 1 ), O h .II, pp. 1 5-16.
26
Committee on P u b lic B e la tlo n s ,
Tork Stock Yrchangei I t s P un etion s
and O perations. (Yew Toric, A p r il, 1 9 3 6 ), p . 14.
-1 9 ▲t p resen t the Hew York Stock Exchange o ccu p ies a p o s it io n
In te r n a tio n a l Importance.
of
I t s Important p erio d o f growth "began during
th e 1890* s and e a r ly 1900* e , when th e l i s t o f in d a s t r ia ls was augpiented
n o t o n ly hy the form ation o f new co r p o r a tio n s, b at a ls o by a great number
o f c o n so lid a tio n s o f sm a lle r com panies, w hich r e s a lt e d In the form ation
o f companies la r g e enough to warrant l i s t i n g .
Meanwhile, m echanical
f a c i l i t i e s had been develop ed w hich could be u sed to in crea se the scope
o f the market.
The sto c k tic k e r was f i r s t u sed i n 1867. and In 1878
th e f i r s t telep h o n es were introduced In th e Exchange.
market had become a "continuous market".
By 1871 th e sto ck
P r io r to t h i s time I t had been
th e custom fo r the f i r s t and second v ic e p r e s id e n ts to " call" the sto ck s
l i s t e d . i n t h e ir ord er, a t w hich tim e trad in g in each s to c k took p la c e
a s I t was c a l l e d .
C a lls were a b o lish e d o f f i c i a l l y in sto ck s In 1882
and in bonds In 1902*
C on tin u ity o f market made I t p o s s ib le to trade
27
In a 11 sto ck s a t any time when the market was In s e s s io n .
S t a t i s t i c s on membership o f th e Hew York Stock Exchange daring the
l a t e n in ete e n th and e a r ly tw e n tie th c e n tu r ie s g iv e l i t t l e in d ic a tio n o f
the growth in th e s e c u r i t i e s markets which a c t u a lly took p la c e .
Member­
sh ip on the Exchange, which has alw ays been determ ined by exchange
p o lic y , to ta le d l.lO O n In 1880 and continu ed a t t h is fig u r e u n t i l 1930,
when i t in crea sed to 1 ,3 3 0 .
Between 1930 end 1933 i t Increased by sm all
a d d itio n s , u n t i l in th e l a t t e r yea r I t reached a t o t a l o f 1,375, which
flg n r e has remained unchanged, and w hich r e p r e se n ts th e p resen t member­
sh ip .
27
Stodc
Procedure. Oh. I I , p . 10.
28
Hew York Stock Exchange ISar Bock. 1940 e d . , p . 26.
20Eie number o f member firm s g iv e s a somewhat b e tte r in d ic a tio n o f
growth sin ce i t la through theae f in e s th a t b u sin e ss la condacted w ith
the public*
Between th e y ea rs 1880 and 1910* the number o f member
f i r a s in c re a sed from 374 to 681.
cen tage in c r e a se s in c e .
There has not been a s la rg e a per­
The g r e a t e s t number o f member firm s on record
appears in 1930, when the t o t a l amounted, to 665.
Between 1930 and 1933
th er e was a d ecrea se which brought the number down to 610, bat sin c e
then they have in crea sed s t e a d ily u n t i l in 1938 th ere were 652, a fig u r e
o n ly s l i g h t l y under th e p reviou s h igh .
Between 1938 a n l 1940, however,
th ere h as been a d ec r e a se ; th e p re se n t fig u r e i s 603.
The in crea se in
o u t-o f-to w n fir m s between 1880 and 1900 i s in d ic a tiv e o f the change o f
scope o f the market which appears t o have taken p la c e a t t h is tim e.
1880 there were o n ly 16 o u t-o f-to w n firm s*
crea sed to a hundred.
In
By 1900 the number had in ­
The h ig h e s t number o f o u t-o f-to w n firm s during
th e 1921-1929 b u l l market occurred in 1936 and again In 1928, when I t
amounted to 131.
W hile the d ep ressio n reduced th e number to 81 In 1933,
o u t-o f-to w n firm s today a re alm ost a s numerous a s they have ever been,
29
t o t a lin g 140 In 3940, o n ly two l e s s than the h ig h reached in 1939*
Branch o ffic e w o f Hew Tork Stock Xxchange nembers lik e w ise show a
rap id In crease between the l a t e n in e te e n th and e a r ly tw en tieth c e n tu r ie s .
In 1895 there w ere 112 branch o f f i c e s o f members.
had in creased to 555.
lXxrlng t h i s p e r io d
By 1910 the number
o u t-o f-to w n branches in ­
crea sed more r a p id ly than th o se In Hew York.
The former Increased from
67 to 367, i& ils th e l a t t e r in crea sed from 45 t o 188.
29
I b id . . 1929-1929 e d . , p . 2 1 , and 1940 e d ., p . 26.
Total branch
o f f i c e s reached a peak In 1930, when th ere were 1,656 o f than; the low
p o in t s in c e 1929 occurred in 1936, when the fig u r e f e l l to 1 ,0 9 2 .
is
o f the f i r s t o f the year 1938, they had in crea sed to 1 ,1 6 5 , hut th ey
have decreased s in c e th en u n t i l a t p resen t (1 9 4 0 ) th ey unrober 1,057,
In 1936 th ere were o n ly 179 branches i n HewToik, w h ile there were 1,006
o u t o f town,
i t p resen t Hew Toxfc Branches number 156, w h ile th ose out
o f town have d ecreased to 901.
furtherm ore, the number o f non-member
correspondents o f Hew Tork Stock lanhange member firm s in crea sed from
3 ,1 3 2 to 4 ,4 7 6 .
r e s p e c t iv e ly .
S in ce 1938 the fig u r e s have f a l l e n to 3,8 2 5 and 3,976
W hile I t i s Im possible to t e l l what p rop ortion o f non?*
member correspondents are lo c a te d o u tsid e o f Hew Tork C ity, from th e
d ata a v a ila b le i t seems reason ab le to assume th a t o u t-o f-to w n firm s
have been a t l e a s t proportion^, l y r e s p o n sib le fo r t h i s growth in view
o f t h e ir g en era l trend.
Bakon as a whole, the s t a t i s t i c s on growth o f
branch o f f i c e s seem to in d ic a te a v ery d e f in it e trend toward p a rticlp et30
t io n in the Hew Tork Stock market b y p eop le o u tsid e o f Hew Tork.
3he in c r e a se in the p r ic e o f s e a ts on the Hew T<rk Stock Exchange
g iv e s fu rth e r evid en ce o f the growth o f i t s Importance.
I t shou ld be
n oted , however, th a t th e v a lu e o f s e a ts i s determ ined p rim a r ily by the
amount o f money which may be made through the ownership o f s e a ts , and
t h is amount i s determ ined b y the volume o f tra d in g r a th e r than by any­
th in g e l s e ,
f lu c t u a t io n s i n th ese v a lu e s may in d ic a te the e x te n t o f
p u b lic sp e c u la tio n from time to time; n e v e r th e le s s , when con sid ered along
w ith o th er fig u r e s , th e s ig n if ic a n c e o f t h e i r lo n g tim e trend can h ard ly
be overlooked.
In 1870 th e p r ic e o f a stock exchange sea t v a ried from
30
■Hew Tork Stock Exchange Tear Bock. 1928-1929 e d , , p .22, 1938 e d ,, p p .22 2 3 , and 1940 e d ., p p .2 6 -2 7 .
-2 2 from $4,000 to $4,500.
By 1880 the p r ic e had r is e n so th a t I t v a r ie d
from $14,000 to $2 6 ,0 0 0 .
There I s o n ly one o th er p erio d when the r a te
o f Increase compares w ith t h i s .
Between 1920 and 1929 the h igh fig u r e
p a id fo r s e a ts in crea sed from $115,000 to $625,000, w hich rep resen ted
approxim ately th e same r a te o f in c r e a se a s th at which obtained between
1870 and 1880. The 1929 h ig h p r ic e o f $625,000 was 156 tim es the low est
p r ic e o f 1870, w h ile in 1937 th e h ig h e st p r ic e p a id fo r a se a t was $134,000,
o n ly about 33 tim es the lo w est p r ic e o f 1870.
She l a s t s a le o f a se a t
took p la c e on Hovsmber 4 ,1 9 4 0 a t $ 4 0,000. ( f i l l s fig u r e should be a l i t t l e
h ig h er I f allow ance i s made f o r the d il a t i o n which occurred when member31
sh ip was Increased between 1929 and 1 9 3 3 .) Since sto c k exchange s e a ts
d eriv e th e ir vaLue from th e amount o f b u sin e ss done, the sm all volume o f
trad in g * i c h has taken p la c e in recent y ea rs has r e f le c t e d i t s e l f in
t h e ir p r ic e s .
In 1870 th ere were o n ly 143 sto ck s and 200 bonds l i s t e d on the
Hew Tork Stock Jxchange.
In term s o f p ercen ta g es, th e in c r e a se between
1870 and 1885 was very g r e a t .
in crea sed over 200 %
u n t i l about 1910.
Spooks In creased over 100
i»
and bonds
filer s was a stea d y growth in both sto ck s and bonds
Between 1910 and 1925 th e number o f l i s t e d sto ck s
more than doubled, w h ile the xssrfber o f l i s t e d bonds in crea sed on ly mod­
e r a t e ly .
The h ig h fig u r e f o r s to c k s occurred in 1931, when the number
o f sto c k s l i s t e d was 1 ,3 0 6 , about three tim es the fig u r e f o r 1910.
d u rin g t h is p erio d in crea sed i n number from 1 ,0 1 3 t o 1 ,6 0 7 .
Bonds
L isted
s e c u r i t i e s , both s to c k s and bonds, d id not d ecrea se in number ap p reciab ly
during th e d ep ressio n .
The number o f l i s t e d sto ck s decreased from 1,308
31
Hew Tork Stock Exchange Tear Book. 1940 e d . , p . 2 3 .
-2 3 i n 1931 to 1 ,185 In 1936, the lo w est year s in c e .
f i r s t p a rt o f 1940 stan d s a t 1 ,2 3 3 .
l a r d ecrea se t o d a t .
Die fig u r e in the
Bonds seam to have shown a sim i­
Tram a h igh o f 1 ,6 0 7 is s u e s in 1931, the number
o f l i s t i n g s has decreased alm ost co n tin u o u sly , u n t i l a t the b egin n in g
o f 1938 the fig u r e stood a t 1,376; a t the beginning o f 1940 th ere were
32
1 ,3 9 5 is s u e s l i s t e d .
Toltane of trad in g in b oth sto ck s and bands on the Hew Tork Stock
Exchange la su b ject to v io le n t f lu c t u a t io n s , althou gh trad in g in bonds
h as been more s ta b le than in s to c k s , e s p e c ia lly s in c e 1915.
Between
1900 and 1937 trad in g in bonds shows a g r e a te r in c r e a se th a i tra d in g
i n s to c k s.
IXiring t h is p erio d the par valu e o f bonds traded in in crea sed
from $577,763, 080 to $ 2 ,7 9 2 ,5 3 1 ,0 0 0 an in c r e a se o f 4 .8 tim es the 1900
f ig u r e .
This fig u r e f e l l between 1937 and 1938 to $ 1 ,8 5 9 ,8 6 5 ,0 0 0 , but
recovered in 1939 to $ 2 ,0 4 6 ,0 8 3 ,0 0 0 .
Trading I n s to c k s Increased from
1 3 9 ,0 7 4 ,6 5 1 shares in 1900 to 4 0 9 ,4 6 4 ,5 7 0 shares In 1937, an in c r e a se
o f 2 .9 tim es the fig u r e f o r th e e a r l i e r d a te .
Since th en sto c k trad in g
h a s f a l l e n to 262 ,0 2 9 ,5 9 9 sh ares, i n 1939, but t h i s may be more e a s il y
co n stru ed a s a temporary c o n d itio n than a s an I n d ic a tio n o f a change in
g en era l trend.
Hie lo w est fig u r e f o r bond trad in g s in c e 1900 occurred
in 1914, when bonds o f a par v a lu e o f $461,649,200 were traded.
h ig h occurred in 1922, when the an aunt was $ 4 ,1 4 5 ,5 6 8 ,0 0 8 .
f ig u r e i s about nine tim es th e former.
Die
O ils l a t t e r
Stocks lik e w is e were d u lle s t in
1914, during whldh year o n ly 4 7 ,4 3 1 ,2 2 7 sh ares were trad ed.
Die h ig h
32
Hew Tork Stock S s h a g g e Tear Book. 1938 e d . , p. 6 0 , and 1940 e d . , p . 49.
On Hovsmber 1 , 1940, the Hew Tork Stock Hxchsuoge reported th a t there were
1 ,2 3 0 is s u e s o f sto c k s and 1,312 is s u e s o f bonds l i s t e d .
-2 4 f ig u r e fo r sto c k trad in g occurred in 1929, when 1 ,1 2 4 ,6 0 8 ,9 1 0 sh ares
w ere traded; t h is fig u r e rep resen ted about tw en ty-fou r tim es th a t f o r
1914.
D esp ite the wide f lu c t u a t io n s w hich occur
i n th e se s e r i e s , mfftrtug
a ccu ra te a p p r a isa l d i f f i c u l t , a s u b s ta n tia l ra te o f growth i s e v id e n t.
S in ce the b egin n in g o f the d ep ressio n the volume o f tr a d in g i n bonds has
n ot receded below th e 1917 fig u r e , and th a t o f sto c k s has remained w e ll
33
above th e fig u r e fo r 1923.
Perhaps th e most slfn lg ic a m t in d ic a tio n o f th e in c r e a sin g importance
o f tha Hew Tork Stock Exchange i s found in the growth in recen t y ea rs
i n v a lu e o f sto ck s and bonds l i s t e d on i t .
I t has been estim ated th a t
i n 1880 the v alu e o f l i s t e d dom estic sto ck s and bonds was 5 .6 b i l l i o n s
o f d o lla r s .
Between 1880 and 1900 t h is amount doubled.
By 1912 th e f i g ­
u re f o r 1900 had more than doubled, making th e t o t a l valu e o f sto c k s and
bonds on th a t year 2 4 .8 b i l l i o n s , or more than fo u r tim es th a t o f th e
y e a r 1880.
Between 1912 and 1922 the fig u r e was doubled a g a in , making
th e t o t a l v a lu e of sto ck s and bonds over n in e tim es i t s m ou n t in 1880*
Between 1922 and 1929 th is fig u r e in crea sed from 5 2 .2 b i l l i o n s to 100.7
b illio n s ,
i t the low o f the 1929 to 1932 "bear" market, th ere was a de­
c r e a se to 4 8 ,6 b i l l i o n s , but by 1933 valu e in crea sed to 5 4 .9 b i l l i o n s ,
o r 2 .7 b i l l i o n s above the 1922 figu re*
Die l a t e s t a v a ila b le data (Hovan-
b er 1, 1940) show th e v a lu e o f l i s t e d sto c k s and bonds to be ap p ro x i34
m a tely 96*9 b i l l i o n s o f d o lla rs*
33
gew Toifc Stock Exchange Tear Bock. 1940 e d ., p . 72.
34
A.A* B e r le , J r . , and 7 .J . Pederson, Liquid Claims and n a tio n a l H ea lth .
(U acm lllan C o., Hew Tork, 1934), Ch.7. p . 73; the l a t e s t fig u r e i s taken
from the C qnaercial and f in a n c ia l C h ron icle. V ol. 151, Hov. 9 ,1 9 4 0 , p .
2730; t h is fig u r e i s n ot a d ju sted fo r fo r e ig n a d fin a n ce s e c u r i t i e s , but
s in c e fo r e ig n bonds, which make up about 4 /5 o f t h is item , have v i r t u a l l y
d isappeared from the exchanges, th ese f ig u r e s are rou ghly comparable w ith
th e o th e r s.
-
25-
th e fu n c tio n in g of th e Hew Toric Stock Exchange
While th e volume o f hu eln eee tra n sa cted by the Hew Tork Stock
Exchange has g iv e n r i s e to m in t r ic a t e mechanism fo r handling tr a n sa c tio n s
i t has a ls o brought about a s p e c ia lis a t io n o f fu n c tio n on the p a rt o f
i t s members w hich exceeds th a t o f the sm a ller exchangee,
f o r t h i s reason
i t i s p o s s ib le to g iv e a g en era l p ic tu r e o f i t s o p era tio n through a des­
c r ip t io n o f th e fu n ctio n o f each c la s s o f member,
f i r s t , however, a
b r i e f d e s c r ip tio n o f the member f lr a i s n e c essa ry , s in c e i t i s through
th e se firm s th a t the p u b lic g a in s a c c e s s to the market.
Member firm s d eal d ir e c t ly w ith the p u b lic ,
fo r t h is purpose they
o f t e n m aintain la r g e o rg a n iza tio n s which extend a v a r ie t y o f s e r v ic e s to
cu stom ers.
Biey may have branch o f f i c e s , employ custom ers' men to s o l i c i t
b u s in e s s , m aintain s t a t i s t i c a l departm ents, p u b lish market l e t t e r s , and
g iv e a d v ice on s e c u r it ie s and market*
I t i s through th e se firm s th a t
c r e d it i s extended to the p u b lic ; they a ls o h old custom ers' cash b a la n ces,
keep s e c u r i t l e s i n s a fe k eep in g , and perform o th er s im ila r fu n c tio n s.
mm ^p"^ls a io n broker i s a partner in a member firm , and e x e c u te s
o rd ers which h i s firm r e c e iv e s from the p u b lic .
Orders which he r e c e iv e s
are o f th ree k ln d si ( l ) market orders, ( 2 ) orders which cure "away from
the m arket11, ( th a t 1b, orders which o a l l fo r purchase o r s a le a t p r ic e s
w hich do n o t o b ta in a t th e time o f t h e ir r e c e ip t ) , and ( 3) orders fo r l e s s
than th e u n it o f tra d in g on th e exchange, w hich, excep t in th e c a se o f
I n a c tiv e sto c k s , means orders o f l e s s than 100 sh a res,
llaxket orders
a re u s u a lly execu ted by the com aission broker h im s e lf, but o fte n i t i s to
h i s advantage to employ the s e r v ic e s o f another broker, e s p e c ia lly i f
b u sin e s s i s b r is k .
-2 6 The f lo o r hnokar, or “two d o lla r broker", a s s i s t s the cotmnisBlon
broker tinder such circum stan ces.
He i s a broker fo r brokers, and f o r
t h is reason does not come in to con tact w ith the p u b lic .
He o fte n trad es
s u b s t a n t ia lly f o r h is own account, s u b je c t to r e s t r ic t i o n s w hich are
d esig n ed to make i t d i f f i c u l t fo r him to take advantage o f h i s custom ers.
He may. however, o u t-b id or u n d e r -s e ll them, but co m p etitio n between flo o r
brokers fo r the b u sin e ss o f cam nlesion brok ers ten d s to preven t t h is in
c o n sid e r a b le measure,
She f lo o r b r o k e r s fu n c tio n i s a dual one. sin c e
M s p e rso n a l tr a n sa c tio n s make for in crea sed l i q u i d i t y in the m arket.
Tha
i s c a lle d upon t o e x ecu te th ose orders r e c e iv e d by
the coom lsalon broker which a re "away from th e market".
Be c e n te r s h is
a c t i v i t y in one or more sto ck s which are lo c a te d a t the same tra d in g
p o st on the exchange f lo o r .
Orders away from th e market w hich are re­
c e iv e d by him are p laced In hls"book".
market c o n d itio n s p erm it.
These ord ers are execu ted when
Be may a ls o ex ecu te a market order when i t
r e p la c e s an order away from the market, o r when i t i s f e l t th a t he i s
b e s t a b le to ex ecu te an order because o f h is exp erien ce end a b i l i t y .
He a ls o trad es f o r h is own account, th ereb y c o n tr ib u tin g to th e li q u i d i t y
35
and c lo s e n e s s o f th e market.
P ie odd l o t d e a le r i s r e so rted to by the com n lssion broker when orders
a re r e c e iv e d fo r l e s s than 100 sh a res.
S in ce the u n it o f trad in g on the
exchange i s 100 sh a res, i t i s im p o ssib le f o r the commission broker to
36
ex ecu te such orders d i r e c t ly . Odd l o t ord ers a re execu ted a t l/s o f a
35
The b r o k er-d e a le r fu n c tio n of the s p e c i a l i s t was one o f the c h ie f ta r g e ts
o f a ttftd c by the Senate Committee in v e s t ig a t io n , and h as been th e su b je c t
o f much study by the S.X.O. s i n c e
see Chapters I I . I l l , and VIII below,
36
This d oes n ot ap p ly to in a c tiv e s to c k s , i n which the u n it o f tra d in g i s
10 sh a res; tr a n sa c tio n s in th ese sto c k s are handled by s p e c i a l i s t s a t the
p o st where such sto ck s are traded.
p o in t ( o r more) above or below the market p r ic e o f the n ext tr a n sa c tio n
which tak es p la c e in the d esign ated sto c k , depending upon whether the
order i s a purchase o r a s a le .
In the even t th a t custom ers do n ot w ish
to w a it u n t i l a s a le ta k es p la c e , the order may be execu ted a t a p r ic e
l /8 o f a :p o in t ( o r more) from th e b id or th e o f f e r , depending upon the
nature o f th e ord er.
In both c a s e s t h is d iffe r e n c e between th e market
p r ic e and th a t p a id or re c e iv e d b y the custom er c o n s t it u t e s the compel**
s a tlo n which th e odd l o t d e a le r r e c e iv e s f o r h i s s e r v ic e s ; t h is d i f f e r ­
ence i s c a lle d th e "odd l o t d if f e r e n t ia l" .
S h is o p era tio n i s c a r r ie d
on by the odd l o t d e a le r , whose r e p r e s e n ta tiv e r e c e iv e s th e se orders
on the f lo o r .
H iese r e p r e s e n ta tiv e s, who a r e known as odd l o t b rok ers,
f i l l such ord ers by ta k in g or supplying s to c k f o r the account o f the
d e a le r .
Stock isb ou gh t or so ld in 100 share l o t s in the amount n ecessa ry
to keep th e d e a le r 's p o s it io n ad ju sted to h is odd l o t commitments.
IThe bond broikBr and d e a le r i s th e medium through which bonds are
traded*
Because o f the nature of the bond b u s in e s s , a la r g e p a r t o f
which I s tra n sa cted in o v er-th e-co u n ter m arkets, th e bond broker and
d e a le r perform s a v a r ie t y o f fu n c tio n s.
On th e f lo o r o f the exchange
the bond broker a c t s a s a commission broker when tr a n s a c tin g b u s in e s s
f o r easterners o f M s own f lim , as a f lo o r broker when he ex ecu tes orders
fo r o th er fir m s, A d as a flo o r trader when h e tr a n sa c ts b u sin ess f o r
h im se lf or h is firm ,
3fae f lo o r trad er engages p rim a r ily in buying and B e llin g f o r h i s
own account on th e f lo o r o f the exchange.
gen eral p u b lic and I s u s u a lly
He has no
c o n ta c t w ith th e
a l l i e d w ith no member firm .
f e s s lo n a l sp e c u la to r who o p era tes fo r quick p r o f i t s .
Be
I s a pro*
O cca sio n a lly he
-2 8 may have a few p erso n a l
cub ton ers,
or he may ex ecu te la r g e orders f o r
usetfbers o f firm s who d e s ir e to con ceal t h e ir p resen ce in the market.
S i s main c o n tr ib u tio n i s that o f enhancing the l i q u i d i t y o f th e mar­
k e t , hut he i s l i k e l y to have an in ju r io u s e f f e c t on p r ic e s under
c e iv
t a in c o n d itio n s.
I n a c tiv e mamhers c o n s is t o f th o se who have r e t ir e d from a c tiv e
b u s in e s s , th ose who h old t h e ir s e a ts fo r the b e n e f it s o f reduced con*m isa lo n s which th ey pay, those who own s e a ts a s a s p e c u la tio n and hope
to p r o f it from an in c r e a s e in market p r ic e , and f i n a l l y in d iv id u a ls who
are connected w ith Investm ent banking h ou ses.
I n a c tiv e members are f r e ­
q u en tly la r g e tr a d e rs f o r th e ir own a ccou n ts, and th o se connected w ith
investm ent banking firm s sometimes do a g rea t d e a l o f b u sin e ss in connec37
tlo n w ith u n d erw ritin g and as d e a le r s in s e c u r i t i e s .
I t i s through th e op eration o f th e va rio u s groups which have been
d escrib ed th a t the b u s in e s s o f th e exchange i s c a r r ie d on; and i t i s through
the I n te r a c tio n o f th e b id s and o ffe r s emanating from them th a t p r ic e s on
the exchanges are determined.
The exchanges and the crash o f 1929
In order th a t th e exchanges may par form a l l the fu n c tio n s which have
been a t tr ib u t e d t o them, i t i s n ecessary th a t the p a r tic ip a n ts are w e ll
Informed as to p r e se n t v a lu es and probable fu tu re economic developm ents.
Such a s it u a t io n may o b ta in in seme measure a s lon g a s trad in g on the
exchanges i s e s s e n t i a l l y c a rried on by w e ll inform ed in d iv id u a ls , and
s p e c u la tio n i s c o n fin ed la r g e ly to th e p r o fe s s io n a l sp e cu la to r.
In the
l a t e tw e n tie s , however, when the g en eral p u b lic en tered the market to
37
S h u ltz , Stock Exchange P rocedure. Oh. 711, V III, and IX, p p .51-76.
mi
-2 9 unprecedented d egree, th o se who purchased w ith investm ent in mind were
1X1 inform ed, and the s p e c u la tiv e fu n c tio n p assed from th e hands o f the
p r o fe ss io n a l to th e s p e c u la tiv e p u b lic.
Their g u l l i b i l i t y ( th a t o f the
p u b lic ) tended to cau se p r o fe s s io n a ls to turn from t h e ir fu n c tio n o f
d isco u n tin g the fu tu re and r e s o r t to " riggin g the market".
With the
r i s e o f p r ic e s , th e ord inary standards by which in vestm en ts were measured
no lo n g er a p p lied ; in s te a d , prudence became a m atter o f ju dging prublic
o p in io n ra th er than companies or b u sin ess p r o sp e c ts.
Under such c o n d itio n s , most o f the fu n c tio n s which sto ck exchanges
were supposed to perform became in o p era tiv e.
JL con tin u ou s market re­
mained, bu the m o b ility which i t gave to prop erty bore l i t t l e resemblance
to the l i q u id it y req u ired by in v e s to r s .
With s p e c u la tiv e a c t i v i t y rath er
than earn in gs and fu tu re p ro sp ects determ ining p r ic e s o f in d iv id u a l
is s u e s , c a p ita l was no lo n g er d irected from u n p r o fita b le to p r o f it a b le
in d u s tr ie s and c e r t a in ly n ot in eny exact manner.
P r ic e s no lon ger hai—
monized w ith investm ent v a lu es; increased c o lla t e r a l v a lu e s made fo r
in crea sed sp e c u la tio n r a th e r than an expansion o f c r e d it based upon b u si­
n e s s ea rn in g s.
Short s e l l i n g became a d e v ic e f o r a ccen tu a tin g "breaks"
i n th e market ra th er than a c o rrecto r o f v a lu e s.
Die change in the r o le
o f sp e c u la tio n and the sp ecu la to r has been d escrib e d .
In sh o r t, during
th e l a t e tw en ties th e exchanges did l i t t l e more than to a c t as a v e h ic le
fo r u n b rid led s p e c u la tio n .
rurthermore, I n f la t e d s e c u r ity p r ic e s in ­
duced nameroue c o n s o lid a tio n s among companies, which i n many in sta n c e s
d id n o t b e n e f it the b u s in e s s e s which were combined, but had b e n e f ic ia l
e f f e c t s on the p r ic e s o f th e s e c u r it ie s o f the new com panies.
Uhls f a c t
made f o r c o n d itio n s which might be e x p lo ite d by p r o fe s s io n a l sp e c u la to r s
-3 0 a t the expense o f the Inexperienced.
F in a lly , between 1928 and 1929
th e standards o f investm ent rela x ed , because by th a t time th ere were
few sound s e c u r i t i e s b ein g o ffe r e d .
Houses were forced to s e l l what
th e market o ffe r e d or do no b u s in e s s , and the divergen ce between c l i e n t
38
and banker in t e r e s t was thus widened.
These f a c to r s which have been enumerated were fundamenta in de­
v e lo p in g a s it u a t io n where investm ent was unsound even i n the moBt fo r­
tu n a te ly s it u a t e d com panies.
Almost any in d iv id u a l who purchased sto ck s
o r bonds between 1925 and 1932 found h im se lf w ith a lo s s a t th e end o f that
tim e.
In a d d itio n to the more d ir e c t ly r e la te d elem ents in th e s it u a t io n
which have been d esc rib e d , th ere are oth ers which, i f l e s s obvious, are
e q u a lly fundamental i n the r e a ltio n s h ip o f sto ck exchanges to b u s in e s s .
These were d escrib ed by Hr. X.A. Ooldenwelser b efore the Senate Committee
on Banking and Currency a s fo llo w s t
In a d d itio n to encouraging th e f lo t a t io n o f s e c u r it ie s ,
w hich, o f co u rse, r e s u lt s in an enormous amount of funds a c ­
cum ulating i n th e hands o f b u sin e ss concerns, and over-ex­
p a n sio n o f p la n t th a t l a t e r has ser io u s consequences, a rapid
r i s e In s e c u r ity p r ic e s in a d d itio n means p r o f it s tak en out o f
the maxket by th o se who s e l l a s r i s e s occur, and r e s u lt s in an
enormous demand fo r a g r e a t many k ind s o f goods on th e p art o f
th o se p r o f it ta k er s.
These demands, however, are concentrated to a v ery la rg e
e x te n t in what a re g e n e r a lly known a s luxury goods, and th at
r e s u lt s in o v er-exp an sion in the p rodu ction o f such g o o d s, o f
p la n ts which c a te r to tb s r ic h , or more p a r tic u la r ly to the
newly r ic h ,
w h ile the demands fo r oth er goods a r e n o t l i k e l y
to be a f f e c t e d so much, or not to in c r e a se a t a l l , so th a t th ere
i s a d is lo c a t io n o f in d u stry .
When, on th e o th er hand, th e boom breaks and d ep ression
d e v e lo p s, th ere i s a v e r y rap id d e c lin e In th ese lu xury goods,
fo llo w e d by a v e r y g r e a t d i f f i c u l t y on th e p art o f th ose concerns
38
Benjamin Grahem and David Dodd, S ecu rity A n a ly sis . (McGraw-Hill Book
C o., I n c ., Hew Tork and London, 1934), G h.I, p p .1 -7 .
-3 1 w hich b u i l t th em selves up on such trade; and there i s a lso
an a b so lu te drying up o f the c a p ita l market, because whereas
one year everyone would buy alm ost ev ery th in g b lin d ly , the
n ex t year th ey would not buy anything w hatsoever because o f
two reasons - fo r one reason , because t h e ir f a it h i n an ythin g
th ey might buy had been fo r g e ite d ; and fo r another reason , and
perhaps the more Im p ellin g reason , th a t they do not have the
means w ith which t o buy.
So th a t the d e c lin e in b u sin e ss fo llo w in g upon a c o lla p s e
o f the sto c k exchange i s a ls o d is a s tr o u s , end i t accen tu a tes
th e d e c lin e in b u sin e ss a c t i v i t y , whloh may be due in the f i r s t
in sta n c e to o th er m aladjustm ents in our economic l i f e .
I t i s not my purpose here to g iv e th e im p ression th a t s to c k
exchange s p e c u la tio n i s the o n ly th in g th a t ca u ses g r e a t changes
in our b u sin e ss a c t i v i t i e s , I th in k i t i s on ly one o f the fa c to r s .
I th in k i t i s , however, a f a c to r that does co n trib u te to the e x ­
c e s s iv e r i s e s a t the h e ig h t o f a boom and to th e e x c e s s iv e d e ­
c l i n e s a t the depth o f a d e p r e s s io n .(3 9 )
During the p erio d from 1925 to 1932, on th e other hand, p r o f it s
from brokerage op era tio n s and from o th er fu n c tio n s conceraed w ith the
s e c u r it y markets reached new h igh l e v e l s through accomodation o f the
s p e c u la tiv e p u b lic .
The p r ic e o f a se a t on the New Tork Stock Exchange
in c r e a se d from a low o f $ 99,000 in 1925 to a high o f $625,000 in 1929;
th e low fig u r e fo r 1925 was n o t reached th e r e a fte r u n t i l 1932.
It
should be p o in ted o u t, however, th at volume of trad in g In sto ck s during
th e f i r s t p a rt o f t h is p erio d remained in a more or l e s s co n sta n t r a tio
to the number o f shares l i s t e d , and has r e c e n tly d e c lin e d .
Between 1925
and 1929 the mmber o f sh ares l i s t e d in creased about 2 .5 tim es.
Between
1929 and 1932 the nmnber o f shares l i s t e d in crea sed s l i g h t l y w h ile the
volume o f tra d in g i s o n ly 38 per c e n t of i t s 1929 f ig u r e .
At the c lo s e
o f 1937 the t o t a l number o f shares l i s t e d was 24 per cen t above the 1929
f ig u r e , w h ile th e volu n e o f tr a d in g was o n ly 36 per cen t o f the 1929
39
73rd Cong. 2nd S e e s ., H earings b efo re the Senate Ooranittee on Banking
and Currency, on S. Has. 8 4 ,5 6 , and 9 7 , P t. X7, p p .6441 f .
-3 2 40
to ta l.
N e v e r th e le ss, there i s l i t t l e doubt th at during the g r e a te r
P a r t o f t h i s p eriod d isp ro p o rtio n a te a c t i v it y occurred In is s u e s th at
were s p e c u la tiv e f a v o r it e s .
This f a c t g iv e s grounds fo r the charge
th a t b rokers encouraged s p e c u la tio n and took la r g e p r o f it s from the
s p e c u la tin g p u b lic , and d ata on p o o l operations which were l a t e r u n convered by in v e s t ig a tio n s p o in t to the f a c t th a t brokers were in many
c a s e s op eratin g f o r t h e ir accou n ts in p ools on th e o p p o site sid e o f
th e market from t h e ir custom ers.
Demand fo r
Die c o lla p s e in s e c u r ity p r ic e s which took p la c e in 1929, and the
bear market w hich fo llo w e d , r e s u lt e d in w ide-spread p u b lic l o s s .
Not
o n ly d id the p u b lic s u f f e r d ir e c t l y through i t s s e c u r ity h o ld in g s, but
a ls o in d ir e c t ly through the d i f f i c u l t i e s ifcich were exp erien ced by
banks and o th er fin a n c ia l i n s t i t u t i o n s a s a r e s u lt o f shrinkage in se­
c u r it y v a lu e s ,
i e the d ep ression gained headway and p u b lic d isc o n te n t
grew, a stro n g f e e l i n g a g a in st the s e c u r i t i e s exchanges becane e v id e n t,
w hich culm inated in demands f o r th e ir r e g u la tio n .
B d b llc r e a c tio n a g a in st s e c u r it i e s exchanges was in i t s e l f n othin g
new; i t had occurred from time to tim e throughout t h e ir h is t o r y .
It
becane n o tic e a b ly stron ger during th e l a t t e r p art o f the n in etee n th
cen tu ry , p a r t ic u la r ly during the e ig h t ie s and n in e t ie s .
Daring t h is
p erio d many u t i l i t y and in d u s t r ia l is s u e s , over which inadequate con­
t r o l was e x e r c ise d by exchange a u t h o r it ie s , made t h e ir appearance on
th e New Tork Stock Exchange,
furtherm ore, t h is was th e era which p ro41
duced such noted m anipulators a s J is k , Gkmld, m d Drew.
40
Computed from New Tork Stock Bachange Tear Book. 1940 e d ., p p .2 3 ,4 9 ,7 2 .
41
U yers, ghe New Tork Honey Market, V ol. I , Ch. XIV, p . 307.
-3 3 A fte r tbs panic o f 1907, p u b lic f e e lin g a g a in st the exchanges was
such th at a commission was appointed by Governor Hughes o f New Tork fo r
th e purpose o f form ulating law a concerning sp e cu la tio n in s e c u r it ie s
and consnodities.
This ccm nittee subm itted i t s rep ort in June 1909*
The Bighes in v e s tig a tio n Included p r a c t ic a lly a l l a sp e c ts o f exchange
o p era tio n , but recommended reform by the New Tork Stock Exchange i t ­
s e l f ra th er than l e g i s l a t i v e a c tio n , excep t in a few m atters p e r ta in in g
to the conduct o f brokers toward th e ir custom ers.
The most important
changes suggested in the Hughes report were (1 ) the r a is in g o f the
margin requirem ents to 20 p er c e n t, to be based on the average rath er
than the current p r ic e o f a se c u r ity ; (2 ) the v e s tin g in th e Board o f
Governors o f the exchange the power to deteim ine when a corner e x is te d
and to f i x the settlem en t p r ic e ; (3 ) the req u irin g o f more adequate r e ­
p o r ts from corp oration s by the l i s t i n g committee; (4 ) the lim it in g o f
trad in g to 100 s h a r e u n its ; and the a b o lish in g o f u n lis te d trading; and
( 6 ) the keeping o f c le a r in g house records on f i l e for p eriod s o f s ix
42
y e a rs. Die exchange responded to the Hughes rep ort by p u ttin g many of
i t s recommendations in to e f f e c t , which r e s u ite d in con sid erab le im­
provement in sto ck exchange t e c h n ic s .
Tour y ears la t e r the Fujo coosnlttee o f the House o f R ep resen tatives
turned i t s a tte n tio n to exchange p r a c tic e s as a p a rt o f i t s money tr u st
in v e s t ig a t io n .
This conm ittee recommended s p e c if ic l e g i s la t i o n a g a in st
the exchanges.
I t s most Important recommendations were: (1 ) that the
New Tork Stock Exchange be incorporated under s ta te law; (2 ) th a t cor­
p o ra tio n s d e s ir in g to l i s t th e ir s a c u r it ie s be com pelled to make complete
42
63rd Gong. 2nd S e e s ., Hearings before the Senate Coma, on B cg.and C urr.,
on S. 3895, pp.797 f f .
-3 4 re p o r ts; (3 ) th a t margin requirem ents he f ix e d a t 20 per ce n t or over;
(4 ) th a t "wash11 Bales and m an ip u lative p r a c tic e s he p ro h ib ited ; (B)
th a t h yp o th eca tio n o f custom ers' s e c u r it ie s he lim ite d to unpaid b a l­
ances; ( 6 ) th a t the customer' s consent must he obtained b efo re s e c u r it ie s
cou ld he le n t by brokers; ( 7 ) th a t l i s t i n g o f s e c u r it ie s and e x c lu sio n
from l i s t i n g he su b je c t to j u d ic ia l review ; and ( 8 ) that brokerage hocks
be su b jec t to Federal exam ination under a ith o r lt y o f t h e P ost U aster
43
G eneral.
A h i l l embodying th ese changes f a ile d to p ass in Congress, but
the Hew York Stock Exchange adopted many changes to conform w ith th e
44
proposed law* Ho fa r th e r attem p ts were made by the Federal Government
to r e g u la te s e c u r i t i e s exchanges u n t i l a f t e r th e crash o f 1929.
She
c o n g r e ssio n a l in v e s t ig a t io n s which le d to the passage o f th e S e c u r itie s
Exchange Act o f 1934, and th e co n ten t and op eration o f t h is Act are
d isc u sse d in the fo llo w in g chapters*
43
62nd Cong. 3rd S e s s ., House Conmlttee Appointed Pursuant to H. Bss*
489 and 504 t o I n v e s tig a te th e C oncentration o f Control o f Honey and
C red it (Pujo C onm lttee), R eport. Ch. IT, p . 163.
44
Myers, o n . d t . . p . 313
O&AFTEB II
THE CASE AQAIHST THE STOCK EXCHANGES
Ihe growing demand f o r r e g u la tio n o f the stock exchangee during
the d e c lin e in th e market from 1929 and 1932 r e s u lte d in a s e r ie s o f
in v e s t ig a tio n s and the p r e s e n ta tio n o f v a rio u s b i l l s in Congress which
were to culm inate in H.B. 9323, enacted In 1934, and known as the Se­
c u r i t ie s Exchange A ct o f 1934.
As e a r ly as February, 1932 there were
h ea rin g s b efore a sub-conxnittee o f th e House J u d ic ia r y Conmlttee to
in v e s t ig a te th e p r a c tic e o f sh ort s e ll i n g o f s e c u r i t i e s .
Although
o e r ta in v a lu a b le evid en ce was brought out a t th at time in the t e s t i ­
mony o f Ur. Bichard Whitney and o th e r s, the House and Senate hearings
on the r e s o lu tio n s which le d more d ir e c t ly to the p a ssin g o f the Se­
c u r i t ie s Exchange Act g iv e a much more com plete and b e tte r form ulated
statem ent o f the ca se , and show, e s p e c ia lly in th e la t e r s e s s io n s o f
the h ea rin g s, a more balanced and j u d ic ia l p o in t o f view on th e p art
o f the in v e s t ig a to r s .
She p resen t summary o f th e ca se a g a in st the
exchanges, and the d efen se in the fo llo w in g ch ap ter o f th ose who t e s t i ­
f ie d in th e ir fa v o r, w i l l be drawn p rim a r ily , th e r e fo r e , from the abovem entioned House and Senate h e a r in g s, and in p a r tic u b r from th e Senate
h ea rin g s, which are much more e x te n siv e in scop e.
Stock exchange o f f i c i a l s , b rok ers, s p e c i a l i s t s , r e p r e se n ta tiv e s
o f la rg e co rp o ra tio n s, law yers, econ om ists, accou n tan ts, a id many oth ers
were brought b efo re the Senate Committee on Banking and Currency, be­
gin n in g in A p ril 1932; th e committee attem pted to e s t a b lis h , from the
testim ony o f th ese p erso n s, evid en ce in support o f com plaints a g a in st
th e sto ck exchangee on a b a s is o f ( l ) the o r g a n isa tio n o f exchange
36—
m achinery, which was assumed to have "been ev o lv ed In the I n te r e s t o f
exchange members, ( 2 ) a lle g e d f a u lt y a d m in istra tio n o f stock exchanges
by o f f i c i a l s , and (3 ) c e r t a in phases o f the str u c tu r e and op eration o f
corporate b u sin e ss and fin a n c e th a t have b earin g upon the conduct o f
exchange b u s in e s s .
I t was claim ed th at th e se f a c to r s gave r i s e to
p r a c tic e s which were disadvantageous to purchasers o f s e c u r it ie s , enc our aged sp e c u la tio n , and a f f e c t e d a d v e r se ly th e o rg a n iza tio n and op­
e r a tio n o f economic l i f e .
C oncentration o f power
I t was a lle g e d hy th o se conducting the in v e s t ig a t io n o f the ezH
changes th a t t h e o r g a n iz a tio n of the Hew Tork Stock Exchange, w h ile
t h e o r e t ic a lly s e t up f o r co n sid era b le democracy o f c o n tr o l, a c t u a lly
v e s te d c o n tr o l i n the p r e s id e n t and the law com m ittee.
This p o in t was
brought out in th e testim on y o f Ur. George U. H a rris, member of the
brokerage firm o f B S rris, Upham, A Co.
Mr. Pec ora, in d what are the powers and d u tie s o f th e law
committee o f the Hew Tork Stock XzchaageT
Ur. H arris! I t p ro v id es a law committee to c o n s is t o f f iv e
members, which s h a ll d ea l w ith m atters a f f e c t in g the in t e r e s t s
of th e exchange.
I t s h a l l a c t in an a d v iso ry c a p a c ity to the p r e sid e n t when
req u ested by Mm and s h a l l, in a s s o c ia t io n w ith the p r e sid e n t,
rep resen t the exchange in a l l m atters a f f e c t in g itB gen eral in ­
t e r e s t s and i s a u th o r ised and empowered, a t i t s d is c r e tio n , to
examine in to the d e a lin g s o f any member o f the exchange.
Mr. Peep rat Bie members o f the law con m lttee are appointed by
the p r e s id e n t, are th ey not?
My.
Tes s i r .
Mr. Pecorat How, has t h is law committee v i r t u a l l y super­
seded th e governing con m lttee w ith regard to the r e p r e se n ta tio n o f
the exchange in m a tters a f f e c t in g i t s g e n e r a l ln te r e stsT
Mr.
Ho, s ir ; I would not say th a t.
Mr. Pecorat W ell, th en , l e t me r e fe r you to the e ig h th pare**
graph o f a r t i c l e 10 o f th e c o n s t it u t io n , p ro v id in g fo r t h e crea­
t io n o f a law com m ittee, and d efin in g i t s d u tie s and powers, which
paragraph says in p a r t, regarding th e law com mittee!
-3 7 I t s h a ll a c t in aa. a d v iso ry c a p a c ity to the p r e s id e n t, when
req u ested by Mm, and s h a l l , i n a s s o c ia t io n w ith the p r e sid e n t,
rep resen t the exchange in a l l m atters a f f e c t in g i t s g en eral in t e r e s t s .
Poe an11 th a t g iv e the committee v e r y , v e r y broad powers, a
v e r y broad grant o f power, to fu n c tio n fo r th e exchange in a l l
m a tters th a t might be deemed to a f f e c t th e in t e r e s t s o f the exchange?
S h is con cen tra tio n o f power in the hands o f a few p eop le was coz*1
sid e r e d con trary to the p u b lic in t e r e s t .
Ixchangp d is c ip lin e
I t was charged th a t d is c ip lin a r y a c t io n on the p a rt o f th e Hew
Tork Stock Exchange was l a x .
D is c ip lin a r y a c t io n a g a in st members o f
th e Hew Tork Stock Exchange was in s t it u t e d upon com plaint o f th e members
them selves or upon th a t o f cu stom ers.
While the exchange p resen ted e v i­
dence to show th at offen d in g members had been p u nished, one senator f e l t
th a t attem pts a t v io la t io n o f r u le s would n o t be made u n le s s th ere were
a good p o s s i b i l i t y o f the o ffe n d e r 's esca p in g d isc o v e r y .
Another sena­
to r c it e d the ca se o f a lU s s B oberts, who cou ld not g e t r e d ress from
th e exchange a u t h o r it ie s , but was a b le to g e t i t in th e c o u r ts .
C ertain
o f the s a lie n t p o in ts in t h is testim ony appear in the fo llo w in g e»*
cex p ts from th e hearings!
Mr. Pecorat I t seems th a t between January 1 ,1 9 2 8 , and Sep­
tember 1 ,1 933, s p e c i a l i s t s receiv ed w arnings and d is c ip lin a r y
a c t io n in a t o t a l o f 9 3 in s ta n c e s .
S e n a t o r Canzonet Does th a t in d ic a te whether th a t i s 93
d if f e r e n t s p e c ia lis t s ? I f i t i s , i t i s a la r g e p ercen tage. I f
i t i s a r e p e t it io n o f th e same s p e c i a l i s t s , why, th ere i s some­
t h i n wrong w ith the exchange to perm it such r e p e t it io n .
Mr. Pecorat I t appears th a t th ere was r e p e t it io n .
Senator JsUslfiZ' lu what p eriod was that?
Mr^ Pec ora: Between January 1, 1928 and September 1,1933.
Senator lea n t l i v e y e a r s.
Mr. Pecorai Tor m ajor in fr a c tio n s o f r u le s th ere were seven
s p e c i a l i s t s e x p e lle d , two suspended, 3 censured, and one perm itted
to s e l l h is membership.
1
U .S. Congress. Senate, 72nd C one.. 1 s t and 2nd S e e s ., and 73rd Cong. 1 s t
on jjEuuc^ng ana uorrency, neari nas on £ . Bee. 84.
5 6 ,9 7 , (S to ck Exchange P r a c tic e s ; 1932-1934, Pt.XIV,' ppi.o 3 9 9 f f .; q uotation
from pp. 6397-6400.
Sif'i.S**, i«Bs. ,_ w« b i h w
-3 8 Senator gqiftiey* Would a man in v a r ia b ly be e x p e lle d fo r
buying stock fo r h ie own account when he had a custom er1b order
a t the flame time?
Mr. Whltnev i So fa r a s I have ever known, Senator Bulk le y ,
1 have known o f no e x c e p tio n s th a t I can th in k o f .
Senator w nivi^r. Would he q u ite c e r t a in ly be ejected ?
Mr. Whltneyt We b e lie v e so; y e s .
Senator
She reason I ask th a t i s th e man that you
t o ld about a few m inutes ago th at bought 1 ,5 0 0 sh ares mast have
had some hope o f g e t t in g o a t. Do you know how h e fig u re d it ?
Mr. Whitney: Ho, I do n ot; b a t, n a tu r a lly , anybody who i s
breaking rule s o r com m itting a crime h as a hope th a t th ey are
golqg to g e t away w ith i t .
Senator C ostiaunt Was th e c a s e o f M iss B oberts o f Hew Tork
brought to your a t t e n t io n , Mr. Whitney?
Mr. WMtnwvn At variou s tim es, s i r .
Senator
Was her com plaint in v e s t ig a te d m d a cted
upon?
Mr. Whitney; Most thoroughly; y e s .
Senator O ostlgani What form o f action ?
Mr. Whit nay i We did n ot gran t her com plaint.
Senator C oetlgani 3here was in th a t In sta n c e , was th e r e n ot,
a Jndgnent in one o f the c o u rts o f Hew Tork which seemed to support
h er claim?
Mr. Whitney: A c e r t a in p a rt o f i t in which she g o t Jud®nent.
Senator f o a t ig « u Tcm f e l t th a t the judgment d id not J u s t if y
h er complaint?
Mr. Whitney: Did n o t j u s t i f y any fa r th e r a c t io n by the ex ­
change; y e s s i r . ( 2 )
She members o f the committee were r e lu c ta n t to accept the argument
o f Bichard Whitney, then P r e sid e n t o f the Hew Tork Stock E xchaige, that
unromedled abuses were o f such a k in d a s to f a l l o u tsid e o f the scope
o f power of th e exchange a u t h o r it ie s .
Purtheim ore, there 1b l i t t l e
to in d ic a te th a t, i f t h is bad been the c a s e , i t c o n s titu te d grounds
3
f o r t o le r a t io n o f ab u ses.
L is t in g requirem ents
L is tin g requirem ents were lik e w is e co n sid ered f a u lt y both from
th e p o in t o f view o f the nature o f the procedure In volved and th at o f
2
Tor fu rth er d isc u s sio n o f M iss Boberts* c a se see Senate Hearings on
S tock Exchange P r a c tic e s . P t. I l l , pp. 1127 f f .
3
Senate Hearings on Stock Exchange P r a c tic e s , P t. XT, p p .6870-6885q u o ta tio n from p p. 6878 f ,
~
39l t 8 a d m in istra tio n .
I t appeared t i n t , w h ile th e f l r e t l i s t i n g in ­
v e s t ig a t io n m ight he f a i r l y thorough, subsequent l i s t i n g in v e s t ig a tio n s
were s u p e r f ic ia l.
She stock l i s t com m ittee, in a l l c a s e s , a Banned
th a t the d ir e c to r s o f a corp oration were a c tin g in i t s I n t e r e s t , and
d id n o t f e e l i t t h e ir o b lig a tio n to in v e s t ig a t e e x h a u stiv e ly .
more, the reguhr procedure was n ot alw ays c a r r ie d cut*
l i s t e d which rep resen ted
and
s u b s t a n t ia lly n oth in g
th er e were In sta n c es where a s s e t s had b een
Turtheit-
S e c u r itie s were
in the wayo f a s s e t * ,
w r itte n up f i c t i t i o u s l y .
In th e ca se o f the O eneral th e a tr e s C orporation, a s s e t s were w r itte n
up from four to tw en ty-fou r m illio n s o f d o lla r s , and a t the tim e o f
i t s o r ig in a l l i s t i n g i t p assed th e l i s t i n g com n ittee w ith ou t cau sin g
q u e stio n .
When th e f a c t s sub seq u en tly were brought o u t, no a c t io n was
taken by th e exchange,
Ur. Pec oral When that testim on y o f Olarice, w hich was g iv en
l a s t November, came t o your n o t ic e d id i t
n ot arou se in you a
d e s ir e to fin d o u t, a s chairman o f tbs sto c k l i s t co n m lttee, how
i t was th a t your com m ittee, a f t e r a thorough in v e s t ig a t io n o f th a t
a p p lic a tio n fo r an o r ig in a l l i s t i n g , approved i t , alth ou gh there
had been a mark 19 in a s s e t v a lu e o f from $ 4 ,0 0 0 ,0 0 0 to over
$ 3 4 ,0 0 0 , ooor
Mr. A lt ■ahull Bie g en era l h is t o r y o f th e Vox f ilm and Oen­
e r a l B iea tres Equipment Oo. development was such th a t th e com­
m itte e was m isle d . . . .
Mr. Pec ora: Sven when you learn ed through th e testim on y g iv en
h ere by Ur. Clarke l a s t November th a t your co n m lttee had been m is­
l e d in to the approval o f the a p p lic a tio n fo r the l i s t i n g o f the
sto d o o f a ccmpany which in i t s a p p lic a tio n showed a s s e t s worth
$ 3 4 ,0 0 0 ,0 0 0 which in r e a l i t y were worth on ly about $ 4 ,0 0 0 ,0 0 0 ,
d id not th a t arouse in you an in te n s e d e s ir e to fin d out how your
con m lttee had b een m isled i n th a t fashion?
Ur. A ltec h u li Of course the committee i s guided Ty i t s
d e s ir e to d e te r a ln e th e f a c t s in a l l th e se c a s e s . I cannot sgy
t h a t t h is p a r tic u la r r e v e la t io n had lnqoressed u s w ith any new
d e s ir e to look in t o th at p a r tic u la r th in g which was a m atter o f
h is t o r y ; but a d e s ir e to nuke our in v e s t ig a t io n more s a t is f a c t o r y
i n the fu tu re than in th e p a s t . When th e damage was done I on
a f r a id we d id n o t go in t o i t .
-4 0 The r e s u l t s o f c a r e le s s n e s s on the p a rt o f the l i s t i n g conm lttee were
considered, m islea d in g to the p u b lic , In view o f the f a c t th a t a l i s t e d
company might a d v e r tise th e f a c t th a t I t s s e c u r it i e s were so l i s t e d ,
and th a t the p u b lic g e n e r a lly b e lie v e d th at l i s t i n g in v e s t ig a tio n s
4
w ere c a r e f u lly made,
Exchange machinery
There were c e r t a in fe a tu r e s o f th e o rg a n isa tio n o f exchange ma­
ch in e ry which were co n sid ered to produce d i f f i c u l t i e s In th e carryin g
out o f the fu n c tio n s o f the exchange w ith r e la t io n to th e public*
It
appeared that many o f th e se grew from the f a c t th a t the exchange was
org a n ised and h as evolved w ith the in t e r e s t s o f the members ra th er
than th o se o f th e custom ers as the primary c o n s id e r a tio n .
Others were
co n stru ed as r e s u lt in g from r u le s which had been drawn up alon g the
same l i n e s .
Tor example, w ith th e growth o f the m arkets, s p e c ia l i s t s
came in to being a s a r e s u lt o f demands f o r more e f f i c i e n t han dling o f
tr a n sa c tio n s, and w ith them came c e r t a in e v i l s .
1, Tunctions o f the B u e c la lls t
The s p e c i a l i s t , w h ile tra d in g fo r the account o f o th e r s, trad es
f o r h i s own account a s w e l l.
That i s , he may buy stock for h im se lf
when he ch o o ses, as lon g a s he does not have ord ers from customers on
h i s books.
This f a c t w a sln terp reted a s meaning th a t th ere was a d i­
vergen ce o f in t e r e s t between th e s p e c i a l i s t end h is custom er.
While
in h i s c a p a c ity as broker he had no other i n t e r e s t , than making com­
m is s io n s , a s soon a s he became i n any way in te r e s t e d in a stock on
4
Senate Hearings on Stock
P r a c tic e s . P t. X III, p p .5966-6027;
q u o ta tio n from p p .5977 f . See a ls o P t. XIV, p p .6200-6305.
-4 1 h i s own account
he had an in t e r e s t in the trend o f the market,
Furtherm ore, the k eep in g o f hooks in which the orders f o r sto ck s
a re l i s t e d , g iv e s the s p e c i a l i s t inform ation w hich he may u s e fo r
h i s own advantage o r d iv u lg e to o th er p a r t ie s i f he ch o o ses.
I t was
through th is inform ation th a t th e s p e c i a l i s t was supposed to make s u V
o t a n t ia l p r o f it s a t the expense o f th e l e s s w ell-in fo rm ed people in
th e market,
Ur. Charles C, W right, a s p e c i a l i s t , was r e lu c ta n t to admit th at
a s p e c ia lis t * s hock i s o f any advantage to him.
H is testim on y, however,
In d ica ted th a t i t i s o f co n sid e r a b le a id i n f o r e c a s tin g market tren d s.
Mr. Pecorat As a s p e c i a l i s t , you g e t buying and s e l l i n g
orders fo r the sto ck , do you not?
Mr. Wrighti Tew, s i r .
Mr. Pecorat And w ith th a t in form ation are you not in a
b e t t e r p o s it io n to determ ine what the tre n d o f th e market i s going
to beT
ME* W righti Wo, s i r .
Mr. Pecorat Why does n ot th a t in form ation g iv e you th a t
advantage!
Mia
Because the trend o f th e market i s o p p o site
t o what the book i s .
Mr. Pecorat Does th a t n ot g iv e you knowledge o f th e trend
o f th e market i f i t runs o p p o site from the tra d in g in d ic a te d by
th e buying ad s e l l i n g ord ers on your bock!
j f e a l E ^ I . Tee, you could say th a t i t d id .
Mr. Pecorat I s n o t th a t an advantage!
Mr. Wrighti Sometimes; sometimes not.
Mr. Pecorai When 1 b i t an advantage and when i s i t a d is ­
advantage?
Mr. Wrighti That I cannot answer. I would have to have
a book in a c tu a l o p era tio n to be able to t e l l you,
Mr. Pecorat I t i s an a d v a ite g e to one tra d in g in the market
to know what th e trend o f the market i s l i k e l y to b e , i s i t n ot!
MEi . Wglghtt I t c e r t a in ly i s .
Mr. Pecorat Ten alw ays hare th a t advantage from the know­
le d g e you have a s a s p e c i a l i s t , do you n ot!
Mr. Wright! I f I alw ays had th a t ad van teg e , I would not
ev er lo s e money; a d I v ery fr e q u e n tly lo s e money.
Mr. Pecorai I t m ight n ot be an advantage which would
c o n c lu s iv e ly enable you to make money every tim e on a trad e, but.
i t i s always an advantage, i s i t n o t, to have th a t knowledge!
—42**
Mr. W righti Tea, a ir ; I f you have i t .
Mr. Pecorai Aid th e s p e c ia l! a t has g o t It?
Mr. Wrighti At tim e s. ( 5 )
One o f th e arguments which had been advanced i n favor o f the
s p e c i a l i s t ' s op eratin g on h is own account was th at by doing so he
made a continuous market f o r the b e n e f it o f both sp ecu la to rs and
in v e s to r s .
I t was charged th a t a con tin uou s market was not made a s
a p art o f the s p e c i a l i s t ' s du ty, b u t cane about o n ly a t such tim es
a s i t might be p r o f it a b le f o r him to trad e, and th a t the e f f e c t o f
6
a continuous market was th e encouragement o f s p e c u la tio n .
f i n a l l y . i t was charged th at the s p e c i a l i s t , because o f h is
p o s it io n , was prone to op erate w ith m anipulators fo r the purpose
d is tr ib u tin g sto ck to the p u b lic .
of
She o p era tio n o f poolB, and the
p a r t ic ip a t io n o f s p e c i a l i s t s in them w i l l be tr e a te d more f u l l y under
a g en era l d isc u s sio n o f market m anip ulation.
The main p o in ts o f d is ­
agreement between the s p e c i a l i s t s and th e in v e s t ig a to r s had to do w ith
th e r is k s and r e s p o n s i b i l i t i e s in v o lv ed , and the opportunity fo r pro­
f i t s from t h e ir o p er a tio n s.
2 . M u ltip le fu n c tio n s o f brokers
Another source o f g rievan ce m s found in the f a c t th at brokers
perform m u ltip le fu n c tio n s.
Very o fte n a sto ck exchange house per­
forms a t one and the same time the fu n c tio n s of a broker, u nderw riter,
and s e l l e r o f s e c u r it ie s .
account as w e l l .
Such a house may a ls o d e a l fo r i t s own
Such a grouping o f fu n c tio n s in the hands of one
5
Senate Bearings on Stock Bnchange P r a c tic e s , pp. 6106 ff-q u o ta tio n from
p . 6105. See a ls o 73rd Cong.. 2nd S e e s .. H earings b efo re the House C a m ltt e e on I n te r s ta te and f o r e ig n Commerce, on E. E. 7852 and H.E. 8720 ( Stock
Zxchange BegulationJT Feb. 14-Mar.2 4 ,1 9 3 4 . pp. 218 f f . , pp. 431 f f , , e t c .
6
Senate B earings on Stock Exchange P r a c tic e s , P t . H V . p p .6806-6824.
-
43-
p erson or firm m ight make i t alm ost im p ossib le f o r a customer to ob­
t a in unbiased in form ation, which many custom ers seek, even though th o se
concerned m ight be h o n est,
furtherm ore, th e performance o f many func­
t io n s was dangerous to the so lv en cy o f the b u sin e s s, i t was h e ld .
Many
important brokerage h ou ses, which had been s o lv e n t as fa r as t h e ir
brokerage b u sin e s s was concerned, had f a ile d ; they had had d i f f i c u l t i e s
7
in co n n ectio n w ith s e c u r it ie s which they had sponsored.
B ro k e ra g e f i r m s w e re a l s o a c c u s e d o f b e i n g I n v o lv e d i n p o o l s f o r
8
the purpose o f m anipulating s to c k s .
3 . Margins
The system o f buying sto ck s on margin was attacked in two ways;
( l ) the system o f margin trad in g i t s e l f was condemned, and ( 2 ) th e o p ­
e r a tio n o f th e system was con sid ered f a u lt y and d etrim en tal to pur­
c h a s e r s.
The system o f margin tra d in g was condemned on th e broad
ground th a t i t fu rn ish ed o p p o r tu n itie s fo r sp e c u la tio n to a degree
w hich o th erw ise would not e x i s t - s p e c u la tio n accom plished w ith o th er
p e o p le 's money.
I t was fu r th e r h e ld th a t th e margin requirem ents were
to o low to fu r n is h adequate p r o te c tio n
fo r custom ers; th a t b rckers
encouraged the purchase o f sto ck to th e li m i t s o f th e ir own s a fe ty ,
w ith the r e s u lt th a t bear r a id e r s m ight s t a r t a downward movement which,
a c c e le r a te d by the ex e c u tio n o f stop l o s e o rd ers, would fo rce custom ers
9
to liq u id a te w ith l o s s e s .
7
Senate B earings on Stock Exchange P r a c tic e s . Ft . XT. pp. 6521-6522. See
a ls o H o u s e H earings on Stock Exchange B egu latlon . pp. 360,400 f . , 413 f f *
4 4 3 ,4 8 7 f f . , 778, 783, e t c .
8
S ee d i s c u s s i o n o f m a r k e t m a n i p u l a t i o n b e lo w , p p . 6 2 - 6 6 .
9
S e n a te H e a r in g s o n S to c k E x ch an g e P r a c t i c e s . P t . I , p p . 7 f . , a n d p * 4 0 .
See a l s o Houbb H e a r in g s o n S to c k Exchem ge B e g u l a tl o n , p p . 51 f f . , 7 3 f . .
8 7 ,9 4 f f . , 180 f f . , e t c .
m
A
A
4 . S h o rt g e llin g
Ho lo s e d etrim en ta l than margin tra d in g I t s e l f , and c lo s e ly a l l i e d
to I t , la the p r a c tic e o f sh o rt s e l l i n g .
Short s e ll i n g was viewed as
one o f the most Important d e v ic e s hy means o f which hear ra id in g was
accom plished.
In h r l e f , the short s a le c o n s is t s o f borrowing sto ck ,
which i s so ld in th e hope o f re-p arch ase a t a la t e r date a t a more
fa v o ra b le p r ic e .
By r etu rn in g th e s to c k , the short s e l l e r makes as
a p r o f it the d iffe r e n c e s between the s e l l i n g p r ic e and the purchase
p r ic e , as the len d er le n t m erely a number o f sh ares and n ot a s p e c if ie d
v a lu e im atocfc.
To accom plish the short s a le , i t i s necessaxy th a t
stock be a v a ila b le to len d .
The supp ly o f loanab le stock a r is e s la r g e ly
from custom ers1 sto c k s in the hands o f b rok ers who put p ressu re on
custom ers to ca u se them to agree to lo a n s o f t h e ir sto c k s.
p aid for th e lo a n o f sto c k s were con sid ered inadequate.
P r ic e s
I t was brought
out in the h ea rin g s th a t brokers took a p o s it io n in the market op p osite
to th a t of t h e ir custom ers, UBing custom ers1 sto ck fo r t h i s purpose,
and the p r a c tic e o f sto ck len d in g w as, th e r e fo r e , condemned.
4n example o f testim on y on t h is p o in t fo llo w s :
Senator Oouzensi While Ur. Whitney i s reading th a t paragraph,
i t has come to my a t te n t io n th a t i t i s q u ite p o s s ib le fo r the
broker to u s e h is cu stom er's stock to depress th e valu e o f the
cu stom er's s to c k , and I wondered what k in d o f an agreement e x is t e d
between a b rok er and h is customer w hich gave the broker the oppor­
tu n ity o f s e l l i n g sh ort and d ep ressin g the v a lu e o f h is customer* s
sto c k .
Ur. Whitney: Senator Couzens, I deny i t .
Senator Oouzens: That a broker may u se h is custom er's sto ck
in d ep re ssin g the market. Ho broker under our r e g u la tio n s may
s e l l sto ck s sh ort and u se h is cu stom er's sto ck or may he s e l l in
any way fo r h i s own account and u se h is custom er's sto c k . That i s
an a b so lu te v i o l a t i o n of our r u le s .
Senator Couzens; Bow do you d e t e c t th at when th a t happens?
U r . W h itn e y : When i t h a p p e n s .
-4 6 Senator Couzens: Tes. Oh, i t does happen. Ho u se to he so
innocent about i t .
Mr. Whitney: I am not in n ocen t about i t , I r e g r e t to s t a t e .
The l a s t case I car remember was Z.W. Wagner A Co. o f Chicago.
They were sh ort in t h e ir own account o f some 300,000 shares of
sto c k which th ey had taken fra n t h e ir custom er1s account fo r
d e liv e r y . I t was n othin g more or l e s s than a bucket shop op­
e r a tio n , and we e x p e lle d them prom ptly from the Hew Toxk Stock
Zxchsge. ( 10)
5 . Options
Puts and c a l l s , o p tio n s fo r the purchase or s a le o f sto ck a t a
s p e c if ie d p r ic e w ith in a s p e c if ie d tim e, were con sid ered e s s e n t i a lly
gambling d e v ic e s .
In view o f the f a c t th at a sm all percentage o f
th e se o p tio n s were a c t u a lly e x e r c is e d , i t was thought th a t they served
o n ly a p o t e n tia l purpose in any c a s e , and th at by t h e ir u se people
m ight f o r a sm all sum take a gambling p o s it io n in the market.
Further**
more, o th er o p tio n s o f sim ila r ch a ra cter were con sid ered instrum ents
o f m an ip u lation .
I t was brought o u t in th e testim on y o f s p e c i a l i s t s
and sp e c u la to rs th a t o p tio n s were u sed i n the d is t r ib u tio n o f Btocks
11
to the p u b lic .
Bftercjfl fee torn
In a d d itio n to th e com plaints d ir e c te d a g a in st th e s e c u r ity
m arkets th em selves, th ere were o th ers which cou ld not be d ir e c t ly
a ttr ib u te d to the m arkets, but which n e v e r th e le s s had bearing upon
th e o p era tio n o f th e m arkets and th e r e la tio n s h ip o f the p u b lic to
them.
I t was b e lie v e d th a t co rp o ra tio n s did not g iv e the p u b lic
s u f f i c ie n t in form ation to fu r n ish grounds f o r jud&oent o f t h e ir
10
Senate Hearings on Stock Exchange P r a c t ic e s . P t. I , p . 76 See a ls o
House Hearings on Stock Exchange R egu lation , p p .47, 194 f . , e t c . ,;
a ls o 72nd Cong., 1 s t S e e s ., Hearings b efo re the House J u d ic ia r y Com­
m it t e e . on E .B .4 , H.B. 4604, H.H.4638, H.H.4639 (S h ort S e llin g o f
b S c d P itie s ), Feb. 16-Mar. 5 ,1 9 3 2 , P t s . I , I I , and I I I , passim.
11 Senate H earings on Stock Exchange P r a c tic e s . P t. XV, p p .7062-7168.
A lso P t. XXXI, p p .5861-5963.
—46“
s e c u r itie s .
Die q u estio n s was 'brought up a s to whether or not
corp orate accou n tin g system s were adequate fo r t h is purpose.
It
was charged th a t
co rp o ra tio n s were u n n e c e s sa r ily s e c r e tiv e in the
conduct o f t h e ir
a f f a i r s , and th a t because o f t h is se crecy the p u b lic
wae m isled ,
f i n a l l y , i t was s ta te d th a t co rp o ra tio n s o f p u b lic is s u e
were in a fid u c ia r y r e la tio n s h ip to the p u b lic , end th a t th ey did not
r e c o g n ise t h is r e la t io n s h ip .
Ur. Terdinand Pecora, co u n sel to the
Committee on Banking and Currency s ta te d th e p o in t o f the in v e s t i­
g a to r s on th a t m atter a s fo llo w st
. . . i f th e p u b lic i s in v it e d to su b scrib e to shares o f a cor­
p o r a tio n through the f a c i l i t y o f having th ose
shares l i s t e d ona
p u b lic exchange, I submit th a t the p u b lic should be safeguarded
a s much a s i t can reason ab ly be accom plished in the Inform ation
which i s g iv e n to i t and th a t i t mould enable the p u b lic to a r r iv e
at an i n t e l l i g e n t Judgment.
furtherm ore, i t was f e l t th a t the growth o f surplus funds in the hands
o f la r g e co r p o r a tio n s, and the in f lu x o f fo r e ig n funds from abroad,
made money to o ea sy to o b ta in fo r purposes o f sp e cu la tio n and, th e r e fo r e ,
encouraged i t .
f i n a l l y , the growth o f Investm ent t r u s t s created la rg e
h o ld in g s o f s e c u r i t i e s which might a t any tim e be dumped upon th e mar12
k e t w ith s e r io u s e f f e c t s on p r ic e s .
M anipulative p r a c t ic e s
I t was charged by th e in v e s t ig a t in g coum ittee th a t c e r ta in o f the
phases o f exchange o p era tio n which have been enumerated had g iv en r i s e
to a number o f p r a c t ic e s on th e p a rt o f members o f s e c u r ity exchanges,
and th ose a s s o c ia te d w ith them, which were e s p e c ia lly d etrim en tal to
p erson s purchasing s e c u r it ie s and to th e economic stru ctu re o f the
12
Senate Hearings on Stock Exchange P r a c tic e s . P t. XV, p p .6672 f f . q u o ta tio n from p . 6676.
-
cou n try g e n e r a lly ,
47 -
Jhese p r a c t ic e s , c h i e f ly o f a m anipulative ch a ra cter,
were s a id to he c a r r ie d on w ith ou t In te r fe r e n c e from the exchanges.
1 . P r i c e p e g g in g
Pegging th e market was p r a c tis e d in the i n t e r e s t o f keeping a
sto ck from go in g up or down, depending upon th e p o s it io n o f the p ool
op era to rs or o f the in t e r e s t s in v o lv ed .
Uhis p r a c tic e was considered
to c r e a te a f a c t i t i o u s p r ic e i n a s to c k , b ecau se i t counteracted the
fo r c e s which were o p er a tiv e in the market a t the tim e.
th a t pegging k e p t
I t was thought
th e p r ic e out o f l i n e w ith v a lu e s in the sane man­
ner i n w h ich sh ort s e l l i n g or margin buying d id .
Pegging might be re­
so rted to in order to keep a sto ck low enough so th a t i t could be
accumulated by a group who d esired to op era te in i t , or i t might be
used to g iv e f i c t i t i o u s v a lu e s to s to c k s or bonds in the in t e r e s t o f
the houses which were f lo a t in g them.
I t m ight a ls o be reso rted to fo r
the puxpose o f m aintaining th e p r ic e o f a s e c u r ity which had previouslybeen f lo a t e d , so th a t th e p r e s t ig e o f th e house which had flo a te d i t
m ight not be endangered.
In any c a s e , i t was th ou ^ it to be a p r a c tic e
in c o n s is te n t w ith the ex p r e ssio n o f the true valu e o f s e c u r it ie s on
the exchange.
i n excerp t from Ur. Bichard Whitney* s testim ony on pegging the
market fo llo w s!
Mr. Gray: I mean by th at th a t th e sh o rt s e ll i n g has the pur­
p ose o f d r iv in g th e market down, w h ile your margin buying has the
purpose o f d r iv in g the market up, w h ile p eggin g i s done f o r the
purpose o f e it h e r p rev en tin g th e market from going down below a
c e r ta in fig u r e or from g o in g above a c e r t a in fig u r e , i s i t not?
Mr. Whitneyi Tes; but I see no r e la tio n s h ip between pegging
and sh ort s e l l i n g .
Mr. G ran I mean i t i s c r e a tin g aa a r t i f i c i a l value a l l the
way through, i s n ' t that true?
-4 8 Ur. W hitney: Wo; I t i s not a r t i f i c i a l a s 1 see I t .
Mr. gray: W ell, suppose the sto ck I s 'feeing so ld - Mr. Whitney: ( In terp o sin g ) Ton buy s to c k , you s e l l sto ck .
Mr. O ran Tea s ir ; suppose the s to c k I s h eln g sold or fo o ted
on the market today a t about 4 0 , o r we w i l l say 41, u se th a t
fig u r e , and the man that i s I n te r e s te d in t h a t stock does not
w ent i t to f a l l helow 4 0 , and i f he l e t s i t alone market c o n d itio n s
would be such th a t i t would probably go to 39 or 38. What he
d o es i s p u t an order i n t o a broker to buy a l l of th at sto ck that
i s o ffe r e d above 40 in ord er to keep the p r ic e from dropping,
d oes he notT
Mr. W hitney: Ee may
Mr. flravt And i s he n o t c r e a tin g en a r t i f i c i a l value?
Mr. Whitney: Mo, s i r . Ee i s buying sto ck m d paying d o lla r s
fo r i t . (1 3 )
S . P o o ls an d s y n d i c a t e s
B ie op era tio n o f p o o ls and sy n d ic a te s was sa id to be very bad
f o r s e c u r ity p u rch asers and th e p u b lic .
Bhe main o b ject o f th ese
p o o ls was to buy sto c k cheap ly and to r e d is t r ib u t e i t to the p u b lic a t
h igh er p r ic e s .
To accom plish t h i s se v e r a l p r o c e s se s were reso rted to .
In order to in t e r e s t th e
p u b lic i n a p a r t ic u la r stock i t was n ecessa ry
to g iv e th e appearance o f market a c t i v i t y in th a t sto ck .
This was done
by means o f buying and s e l l i n g co n sid era b le q u a n titie s o f t he stock so
th a t s a le s would appear on the tape and g iv e the appearance o f genuine
a c tiv ity .
I t appeared th a t p u b lic p a r t ic ip a t io n was n ecessary fo r
th e op eration o f a p o o l.
Aa one s p e c i a l i s t put i t , *U atu rally when
you rneke a stock a c t iv e th e p u b lic w i l l trad e in th a t sto ck . . . and i f
you are running a p o o l ahd th ey do not trade in th e sto ck , th at i s your
14
hard lu ck . ■ This o p era tio n has been d escrib ed as "churning- .
B efore a p ool co u ld makde a p r o f it i t was n ecessary that i t have
co n sid era b le o f t h e sto c k in w hich i t was o p era tin g on hand.
This
sto ck was ob tain ed in one o f two ways: i t was e it h e r purchased g ra d u a lly
13
Senate Hearin g s on Stock Ssohax^e P r a c tic e s , P t. I , pp. 166 f f . Q uotation
f f d
14
f l i
p
r
u
j v
.
—
—
— —
—
Senate B earin gs o n S ta c k Mnchanga
-
pp. 6063-6084.
-
49-
in th e market so th a t the p r ic e o f th e sto ck would not he g r e a tly
a ffe c te d , or i t wae obtained through o p tio n s.
Options were given to
in te r e s t e d p a r t ie s by someone who had a la rg e b lo ck o f sto ck which
he w ished to d isp o s e o f .
She p r ic e s a t which stock m ight be obtain ed
under th ese o p tio n s was s e t so th at i t was to the in t e r e s t of the
h o ld er to have the sto ck r i s e .
A somber o f shares were u s u a lly pur­
ch asable a t or near the market, some more a b i t above i t and more above
th a t a gain .
Sometimes th e y covered a c o n sid e r a b le p r ic e range, in
o p tio n g iv en to Wright and Sexton, b y Bedmond and Company on September
14, 1933, co n ta in ed th e fo llo w in g s c a le o f p r ic e s on 15,000 shares o f
Warren foundry and Pipe Corporation:
NUUB1R 07 SHAKES
PXICZ HEfi SHAHK
1 .0 0 0
2 .5 0 0
2 .5 0 0
3 .0 0 0
3 .000
3 .0 0 0
$13.00
14.00
15.00
16.00
17.00
IB .00
Under such an arrangement i t was p o s s ib le by an advance in p r ic e to
purchase the sh ares under th e o p tio n a t a p r o f i t .
Such an arrangement
a s th e above fa m is h e d an in c e n tiv e to r a is e the p r ic e o f Warren
15
foundry above e ig h te e n d o lla r s p er sh are.
In order t o r a is e p r ic e s i t was n ecessa ry to buy con sid erab le
q u a n titie s o f a s to c k .
U su a lly th e amount n ecessa ry for a la rg e
r i s e in p r ic e s wae beyond th e scope o f the fin a n c e s o f most p o o ls
w ith ou t the h e lp o f the p u b lic .
I t wae fo r t h i s reason th a t the
p r o c e ss o f "churning11 which has p r e v io u s ly been mentioned was re­
so rted to .
In co n n ection w ith a p o o l i n American Commercial A lcoh ol,
15
S e n a te H e a r in g s o n S to c k E x change P r a c t i c e s , P t . X I I I , p p . 6136 f . a n d
P .6159.
a s p e c i a l i s t t e s t i f i e d th a t Ur. Biomas Bragg' 8 purchases o f t h is sto ck
could not he con sid ered m an ip u lative.
16
market - th e p u b lic d id th e r e s t .
Ee m erely bought to support the
The trend o f the q u estio n in g o f w itn e s s e s conceralxg the op eration
o f p o o ls , I n d ic a te s th a t p o o l op erators were suspected of conducting
e x te n siv e o p era tio n s which d is tr ib u te d la r g e b lock s o f stock to the
p u b lic a t la r g e p r o f i t s to the o p e r a to rs, and th a t l i t t l e c a p ita l was
req u ired on th e ir p a rt to conduct t h e ir o p era tio n s.
I t was brought out
in the testim on y o f Ur. Mason Day th a t a p ool which operated a t a
p r o f it o f about $400,000 was conducted w ith ou t any co n trib u tio n o f
funds by the p a r t ic ip a n t s .
The p oceed in gs run a s fo llo w s:
Ur. Pecorai Now, were any members o f the p o o l a c tu a lly
c a lle d upon during th e l i f e o f the op era tio n s and trad in g by
th e p o o l under t h is o p tio n , req u ired to put up any cash a s a
m atter o f fa c t?
Ur. Day: Ho, s ir *
Ur. Pecorai And what was th a t due to , and what circum stances
or f a c t s were p resen t during the l i f e o f the pool which rendered
i t u n n ecessary fo r m y pool p a r tic ip a n t to a c t u a lly put up any
cash during the p o o l o p era tio n s, alth ough th e p o o l c lo se d w ith a
p r o f it o f c lo s e to $400,000, and traded in over 1 ,0 0 0 ,0 0 0 shares
o f th e stock? (17)
She answer to t h i s l a s t q u estio n was g iv en by Prank: J . Gibson,
a u d ito r fo r the firm o f Bedmond and Company, who adm itted th a t the
p o o l had taken a sh o rt p o s it io n o f 4 0 ,0 0 0 shares o f stock which
y ie ld e d them a p r o f it o f about $1 0 0 ,0 0 0 a f t e r which they were ab le
to take down sto c k a g a in s t the o p tio n , and pay fo r i t out o f p roceeds
o f s a le s which i t had a lre a d y made a g a in st th e o p tio n , and th a t i t
was a t no tim e n ecessa ry fo r anyone to put up any money.
I t appeared
p o s s ib le f o r in d iv id u a ls to handle la rg e b lock s o f sto ck a t s u b s ta n tia l
16
Senate B earings on Stock Exchange P r a c tic e s , P t. X III. p . 6104.
17
-51p r o f i t s w ith l i t t l e
or no f u n d s i n v o l v e d .
The e x t e n t to w h ic h t h i s
w as d o n e i n t h e m a r k e ts a s a w h o le w as n o t so r e a d i l y e s t a b l i s h e d .
I t w as e s t a b l i s h e d , h o w e v e r, t h a t th e p r a c t i c e w as r a t h e r common,
a n d t h a t w hen a c o r p o r a t i o n o r i n d i v i d u a l h a d a l a r g e b lo c k o f s t o c k
on h a n d , th e l a r g e o p e r a t o r s u s u a l l y knew a b o u t i t , a n d made o f f e r s
18
t o t h e h o l d e r s u n d e r w h ic h I t m ig h t be d i s t r i b u t e d .
T hose in v o lv e d
i n p o o l o p e r a t i o n s a n d o t h e r m a n ip u la t iv e d e v i c e s i n c lu d e d b r o k e r s ,
s p e c ia lis ts ,
la r g e m a rk e t o p e r a to r s a n d o th e r s .
I t w as h e l d t h a t b r o k e r a g e f i r m s , b e c a u s e o f t h e p o s i t i o n w h ic h
th e y o c c u p ie d w i t h r e l a t i o n
w ere p a r t i c u l a r l y b a d .
to t h e p u b l i c , h a d d e v e lo p e d a b u s e s w h ic h
H ot o n ly d id t h e y o p e r a t e i n p o o l s a t th e e x ­
p en se o f th e p u b lic a s o th e r o p e r a to r s d id , b u t t h i s o p e r a tio n , a lo n g
w ith o th e r f a c to rB , gave r i s e
to a s e t o f p r a c t i c e s w h ic h made th e
c u s t o m e r 's p o s i t i o n v e r y d i f f i c u l t .
B e c a u se o f t h e f a c t t h a t th e y
o p e r a t e d i n p o o l s , i t w as to t h e i r I n t e r e s t to i n f l u e n c e th e p u b l i c
i n w ays t h a t w o u ld be b e n e f i c i a l to th e m s e lv e s .
F u r th e r m o r e ,
to th e
e x t e n t t o w h ich t h e y w e re p a r t i c i p a n t s i n th e f l o t a t i o n o f new s e c u r i t y
i s s u e s , i t w o u ld b e to t h e i r i n t e r e s t t o c a u s e c u s to m e r s to b u y th e s e
is s u e s .
U n d er s u c h c i r c u m s t a n c e s i t w o u ld b e im p o s s ib le f o r c u s to m e r s
t o g e t u n b ia s e d i n f o r m a t i o n .
I t w as b r o u g h t o u t b y th e S e n a te com­
m itte e th a t m a rk e t l e t t e r s h ad b e e n p u b lis h e d b y b ro k e ra g e h o u ses i n
w h ic h p u r c h a s e o f s t o c k s i n w h ic h th e f i r m w as i n t e r e s t e d w as recom ­
m ended.
make i t
I n a d d i t i o n , th e p o s i t i o n o f b r o k e r a g e f ir m s w as s u c h a s to
to t h e i r a d v a n ta g e to c a u s e c u s to m e r s t o e x te n d th e m s e lv e s
on m a r g in , b e y o n d th e p o i n t o f s a f e t y .
A f i r m m ig h t w a n t t o do t h i s
18
Senate H earings on Stock gxchange P r a c tic e s . P t. XIV, p p .6218-6246.
f o r tw o r e a s o n s : ( l )
I t w o u ld w a n t t o make a s much I n c o m m issio n s
a s p o s s i b l e , a n d ( 2 ) i t w o u ld w a n t to le n d a s m uch m oney a s p o s s i b l e .
As a r e s u l t o f t h i s ,
i t becam e n e c e s s a r y f o r b r o k e r a g e f i r m s to s e l l
o u t c u s to m e r s q u i c k l y , i n o r d e r t o p r o t e c t th e m s e lv e s i n t h e e v e n t
19
o f a r e c e s s i o n i n th e m a r k e t.
3 . P u b lic in fo rm a tio n
I n a d d i t i o n to th o s e l e t t e r s w h ic h w e re i s s u e d b y b r o k e r a g e
h o u s e s , c e r t a i n " i n v e s t m e n t 11s e r v i c e s , o p e r a t e d i n c o n j u n c t i o n w i t h
p o o l s , d i s s e m i n a t e d i n f o r m a t i o n a im e d t o b r i n g a b o u t p u b l i c p a r t i c i ­
p a t i o n i n m a n ip u la t e d s t o c k s .
F u r th e r m o r e , n e w s p a p e r c o l u m n is ts w ere
known t o h a v e " t o u t e d 11 s t o c k s f o r v a r i o u s p o o l s .
i n e x i s t e n c e a v a s t num ber o f " t i p s t e r "
F in a lly ,
t h e r e w e re
s h e e t s , w h ic h w e re s o l d t o
t h e p u b l i c f o r s u b s t a n t i a l a m o u n ts , a n d w h ic h w e re so e r r o n e o u s a s t o
a s s u r e l o s s e s to th o s e who f o ll o w e d th em .
T h ese m ig h t o r m ig h t n o t
b e c o n n e c te d w i t h th e o p e r a t i o n o f p o o l s .
F b r th e s e re a s o n s i t a p p e a re d
t h a t th e s e r i o u s n e s s o f th e p ro b le m o f p u r v e y in g i n f o r m a t i o n t o th e
20
p u b l i c w as s u c h a s t o c a l l f o r s p e c i f i c l e g i s l a t i o n .
4 . P ra c tic e s o f s p e c ia lis ts
S p e c i a l i s t s , o f t e n m em bers o f f i r m s d e a l i n g d i r e c t l y w i t h th e
p u b l i c , w e re a l l e g e d to h a v e d e v e lo p e d a s e t o f p r a c t i c e s w h ic h w e re
c o n t r a r y to p u b l i c p o l i c y .
The f a c t t h a t t h e y w e re e n g a g e d i n p o o l
o p e r a t i o n s w as f r e e l y a d m i t t e d b y c e r t a i n o f them who a p p e a r e d b e f o r e
t h e S e n a te c o m m itte e .
The n a t u r e o f t h e i r p o s i t i o n made i t p o s s i b l e
19
P o o l o p e r a t i o n s o f b r o k e r a g e h o u s e s w e re e s t a b l i s h e d b y th e te s t im o n y
o f s e v e r a l m em bers o f b r o k e r a g e f i r m s who a d m i t t e d i t , a n d b y s e v e r a l
s p e c u l a t o r s who o p e r a t e d i n c o n n e c t i o n w i t h th em .
See t e s t im o n y o f
H e n ry U aeon Day o f th e f i r m o f Bedmond & C o ., S e n a te H e a r in g s o n S to c k
P r a c t i c e s . P t . XIV, p p . 6 2 1 8 -6 2 4 6 a n d o t h e r s .
S ee a l s o m a rk e t
l e t t e r s o f Z .F. H u tto n & C o ., I b i d . . P t . X I I I , p p .5 9 0 0 -5 9 0 2 .
20
S e n p || JBearlngs on Stock Exchange P r a c tic e s . P t. XV, p p .6511 f f .
-5 3 f o r th a n to b e p a r t i c u l a r l y e f f e c t i v e i n a l l m a n i p u l a t i v e o p e r a t i o n s ,
*
a n d t h e y v e r y o f t e n e x e c u te d o r d e r s f o r p o o l s w h e th e r o r n o t th e y
21
w e r e m em b ers.
5 , P r a c t i c e s c o n n e c te d w i t h s h o r t s e l l i n g
I t w as a l s o c h a r g e d t h a t l a r g e g r o u p s o f o p e r a t o r s b a n d e d t o ­
g e t h e r f o r th e p u r p o s e o f d e p r e s s i n g t b s m a r k e t s , t h e r e b y b r i n g i n g
a b o u t g r e a t d e c l i n e s i n p r i c e s a t t h e e x p e n s e o f th e p u b l i c .
As
S e n a to r B r o o k h a r t p u t i t ,
U r. V h itn e y , i t w as r e p r e s e n t e d t o t h i s c o m m itte e t h a t t h e r e
w as a l i s t , o r a c o m b in a tio n r a t h e r , o f b i g b e a r d e a l e r s who
w ere s e l l i n g on F r id a y l a s t a la r g e q u a n t ity o f s to c k s s h o r t,
an d t h a t t h e y h a d p la n n e d t o make a b l a c k F r i d a y c u t i f S a tu r ­
d a y , a n d t h a t y o u h a d t h e nam es o r knew who t h e y w e re b u t r e ­
fu s e d to d is c lo s e t h a t in fo rm a tio n .
The p r e e m p t i o n a p p e a r s to h a v e b e e n t h a t t h e r e w ere w ay s o f s e l l i n g
s h o r t so t h a t i t d i d n o t a p p e a r i n t h e c o m p i l a t i o n s o f t h e s h o r t i n ­
t e r e s t , a n d t h a t th r o u g h t h i s s h o r t s e l l i n g a downward m ovem ent m ig h t
b e s t a r t e d w h ic h w o u ld to u c h o f f s t o p l o s s o r d e r s a n d f o r c e s e l l i n g
22
o n t h e p a r t o f p e o p le who h e l d s t o c k s o n m a r g in . When l a r g e o p e r a t o r s
a p p e a r e d b e f o r e t h e c o m m itte e , t h e y w e re i n v a r i a b l y q u e s t i o n e d t h o r ­
o u g h ly c o n c e r n in g t h e i r s h o r t s e l l i n g a c t i v i t i e s i n t h e m a r k e t, tsxd
a s k e d m sn y q u e s t i o n s a b o u t s h o r t s e l l i n g a c t i v i t i e s i n g e n e r a l .
6 . L o an s b y c o r p o r a t i o n s
I n a d d i t i o n t o t h o s e a b u s e s w h ic h w e re h e l d to b e p r a c t i s e d b y
m em bers o f th e to c k e x c h a n g e an d t h e i r a s s o c i a t e s , s e v e r a l o t h e r s
w e re n o t e d w h ic h w e re n o t d i r e c t l y a t t r i b u t a b l e
t o t h e e x c h a n g e s them ­
s e l v e s , b u t ^khich h a d i m p o r t a n t a f f e c t s u p o n t h e o p e r a t i o n o f e x c h a n g e a
21
F o r a g o o d sum m ary o f m a r k e t s e r v i c e s an d o t h e r new s f a c t o r s w h ic h i n ­
f l u e n c e th e c o u r s e o f s e c u r i t y p r i c e s , s e e T w e n tie th C e n tu r y F u nd, S to c k
M a rk e t C o n t r o l . C h .V II.
22
Senate H earings on Stock im tm u w P r a c t i c e s , P t. I , p p .7-58.
-5 4 One o f t h e m o s t I m p o r t a n t w as th e p r a c t i c e o f l e n d i n g b y c o r p o r a t i o n s
o f l a r g e stuns o f m oney f o r s p e c u l a t i v e p n r p d s e s .
I t w as b r o u g h t o u t
i n t h e h e a r i n g s t h a t , w h ile s u r p l u s f u n d s w e re b e in g l e n t b y c o r p o r a ­
tio n s ,
t h e s e sam e c o r p o r a t i o n s w e re i s s u i n g s t o c k w h ic h w as b e i n g s o l d
to th e p u b lic to o b ta in s u r p lu s fu n d s .
D u rin g 1928 an d 1 9 2 9 , when
I n t e r e s t r a t e s w e re e x tr e m e ly h i g h , t h e d iv i d e n d r a t e s o n s t o c k w e re
e x t r e m e l y low w i t h r e l a t i o n to th e p r i c e s a t w h ic h th e y w e re s e l l i n g .
T h e re fo re ,
B to c k s c o u l d b e s o l d so t h a t th e m oney o b t a i n e d dem anded
a p ay m e n t o f t h r e e p e r c e n t o r u n d e r i n d i v i d e n d s , w h ile t h i s m oney
m ig h t b e l e n t i n t h e c a l l m a r k e t a t frc m t e n to f i f t e e n p e r c e n t .
An e x c e r p t fro m t h e te s t i m o n y i n th e c a s e o f th e C i t i e s S e r v ic e
Company f o l l o w s :
S e n a t o r T ow nsend: U r. J o h n s t o n , how w as t h i s s u r p l u s
m oney w h ic h C i t i e s S e r v i c e w as l o a n i n g i n th e S t r e e t o b ta in e d ?
U r . J o h n s t o n : P a r t l y fro m t h e e a r n i n g s o f th e o p e r a t i n g
c o m p a n ie s , a n d p a r t l y fro m t h e s a l e o f s e c u r i t i e s .
S e n a t o r Tow nsend: S a le o f s e c u r i t i e s - w h a t do y o u mean
by th a t?
U r. J o h n s t o n :
C i t i e s S e r v i c e Co. a n d i t s s u b s i d i a r i e s .
U r. C h airm an : I s s u i n g s t o c k a n d s e l l i n g s to c k .
U r . J o h n s t o n : D i f f e r e n t k i n d s o f s e c u r i t i e s w ere i s s u e d .
T h e re w as s t o c k i s s u e d ; y e s s i r .
S e n a t o r T ow nsend: W hat p o r t i o n o f t h i s m oney w as r e ­
c e i v e d b y th e s a l e o f C i t i e s S e r v i c e S to c k I t s e l f ?
M r. J o h n s t o n : W e ll, i t i s h a r d t o t e l l j u s t w h e re a n y
p o r t i o n o f c e r t a i n sums o f m oney com es f r c m .
S o u r c e s o f incom e
a r e v a r i e d , a n d th e d i s b u r s e m e n t s a r e a l s o v a r i e d .
F u r th e r m o r e , d i v i d e n d s o n s t o c k w ere p a i d a t t h e d i s c r e t i o n o f
th e c o r p o r a t i o n s , a n d d i d n o t h a v e t o b e c o n t i n u e d i n t h e e v e n t o f
c o lla p s e .
J m o i£ th e m o s t im p o r ta n t c o r p o r a t i o n s l e n d i n g w e re C i t i e s
S e r v i c e , H e c t r l c Bond a n d S h a r e , S ta n d a r d O i l Company I n c . o f Hew
J e r s e y , a n d S i n c l a i r C o n s o lid a te d O i l C o r p o r a t i o n .
I t w as f u r th e r
-5 5 b r o u g h t o u t t h a t t h e s e c o r p o r a t i o n s rem o v e d t h e i r f u n d s fro m th e c a l l
lo a n m a r k e t a s s o o n a s th e
s i t u a t i o n becam e d a n g e r o u s , w h ic h th r e w
t h e b u r d e n o f c r e d i t m a in te n a n c e u p o n t h e b a r k s .
C it ie s S e rv ic e , f o r
23
e x a m p le , h a d n o c a l l l o a n s a t a l l b y t h e e n d o f 1 9 2 9 .
7 . C o lla b o r a tio n o f c o r p o r a te o f f i c i a l s w ith m a rk e t o p e r a to r s
She c o n d u c t o f c o r p o r a t i o n s w i t h r e l a t i o n to t h e i n v e s t i n g p u b l i c
wae l i k e w i s e a c a u s e o f c o m p la in t .
o f th e
I t w as b ro u g h t o u t in th e h e a r in g s
S e n a te C o m a ltte e t h a t t h e r e h a d b e e n m a n i p u l a t i o n o n th e p a r t
o f c o r p o r a t e o f f i c i a l s w h ic h w as d e t r i m e n t a l to th e i n v e s t i n g p u b l i c .
C o r p o r a te o f f i c i a l s h a d h a n d l e d i n t e r n a l a f f a i r s o f t h e i r c o m p a n ie s to
t h e i r own a d v a n ta g e a t
th e e x p e n s e o f s t o c k h o l d e r s , a n d i n f o r m a t i o n
g iv e n o u t t o s t o c k h o l d e r s w as I n a d e q u a te a n d m i s l e a d i n g ,
fic titio u s
c o r p o r a t i o n s h a d b e e n s e t u p to e v a d e th e p r o v i s i o n s o f c o r p o r a t e
c h a r t e r s , c o r p o r a te o f f i c i a l s h ad e n te r e d i n t o p o o ls w ith m a rk e t op­
e r a t o r s , a n d th e t r u e c o n d i t i o n o f c o r p o r a t e a f f a i r s h a d n o t b e e n
g i v e n to th e p u b l i c .
She c a s e o f .A m erican C om m ercial A lc o h o l b r o u g h t
o u t r a t h e r c l e a r l y how c o r p o r a t e o f f i c i a l s , m a r k e t o p e r a t o r s , b r o k e r s ,
an d s p e c i a l i s t s m ig h t g e t t o g e t h e r a n d m a n ip u la t e th e a f f a i r s o f a
c o rp o ra tio n .
I n t h i s i n s t a n c e a f i c t i t i o u s c o r p o r a t i o n was c r e a t e d
a n d l i s t e d on t h e Hew T o rk S to c k IS xchaige w i t h o u t c o m p la in t b y t h e
24
l i s t i n g c o m m itte e .
B ie e x t e n t t o w h ic h t h i s ty p e o f m a n i p u l a t i o n w as p r e v a l e n t
w ae d i f f i c u l t t o e s t a b l i s h .
T e s tim o n y i n d i c a t e d , h o w e v e r, t h a t i t w as
23
S e n a te H e a r in g s o n S to c k E x ch an g e P r a c t i c e s . P t . H 7 , p p . 6 3 0 9 -6 3 4 6 ;
q u o t a t i o n fro m p . 6 3 1 8 .
24
I b i d . . P t. m i , pp. 5851 f f .
-5 6 a common p r a c t i c e f o r c o r p o r a t e o f f i c i a l s an d p o o l o p e r a t o r s to L and
t o g e t h e r w hen c o n d i t i o n s w a r r a n t e d i t ,
a n d t h a t w h i l e th e d e t a i l s o f
o p e r a t i o n m ig h t d i f f e r m a t e r i a l l y , i n d i f f e r e n t c a s e s , some form o f
25
m a n i p u l a t i o n w as g u i t e common.
S ta a lle r ex ch an g es
I t a p p e a r e d t h a t i n th e m in d s o f s a n e t h e c o m p la in t s w h ic h w e re
made a g a i n s t s e c u r i t y e x c h a n g e s m ig h t m ore p r o p e r l y h e d i r e c t e d a g a i n s t
th e m a i l e r e x c h a n g e s .
I t w as s t a t e d i n th e h e a r i n g s t h a t t h e Hew
Y oik S to c k E x c h a n g e , d e s p i t e i t s
s h o r tc o m in g s , w as g r e a t l y s u p e r i o r
i n i t s p r a c t i c e s t o th e s m a l l e r e x c h a n g e s .
I t w as f e l t t h a t some
o f t h e r u l e s w e re h a r d l y n e c e s s a r y f o r th e Hew York e x c h a n g e w o u ld h e
a b s o l u t e l y n e c e s s a r y I n t h e c a s e s o f m o st o f t h e o t h e r s .
ex ch an g es d e a l t m o s tly i n l o c a l s e c u r i t i e s .
The s m a l l e r
I n many s t a t e s c o r p o r a ­
t i o n s h a d o b t a i n e d e x e m p tio n fro m B lu e Sky la w s i f t h e i r s e c u r i t i e s
w e re r e g i s t e r e d o n a l o c a l e x c h a n g e .
I n many c a s e s t h e r o l e s o f t h e
l o c a l e x c h a n g e s w e re so l a x a s t o g i v e t h e c u s to m e r p r a c t i c a l l y n o
p ro te c tio n a t a l l ,
p o in t.
n e v e r t h e le s s , l i s t i n g c o u ld he u s e d a s a s e l l i n g
S t a t e r e g u l a t i o n o f s m a l l e x c h a n g e s w as h e l d t o h e im p o s s i b l e
b e c a u s e o f th e p o l i t i c a l p r e s s u r e w h ic h t h o s e who w ere i n t e r e s t e d i n
26
them w e re a b l e to e x e r t .
3umaary
I n sum m ary, m o s t o f th e t e c h n i c a l meanB b y w h ic h th e p u b l i c was
s u p p o s e d t o h a v e b e e n f l e e c e d w e r e r e a d i l y b r o u g h t o u t i n th e com ­
m itte e h e a rin g s .
F u r th e r m o r e ,
th e o p e r a t i o n o f p o o ls a n d t h e d i s ­
s e m i n a ti o n o f b i a s e d i n f o r m a t i o n b y b r o k e r s , w as f o r t h e m o st p a r t
25
T o r v a r i o u s ty p e s o f m a r k e t m a n i p u l a t i o n s e e a l s o H ouse H e a r in g s o n
S to c k E x c h a n g e R e g u l a t i o n , p p . 1 1 5 . 305 f . , 3 3 7 ,4 8 5 ,7 2 9 ,7 8 5 ,e t c .
26
fiSsafefi H earings
Stock gjghaage P r a c tic e s . P t. 17, pp. 6467-6469.
-5 7 f r e e l y a d m i t t e d b y p o o l o p e r a t o r s a n d b r o k e r s th e m s e lv e s .
The
e f f e c t s o f th e u s e o f t h e s e d e v i c e s , h o w e v e r, a n d th e e f f e c t s o f
t h e a c t i o n o f th e m a r k e t o n th e c o u n t r y a s a w h o le , w e re n o t so
r e a d ily e s ta b lis h e d .
th e n o tio n
W h ile t h e r e a p p e a r s to b e l i t t l e
doubt th a t
o f th e m a r k e t o n t h e c o u n t r y a s a w h o le , w e re n o t s o
r e a d ily e s ta b lis h e d .
W h ile t h e r e a p p e a r s t o b e l i t t l e
doubt
t h a t t h e a c t i o n o f th e m a r k e t b o th o n th e u p a n d t h e down s i d e , h a s
h ad c o n s id e r a b le in f lu e n c e on g e n e r a l p r o s p e r ity and d e p r e s s io n , i t
w as d i f f i c u l t to im p u te t h e c a u s e to
s p e c i f i c a s p e c t s o f m a rk e t
b e h a v io r o r to s to c k exchange te c h n iq u e .
I t w ae h e l d , h o w e v e r, t h a t a s a r e s u l t o f th e p r a c t i c e s d e s c r i b e d
a b o v e , t h e p u b l i c h a d s u f f e r e d s e v e r e l o s s e s , th e s m a l l i n v e s t o r w as
a b u s e d , a n d m any p e o p l e w e re f o r c e d i n t o b a n k r u p tc y an d s u i c i d e — t h a t
th e c o u n try had b een b ro u g h t to r u in .
O ie re a p p e a r s to h a v e b e e n no
q u e s t i o n t h a t t h e p u b l i c h a d s u f f e r e d s e v e r e l o s s e s o r t h a t t h e m a r­
k e t s i t u a t i o n had b e e n su ch t h a t t i e
s m a ll i n v e s t o r fo u n d i t im p o s s i b l e
to p u r c h a s e s e c u r i t i e s w h ic h w e re r e a s o n a b l y v a l u e d .
L ik e w is e i t w as
e s t a b l i s h e d t h a t m m y p e o p le h a d b e e n f o r c e d i n t o b a n k r u p tc y , d i s ­
h o n e s t y a n d s u i c i d e b e c a u s e o f l o s s e s - L w eorred th r o u g h m a rg in a c c o u n ts ,
F i n a l l y , i t w as m a i n t a i n e d t h a t t h e s t o c k e x c h a n g e s h a d d e v e lo p e d
s u c h s t r e n g t h a s t o make s t a t e c o n t r o l o f t h e i r o p e r a t i o n s I m p o s s ib le .
I t w as b e l i e v e d t h a t t h e i r g r o w th b a d p l a c e d them i n a p o s i t i o n o f
p ro m in e n c e a n d pow er w h ic h m ade them d i f f i c u l t t o c o n t r o l .
a ssu m e d t h a t i n th e c a s e o f t h e Hew Y ork S to c k E x ch an g e,
h a s b e e n u n a b l e to l e g i s l a t e a g a i n s t i t .
I t w as
th e s t a t e
T h is e x c h a n g e h a d a w e l l -
d e v e lo p e d p u b l i c i t y o r g a n i z a t i o n w h ic h d i s t r i b u t e d a g r e a t d e a l o f
-5 8 m a t e r i a l , i n c l u d i n g m a iy p a m p h le ts a n d a b o u t 1 ,5 0 0 c o p i e s o f U r.
K e e k e r 1s 'book on s h o r t s e l l i n g .
D ie c o s t s f o r p u b l i c i t y h y t h e
New Y ork S to c k E sc h a n g e d u r in g th e p e r i o d b e tw e e n 1929 a n d 1935
w as s l i g h t l y o v e r a m i l l i o n d o l l a r s .
I t a l s o s e n t m o v ie f i l m s t o
t h e a t r e o w n ers f r e e o f c h a r g e , w h ic h d e p i c t e d t h e o p e r a t i o n s o f
th e e x c h a n g e .
The p r e s i d e n t o f t h e s t o c k e x c h a n g e r a t h e r t h a n t h e
p u b l i c i t y c o m n i t t e e , h a d c h a r g e o f t h e d o c u m e n ts w h ic h w e re d i s t r i b u t e d
27
to th e p u b lic .
From t h e s e f a c t s i t w as c o n c lu d e d t h a t t h e New Y ork
E x ch an g e w as i n a p o s i t i o n w h ich made i t a m enace t o t h e c o u n t r y ,
to o p o w e r f u l to b e a d e q u a t e l y c o n t r o l l e d ,
e x c e p t th r o u g h F e d e r a l
le g is la tio n .
D ie d e f e n s e o f t h e s to c k e x c h a ig e , w h ic h f o l l o w s , i s n o t so
much a d e n i a l o f t h e w ay i n w h ic h th e m a r k e t o p e r a t e s o r o f th e a b u s e s
w h ic h h a v e b e e n c la im e d to b e a p a r t o f t h a t o p e r a t i o n , b u t i t i s b a s e d
r a t h e r o n th e d i f f e r e n c e o f o p i n i o n c o n c e r n in g w h at c o n s t i t u t e s a
g ro u n d f o r c o m p la in t , th e p r e v d e n c e o f p r a c t i c e s c o n t r a r y t o p u b l i c
p o l i c y , a n d th e eco n o m ic r e s u l t s o f t h e o p e r a t i o n o f th e m a r k e t.
27
S e n a te H e a r in g s o n S to c k E x ch an g e P r a c t i c e s . P t . X 1 7 , p p . 6 3 4 7 -6 4 1 7 .
CHAPTER I I I
TEE DEFENSE OF TEE STOCK EXCHANGES
I n th e f a c e o f t e s t i m o n y g iv e n b y b r o k e r s a n d s p e c i a l i s t s c o n ­
c e rn in g t h e i r o p e ra tio n s ,
i t w as u s e l e s s f o r th e e x c h a n g e t o d e n y
t h a t q u e s tio n a b le p r a c t ic e s e x is te d .
To t h e e x t e n t t h a t th e d e f e n s e
d id n o t c o n s i s t o f d e n i a ls o f w h at a p p e a re d to b e e s ta b lis h e d f a c t ,
i t c o n s is te d o f s t r e s s i n g th e b e n e f i c i a l a s p e c ts o f th e s e p r a c t i c e s
and b e l i t t l i n g t h e i r b ad e f f e c t s .
I t had b een e s ta b l is h e d d e f i n i t e l y
t h a t b r o k e r a g e f i r m s , s p e c i a l i s t s a n d m a r k e t o p e r a t o r s foxm ed p o o l s ,
a d v i s e d t h e p f b l i c t o b u y B to ck i n w h ic h th e y w e re i n t e r e s t e d ,
some­
tim e s o p e r a t e d on t h e s h o r t s i d e o f t h e m a r k e t a n d made s u b s t a n t i a l
p r o f i t s o u t o f th e ir o p e ra tio n s .
I t w as b r o u g h t o u t t h a t t h e p o s i t i o n
o c c u p ie d b y b r o k e r s a n d s p e c i a l i s t s w as s u c h t h a t t h e i r im m e d ia te
i n t e r e s t s c o u l d r e a d i l y b e c o n s t r u e d a s b e i n g o p p o s e d to t h a t o f t h e
1
p u b l i c i n m any w a y s.
T hose b u i l d i n g th e c a s e a g a i n s t th e s to o k e x c h a n g e w e re a b l e
t o e s t a b l i s h b e y o n d r e a s o n a b l e d o u b t, th r o u g h t h e t e s t im o n y o f t h e
i n d i v id u a l s in v o lv e d , th e f o llo w in g f a c t s t t h a t p o o ls o p e ra te d i n
th e m a r k e t;
s a le s ;
t h a t t h e s e p o o l s in d u c e d p u b l i c b u y in g th r o u g h w ash
th a t f i c t i t i o u s p r ic e s had been c re a te d ;
th a t p r ic e s had been
" p e g g e d " ; t h a t f a l s e ru m o rs h a d been c i r c u l a t e d th r o u g h m a r k e t l e t t e r s
to I n f l u e n c e th e m a r k e t;
th a t
t h a t s to c k s had b e e n " ju g g le d " ;
o p tio n s had been u se d f o r p o o l p u rp o se s;
t h a t la r g e b lo c k s o f s to c k h ad b e e n
d l s t r l t u t e d to t h e p u b l i c a t h i g h p r i c e s ; a n d t h a t s u b s t a n t i a l p r o f i t s
h a d b e e n m ade b y t h e i n d i v i d u a l s I n v o lv e d I n t h e s e p r a c t i c e s .
1
7 3 r d C o n g re s s , 2 n d S e s s i o n , H e a r in g s b e f o r e th e S e n a te C o m m ittee
o n B a n k in g an d C u r r e n c y , o n S .B e e . 8 4 ,5 6 ,4 9 7 ( S to c k E xchange P r a c t i c e s ) ,
P t . X IT, p . 6 2 4 1 .
-6 0 They w e re a l s o a b l e to e s t a b l i s h t h a t b r o k e r a g e h o u s e s h a d
p r o f i t e d b y p a r t a k i n g i n m a r k e t m a n i p u l a t i o n ; t h a t t h e r e was s e r i o u s
d o u b t c o n c e r n in g l n f o n n a t i o n w h ic h b r o k e r s m ig h t g i v e to c u s to m e r s ;
a n d t h a t m a r k e t l e t t e r s p u b l i s h e d b y b r o k e r a g e f i r m s recooanendedn
s t o c k s i n w h ic h th e f i r m w as i n t e r e s t e d .
S u s p ic io n w as c a s t on th e
i n t e g r i t y o f c u s to m e r s 1 m en; i t w as u r g e d t h a t c u s to m e r s w e re q u i c k l y
s o l d o u t t o p r o t e c t b r o k e r s a n d t h a t b r o k e r s e n c o u r a g e d c u s to m e r s t o
o v e r-e x te n d .
W h ile t h e s e l a t t e r a c c u s a t i o n s c o u ld n o t be e s t a b l i s h e d
a s r e a d ily a s th e o th e rs ,
th e f a c t t h a t i t m ig h t b e i n th e i n t e r e s t
o f b r o k e r a g e h o u s e p r o f i t s t o b e h a v e i n t h e s e w ay s g a v e them c o n s i d ­
e r a b l e w e ig h t.
I t w a s l i k e w i s e e s t a b l i s h e d t h a t s p e c i a l i s t s in d u l g e d i n p o o l
a c t i v i t y , m a n ip u la t e d t h e m a r k e t, sm n e tim e s s o l d s h o r t , a n d m ade
s u b s ta n tia l p r o f its .
A lth o u g h I t w as m ore d i f f i c u l t to p l a c e b lam e d i r e c t l y u p o n
th e s e c u r i t y ex ch an g es f o r a b u s e s o u ts id e t h e i r c o n t r o l , f a c t s
e s t a b l i s h e d c o n c e r n in g t h e s e a b a s e s w e re v e r y d e f i n i t e .
C o r p o r a ti o n s
h a d i s s u e d s t o c k a t h i g h p r i c e s a n d l e n t th e m oney th u s o b t a i n e d
i n t h e c a l l l o a n m a r k e t, w ith d r a w in g i t q u i c k l y i n tim e o f s t r e s s ,
m i s l e a d i n g s t a t e m e n t s h a d b e e n g i v e n o u t b y c o r p o r a t i o n s a n d m a n i­
p u l a t i v e o p e r a t i o n s h a d b e e n c o n d u c te d b y c o r p o r a t e o f f i c i a l s , a n d
t h e p u b l i c h a d g am b le d i n s t o c k s an d l o s t .
W h ile th e ex ch a n g e c o u ld
n o t b e a c c u s e d o f f o s t e r i n g t h e s e p r a c t i c e s a s r e a d i l y a s i n th e
c a s e o f th o s e w h ic h w e re c a r r i e d on b y t h e i r m em bers, th e y w e re d e ­
f i n i t e a n d w e re c o n s i d e r e d a s a p a r t o f a s i t u a t i o n w h ic h c a l l e d
f o r re m e d ia l a c t i o n .
*61I t rem ained f o r th e sto c k exchange to e s t a b l is h th e f a c t s th a t
b r o k e r s d i d n o t o p e r a t e i n w ay s w h ic h w en s d e t r i m e n t a l t o t h e p n b l i c t
a n d t h a t th e s i t u a t i o n w as s u c h t h a t t h e y c o u l d n o t r e a d i l y do s o .
X h e ir d e f e n s e c o n s i s t e d m a in ly o f an e v a l u a t i o n o f i n d i r e c t b e n e f i t s
w h ic h a p p e a r e d I n c i d e n t a l t o t h e p r o c e s s fro m w h ic h t h e y a r o s e .
S ta te m e n t o f f u n c t i o n o f e x c h a n g e s b.v d e f e n s e
I t w as p o i n t e d o u t t h a t t h e
s to c k e x c h a n g e s w ere n e c e s s a r y p a r t s
o f th e s y s te m o f c o r p o r a t e c e p l t a l l s m a n d p e r f o r m e d many u s e f u l s e r v i c e s ,
n o t o n ly to I n v e s t o r s b u t a l s o to th e e c o n o m ic s y s te m a s a w h o le .
It
w as u r g e d t h a t e a r n i n g s w e r e t h e b a s i c f a c t o r i n i n f l u e n c i n g p r i c e s ,
W h ile th e p r e s e n c e o f s p e c u l a t i o n i n t h e s e c u r i t i e s m a r k e ts t o th e
e x t e n t t h a t i t o c c u r r e d i n 1 9 2 8 -1 9 2 9 w as a d m i t t e d t o b e a b a d t h i n g ,
i t w as th o u g h t o f a s a b a s i c f a c t o r i n hum an n a t u r e a n d th e f u n d a m e n ta l
f o r c e i n th e d e v e lo p m e n t o f th e c o u n t r y ,
T u r th e r m o r e , a n o r g y o f
{ ( p e c u la tio n s u c h a s o c c u r r e d b e tw e e n 1 9 2 7 a n d 1929 w as c o n s i d e r e d
b y e x c h a n g e sp o k esm en a b r o a d p u b l i c t h i n g , w h ic h o c c u r r e d i n r e a l
e s t a t e a n d i n c o m m o d itie s a s w e l l a s i n s e c u r i t i e s , a n d s o m e th in g f o r
2
w h ic h th e s e c u r i t y e x c h a n g e s c o u l d n o t b e h e l d r e s p o n s i b l e .
I n f u r n i s h i n g a c o n t in u o u s m a r k e t f o r s e c u r i t i e s ,
th e e x c h a n g e s
w e re h e l d to p e r f o r m a v a l u a b l e s e r v i c e f o r th e I n v e s t o r , a n d i t was
f e l t t h a t th e m a in te n a n c e o f s u c h a m a r k e t b y e x c h a n g e s w as I n no
3
w ay t h e same t h i n g a s e n c o u r a g in g s p e c u l a t i o n .
I t w as p o i n t e d o u t
t h a t i f l i q u i d i t y o f m a r k e ts w e re d e c r e a s e d a n d s p e c u l a t i o n i n c r e a s e d ,
t h e p l i g h t o f t h e i n v e s t o r w o u ld b e m uch w o r s e th a n i t w as u n d e r
Z
S e n a te H e a r in g s o n S to c k E x ch a n g e P r a c t i c e s . P t . I , p p . 2 8 ,9 8 a n d P t.X V ,
p . 6712.
3
i b i d . . P t. XV, p . 6809.
-6 2 e x ls tin g c o n d itio n s .
ffliere w as t h e a d m is s i o n t h a t s p e c u l a t i o n e x a g g e r a t e d a r i s i n g
m a r k e t a n d t h a t s e l l i n g e x a g g e r a t e d a f a l l i n g o n e , h u t a t t e n t i o n w as
c a l l e d t o th e f a c t t h a t d e c l i n e i n s e c u r i t y p r i c e s w e re n o t a s g r e a t
4
a s t h a t o f w h e a t d u r i n g th e p e r i o d o f m o s t v i o l e n t l i q u i d a t i o n .
I t w as f a r t h e r h e l d t h a t th e e x c h a n g e h a d b e e n b la m e d b ey o n d i t s
d e s e rts ,
t h a t i t w as a m a r k e t p l a c e a n d n o t h i n g m o re , a n d t h a t I t c o u ld
n o t b e c o n s i d e r e d r e s p o n s i b l e f o r th o s e h a p p e n in g s w h ic h o c c u r r e d o u t 5
s i d e t h e sc o p e o f i t s a c t i v i t y a n d c o n t r o l .
D e fe n s e o f organizational s e t- U P a n d g e n e r a l p r a c t i c e s
P r a c t i c e s o f th e s t o c k e x c h a n g e w e re n o t c o n s i d e r e d f a u l t y b u t
r a t h e r a m a t t e r o f e v o l u t i o n w h ic h h a d b e e n w o rk ed o u t o v e r a lo n g
p e r i o d o f tim e , c o n s t a n t l y a d j u s t i n g them s e l v e s to t h e p r a c t i c a l r e a l i ­
t i e s o f th e s i t u a t i o n .
They w e re t i e d u p w i t h th e b e h a v i o r o f th e
p u b l i c , a n d r e f o r m c o u l d cam e o n ly th r o u g h e d u c a t i o n o f t h e p u b l i c a s
w e ll a s th ro u g h r e v i s i o n o f s to c k exch an ge te c h n iq u e s .
The e x ch a n g e
w o u ld l i k e to h a v e t h i n g s b e t t e r , b u t th e e x i s t i n g a b u s e s w e re p r i 6
m a r i l y m a t t e r s o f human n a t u r e an d w e re v e r y d i f f i c u l t to m o d ify .
The m a in p ro b le m o f t h e s e c u r i t y e x c h a n g e s w as th o u g h t o f a s th e
p r o t e c t i o n o f th e nla m b H.
E ven th o u g h t h e e x c h a n g e s m ig h t p e r m it th e
l i s t i n g o f ris k y s e c u r itie s ,
t h e r e w as some m e a s u r e o f p r o t e c t i o n i n
t h i s a s o th e r w is e t h e lem b w o u ld go to a " b o o tle g g e r * w h ere h e w o uld
7
b e u n p r o t e c t e d b y th e r u l e s o f t h e e x c h a n g e s .
I t w as a s s e r t e d t h a t t h e e x c h a n g e s d i d n o t e m it p r o p a g a n d a b u t
c o n f i n e d th e m s e lv e s t o k e e p i n g th e p u b l i c c o r r e c t l y In fo rm e d a b o u t
4
I b i d . , P t . l , p . 1 1 7 a n d P t . X 7 ,p .6 6 2 3 .
5 I b ld . . P t. I ,p .8 5 .
6 I b i d . , P t.X V , p p . 6 6 0 5 -6 6 0 7
?
J S iS * .
p . 6773
-63-
t h e m a r k e t.
M oat o f th e ezp e n B e w h ic h w as i n c u r r e d f o r p u b l i c i t y w as
a ttr ib u te d to the p u b lic a tio n o f B ta tiB tlc a l m atter.
I t was p o i n t e d
o u t t h a t th e e x c h a n g e h a d r e f u s e d t o a d v e r t i s e a g a i n s t t h e B o o s e v e lt
a d m i n i s t r a t i o n i n t h e p a p e r s a n d t h a t p a m p h le ts w e re l a r g l e y o f i n -
8
fo im a to ry c h a r a c te r .
E x ch an g e o f f i c i a l s d e n i e d t h a t t h e r e w as a c o n c e n t r a t i o n o f c o n t r o l
i n th e h a n d s o f t h e p r e s i d e n t a n d t h e l e g a l c o m m itte e *
They p o i n t e d
o u t t h a t t h e c o n s t i t u t i o n p r o v i d e d f o r a much b r o a d e r d i s t r i b u t i o n o f
p o w e r, an d h e l d t h a t th e e x c h a n g e a c t u a l l y f u n c t i o n e d a l o n g th e l a t t e r
9
lin e s .
I t w as a l s o p o i n t e d o u t t h a t t h e e x c h a n g e d i d a t t e m p t to c o n t r o l
a b u s e s , b u t t h a t i t c o u ld n o t e x e r t c o n t r o l o v e r th o s e who w ere n o t
m em b ers.
They b e l i e v e d t h a t t h e e x c h a n g e w as f o r c e d t o b e a r th e b r u n t
o f c ritic is m
f o r a c t s c o m m itte d b y p e o p l e o t h e r th a n m em bers.
I t waB
p o i n t e d o u t t h a t t h e r e w as a lw a y s c o o p e r a t i o n b e tw e e n t h e Hew York
S to c k E x ch an g e a n d th e A t t o r n e y G e n e ra l o f New Y o rk .
F u r th e r m o r e , i t
w as u r g e d t h a t t h e e x c h a n g e h a d no c o n t r o l o v e r c o r p o r a t i o n s e x c e p t
t h a t e h i c h a r o s e fro m t h e i r p o w e r t o s t r i k e c o r p o r a t e s e c u r i t i e s fro m
th e l i s t .
O ver t h e i r own m em b ers, h o w e v e r, th e y f e l t t h a t t h e i r c o n ­
t r o l w as a d e q u a te a n d e f f e c t i v e .
I t w as p o i n t e d o u t t h a t t h e i r p u n i s h ­
m e n t o f m em bers w as n o t l a x a n d i n s t a n c e s w e re c i t e d w h e re members h a d
b e e n e x p e l l e d an d o t h e r w i s e d i s c i p l i n e d f o r m is c o n d u c t.
C u s to m e rs '
men h a d to b e a p p ro v e d b y th e e x c h a n g e , a n d i t h a d , o n o c c a s i o n , d e ­
m anded t h e i r r e m o v a l.
D ie same w as t r u e o f m em bers o f s t o c k e x c h a n g e
8
I b i d . , P t . XIV, p . 6 3 4 8 .
9
I b i d ., P t. XIV, p p .6400 f .
-64—
firm s .
I h e y " b e lie v e d t h a t t h e p ro b le m o f c o n t r o l w as n o t p r i m a r i l y
i n t h e i r h ands, b u t In s te a d ,
i n th e h a n d s o f t h o s e who c o n t r o l l e d
th e c r e d i t s y s te m o f th e c o u n t r y .
A t t e n t i o n w as c a l l e d t o th e f a c t
t h a t th e ex c h a n g e h a d p r e v i o u s l y recom m ended F e d e r a l l e g i s l a t i o n f o r
those phaseB o f s t o c k exchange operation over which th e y could not
10
e x e r t e ffe c tiv e c o n tro l.
D e fe n s e o f s p e c i f i c p r a c t i c e s
1. L is tin g
B ie C om m ittee on S to c k L i s t o f t h e New Y ork S to c k E x c h a n g e , w h ic h
h a d b e e n s u b j e c t to c o n s i d e r a b l e c r i t i c i s m , w as u p h e l d s t r o n g l y .
It
w a s s t a t e d t h a t w h ile th e e x c h a n g e t o o k th e w o rd o f c o r p o r a t i o n s t a t e ­
m e n ts a s a b a s i s f o r l i s t i n g ,
a c c u ra te ,
t h e y h a d fo u n d t h a t t h e y w e re u s u a l l y
J U r th e im o r e , l i s t i n g r e q u ir e m e n t s w ere a s s t r i c t a s t h e y
c o u ld b e made a n d w e re g o o d e n o u g h i n m o s t c a s e s .
I t w as p o i h t e d o u t
t h a t t h e ex c h a n g e c o u l d n o t a t t e m p t t o e v a l u a t e c o r p o r a t e a s s e t s o r
m ake ju d g m e n t o f c o r p o r a t e p o l i c i e s , b u t m u s t assu m e t h a t t h o s e i n
c h a r g e w ere w o rk in g i n th e i n t e r e s t o f th e c o r p o r a t i o n .
A ls o , th e
l i s t i n g r e q u ir e m e n t s w e re th e r e s u l t o f lo n g e x p e r i e n c e ; a n d f i n a l l y ,
c o m p le te c h e c k s on c o r p o r a t i o n s l i s t i n g c o u l d n o t b e m ade a s t h e p r o c e s s
11
w o u ld ta k e y e a r s .
2 . L o an s f o r t h e a c c o u n t o f o t h e r s
f ie g a r d in g l o a n s b y c o r p o r a t i o n s f o r s p e c u l a t i v e p u r p o s e s ,
th e
e x c h a n g e p o i n t e d o u t t h a t th e y d i d n o t l i k e th e m , b u t f e l t t h a t c o n t r o l
o f s u c h lo a n s w as th e p ro b le m o f th e b a n k s r a t h e r t h a n t h a t o f th e
10
S e n a te H e a r in g s on S to c k E x c h a n g e P r a c t i c e s . P t . XV, p p . 6619 f , p p . 6670 f f
11
I b i d « » p t . I . P .4 8 ; a l s o P t . X t l l , p p .5 9 6 6 f . , p .6 0 2 4 , P t . XIVt p .6 2 0 4 ,
P t.X 7 , p p . 6 6 8 0 f f .
—65^
s to c k exchange.
To th e c h a r g e t h a t m a k in g l o a n s f o r c a r r y i n g s e c u r i t i e s
o n m a r g i n wae s p e c u l a t i n g o n o t h e r p e o p l e 's m o n ey , e x c h a n g e o f f i c i a l s
s a i d t h a t t h e y c o u ld s e e n o t h i n g w ro n g w i t h t h i s p r a c t i c e a s lo n g a s
a d e q u a te s e c u r i t y w as g i v e n .
I n a n y c a s e , h o w e v e r, t h e y f e l t t h a t
c r e d i t c o n t r o l s h o u ld h e i n th e h a n d s o f th o s e who w e re f a m i l i a r w i t h
th e s itu a tio n .
I t h a d becom e a n o im a l p a r t o f c o r p o r a t e p r o c e d u r e
t o p l a c e s u r p l u s f u n d s i n t h e c a l l l o a n m a r k e t, a n d w h ile g r e a t q u an ­
t i t i e s w e re p u t i n d u r i n g 1928 a n d 1929 b e c a u s e i n t e r e s t r a t e s w e re
f a v o r a b l e , e v e n a t ti m e s o f low i n t e r e s t r a t e s a g r e a t d e a l o f m oney
12
w as p u t in .
3 . A c t i v i t i e s o f th e s p e c i a l i s t
She p o s i t i o n o f th e s p e c i a l i s t , w h i c h h a d b e e n q u e s t i o n e d s e r i o u s l y
b y th e c o m m itte e , w as u p h e l d b y s t o c k e x c h a n g e o f f i c i a l s a n d s p e c i a l i s t s
on s e v e r a l g ro u n d s.
I t w as p o i n t e d o u t t h a t t h e s p e c i a l i s t h a d come
i n t o b e i n g a s a r e s u l t o f th e e v o l u t i o n o f th e m a r k e t.
w as n o t m o n o p o lis tic i n any s e n s e .
H is p o s i t i o n
He b ecam e a s p e c i a l i s t a s a r e s u l t
o f d e a l i n g i n p a r t i c u l a r s t o c k s , a n d u p o n h i s own v o l i t i o n , u n l e s s h e
w a s a s k e d by th e co m m issio n h o u s e s , who w is h e d to h av e a m a rk e t f o r
c e r t a i n s to c k s ,
in
t o ta k e th em .
V or d i d h e h a v e a n y m o n o p o ly i n t r a d i n g
th e s t o c k s i n w h ic h h e s p e c i a l i z e d .
Buy o r s e l l o r d e r s m ig h t b e
e x e c u te d i n any s to c k by an y b ro k e r a id th e r e f o r e h e h e ld h i s p o s i t i o n
b e c a u s e o r d e r s m ig h t b e m ore e f f i c i e n t l y e x e c u te d th r o u g h h im .
F u rth e r­
m o r e , h e o p e r a t e d u n d e r s t r i c t r u l e s o f t h e e x c h a n g e w h ic h w e re d e ­
s i g n e d to p r e v e n t a b u s e s b y s p e c i a l i s t s .
The e x c h a n g e o f f i c i a l s f e l t
13
t h a t e v e r y t h i n g t h a t c o u ld b e done to c o n t r o l s p e c i a l i s t s h a d b e e n d o n e .
12
S e n a te H e a r in g s on S to c k E x ch an g e P r a c t i c e s . P t . I
p p .6330 f f . , P t. 1 7 ., p . 6708.
I 3 l b i d *.* P t * I *P*7 1 » p t * H U . P P .6 0 7 3 f f . ,
p p . 6780 f f .
» .« w
p*
ttv
’
P t . XIV, p p . 6665 f f . ,
’
pt.xv
-6 6 I n a n s w e r to th e c h a r g e t h a t e v i l s a r o s e fro m t h e co m b in ed b r o k e r d e a l e r f u n c tio n o f th e s p e c i a l i s t , th e exchange a u t h o r i t i e s p o in te d
o u t t h a t a s a r e s u l t o f t h i s c o m b in a tio n , t h e s p e c i a l i s t w as a b l e t o
m ake a m a r k e t b e tw e e n b id a n d a s k e d p r i c e s i n h i s s t o c k s ,
th e r e b y
c r e a t i n g a c o n t in u o u s m a r k e t w h ich w as v a l u a b l e t o th e p u b li c *
T h ere
w as no p o s s i b i l i t y o f th e s p e c i a l i s t ' s a b u s in g c u s to m e r s a s h e w as
s t r i c t l y b o u n d t o e x e c u te c u s to m e r s ' o r d e r s f i r s t ,
a n d c o u ld n o t t r a d e
14
f o r h i s own a c c o u n t w h ile h e s t i l l h a d c u s t o m e r s ' o r d e r s o n h i s b o o k s .
I t w as h e l d t h a t th e s p e c i a l i s t ' s b o o k w as n o t o f a s m uch u s e to
h im a s w as g e n e r a l l y s u p p o s e d .
I t wae d i f f i c u l t f o r s p e c i a l i s t s to
d e t e r m in e th e t r e n d o f th e m a r k e t fro m th e o r d e r s w h ic h th e y h a d on
hand,
l h e y w e re n o t o f t e n r i g h t an d th e y m ade a n e t p r o f i t o n l y b e c a u s e
t h e y g a i n e d s u f f i c i e n t l y w hen r i g h t t o o f f B e t t h e i r l o s s e s w hen w ro n g .
I t w as h e l d t h a t s p e c i a l i s t s made p r o f i t s o u t o f t h e " lo n g p u l l " r a t h e r
th a n o u t o f s h o r t tim e f l u c t u a t i o n s , a n d t h a t th e y w o rk e d o n th e p r i n ­
c i p l e o f s t a y i n g ixxwwhen r i g h t an d q u i c k l y g e t t i n g o u t when w ro n g .
It
w as a l s o p o i n t e d o u t t h a t t h e c o n t e n t s o f a s p e c i a l i s t ' s b o o k w e re n o t
g i v e n o u t to i n t e r e s t e d p a r t i e s .
One s p e c u l a t o r , i n t e s t i f y i n g I n
a n o th e r c o n n e c tio n , a d m itte d tr y in g u n s u c c e s s f u lly to g e t in fo r m a tio n
fro m s p e c i a l i s t s c o n c e r n in g t h e c o n d i t i o n o f t h e i r b o o k s ; t h e e x c h a n g e
15
r u le s p ro h ib ite d it*
I t w as i m p l i e d t h a t i t w as n o t t h e u s u a l t h i n g f o r s p e c i a l i s t s
t o p a r t i c i p a t e i n p o o l s , a l t h o u g h th e te s t im o n y o f th e s p e c i a l i s t s
14
S e n a t e H e a r in g s on S to c k E xchange P r a c t i c e s . P t . I , p . 7 1 , P t.X 7 ,p .6 6 6 1
15
I b l d » . P t . I , p . 3 0 5 , P t n i l , p p . 6 1 0 2 f f . , P t.X 7 , p p . 6 8 0 4 f f .
th e m s e lv e s d i d n o t s u b s t a n t i a t e t h i s c o n t e n t i o n .
S p e c i a l i s t s e x e c u te d
16
o r d e r s f o r p o o l s w h e th e r th e y w e re in v o lv e d i n them o r n o t .
I t w as
h e l d , h o w e v e r, t h a t t h i s m ade l i t t l e
d iffe re n c e .
The m a n i p u l a t i o n
o f .A m erican C om m ercial A lc o h o l, a f l a g r e n t c a s e o f m a n i p u l a t i o n i n th e
e y e s o f th e c o m m itte e , w as d e s c r i b e d b y U r. W h itn e y , th e n p r e s i d e n t
o f th e NewYork S to c k E x c h a n g e , a s n o t c o n s t i t u t i n g a n u n d u e i n f l u e n c i n g
17
o f t h e m a rk e t i n h i s o p i n i o n .
S p e c i a l i s t s w ere c o n s i d e r e d p a r t i c u l a r l y b e n e f i c i a l t o th e m a rk e t
i n tim e s o f s t r e s s .
They w e re su p p o se d to b e m uch m o re e f f i c i e n t t h m
o t h e r b r o k e r s , a n d te n d e d to t r a d e f o r t h e i r own a c c o u n t o u t o f a s e n s e
o f d u t y , an d o f t e n to t h e i r l o s s , i n o r d e r t h a t a m a rk e t f o r t h e i r
s t o c k s m ig h t b e m a i n t a i n e d .
I f i t w ere n o t f o r t h i s f u n c t i o n , p r i c e
c h a n g e s b e tw e e n s a l e s w o u ld h a v e b e e n much b r o a d e r t h a n t h e y w e re a t
18
s u c h ti m e s .
I n a n s w e r t o th e c h a r g e t h a t s p e c i a l i s t s m ade v e r y l a r g e p r o f i t s ,
e x c h a n g e o f f i c i a l s f e l t t h a t t h e r e w as no r e a s o n why th e y s h o u ld n o t .
From t h e i r p o i n t o f v ie w , t h e p r o f i t s o f th e s p e c i a l i s t a p p e a r e d s i m i l a r
t o s p e c u l a t i v e p r o f i t s i n a n y o t h e r fo rm o f s p e c u l a t i o n ,
19
e s t a t e o r c o m m o d itie s ,
such a s r e a l
The e x c h a n g e f e l t t h a t , f a r fro m b e i n g a m en ace o f a n y d e s c r i p t i o n ,
th e s p e c i a l i s t w as a m o s t u s e f u l member o f th e s t o c k e x c h a n g e o r g a n i z a t i o n .
16
S e n a te B e a r in g s on S to c k
17
P r a c t i c e s . P t . X X I I .p . 6 0 7 3 f f .
4. B ro k e r-d e a le r fu n c tio n and the customer* a Int-Areat.
From t h e p o i n t o f v ie w o f t h e JTew Y ork S to c k E x ch an g e th e co m b in ed
f u n c t i o n o f b r o k e r a n d d e a l e r w as a b e n e f i t t o t h e p u b l i c .
To t h e
c h a r g e t h a t b r o k e r s in d u c e d c u s to m e r s t o s p e c u l a t e , i t w as a n s w e re d
t h a t c u s to m e r s s p e c u l a t e o f t h e i r own a c c o r d , a n d t h a t b r o k e r s h ad
little
to do w i t h f o m e n tin g s p e c u l a t i o n .
I t w as p o i n t e d o u t t h a t t h e
i n t e r e s t s o f b r o k e r a n d c u s to m e r a r e m ore n e a r l y i d e n t i c a l t h a n w as
20
su p p o sed .
P r o f i t s to c u s to m e r s m e a n t p r o f i t s to b r o k e r s r a t h e r th a n
th e r e v e r s e .
F o r t h i s r e a s o n a d v i c e w h ic h b r o k e r s g a v e t o c u s to m e r s
w as o f t e n g o o d .
I t w as b ro u g h t o u t t h a t i n th e c a s e o f p o o l o p e r a tio n s
w h e re m a r k e t l e t t e r s h a d b e e n p u b l i s h e d recom m ending s t o c k s i n w h ic h
b r o k e r s w e re i n t e r e s t e d ,
s t o c k s h ad a c t e d i n a c c o r d a n c e w i t h t h e a d v i c e
21
g iv e n .
I t w as f u r t h e r s t a t e d t h a t th e
a g a i n s t b r o k e r s who t r i e d
s to c k e x c h a n g e e n f o r c e d r u l e s
to e x e r t u n d u e p r e s s u r e u p o n t h e i r c u s to m e r s
a n d t h a t i f a f i r m w as fo u n d t o b e t a k i n g a p o s i t i o n i n th e m a rk e t o p ­
p o s i t e to t h a t o f i t s c u s to m e r s , i t was s u b j e c t t o d i s c i p l i n e b y th e
22
exchange a u th o r itie s .
F i n a l l y , a r u l e had b e e n p a s s e d s h o r tly b e fo r e
th e h e a r i n g to o k p l a c e , w h ic h f o r b a d e b r o k e r s to e n t e r i n t o p o o l o jh
23
o r a t i o n s o f a n y k i n d , o r t o b e i n a n y way c o n n e c te d w i t h them .
*
As f o r b r o k e r s * s e l l i n g t o c u s to m e r s s t o c k i n w h ic h th e y w e re
u n d e r w r i t e r s , i t w as h e l d t h a t b r o k e r s becam e i n t e r e s t e d i n s p o n s o r i n g
a n i s s u e o f s t o c k w h ic h th e y b e l i e v e d w as so u n d fro m th e c u s t o m e r 's
p o i n t o f v ie w b e c a u s e i t w o u ld o t h e r w i s e b e b a d b u s i n e s s .
B ie r e w a s ,
20
S e n a t e H e a r in g s o n S to c k E x ch a n g e P r a c t i c e s . P t . X7, p . 6 8 2 4 f f , p .
21
6975.
-6 9 t h e r e f o r e , a u n i t y r a t h e r th a n a c o n f l i c t o f i n t e r e s t b e tw e e n b r o k e r
34
a n d c u s to m e r u n d e r s u c h c i r c u m s t a n c e s .
5 . S to ck -lea d in g
A t t e n t i o n w as c a l l e d t o t h e f a c t t h a t b r o k e r s c o u ld n o t u s e s t o c k
f o r t h e i r own p u r p o s e s b u t i n s t e a d c o u l d u s e o n ly t h a t am ount o f a
c u s t o m e r 's s t o c k w h ic h w as n e c e s s a r y f o r c a r r y i n g t h e c u s t o m e r 's
a c c o u n t.
F u r th e r m o r e , w hen s t o c k w as owned o u t r i g h t ,
b e l e n t w i t h o u t th e c u s t o m e r 's p e r m i s s i o n .
p u rp o se s.
She le n d i n g o f s to c k
was n o t r e s o r t e d to m e r e ly
w as n o t c o n s i d e r e d a n e v i l , a n d
poses o f sh o rt s e llin g ;
i t c o u ld n o t
f o r p u r­
i t w as h e l d to b e n e c e s s a r y f o r many o t h e r
I t w as p o i n t e d o u t,
f o r e x a m p le ,
s a r y f o r " s a l e s a g a i n s t th e b o x " .
t h a t b o rro w in g w as n e c e s ­
I n o r d e r t h a t a p e r bon m ig h t s e l l
a s t o c k i m n e d l a t e l y w hen i t w as i m p o s s ib l e f o r him t o d e l i v e r i t f o r
some ti m e , h e m u s t b o rro w s t o c k t o s e l l a n d l a t e r d e l i v e r h i s own
s t o c k t o c o v e r h i s s h o r t co m m itm en t.
S u ch u s e s o f s to c k w e re c o n s i d e r e d
m e re ly m a t t e r s o f m e c h a n ic a l c o n v e n ie n c e i n t h e o p e r a t i o n o f th e m a rk e t,
a n d w e re i n no s e n s e a b u s e s , b u t i n s t e a d w e re d i r e c t b e n e f i t s t o c u s 25
ta m e r s .
I t w as a l s o
p o i n t e d o u t t h a t b r o k e r s w e re e s s e n t i a l l y a n h o n e s t
g r o u p o f men a n d t h a t t h e n a t u r e o f t h e i r b u s i n e s s w as s u c h a s t o make
i t n e c e s s a r y f o r th em t o o p e r a t e on a n h o n o r b a s i s t o a l a r g e e x t e n t
th e b o rro w in g o f s t o c k , a s w e l l a s o t h e r p r a c t i c e s ,
s i d e r e d i n th e l i g h t o f t h i s a s s u m p tio n .
s h o u ld b e
con-
Humors a b o u t th e m a rk e t c o u l d
24
S e n a te H e a r in g s o n S to c k E x ch an g e P r a c t i c e s , P t . 1 7 , p p . 6865 f .
25
I b i d .. P t. I , p . 77, pp. 137 f f .
n o t b e a t t r i b u t e d to b r o k e r s who c i r c u l a t e d them f o r t h e i r own p u r p o s e s ,
26
b u t w e re o f unknow n o r i g i n , p r e s u m a b ly s t a r t i n g fro m m any s o u r c e s .
To t h e c h a r g e t h a t b r o k e r a g e h o u s e s h a d o f t e n f a i l e d b e c a u s e o f
com m itm en ts w h ic h a r o s e fro m t h e i r f u n c t i o n s a s d e a l e r s a n d u n d e r w r i t e r s ,
t h e e x tr e m e ly low p e r c e n t a g e o f f a i l u r e s on th e p a r t o f s t o c k e x c h a n g e
m em bers a l s o w as c i t e d ( t h r e ^ - e i g h t h s o f one p e r c e n t o f th e t o t a l
27
m e m b ersh ip p e r an n u m .)
6.
M a rg in r e q u ir e m e n t s
C o n c e rn in g m a r g in r e q u i r e m e n t s a n d s h o r t s a l e s , i t w as p o i n t e d o u t
t h a t t h e y w ere c l o s e l y r e l a t e d to e a c h o t h e r , a n d w e re n e c e s s a r y p a r t s
o f th e m a rk e t m ech an ism .
M a rg in r e q u ir e m e n t s h a d b e e n w o rk e d o u t a s
a r e s u l t o f lo n g e x p e r i e n c e , a n d w e re a s w e l l a d j u s t e d t o t h e s i t u a t i o n
a s p o s s ib le .
I t w as s t a t e d t h a t r a i s i n g m a r g in r e q u i r e m e n t s d i d n o t
s e r v e a s a b r a k e o n s p e c u l a t i o n , & p o i n t w h ic h
w as d e m o n s tr a te d b y th e
f a c t t h a t w hen b r o k e r s h a d i n c r e a s e d m a r g in r e q u i r e m e n t s i n 1 9 2 9 ,
s p e c u la tio n c o n tin u e d .
F u r th e r m o r e , low m a rg in r e q u i r e m e n t s w e re h e l d
to h a v e n o th i n g to do w i t h f o m e n tin g s p e c u l a t i o n .
I t w as p o in te d o u t
t h a t th e y h a d n o m ore r e l a t i o n to s p e c u l a t i o n th a n low i n t e r e s t r a t e s
h a d to b u s i n e s s a c t i v i t y .
JTor w e r e I n a d e q u a te m a r g in s c o n s i d e r e d r e ­
s p o n s i b l e f o r d e c l i n e s i n th e m a r k e t.
I t w as th o u g h t t h a t m o st s e l l i n g
o c c u r r e d a s a r e s u l t o f l i q u i d a t i o n b y i n v e s t o r s r a t h e r t h a n th r o u g h
28
l i q u i d a t i o n o f m a rg in a c c o u n t s .
A s f o r f i x i n g m a r g in r e q u ir e m e n t s o n a r i g i d b a s i s , i t a p p e a r e d
to
th e e x c h a n g e a u t h o r i t i e s t h a t s u c h a p r o c e d u r e w as u n s o u n d a n d u n ­
w o r k a b le .
I t w as p o i n t e d o u t t h a t i n a n y r a p i d l y c h a n g in g s i t u a t i o n ,
26
S e n a te H e a r in g s on S to c k E x ch a n g e P r a c t i c e s . P t . I , p . 1 4 5 .
2 7 l b i d ., P t . XV, p p . 6865 f .
28 I b i d . , P t. I , p p . 3 7 ,9 7 a n d P t . XV, p p . 6 7 0 7 .
-7 1 f i x e d r e q u i r e m e n t s w o u ld r e s u l t I n f o r c e d s e l l i n g .
F u r th e r m o r e , I t
w as f e l t t h a t m a r g in r e q u ir e m e n t s m u st h e v a r i e d g r e a t l y fro m tim e
29
t o tim e t o p r o v id e a c o n s i s t e n t d e g r e e o f s a f e t y to c u s to m e r s .
7 . S h o rt-s e llin g
S h o r t - s e l l i n g w as n o t c o n s id e r e d a n e v i l , h u t a n e c e s s a r y e le m e n t
f o r th e b a l a n c e o f t h e m a r k e t.
I t waB p o i n t e d o u t t h a t th e s h o r t I n f
t e r e s t i n p a r t i c u l a r s t o c k s w as im p o s s ib l e f o r e x p e r t s t o g u e s s , a n d
t h a t t h e r e w as n e v e r en o u g h s h o r t - s e l l i n g to i n f l u e n c e th e m a rk e t t o
an a p p re c ia b le e x te n t.
M a rk e t o p e r a t o r s who w e re c a l l e d t o t e s t i f y
d e n i e d t h a t t h e y o p e r a t e d on t h e s h o r t s i d e o f t h e m a r k e t, e x c e p t i n ­
c i d e n t a l l y , a n d w hen t h e y assu m ed a s h o r t p o s i t i o n t h e y d e n ie d d o in g
a n y t h i n g t o h e l p s t o c k s down.
A s p e c i a l i s t lik e w is e t e s t i f i e d th a t
h e h a d n e v e r h e a r d o f a p o o l t o d e p r e s s th e p r i c e o f s t o c k s .
I t w as
u rg e d t h a t h e a r r a i d i n g d id n o t e x i s t to any Im p o rta n t e x te n t an d t h a t
if
t h e r e s h o u ld h e a n a t t e m p t t o d e p r e s s th e s t o c k p r i c e s i t c o u ld h e
30
a c c o m p lis h e d b y a lo n g p o s i t i o n a s w e l l a s a s h o r t o n e .
W h ile i t w as a d m i t t e d t h a t t h e r e h a d b e e n d i f f i c u l t i e s d u e t o o v e r s p e c u l a t i o n i n th e m a r k e ts d u r in g th e e r a o f 1 9 2 8 -1 9 2 9 , i t w as h e l d t h a t
t h e s e a r o s e fro m s o u r c e s o t h e r th a n i n h e r e n t d e f e c t s i n th e m e ch an ism
31
o f th e m a r k e t o r i n i t s a d m i n i s t r a t i o n .
8 . P u ts and c a l l s
I n r e p l y to th e c h a r g e t h a t p u t s a n d c a l l s w e re e s s e n t i a l l y g a m b lin g
d e v ic e s , H e rb e rt F i l e r , a p u t and c a l l b ro k e r,
t e s t i f i e d t h a t , w h ile
29
S e n a te B e a r in g s o n S to c k S x o h an g e P r a c t i c e s . P t.X T ,p p .6 7 0 4 .
30
I b i d . , P t . I , p p . 3 3 f f . , p p . I l l f f . , p p . 153 f f . , p . 389 f f . ,
a n d F t. X III, p . 6064.
31
I b i d . . P t. I , p . 83.
p . 3 22 f f . ,
-72.
p a t s and c a l l s had s p e c u la tiv e p o s s i b i l i t i e s ,
th e y w e re a l s o a form
o f in s u ra n c e .
By m ean s o f them p e o p le w e re a b l e to i n s u r e h o l d i n g s
a g a in s t lo s s .
Be h e l d t h a t th e y m in im is e d r i d e s a n d e x e r t e d a s t a b i ­
l i s i n g i n f l u e n c e u p o n th e m a r k e t.
I n d o in g t h e s e t h i n g s , p u t s a n d
c a l l s h a d a d e f i n i t e eco n o m ic v a l u e .
The f a c t t h a t t h e s e o p t i o n s
w e re e x e r c i s e d i n o n l y a b o u t tw e lv e a n d one h a l f p e r c e n t o f t h e
c a s e s i n w h ic h t h e y w e re p u r c h a s e d , d i d n o t m ean to h im t h a t t h e y d i d
n o t p e rfo rm a u s e f u l fu n c tio n .
&
c o n s i d e r e d t h a t th e y w e re o f a s
m uch u s e a s a n y o t h e r k i n d o f i n s u r a n c e , and s h o u ld b e th o u g h t o f
a s p e r f o r m in g a u s e f u l f u n c t i o n e v e n th o u g h th e y m ig h t n o t b e e x e r ­
c is e d .
Be a l s o p o i n t e d o u t t h a t , w h ile t h e y w e re n o t d e a l t i n o n
t h e ITsw T o rk S to c k E x c h a n g e , t h e y w e re d e a l t i n o n t h e o t h e r l a r g e
32
e x c h a n g e s o f t h e w o r ld i n th e same m a n n e r a s o t h e r c o n t r a c t s .
9 . “l a s h *
s a l e s a n d " p r i c e n a g g in g
I n th e c a s e o f m a k in g a m a r k e t th r o u g h w ash s a l e s , U r. W h itn e y
d e n i e d t h a t i t was d o n e , w h i l e o t h e r s f r e e l y a d m itt e d
a n d d e s c r i b e d i t i n some d e t a i l .
th e p r a c t i c e
P r i c e p e g g in g , U r. W h itn e y a d m i t t e d ,
w as so m etim e s r e s o r t e d t o , b u t h e c o n s i d e r e d i t a d a n g e r o u s p r a c t i c e .
I t s u s e a s w e l l a s th e d a n g e r i n h e r e n t i n i t w as a d m i t t e d b y o t h e r s .
S p e c i a l i s t s a d m i t t e d o r i m p l i e d t h a t t h e y w e re f a m i l i a r w i t h t h i s
33
p r a c t ic e .
1 0 . P r ic e m a n ip u la tio n
I n t h e c a s e o f c r e a t i n g f i c t i t i o u s p r i c e s , U r. W h itn e y p o i n t e d
o u t t h a t th e r u l e s o f th e exchange o p e ra te d a g a i n s t f i c t i t i o u s p r i c e s
o n b o t h s i d e s , w h ile t h e te s t im o n y o f b o th s p e c i a l i s t s an d m a r k e t
32
S e n a te H e a r in g s on S to c k E xchange P r a c t i c e s . P t .X 7 ,p . 70 6 2 f f .
33
I b i d . . P t. I , p . 25 f . , p . 167.
-7 3 opera to r s in d ic a te d com plete f a m ilia r it y w ith th e p ro cess o f inducing
34
p u b lic buying to cause an advance in p r ic e . In speaking o f h is
o p era tio n s fo r a p o o l, in which Ur. Thomas Bragg was a p a r tic ip a n t, Ur.
Charles C. W right, a s p e c i a l i s t on the Hew York Stock Exchange, t e s t i f i e d
a s fo llo w s!
Ur. Bragg does n ot work th a t way. When he gave me buying
orders he gave me orders so th a t th ere would on ly be support in
th a t sto ck . Hie d id n11 buy i t up . . . There was no s o -c a lle d
1m a n ip u la tio n 1 in t h is sto ck . (3 5 )
11. Uarket m anipulation - p o o ls and o p tio n s
To the charge th a t p ool op erators had brought about g rea t d e c lin e s
in p r ic e s , the exchange d efen se was stron ger than in the p r e v io u sly
noted in sta n c e s .
Ur. W hitney's statem ent th a t p r ic e d e c lin e s were
brought about by p u b lic liq u id a tio n was s u b sta n tia te d by the testim ony
36
o f market o p era to rs. Ur. Percy R o c k e fe lle r den ied a l l "improper con­
d u ct" , and p o in te d out th a t w h ile he m ight have been te c h n ic a lly sh ort
o f sto c k s, p r a c t ic a lly a l l such sh ort commitments a s he had were in
r e a l i t y s a le s "againBt the box", as he was alw ays in p o sse ssio n o f
enough sto ck to cover them,
furtherm ore, he did n o t f e e l th at short
37
s e l l i n g was an im portant fa c to r in the d e c lin e o f p r ic e s .
Ur. Uatthew Brush t e s t i f i e d that he had been short o f stock fo r
the purpose o f hedging r e a l e s ta t e com nlim ents.
He p oin ted ou t, how­
e v e r , th a t when short o f stock he did nothing to help the stock down.
He a ls o a s se r te d th at he never made a purchase or a s a le o f sto ck w ith ­
out f i r s t in v e s t ig a tin g the company in v o lv ed , thereby im plying th at he
adapted h i s p o s it io n to the economic f a c to r s o p era tiv e in the m a ik et,34
Senate Hearings on Stock Exchange P r a c t ic e s . P t. I , p p .51 f .
35
Ib id . . P t. H I ! , p. 6104.
3| b i d . , P t. I , p. 19
37
I b id . . P t. I , p p .326 f f .
-7 4 38
r a th e r than to attem pt to m anipulate i t .
I t was brought o u t, however,
th a t p o s it io n s had been taken in the market by s e l l i n g a sto ck sh o rt,
thereby g e t tin g the advantage o f the " te c h n ic a l p o sitio n " o f the market.
T h is p r a c tic e had been con sid ered s u f f i c i e n t l y bad by the a u t h o r it ie s
39
o f the exchange to cause them to make a r u lin g a g a in st i t . Furthermore,
i t was t e s t i f i e d th a t the r u le s a g a in st bear r a id in g cou ld be b eaten ,
and th a t short s e ll i n g ought to be p r o h ib ite d .
While th ere was no e v i­
dence th a t "Juggling" the market had taken p la ce in any p a r tic u la r ii>s ta n c e , the p r o ce ss was d escrib ed aB o p eratin g in a stock w ith a th in
40
m arket, and "kicking i t a l l over the p la c e ."
On t h is p o in t the d efense o f th e stock exchanges c o n s is te d o f c a s tin g
s e r io u s doubt th a t major d e c lin e s in p r ic e s came about as a r e s u lt o f
th e a c t i v i t y o f market op era to rs.
At the same tim e, i t appears to have
been e s ta b lis h e d th at w ith in c e r ta in a r e a s , d e c lin e s m ight be su ccess­
f u l l y brought about through short s e l l i n g .
Furthermore, i t appeared
th a t in sto ck s having a th in market, m an ip u lative movements m ight be
brought about s u c c e s s f u lly .
While th e sto c k exchange a u t h o r it ie s
s tr o v e to e s t a b lis h the f a c t th a t m an ip u lative o p era tio n s were n ot a t
a l l r e sp o n sib le fo r major d e c lin e s , they e s ta b lis h e d grounds f o r the
assum ption that w ith in the p r ic e lim it s e s ta b lis h e d by b a s ic economic
f a c to r s and. by p u b lic p a r tic ip a tio n ,m a n ip u la tiv e p r a c tic e s were workable
41
and had been u sed .
38
Senate Hearings on Stock Exchange P r a c t ic e s . P t. I , p p .300 f f .
39
I b i d ., P t. X III, p .6136.
40
I b i d .. P t. XI7, p p .6226 f . ; a le o **t.I, p p .364 f f .
41
For fa r th e r in form ation on p o o ls and a l l i e d a sp e c ts o f market op era tio n
s e e testim on y o f Thomas X. Bragg, I b id . , P t. I I , p p .406 f f , and t e s t i ­
mony o f J.J.B ask ob and o th e r s, p p .712 f f .
-7 5 Concernlng the mi b u b o o f o p tio n s there was l i t t l e fo r the ex­
change a u t h o r it ie s to say, i f the u se o f o p tio n s fo r p o o l purposes
was to he construed, a s a m isuse o f them.
Their u se a s a v e h ic le fo r
the d is t r ib u t io n o f sto c k to the p u b lic was adm itted by s p e c i a l i s t s ,
brokerage fir m s, and market op erators.
I t cou ld o n ly be contended, a s
s ta te d p r e v io u sly , th at th ese op erations were n ot undue in flu e n c in g
o f the market and th a t i t was reasonable to s e l l la rg e b lo ck s o f stock
through market op era tors, in order to p reven t undue d ep ressio n o f
p r ic e w h ile they were b ein g unloaded.
In t h is con n ection i t was
brought out, however, th a t the op tion provided a means
by which p o o ls
might operate in a stock w ith out p u ttin g up much money.
Through the
testim o n y on p ool op eration i t was brought out beyond q u estio n th at
f a l s e rumors were spread to in flu e n c e the market through market l e t t e r s ,
th a t sto ck was so ld to the p u b lic a t high and a r t i f i c i a l p r ic e s , and
42
th a t p r o f it s accruing to market operators were s u b s ta n t ia l. Perhaps
th e b e s t d efen se g iv en fo r the op eration o f p o o ls and the s iz e o f t h e ir
p r o f it s was g iv e n by Ur. Uason Day o f the firm o f Eedjuoni and Company,
who p o in ted out th a t in a pool which d is tr ib u te d 165,000 shares o f
sto c k , the p r o f it was $595,000.
This p r o f it rep resen ted $2.4 0 per share
or about e ig h t per cen t commission fo r d is t r ib u t io n .
In con n ection
w ith a p o o l In Libby Owens 7ord C lass Company i t was brought out th a t
th e p o o l had i t s o r ig in w ith Ur. Day, who thought the sto ck was under­
v a lu ed .
Under p o o l op erations the stock reached a h igh o f th ir ty -s e v e n ,
having r is e n to t h is l e v e l from between tw enty and tw en ty-seven.
At
42
Senate H earings on Stock Exchange P r a c tic e s . P t. n i l , p . 5900, P t. XIV,
p p .6238 f f .
the tim e o f the Senate h earin gs i t was s e l l i n g a t above f o r ty .
The
f a c t was brought o u t, however, th at aL though t h is co rp o ra tio n manu­
fa ctu r e d s h a tte r -p r o o f g la s s fo r autom obiles and made no b o t t le s , i t
43
was regarded by the p u b lic as a rep ea l sto ck .
12. D i f f i c u l t i e s o u tsid e exchange c o n tro l
In answer to the d i f f i c u l t i e s which had a r is e n o u tsid e o f the
exchange, the p o s it io n was taken th a t not only were many o f them o u t­
s id e the Bcope o f exchange c o n tr o l, but th a t th e nature o f the s it u a ­
t io n d id not admit o f su b sta n tia l change,
lh e a t t it u d e o f th e exchange
in co n n ectio n w ith corp orate a c t i v it y has been p r e v io u sly in d ica ted
44
a s one which c o n s titu te d a d e n ia l o f r e s p o n s ib ilit y . In con n ection
w ith corporate a ccou n tin g p r a c tic e s , however, and the g iv in g o f in ­
form ation to the p u b lic , i t was urged th at th ere were s e v e r a l fa c to r s
in th e s it u a t io n which made m a teria l improvements in th e methods u sed
im p o ssib le .
F i r s t l y , i t would be im p ossible to com pile complete
r e p o r ts of corporate o p era tio n s because o f the h ig h co stB Involved;
seco n d ly , the time consumed in g ath erin g data fo r such r ep o rts would
be so g r e a t th a t the inform ation g iv en would be too l a t e to be o f
any u s e to the p u b lic , and fo r th is reason i t m ight be a s m islead in g
a s l e s s adequate or even d ish o n est rep o rts would be; t h ir d ly , i t would
n ot be f a i r to co rp o ra tio n s or to the in d iv id u a ls in volved to make
too much in form ation p u b lic; and fo u r th ly , co rp o ra tio n s and in d iv id u a ls
should n ot be h e ld too c lo s e ly resp o n sib le fo r sta tem en ts, many o f
which were m erely e s tim a te s , and which o fte n , in the l i g h t
43
Senate Hearings on Stock •pj-rpVinngfl
44
See p . 65 above.
o f su b se-
P t, XIV , p p .6229 f f ,
-7 7 quent e v e n ts, proved to tie f a l s e and m islead in g even though they
were h o n e stly meant a t the time a t which th ey were g iv en .
In any
c a s e , the exchange f e l t th a t I t had no way o f making corp oration s
f a l l in lin e and g iv e such Inform ation,
I t was h eld th a t, even
though such in form ation had te e n a v a ila b le in 1929, i t would have
45
done l i t t l e good as the p u b lic would have ignored i t . I t was a ls o
f e l t th a t the exchange had no r e s p o n s ib ilit y fo r the o p eration s o f
investm ent t r u s t s , which were supposed to have dumped la rg e q u a n titie s
o f sto ck on the market in 1929.
I t was denied th at investm ent t r u s t s
made a b u sin e ss o f loan in g sto ck ex cep t through the ordinary channels
o f th e exchange, and were no more a fa c to r in th e d e c lin e in t h is
46
r e s p e c t th a t any o th er custom ers o f brokers.
D efen se o f p a r tic u la r ab uses weak
The d efen se o f the s to c k exchanges concerning p a r tic u la r abuses
tended to be in c o n s is te n t and sometimes c o n tra d ic to ry .
To the e x te n t
th a t o f f i c i a l s o f the exchange were in v o lv ed , there appeared to be a
tendency e it h e r to deny th e f a c t in q u estio n , deny r e s p o n s ib ilit y fo r
i t , or to sa y th a t i t cou ld n ot be avoided.
Brokers and market operas
t o r s , on the o th er hand, were much more frank and tended to d e s c r ib e
the p r o c e sse s by which th ey operated rath er d is p a s s io n a te ly , app arently
f e e l i n g th a t t h e ir conduct needed l i t t l e d efen se.
The f a c t th a t t h e ir
reco rd s were su b je c t to subpoena might a ls o have had some in flu e n c e
on t h e ir conduct.
S n a il exchanges defended
45
Sen ate H earings on Stock
P r a c tic e s . P t. X III, p p .5966 f .
P t . X7, p . 6607, p p .6673 f f . , p .6719, p .6880.
46
I b i d . . P t. I , p . 315
-7 8 Testimony p resented In d efen se o f the sm aller exchanges was
based upon th ree main assum ptions: ( l ) th a t th e ir b u sin ess was
la r g e ly l o c a l i n ch a ra cter, (2 ) th a t there was l i t t l e sp e cu la tio n on
them, and (3 ) th a t they could not stan d d r a s tic changes in th e ir
p r a c tic e s w ith o u t goii*? out o f b u sin e s s.
They were h eld to serv e a
u s e fu l purpose in th e ir spheres and to be n ot a s bad as th ey had been
p ic tu r e d .
The B altim ore Stock Exchange was rep resen ted as d ea lin g p r in c i­
p a lly in the s e c u r it ie s o f Maryland co rp o ra tio n s, most of which were
47
h eld l o c a l l y .
The same appears to be more or l e s s true o f th e other
sm all exchanges.
Perhaps the most n o ta b le ex cep tio n was th at o f the
San F rancisco exchange, which o c c a s io n a lly assumed con sid erab le n a tio n a l
importance b ecau se o f th e f a c t that th e d iffe r e n c e in time between New
York and San F ran cisco brought about tra d in g on the San F rancisco ex­
change a f t e r the Hew York Exchange had c lo s e d .
Under c e r ta in circum­
s ta n c es la t e trading on t h is exchange was c a r e f u lly watched a s an in 48
d ic a to r o f the probable trend o f p r ic e s in New York the next day.
I t waB brought out in con n ection w ith the C a lifo r n ia exchanges that
in C a lifo r n ia th ere was a g r e a t deal o f b u sin e ss of the "wild cat"
type g o in g on, in which th ere was n e c e s s a r ily a g r e a t d ea l o f r is k .
While v ery few o f the s e c u r it ie s o f th ese e n te r p r is e s could be l i s t e d
on rep u tab le exchanges, there was a t the same time no way of rep ressin g
such b u sin e ss and th a t an attem pt to do so would bring about "boot­
le g g in g " , which would be more d etrim en tal to the p u b lic than the system
47
Senate H earings on Stock Exchange P r a c tic e s . P t. XV, p p .6735 f .
48
I b i d . , P t. XV, p p .6826 f .
-7 9 which e x is te d a t th a t tim e.
I t was fa r th e r p oin ted out th a t the ex­
changee in C a lifo r n ia were doing an e f f e c t i v e job a t r e g u la tin g the
conduct o f th e ir members, and th a t the C a lifo r n ia law governing the
l ic e n s in g o f brokers was v e r y ’e f f e c t i v e .
I t was a ls o f e l t th a t specu­
l a t io n was not p rev a len t and did not make much d iffe r e n c e to th e
49
p u b lic , but was n ecessa ry to th e m arkets o f the country,
Qhe Washington Stock Exchange was lik e w is e d escrib ed a s a sm a ll,
l o c a l exchange used la r g e ly fo r investm ent purposes, w ith l i t t l e or
no sp e c u la tio n , but, as in the c a s e s o f the o th e r s , perform ing a
50
n ecessa ry lo c a l fu n c tio n .
The Boston Stock Exchange was s a id
to c o n s is t o f one hundred
th ir ty -n in e members, about a hundred o f whom were a c t iv e .
It lis te d
the bonds o f about two hundred s ix t y co rp o ra tio n s and the common and
p r efe rr ed stock o f about th ree hundred co rp o ra tio n s.
A ll o f th ese
co rp o ra tio n s were sa id to r e p r e s e n t e it h e r Hew England in d u s tr ie s
or in d u s tr ie s in which there was s u b s ta n tia l lo c a l ownership.
I t was
h e ld th a t t h is exchange was n ecessa ry fo r lo c a l fin a n c in g , and i t was
p o in ted out th a t the combined fu n c tio n o f broker and d ea ler was a neces­
sa ry p art o f th e o rg a n iza tio n , and th at a se g reg a tio n would d riv e the
s e c u r ity b u sin ess from Boston to the la r g e r c e n te r s ,
*n the testim on y
o f each r e p r e se n ta tiv e of the small exchanges, i t was brought out th at
the b u sin e ss done was o f such meagre q u a n tity th at the combined fu n c tio n
51
o f broker and d e a le r was an economic n e c e s s it y .
In summary, th e sm all exchanges were p resen ted a s i n s t i t u t i o n s o f
lo c a l importance fo r th e most p a r t, which did a b u sin e ss la r g e ly in
S e n a t e Hearings on S tock Exchange Prac-ticaa. F t. XV, p p .6788 f f .
5 0 I b id . . P t. XV, pp. 6885 f .
5 1 I b i d .. F t. XV, p p .7032 f f .
-80in v estm en ts.
*n th ose in sta n c e s where r isk y s e c u r it ie s were l i s t e d
on them, the d efe n se was made th a t i t was b e t te r to have th e se s e c u r i­
t i e s l i s t e d than so ld o v er-th e-co u n te r.
They were o f one mind in
sup p ortin g the com bination o f broker and d e a le r , a p o stio n ap p aren tly
fo rced upon them by the n e c e s s i t i e s o f th e ir p o s it io n .
C onclusions regard in g the gflse a g a in st the exchanges aa£ .feetr
Any attem pt a t a p p ra isa l o f the m erits o f the c o n ten tio n s o f the
Senate Oomnittee on Backing and Currency or those of th e sto c k exchanges
would be v ery d i f f i c u l t .
C ertain ob servation s may be made, however,
con cern in g t h e ir r e s p e c tiv e ch a ra cters.
The ca se a g a in s t the stock exchange rested upon s p e c if ic fin d in g s
w ith r e la t io n to a c ts consult ted by brokers and o th e r s, i n which i t
appeared beyond rea so n ab le doubt th a t many o p era tio n s had been conducted
which were e it h e r d i r e c t ly opposed to the p u b lic i n t e r e s t , or a t l e a s t
in d if f e r e n t to i t .
Hhe cause and e f f e c t r e la t io n s h ip s in v o lv ed in
th ese fin d in g s were sim ple and d ir e c t .
From the f a c t s , i t appeared
th a t i t would n o t be p o s s ib le to enact p r o h ib itio n s and r e g u la tio n s
w hich would e lim in a te or minimize many o f them.
Hhe d efen se o f the stock exchange re ste d fundam entally upon
accep tan ce by th e committee o f the exchange members' in te r p r e ta tio n
o f exchange o p era tio n .
I t waB d ecid ed ly la ck in g in s p e c if i c m a te r ia l,
and gathered what substance i t had la r g e ly from l i n e s o f reason ing
con cern in g the cau ses o f then e x is t in g s ta te o f a f f a i r s , and con­
cern in g e v i l r e s u lt s which m ight flow from r e s t r i c t i o n s on exchange
a c tiv ity .
At b e s t t h is type o f d efense could h ard ly have exp ected to
do more than h e lp to keep r e g u la tio n w ith in c e r t a in con crete lim it s .
-8 1
I t m i g h t a l s o h e th o u g h t o f a s h e l p f u l I n b r i n g i n g a b o u t some c a u t i o n
o n th e p a r t o f th e r e g u l a t o r s .
B eyond t h i s p o i n t i t c o u ld h a r d l y
b e t h o u g h t o f a s b e in g i n a n y B en se e f f e c t i v e .
E ie n a t u r e o f th e
S e c u r i t i e s E x ch an g e A c t o f 1 9 3 4 an d t h e e v e n t s w h ic h h a v e f o llo w e d
i t s p a s s a g e b e a r o u t t h i s c o n t e n t i o n i n a c o n v i n c in g m a n n e r.
CHAPTER 17
THE SECURITIES EXCHANGE ACT:
CONTROL OF EXCHANGES, BROKERS, ANN SECURITIES
A n a l y s i s o f t h e A ct
The S e c u r i t i e s E x ch an g e A c t o f 1 9 3 4 w as f o r m u l a t e d w ith a
▼lew t o r e g u l a t i n g th e s e c u r i t i e s m a r k e ts i n t h e p u b l i c I n t e r e s t
a n d f o r th e p r o t e c t i o n o f i n v e s t o r s .
The p u r p o s e o f t h e A c t i s d e s c r i b e d m ore s p e c i f i c a l l y b y th e
S e c u r i t i e s a n d E x ch an g e C om m ission a s t h r e e - f o l d .
I t s f i r s t p u r-
p o s e i s t o p r e v e n t u n f a i r p r a c t i c e s i n th e s e c u r i t y m a r k e ts .
By
m ean s o f r e g i s t r a t i o n r e q u i r e m e n t s , a l l I m p o r t a n t e x c h a n g e s a r e
b r o u g h t u n d e r t h e c o n t r o l o f t h e C o n m ls s io n ; a s y s te m o f r e g i s t e r e d
s e c u r i t i e s a s s o c i a t i o n s p r o v i d e s a s i m i l a r th o u g h l e s s comple t e c o n ­
t r o l f o r o v e r - t h e - c o u n t e r m a r k e ts .
M a n ip u la tiv e a c t i v i t y i s p ro ­
h i b i t e d , a n d t r a d i n g p r a c t i c e s a n d th e f u n c t i o n s o f m em b ers, b r o k e r s ,
and d e a le rs a re lim ite d .
The s e c o n d p u r p o s e o f th e A c t i s t o f u r n i s h th e i n v e s t o r w i t h
s u f f i c i e n t I n f o r m a t i o n t o p e r m i t him t o a c t i n t e l l i g e n t l y .
R e g is ­
t r a t i o n <f s e c u r i t i e s o n e x c h a n g e e makeB c o n t r o l o f i s s u i n g c o r p o r a ­
t i o n s p o s s i b l e , p a r t i c u l a r l y w i t h r e g a r d t o i n f o r m a t i o n w h ic h i s
b y them to th e p u b l i c .
F a ls e and m is le a d in g s ta te m e n ts
o f f e n d e r s o p en t o dam age s u i t s b y i n j u r e d p e r s o n s .
th a t re c o rd s,
le a v e
I t i s p r o v id e d
s u b j e c t t o e x a m in a tio n b y t h e C o o m is s lo n , m u s t b e
k e p t Ty a l l e x c h a n g e s a n d t h e i r m e m b ers, a n d r e p o r t s b y o f f i c e r s ,
d i r e c t o r s , an d p r i n c i p a l s t o c k h o l d e r s a r e r e q u i r e d .
-8 3 -
3tie t h i r d p u r p o s e o f th e A c t, w h ic h i s
to r e g u l a t e th e u s e o f
n a t i o n a l c r e d i t to f i n a n c e t r a d i n g i n s e c u r i t i e s ,
i s a c c o m p lis h e d
th r o u g h th e f i x i n g o f m a rg in r e q u ir e m e n t s b y t h e F e d e r a l R e s e rv e
B o a rd , a n d th r o u g h r e s t r i c t i o n s p l a c e d o n b o r r o w in g b y e x c h a n g e mem­
b e rs , b ro k e rs , and d e a le rs .
The S e c u r i t i e s a n d E x ch an g e C o n m lss io n w as c r e a t e d b y th e A c t,
and i s i n v e s t e d w i t h a u t h o r i t y to e n f o r c e i t s p r o v i s i o n s , t o fo rm u ­
l a t e r u l e s u n d e r i t w h ic h m u st b e a d o p te d b y th e e x c h a n g e e , to m ake
s u c h i n v e s t i g a t i o n s a s may a p p e a r a d v i s a b l e , a n d , w hen n e c e s s a r y , t o
r e s o r t t o th e c o u r t s f o r p u n is h m e n t o f v i o l a t i o n s .
G e n e r a l l y s p e a k in g ,
tiie S e c u r i t i e s E x c h a n g e A c t i n v o l v e s a
c o m p re h e n s iv e p ro g ram o f c o n t r o l an d r e f o r m , a n d a t t e m p t s to c o n s t r u c t
a m e ch an ism w h ic h w i l l n o t o n ly c o r r e c t p r e s e n t a b u s e s , b u t a l s o p r o ­
v i d e f o r t h e p r e v e n t i o n o f a b u s e s w h ic h m i g h t o th e r w is e a p p e a r i n t h e
fu tu re .
R e g is tr a tio n
stL exchanges
I n o r d e r t o b r i n g t h e e x c h a n g e s th e m s e lv e s u n d e r th e c o n t r o l o f
th e C o m m issio n , th e A c t p r o v i d e s f o r th e R e g i s t r a t i o n o f a l l s e c u r i t y
e x c h a n g e s d o in g a n i n t e r s t a t e b u s i n e s s .
The a p p l i c a t i o n o f a n e x c h a n g e
a p p l y i n g f o r r e g i s t r a t i o n m u st b e a c c o m p a n ie d b y a n a g r e e m e n t t o e n ­
f o r c e th e p r o v i s i o n s o f th e A c t on i t s m em bers a s f a r a s i t c a n , a n d
to do l i k e w i s e w i t h a l l s u b s e q u e n t am endm ents t o t h e A c t.
c h a n g e m u s t f u r n i s h a l l d a t a c o n c e r n in g i t s
m e m b e rsh ip t h a t th e C o n m lssio n may r e q u i r e .
a r t i c l e s o f in c o rp o r a tio n , and
fu rn is h e d .
Such a n e x ­
o r g a n iz a tio n , r u l e s , and
C o p ie s o f i t s c o n s t i t u t i o n ,
r u l e s o f th e e x c h a n g e m u st a l s o b e
I t m u st l i k e w i s e a g r e e t o f u r n i s h c o p i e s o f a n y am endm ents
w h ic h I t m ay m ake i n i t s r u l e s ,
in m e d ia te ly upo n t h e i r a d o p tio n .
No
94-
r e g is tra tio n w ill
g ra n te d to an exchange u n le s s i t s r u l e s c o n ta in
a p r o v i s i o n f o r e x p u l s i o n a n d s u s p e n s i o n , o r d i s c i p l i n i n g o f m em bers
f o r c o n d u ct in c o n s i s t e n t w ith f a i r and e q u ita b le p r i n c i p l e s o f tr a d e ,
a n d u n l e s s t h e e x c h a n g e w i l l c o n s i d e r v i o l a t i o n s o f th e S e c u r i t i e s
E x ch an g e A c t o f 1934 I n f r a c t i o n s o f t h i s r u l e .
n o t ro b th e e x c h a n g e s o f t h e i r i n i t i a t i v e
O i l s r e q u ir e m e n t d o e s
i n d e v e l o p in g r u l e s o f p r o ­
c e d u re , b u t t h e i r r u l e s m ust b e c o n s is te n t w ith th e A ct an d w ith th e
1
la w s o f th e s t a t e i n w h ic h t h e e x c h a n g e i s l o c a t e d .
W ith in t h i r t y d a y s a f t e r th e f i l i n g o f a n a p p l i c a t i o n , t h e Com­
m is s io n m ust e n t e r an o r d e r e i t h e r g r a n tin g o r , a f t e r o p p o r tu n ity f o r
h e a r i n g , d e n y in g t h e r e g i s t r a t i o n .
3he a p p l y i n g e x c h a n g e m ay, i f
n e c e s s a r y , w ith d r a w i t s a p p l i c a t i o n o r c o n s e n t t o a p o s tp o n e m e n t o f
a c t i o n b y t h e C o m m issio n , so t h a t i t may h a v e a n o p p o r t u n i t y to m ake
su ch a d ju s tm e n ts a s a r e r e q u ir e d .
The A ct a l s o p r o v i d e s t h a t a n ex^
c h a n g e may w ith d r a w i t s r e g i s t r a t i o n on s u c h t e r n s a s th e C om m ission
m ay deem n e c e s s a r y f o r th e p r o t e c t i o n o f i n v e s t o r s .
m ay ta k e p l a c e i f t h e ex ch an g e no l o n g e r d o e s
volum e to r e q u i r e i t s r e g i s t r a t i o n .
S uch w ith d r a w a l
b u s in e s s o f s u f f ic ie n t
O th e r w is e , i t m u s t b e r e g i s t e r e d
2
o r i t i s u n la w f u l f o r i t to do b u s i n e s s .
I t i s f u r t h e r p r o v id e d t h a t a l l l n f o i m a t i o n f i l e d w i t h th e Com­
m i s s i o n b e k e p t u p to d a t e .
P r o m p tly a f t e r a n y c h a n g e s a r e m ade w h ic h
r e n d e r a n y i n f o r m a t i o n no lo n g e r a c c u r a t e , new d a t a m u st b e f i l e d w i t h
t h e C o m m issio n .
A t th e c l o s e o f e a c h c a l e n d a r y e a r , e a c h r e g i s t e r e d
exchange m ust f i l e
s u p p le m e n ts t o d a t a p r e v i o u s l y f i l e d w i t h t h e Com-
m i s a l o n , a n d m u s t p r e s e n t a b a la n c e s h e e t an d Incom e s t a t e m e n t f o r t h a t
y e a r.
I n a d d i t i o n to f o r m a l r e q u i r e m e n t s f o r l n f o i m a t i o n , t h r e e c o p i e s
1 7 3 r d C o n g ., f ti b lic .W o .2 9 1 , H .B. 9 3 2 3 S e c u r l t i e s E x ch an g e A c t o f 19 3 4 .
T i t l e I , s e c tio n 6 ( a ) and ( b ) .
2
I b i d . , se c . 6 (e ) and ( f ) , and sec. 5.
-9 5 -
o f a l l " n o tic e s , r e p o r ts ,
new e d i t i o n s , l i s t s ,
c irc u la rs ,
lo o s e l e a f i n s e r t i o n s , r i d e r s ,
o r o t h e r r e c o r d s o f c h a n g e s c o v e r e d by amend­
m e n ts o r s u p p le m e n ts m u s t b e s e n t t o t h e C o m m issio n ."
I b i s m u s t toe
done a t th e tim e a t w h ic h s u c h i n f o r m a t i o n i s m ade a v a i l a b l e to
m em bers o f t h e e x c h a n g e .
I n a c c o r d a n c e w i t h s e c t i o n 6 o f th e A c t, t w e n t y - f o u r e x c h a r g e s
f i l e d a p p lic a tio n f o r r e g i s t r a t i o n a s n a tio n a l s e c u r ity exchanges.
Of t h e s e ,
two d ro p p e d o u t u p o n i n v e s t i g a t i o n o f t h e i r a f f a i r s ;
th e
New Toxic M in in g E x ch an g e d i s c o n t i n u e d o p e r a t i o n s e n t i r e l y , a n d th e
New Y o rk P ro d u c e E x ch an g e c e a s e d to d e a l i n s e c u r i t i e s .
The l o s
A n g e le s C urb E x ch an g e m e rg e d w i t h th e L os A n g e le s S to c k E x c h a n g e ,
w h ic h l e f t th e t o t a l
m l s s i o n a t tw e n ty - o n e .
num ber o f e x c h a n g e s r e g i s t e r e d
w ith th e Com-
S e c t i o n 5 o f th e A ct p r o v i d e s t h a t s m a ll
e x c h a n g e s may a p p l y f o r e x e m p tio n fro m r e g i s t r a t i o n , a n d u n d e r t h i s
p r o v is io n n in e te e n exchanges f i l e d a p p lic a tio n .
Upon i n v e s t i g a t i o n
th e C a l i f o r n i a S to c k E x c h a n g e , th e B o s to n C urb E x ch a n g e, a n d t h e
E a r t f o r d S to c k E x ch an g e d i s c o n t i n u e d o p e r a t i o n s e n t i r e l y .
The P h i l i p ­
p i n e S to c k E x ch an g e o f M a n ila l i k e w i s e d i s c o n t i n u e d o p e r a t i o n s a s o f
M arch 1 , 1 9 3 5 , w h ic h r e d u c e d
4
th e n u m b er s e e k in g e x e m p tio n to f i f t e e n .
As o f J u n e 3 0 , 19 3 5 , t h e e x c h a n g e s w h ic h h a d r e g i s t e r e d a s
n a t i o n a l s e c u r i t y e x c h a n g e s w e re a s f o l l o w s :
B a l tim o r e S to c k E x ch an g e
B o s to n S to c k E x ch an g e
B u f f a l o S to c k E x ch an g e
3
S . E . C . , G e n e r a l B u ie s a n d B e g u l a t l o n s u n d e r th e S e c u r i t i e s E x ch an g e
A c t o f 1 9 3 4 . a s am ended to F e b . 1 5 , 1 9 4 0 , r u l e Z -6 b ~ 2 ( b ) , ( C ) , an d ( d ) .
p p . 5 0 1 ,5 0 2 .
4
S e c u r i t i e s a n d E x ch an g e C o m m issio n , Ipflt A n n u al R e p o r t . F i s c a l Y e a r
e n d e d J u n e 3 0 , 1 9 3 5 , P t . I I , p p .1 1 - 1 3 .
-8 6 -
Chi cago Board o f Trade
C h ic ag o S to c k E x ch a n g e
C i n c i n n a t i S to c k E x ch an g e
C le v e la n d S to c k E x ch an g e
D en v er S to c k E x ch a n g e
D e t r o i t S to c k E x c h a n g e
L os A n g e le s S to c k E x ch a n g e
New O r le a n s S to c k E x ch a n g e
New Y ork C urb E x ch a n g e
New Y ork B e a l E s t a t e S e c u r i t i e s E x ch an g e
New Y ork S to c k E x ch an g e
P h i l a d e l p h i a S to c k E x ch an g e
P i t t s b u r g h S to c k E x ch an g e
S t . L o u is S to c k E x ch an g e
S a lt Lake St ode Exchange
Sen F r a n c i s c o C urb E x ch an g e
San F rancisco Sto elf: Exchange
W a sh in g to n S to c k E x ch a n g e ( D .C .)
T hose w h ic h h a d b e e n g r a n t e d te m p o r a r y e x e m p tio n fro m r e g i s t r a t i o n
( a s o f J u n e 3 0 , 1 9 3 5 ) w ere a s f o l l o w s ;
A s s o c i a te d S to c k E x ch a n g e ( M a n ila , P . I . )
Chicago Curb Exchange
C o lo ra d o S p r in g s S to c k E x ch an g e
H o n o lu lu S to c k E x ch an g e
L o u i s v i l l e S to c k E x ch an g e
M a n ila S to c k E x ch an g e
M ilw aukee G r a in a n d S to c k E x ch an g e
M i m e a p o l i e - S t . P a u l S to c k E x ch an g e
Beno S to c k E x ch an g e
Richm ond S to c k E x ch a n g e
S a n F r a n c is c o M in in g E x ch an g e
S e a t t l e M in in g E x ch an g e
S e a t t l e S to c k E x ch an g e
S ta n d a r d S to c k E x ch a n g e o f S p o k a n e , W a s h in g to n
W h e e lin g S to c k E x ch an g e
Two o f t h e s e , th e S ta n d a r d S to c k E x ch an g e o f S p o k an e a n d t h e C h icag o
C urb E x c h a n g e , f i l e d a p p l i c a t i o n s a s n a t i o n a l s e c u r i t i e s e x c h a n g e s
a n d w e re a c c e p t e d .
The S an F r a n c i s c o M in in g E x c h a n g e l a t e r becam e
a n a tio n a l s e c u r it ie s exchange.
The A s s o c i a t e d S to c k E x ch an g e o f M anila
w as d i s s o l v e d , w h ile t h e B u f f a l o an d D e n v e r e x c h a n g e s a p p l i e d f o r
e x e m p tio n , w h ic h w as g r a n t e d .
As a r e s u l t ,
t h e num ber o f r e g i s t e r e d
-8 7 -
5
s e c u r i t i e s exchanges, on June 30, 1936, was tw enty-tw o.
It
s h o u ld h e n o t e d t h a t , w h i l e th e num ber o f n a t i o n a l s e c u r i ­
t i e s e x c h a n g e s r e m a in e d p r a c t i c a l l y c o n s t a n t d u r in g t h e p e r i o d o f
a d j u s t m e n t t o t h e new o r d e r o f t h i n g s , t h i s w a s n o t t h e c a s e w i t h
th e ex e m p te d e x c h a n g e s .
A c c o r d in g t o th e l a t e s t a n n u a l r e p o r t
( J u n e 3 0 , 1 9 3 9 ) , t h e r e a r e tw e n ty n a t i o n a l s e c u r i t i e s e x c h a n g e s
i n o p e r a t i o n , th e d i s c o n t i n u a n c e o f th n C h ic a g o Curb E x ch an g e a n d
t h e c o n s o l i d a t i o n o f th e San F r a n c i s c o Curb E x ch an g e w i t h t h e San
F r a n c i s c o S to c k E x ch an g e a c c o u n tin g f o r th e r e d u c t i o n i n n u m b er.
I n th e c a s e o f th e ex em p ted e x c h a n g e s , t h e r e re m a in o n ly s e v e n .
T h is m ovem ent I n th e d i r e c t i o n o f e l i m i n a t i o n and c o n s o l i d a t i o n
a p p e a r s to h a v e r u n i t s c o u r s e , a s t h e e x i s t i n g e x e m p te d
6
a r e i d e n t i c a l w ith th o s e r e p o r te d i n 1936.
exchanges
I t m ig h t b e p o i n t e d o u t t h a t , w h ile t h i s te n d e n c y to w a rd c e n ­
t r a l i z a t i o n o f s e c u r i t y m a r k e ts h a s m uch t o recom m end i t i n th e
f a c i l i t a t i o n o f c o n t r o l , th e f a c t c a n n o t b e o v e r lo o k e d t h a t i t tendB
to f o r c e th e
s e c u r i t y b u s i n e s s i n t o th e l a r g e r c e n t e r s , t h e r e b y
g i v i n g a n a d v a n ta g e t o t h o s e a r e a s i n w h ic h th e
la rg e r exchanges a re
lo c a te d .
R e g i s t r a t i o n o f S e c u r i t i e s on E x c h a n g e s
I n t h e i n t e r e s t o f f u r t h e r c o n t r o l o f th e s e c u r i t y b u s i n e s s ,
th e S e c u r i t i e s E x ch an g e A ct o f 1934 p r o v id e d f o r th e r e g i s t r a t i o n
o f a l l s e c u r i t i e s w h ic h a r e t r a d e d on n a t i o n a l s e c u r i t i e s e x c h a n g e s .
5
S .E .G ., 2 n d A n n u al R e p o r t, J u n e , 1 9 3 6 , P t . I I , p p . 1 1 -1 3
6
^ E x c h a n g e s ex e m p te d a s o f J u n e 3 9 ,1 9 3 9 a re * C o lo ra d o S p r in g s S to c k
E x c h a n g e , H o n o lu lu S to c k E x c h a n g e , M ilw au k ee G r a in and S to c k E x c h a n g e ,
A U iw a u K ee -S t. P a u l S to c k E x c h a n g e , R ichm ond S to c k E x c h a n g e , S e a t t l e
S to c k E x c h a n g e , W h a e liig S to c k E x c h a n g e .
See 5 t h A n n u a l R e p o r t . P t . I I I ,
p p . 4 2 -4 3 .
-8 $ -
T h i s w as a c c o m p lis h e d by m a k in g i t u n la w f u l f o r a n y m em ber, b r o k e r ,
o r d e a l e r t o t r a n s a c t b u s i n e s s i n a n y s e c u r i t y on a n a t i o n a l s e c u r i t i e s
e x c h a n g e u n l e s s s u c h s e c u r i t y i s r e g i s t e r e d <r i n th e c l a s s o f ea>7
e m p te d s e c u r i t i e s .
A s e c u r i t y may b e r e g i s t e r e d b y f i l i n g a n a p p l i c a t i o n w i t h a
n a t i o n a l s e c u r i t i e s e x c h a n g e a n d s e n d in g d u p l i c a t e s t o t h e C om m issio n .
The r e g i s t r a n t m u s t f u r n i s h s u c h i n f o r m a t i o n a s th e C om m ission may
s e e f i t to p r e s c r i b e b y r u l e s a n d r e g u l a t i o n s .
T h is i n f o r m a t i o n m u s t
i n c l u d e n o t o n ly th e s t a t u s o f th e i s s u e r , b u t o f a n y p e r s o n c o n ­
tro llin g ,
o r c o n t r o l le d b y th e i s s u e r , o r u n d e r d i r e c t o r i n d i r e c t
common c o n t r o l w i t h th e i s s u e r ,
a s to p r i n c i p l e o r i n t e r e s t ,
an d o f a n y g u a r a n t o r o f t h e s e c u r i t y
o r b o th .
The la w p r e s c r i b e s t h a t in f o r m a ­
t i o n b e g i v e n on th e f o ll o w i n g it e m s :
( a ) th e o r g a n i z a t i o n ,
b u s in e s s ;
fin a n c ia l s tr u c tu re
an d n a t u r e o f th e
( b ) th e te r m s , p o s i t i o n s , r i g h t s , an d p r i v i l e g e s o f t h e d i f f e r e n t
c la s s e s o f s e c u r i t i e s o u ts ta n d in g ;
( c ) th e te im s on w h ic h t h e i r s e c u r i t i e s a r e t o b e , an d d u r i n g
t h e p r e c e d i n g t h r e e y e a r s h a v e b e e n , o f f e r e d to th e p u b l i c
o r o th e rw is e ;
( d ) th e d i r e c t o r s , o f f i c e r s , a n d u n d e r w r i t e r s , a n d e a c h s e c u r i t y
h o l d e r o f r e c o r d h o l d i n g m ore th a n 10 p e r ce n tu m o f a n y c l a s s
o f a n y e q u i t y s e c u r i t y o f th e i s s u e r ( o t h e r th a n a n e x e m p te d
s e c u r i t y ? , t h e i r r e m u n e r a tio n a n d t h e i r i n t e r e s t s i n th e
s e c u r i t i e s o f , an d t h e i r m a te r ia l c o n t r a c t s w ith , th e i s s u e r
an d any p e rs o n d i r e c t l y o r i n d i r e c t l y c o n t r o l l i n g o r con­
t r o l l e d b y , o r u n d e r d i r e c t o r i n d i r e c t common c o n t r o l w i t h ,
th e i s s u e r ;
(e) r e m u n e r a ti o n to o t h e r s th a n d i r e c t o r s an d o f f i c e r s e x ­
c e e d in g $ 2 0 ,0 0 0 p e r annum;
( f ) b o n u s e n d p r o f i t - s h a r i n g a g r e e m e n ts ;
S ee S e c u r i t i e s E x ch an g e
e x e m p te d s e c u r i t i e s .
s e c . 3 , ( a ) , (1 2 ) f o r d e s c r ip tio n o f
89-
( g ) m anagem ent a n d s e r v i c e c o n t r a c t s ;
( h ) o p t i o n s e x i s t i n g o r t o "be c r e a t e d i n r e p e c t o f t h e i r
s e c u ritie s ;
(i)
b a l a n c e s h e e t s f o r n o t m ore th a n t h r e e p r e c e d i n g f i s c a l
y e a rs , c e r t i f i e d i f re q u ire d by ru le s an d re g u la tio n s of
th e C om m ission b y in d e p e n d e n t p u b l i c a c c o u n t a n t s ;
(j)
p r o f i t an d l o s s s t a t e m e n t s f o r n o t m ore th a n t h r e e p r e ­
c e d in g f i s c a l y e a r s , c e r t i f i e d i f r e q u i r e d b y th e r u l e s
a n d r e g u l a t i o n s o f th e C o n m lssio n b y I n d e p e n d e n t p u b l i c
a c c o u n ta n ts ;
( k ) a n y f u r t h e r f i n a n c i a l s t a t e m e n t s w h ic h th e C om m ission may
8
deem n e c e s s a r y o r a p p r o p r i a t e f o r t h e p r o t e c t i o n o f i n v e s t o r s .
The C om m ission m ay f u r t h e r r e q u i r e , u n d e r t h e la w , c o p i e s o f
a r t i c l e s o f i n c o r p o r a t i o n , b y l a w s , t r u s t i n d e n t u r e s a n d o t h e r s im i­
l a r d o c u m e n ts.
I n th e e v e n t t h a t th e C o n m lssio n f e e l s t h a t a n y t h in g
r e q u i r e d u n d e r th e la w i s n o t a p p l i c a b l e t o a p a r t i c u l a r c l a s s o f
s e c u ritie s ,
i t m ay c a l l f o r a n y m a t e r i a l w h ic h i t c o n s i d e r s p e r t i n e n t .
I f th e ex c h a n g e a u t h o r i t i e s c e r t i f y t h a t a p a r t i c u l a r s e c u r i t y i s
e lig ib le
f o r r e g i s t r a t i o n u n d e r th e la w , i t may becom e r e g i s t e r e d
w i t h i n t h i r t y d a y s a f t e r th e C o n m lssio n r e c e i v e s c e r t i f i c a t i o n .
i t may b e s t r i c k e n fro m th e l i s t ,
m is s io n ,
9
is s u e r.
Ag
on t e r n s p r e s c r i b e d b y tbB Con>»
th e l a t t e r i s n e v e r w ith o u t pow er to ta k e a c t i o n a g a i n s t an
The l a ? f u r t h e r r e q u i r e s t h a t s u c h i n f o r m a t i o n s h a l l b e f i l e d
a s to k e e p l n f o i m a t i o n c o n c e r n in g th e i s s u e r c u r r e n t .
.Annual a n d
10
q u a r t e r l y r e p o r t s m u s t a l s o b e f i l e d a s th e C om m ission m ay p r e s c r i b e .
F in a lly ,
s e c t i o n 14 ( a ) a n d ( b ) o f t h e A ct g i v e t h e C om m ission c o n t r o l
o v e r th e u s e o f p r o x i e s b y th e i s s u e r .
8
S e c u r i t i e s E x ch an g e A flt. s e c . 1 2 , ( a ) a n d ( b ) .
9
I b i d . . s e c . 12, ( e ) and ( d ) .
10
JD&&*. s e c . 1 3 .
-9 0 -
U n lis te d Trading P r iv ile g e a
w as Im m e d ia te ly e v i d e n t t h a t m ere r e g i s t r a t i o n o f s e c u r i t i e s
w h ic h w e re l i s t e d on th e v a r i o u s s e c u r i t y e x c h a n g e s d id n o t g i v e th e
C o m m issio n th e d e s i r e d c o n t r o l o v e r s e c u r i t i e s t h a t w e re t r a d e d
th e re o n .
The p r o b l a n o f u n l i s t e d s e c u r i t i e s w i t h t r a d i n g p r i v i l e g e s .
w h ic h w e re t r a d e d on n a t i o n a l s e c u r i t i e s e x c h a n g e s , re m a in e d u n s o l v e d .
N e v e r th e l e s s , t r a d i n g i n s e c u r i t i e s w i t h u n l i s t e d t r a d i n g p r i v i l e g e s
c o n s t i t u t e d an i m p o r ta n t p a r t o f s e c u r i t y ex c h a n g e " b u s in e s s .
S e c t i o n 12 ( f ) o f t h e S e c u r i t i e s E x ch an g e A ct c o n t a i n e d a a t th e
o u t s e t o n ly a l i m i t e d p r o v i s i o n f o r u n l i s t e d s e c u r i t i e s w h ic h w e re
t r a d e d on e x c h a n g e s .
I t d i r e c t e d th e C om m ission t o m ake a s t u d y
a n d r e p o r t t o C o n g re s s on o r b e f o r e J a n u a r y 3 , 1 9 3 6 .
U n til such
s t u d y c o u l d "be c o m p le te d , i t w as p r o v i d e d t h a t a n y s e c u r i t y a d m i t t e d
t o u n l i s t e d t r a d i n g p r i v i l e g e s "b efo re 1934 m ig h t c o n t i n u e to "be
t r a d e d i n on a n u n l i s t e d " b a s is , s u b j e c t to s u c h r u l e s a n d r e g u l a t i o n s
11
a s t h e C om m ission m ig h t s e e f i t t o p r e s c r i b e .
A t th e tim e a t w h ic h th e C o n m lss io n made i t s
s tu d y t h e r e w e re
tw e n ty * * th re e n a t i o n a l s e c u r i t i e s e x c h a n g e s , s i x t e e n o f w h ic h p m im itte d
tra d in g in u n lis te d s e c u r itie s .
On t h e s e t h e r e werw 1 ,3 7 0 i s s u e s o f
s to c k ( in c lu d in g v o tin g t r u s t c e r t i f i c a t e s , c e r t i f i c a t e s o f d e p o s it,
A m e ric a n d e p o s i t o r y r e c e i p t s , a n d o t h e r s e c u r i t i e s , e x c e p t i n g b o n d s )
i n v o l v i n g a t o t a l o f 1 ,8 7 5 ,2 9 1 ,9 3 1 s h a r e s , a n d 5 6 4 i s s u e s o f b o n d s
w i t h a f a c e v a l u e o f $ 6 ,8 8 2 ,3 9 6 ,4 3 6 , w h ic h w e re a d m i t t e d t o u n l i s t e d
tra d in g p r iv ile g e s .
On a l l n a t i o n a l s e c u r i t i e s e x c h a n g e s t h e r e w e re
11
S ee S e c u r i t i e s E ^ c h a n ^ a A®±, s e c . 12 ( f ) .
The o r i g i n a l law r e a d s * . . .
wm ay c o n t i n u e u n t i l J u n e 1 , 1936 u n l i s t e d t r a d i n g p r i v i l e g e s t o w h ic h
a s e c u r i t y h a s b e e n a d m i t t e d o n su c h ex c h a n g e p r i o r t o M arch 1 ,1 9 3 4 . . .
may e x t e n d , u n t i l J u n e 1 ,1 9 3 5 u n l i s t e d t r a d i n g p r i v i l e g e s t o a n y s e c u r i t y
r e g i s t e r e d o n a n y o t h e r s e c u r i t y e x c h a n g e w h ic h s e c u r i t y w as l i s t e d
o n s u c h o t h e r e x c h a n g e p r i o r t o M arch 1 ,1 9 3 4 ,
-9 1 -
l l s t e d o n ly 2 ,6 4 5 i s s u e s o f s t o c k ( i n c l u d i n g a l l s e c u r i t i e s e x c e p t
b o n d s ) i n v o l v i n g a t o t a l o f 2 ,1 5 8 ,4 6 4 ,2 9 7 s h a r e s , and 1681 i s s u e s
o f b o n d s w ith a t o t a l v a l u e o f $ 2 5 ,4 2 6 ,4 2 2 ,5 4 4 .
I f t h e New T o rk
S to c k E x c h a n g e , w h ic h p e r m i t s no u n l i s t e d t r a d i n g ,
th e c a l c u l a t i o n ,
th e f i g u r e s a r e a s f o l l o w s :
S to c k s
Issu e s
lis te d
u n lis te d .
i s o m itte d from
Bonds
S h a re s
1 ,7 3 5
1 ,3 7 0
Issu e s
1 ,3 2 6 ,7 7 7 ,4 2 8
1 ,8 7 5 ,2 9 1 ,9 3 1
F ace V alu e
513
564
$ 6 ,2 0 7 ,1 0 2 ,9 2 0
6 ,8 8 2 ,3 9 6 ,4 3 6
From th e p o i n t o f v iew o f volum e o f t r a d i n g i n v o l v e d i n th e se
s e c u ritie s ,
th e f i g u r e s a r e s t i l l s t r i k i n g .
As o f J u l y , 19 3 5 , th e
a c t i v i t y i n l i s t e d and u n l i s t e d s e c u r i t i e s w ith u n l i s t e d tr a d in g
p r i v i l e g e s fo llo w :
T o ta l
S h a re s
lis te d
u n lis te d
o f S to c k
3 5 ,4 5 9 ,3 6 4
4 ,2 8 4 ,6 3 0
F ace V a lu e o f Bonds
$ 2 3 7 ,3 1 0 ,3 0 0
1 0 0 ,9 2 2 ,0 0 0
New T o rk S to c k E x ch an g e O m itte d
S h ares
lis te d
u n lis te d
o f S to c k
6 ,0 3 1 ,6 4 4
4 ,2 8 4 ,6 3 0
F a c e V a lu e o f BondB
$
1 ,6 3 5 ,3 0 0
1 0 0 ,9 2 2 ,0 0 0
(1 2 )
The s m a l l e r e x c h a n g e s a p p e a r e d m o s t l i k e l y t o b e s e r i o u s l y
a f f e c t e d b y a n y c h a n g e s w h ic h m ig h t ta k e p l a c e .
I f th e f i g u r e s
f o r th a New T o rk S to c k E x ch a n g e a n d New Y ork C urb E xchange a r e
o m itte d fro m t h e c a l c u l a t i o n s ,
th e s i g n i f i c a n c e o f u n l i s t e d t r a d i n g
12
S e c u r i t i e s a n d E xch an g e C om m ission, R e p o r t on T ra d in g i n U n l i s t e d
S e c u r i t i e s u p o n Exchangee. P a r t I I , p . 4 5 .
■92-
p r i v i l e g e e f o r th e s m a lle r ex ch an g es i s v e ry a p p a r e n t.
H a ls compu­
t a t i o n i s a s fo llo w s :
S to c k s
B onds
Issu e s
lis te d
u n lis te d
S h a re s
1 ,1 3 8
617
Issu e s
6 7 6 ,0 3 5 ,5 3 5
1 ,2 7 5 ,2 7 6 ,4 0 4
The New Y ork Curb E x c h a n g e , h o w e v e r, i s
lis te d s e c u ritie s .
p a c e V alu e
237
42
$ 8 7 3 ,9 1 3 ,4 6 2
5 6 0 ,5 2 2 ,8 0 0
th e p r i m a r y m a r k e t f o r u n -
7 5 3 i s s u e s o f s t o c k i n v o l v i n g a t o t a l o f 600,
0 1 5 ,5 2 7 s h a r e s a n d 5 2 2 i s s u e s o f b o n d s w i t h a t o t a l f a c e
v a lu e
o f $ 6 ,3 8 1 ,8 4 3 ,6 3 6 a r e l i s t e d o n t h i s e x c h a n g e ; 691 i s s u e s o f s to c k
i n v o l v i i ® 4 0 0 ,2 0 4 ,6 9 5 s h a r e s , a n d 499 i s s u e s o f b o n d s w i t h a f a c e
v a l u e o f $ 5 ,9 7 6 ,4 8 8 ,3 3 5 a r e
th i s exchange.
a d m itte d to u n l i s t e d t r a d i n g o n ly on
I t m ig h t a p p e a r t h a t t h e p ro b le m o f t r a d i n g i n u n ­
l i s t e d s e c u r i t i e s on e x c h a n g e s i s a m a t t e r o f g r e a t e s t Im p o rta n c e
on th e New Y ork C urb e x c h a n g e , b u t i t c a n n o t b e b a n d ie d e n t i r e l y
fro m th e p o i n t o f v ie w o f t h i s e x c h a n g e , i n a c c o r d a n c e w i t h th e
m e r i t s o f t h e s i t u a t i o n , b e c a u s e o f th e im p o r ta n c e o f u n l i s t e d
13
t r a d i n g p r i v i l e g e s t o th e e x i s t e n c e o f th e s m a l l e r e x c h a n g e s .
P e rh a p s i t i s
p e r tin e n t a t th is p o in t
to m ake a c l e a r d i s ­
t i n c t i o n b e tw e e n l i s t e d s e c u r i t i e s a n d t h o s e w i t h u n l i s t e d t r a d i n g
p riv ile g e s .
A lis te d
s e c u r i t y i s a d m i t t e d to a n e x c h a n g e a t th e
r e q u e s t o f th e i s s u e r , who i s r e q u i r e d to f i l e p r e s c r i b e in f o r m a tio n .
A s e c u r i t y a d m itt e d t o u n l i s t e d
tra d in g p r iv ile g e s ,
on th e o t h e r
h a n d , i s a d m i t t e d o n a p p l i c a t i o n o f a member o f t h e e x c h a n g e w i t h o u t
r e g a r d t o th e i s s u e r b e y o n d t i e
f a c t t h a t h e m u st f u r n i s h c e r t a i n
13
B eport on
i n U n lis te d S e c u ritie s , F a rt I I , p p .5-6.
-9 3 -
i n f o r m a t i o n c o n c e r n in g s u c h I s s u e r .
W h ile a s e c u r i t y t a d m i t t e d t o
u n l i s t e d tra d in g p r iv ile g e s i s a l i s t e d
s e c u r it y f a r m ost p u rp o se s
o f t h e A c t, i t i s ex e m p te d fro m s e c t i o n s 1 2 ,1 3 ,1 4 , an d 16 o f th e
la w .
T or t h i s re a s o n , i t i s n o t n e c e s s a r y f o r th e i s s u e r to f i l e
d e t a i l e d r e g i s t r a t i o n s ta te m e n ts ( s e c t i o n 1 2 ), n o r n eed he f i l e
p e r io d i c in fo rm a tio n a s r e q u ir e d u n d e r s e c ti o n 14.
H e ith e r need
h e co m p ly w i t h ( s e c t i o n 1 4 ) , th e r e q u ir e m e n t c o n c e r n in g s o l i c i t a t i o n
o f p r o x i e s , n o r d i s c l o s e i n f o r m a t i o n c o n c e r n i n g p r i n c i p a l s to c k
h o ld e rs and tra d in g p r o f i t s by o f f i c e r s ( s e c tio n 1 6 ).
Due to t h e s e
f a c t s , h e l i k e w i s e e s c a p e s r i s k o f c i v i l l i a b i l i t y u n d e r s e c t i o n 18
of th e A c t, a n d c r i m i n a l l i a b i l i t y u n d e r s e c t i o n 32 f o r f a l s e an d
14
m is le a d in g s ta te m e n ts .
I t should be p oin ted out th at the problem in v o lv e d was not one
o f whether or n o t to elim in a te u n lis t e d tra d in g p r iv ile g e s on e x ­
changes; i f such a
coutbo
were fo llo w ed , such s e c u r it ie s would be
thrown onto the o v er-th e-co u n ter market*, where they would be su b ject
to even l e s s c o n tr o l than they would have a s u n lis t e d s e c u r i t ie s , on
organ ized exchanges.
I t a p p e a r s n e c e s s a r y to su m m arize b r i e f l y t h e a r g u m e n ts w h ic h
have b een advanced f o r and a g a in s t u n lis te d tra d in g p r iv ile g e s , in
o r d e r t h a t a c l e a r p i c t u r e o f th e p ro b le m m ay be o b t a i n e d .
The o b j e c t i o n s t o i t a r e a s f o llo w s }
1. F u ll and
v i t a l to
p ro p e rly
p o s s ib le
a c c u r a t e l n f o i m a t i o n c o n c e r n in g th e i s s u e r i s
th e f u n c t i o n i n g o f a f r e e a n d o p e n m a r k e t. A
f u n c t i o n i n g e x c h a n g e m a r k e t i s t h e r e f o r e im­
fo r u n lis te d s e c u r itie s .
14
H e p o r t on T r a d in g i n U n l i s t e d S w c u r l t l e a - P t . I , p . 2 .
•94-
2 . The e x c h a n g e s h o u ld n o t h av e t h e pow er t o d e te r m in e
th e m a r k e t I n w h ic h a s e c u r i t y i s b o u g h t a n d s o l d w i t h o u t
th e c o n se n t o f th e I s s u e r .
3 . E x c h a n g e e f r e q u e n t l y a d m it s e c u r i t i e s t o u n l i s t e d t r a d i n g
when no r e a l m a rk e t f o r t h e s e c u r i t i e s e x i s t s o n th e ext*
change.
I n s u c h c a s e s i t i s f r e q u e n t l y c o n te n d e d t h a t th e
exchange q u o ta tio n r e f l e c t s o n ly a k in d o f a r b it r a g e a g a in s t
th e o v e r - t h e - c o u n t e r m a r k e ts .
4 . M a n ip u l a ti v e p r a c t i c e s h a v e b e e n r i f e i n c o n n e c t i o n w i t h
u n lis te d tra d in g upon ex changes.
5 . The c o n t i n u a n c e o f u n l i s t e d t r a d i n g p r i v i l e g e s w i l l in v o l v e
u n f a ir d is c rim in a tio n a g a in s t is s u e r s o f l i s t e d s e c u r itie s
a n d w i l l , b e c a u s e o f su ch d i s c r i m i n a t i o n te n d t o d is c o u r a g e
l i s t i n g a n d en c o u ra g e d e l i s t i n g .
6 . As a p r a c t i c a l m a t t e r , i t i s e x t r e m e l y d i f f i c u l t t o b r i n g
home t o th e i n v e s t i n g p u b l i c t h e d i s t i n c t i o n b e tw e e n a f u l l y
l i s t e d s e c u r i t y a n d one a d m i t t e d to u n l i s t e d t r a d i n g p r i v i ­
le g e s ,
(1 5 )
T h ese o b j e c t i o n s , w h ile a p p e a r in g v a l i d en o u g h s u p e r f i c i a l l y ,
16
d i d n o t s ta n d u p u n d e r th e s c r u t i n y o f t h e C o m m issio n . H e g a rd in g
th e f i r B t o n e , i t i s p o i n t e d o u t t h a t , w h ile f u l l a n d a c c u r a t e i n ­
f o r m a t i o n may b e n e c e s s a r y t o th e f u n c t i o n i n g o f a f r e e a n d o p en
m a r k e t,
s u c h a n e n d w i l l n o t b e a c c o m p lis h e d b y
o f u n lis te d tra d in g p r iv ile g e s .
In s te a d ,
th e C om m ission b e l i e v e s
t h a t s e c u r i t i e s w i l l te n d to go o v e r - t h e - c o u n t e r ,
m a tte r s w o rse .
th e e l i m i n a t i o n
t h e r e b y m ak in g
I t p o in t s o u t, fu rth e rm o re , t h a t n o th in g o f t h i s
c h a r a c t e r c a n b e d o n e u n t i l th e o v e r - t h e - c o u n t e r m a r k e ts a r e b r o u g h t
under b e tte r c o n tro l.
To th e s e c o n d o b j e c t i o n i t i s p o i n t e d
o u t th a t,
s in c e a
s e c u r i t y w h ic h i s a d m i t t e d to u n l i s t e d t r a d i n g p r i v i l e g e s on a n ext*
change c a r r i e s w ith i t
th e r e p r e s e n t a t i o n t h a t t h e r e i s a n a d e q u a te
15
B e n o r t on T r a d in g i n U n l i s t e d S e c u r i t i e s . P t . I l l ,
p . 7.
16
The C o m m is s io n 's a n a l y s i s o f t h e o b j e c t i o n s i s g iv e n on p p . 7 -1 3 o f
t h e H e p o rt.
-9 5 -
m arket f o r i t , th e d e c is io n a s to i t s adm ission i s a m a tte r which
c o u l d h e d e c i d e d b y a n o u t s i d e p a r t y s u c h a s t h e C om m ission.
To t h e t h i r d o b j e c t i o n , t h a t s e c u r i t i e s a r e a d m itt e d t o u n l i s t e d
t r a d i n g p r i v i l e g e s f o r w h ic h t h e r e i s no r e a l m a r k e t, th e C om m ission
p o i n t s o u t t h a t i t h a s th e p o w e r to t e r m i n a t e s u c h t r a d i n g p r i v i l e g e s
17
i f th e s i t u a t i o n w a rra n ts su ch a c tio n , u n d e r r u le
I n a n s w e r t o th e c h a r g e t h a t u n l i s t e d s e c u r i t i e s h a v e b e e n
s u b j e c t to m a n i p u l a t i o n ,
i t w as p o i n t e d o u t t h a t th e la w w h ic h p r o ­
h i b i t s m a n ip u la tiv e p r a c t i c e s a p p l ie s to s e c u r i t i e s w ith u n l i s t e d
18
tra d in g p r iv ile g e s .
I t f u r t h e r p o in te d o u t t h a t such p r a c t ic e s
a r e h a r d e r t o d e t e c t i n o v e r - t h e - c o u n t e r m a r k e ts th a n on o r g a n iz e d
exchanges.
The C om m ission saw n o g ro u n d f o r th e c o n t e n t i o n t h a t
u n l i s t e d t r a d i n g p r i v i l e g e s d i s c r i m i n a t e d a g a i n s t th e l i s t e d i s s u e r s .
I n t h e i r o p i n i o n , so lo n g a s u n l i s t e d t r a d i n g w as n o t p e r m i t t e d i n
th e c a s e o f s e c u r i t i e s n o t a l r e a d y a d m itte d to i t ,
d is c rim in a tio n .
I t f e l t t h a t t h e r e w as l i t t l e
t h e r e w as no r e a l
chance th a t u n lis te d
t r a d i n g p r i v i l e g e s w ould c a u s e d e l i s t i n g , a s i n c a s e s o f d e l i s t i n g
i t m u s t b e shown t h a t s u c h d e l i s t i n g i s n o t u n d e r ta k e n f o r p u r p o s e o f
17
R e p o r t o n T r a d in g i n U n l i s t e d S e c u r i t i e s . P t , V, A ppend. I , p . 2 7 ;
r u l e J F - 3 , s t a t e s t h a t , " E x c e p t a s o t h e r w i s e s p e c i f i c a l l y p r o v id e d
b y r u l e s a n d r e g u l a t i o n s o r b y o r d e r o f t h e C o n m iss io n , t h e g r a n t i n g
o f p e r m i s s i o n to c o n t in u e o r e x te n d u n l i s t e d t r a d i n g p r i v i l e g e s p u r ­
s u a n t to r u l e J S i- i o r J T - 2 s h a l l i n no w ay l i m i t th e r i g h t o f a
n a tio n a l s e c u r i t i e s exchange to te rm in a te su ch p r iv ile g e s p u rs u a n t
t o th e r u l e s o f th e e x c h a n g e ."
The p r e s e n t r u l e r e g a r d i n g t h i s , G e n e r a l H ula a and R e g u l a t i o n s , r u l e
X -1 2 & .3 , ( c ) , p . 1 2 3 1 , s t a t e s t h a t " U n l i s t e d t r a d i n g p r i v i l e g e s i n
a n y s e c u r i t y on a n y n a t i o n a l s e c u r i t i e s e x c h a n g e may b e s u s p e n d e d o r
t e r m i n a t e d b y su c h e x c h a n g e i n a c c o r d a n c e w i t h i t s r u l e s .
Such
e x c h a n g e s h a l l p r o m p t ly n o t i f y t h e C o n m issio n o f a n y s u c h s u s p e n s i o n
o r t e r m i n a t i o n , th e e f f e c t i v e d a t e t h e r e o f , a n d th e r e a s o n s t h e r e f o r . "
18
See
S e c u r itie s Exchange A ct, a s amended, se c . 9 and 10, pp. 10-12.
-9 6 -
e v a d in g th e la w .
F in a lly ,
t h e C om m ission a d m its t h a t t h e r e i s
r e a l i t y t o tile o b j e c t i o n t h a t t h e p u b l i c d o e s n o t d i s c r i m i n a t e
b e tw e e n l i s t e d
v ile g e s .
an d - u n l i s t e d s e c u r i t i e s w ith u n l i s t e d
tra d in g p r i ­
Much w h ic h i s i n s t r u m e n t a l , h o w e v e r, i n b r i n g i n g t h i s
s i t u a t i o n a b o u t i s b ey o n d th e c o n t r o l o f th e C om m ission — f o r
ex a m p le , s t o c k q u o t a t i o n s i n n e w s p a p e r s .
On t h e o t h e r h a n d ,
t h e r e a r e some v e r y p e r t i n e n t r e a s o n s why
u n l i s t e d t r a d i n g p r i v i l e g e s s h o u ld b e c o n t i n u e d .
F irs t,
t h e r e w ould
be in a l l p r o b a b i l i t y a s e r io u s d e c lin e i n s e c u r i t y v a lu e s i f se­
c u r i t i e s a d m itt e d to u n l i s t e d
t h e o v e r - t h e - c o u n t e r m a r k e ts .
t r a d i n g w ere s u d d e n ly th ro w n u p o n
S e c o n d ly , t h e r e w as th e p o s s i b i l i t y
t h a t t h e s m a l l e r e x c h a n g e s m ig h t s u f f e r s e r i o u s l y e v e n th o u g h
many o f th e i s s u e r s w e r e t o l i s t on th e b e s t know n e x c h a n g e s i f
th e y w e re to b e p u t t o th e t r o u b l e o f l i s t i n g .
F in a lly , i f in fo r­
m a tio n c o n c e r n in g th e I s s u e r i s made a v a i l a b l e to
th e p u b l i c , a s i n
c a s e s w h ere s e c u r i t i e s l i s t e d on o n e e x c h a n g e a r e a d m i t t e d to u n ­
l i s t e d tr a d in g p r i v i l e g e s on a n o th e r , su ch u n l i s t e d tr a d in g , w ith
p r o p e r s a f e g u a r d s , w o u ld b e i n t h e p u b l i c i n t e r e s t .
I t w as f u r th e r
p o i n t e d o u t t h a t i f u n l i s t e d t r a d i n g p r i v i l e g e s w e re n o t i n c r e a s e d ,
b u t m e r e ly e x te n d e d t o tiao se i s s u e s a l r e a d y a d m i t t e d , t r a d i n g i n
19
u n l i s t e d s e c u r i t i e s m o u ld g r a d u a l l y d e c l i n e .
As a r e s u l t o f t h e C o m m is s io n 's I n v e s t i g a t i o n o f th e p ro b le m
o f tra d in g in u n li s t e d s e c u r i t i e s ,
i t m ade th e f o l l o w i n g recommen­
d a tio n s !
1 . S u b s e c ti o n ( f ) o f S e c t i o n 12 o f th e S e c u r i t i e s E x change
19
Beport on grading i n U n lis te d S e c u r itie s . P t, I I I , pp.14-17.
•97-
A ct o f 1934 s h o u ld "be am ended t o p r o v id e s
(a )
T h at u n l i s t e d t r a d i n g p r i v i l e g e s o n a n y e x c h a n g e t o w h ic h
a s e c u r i t y h a d b e e n a d m i t t e d p r i o r to M arch 1 , 1 9 3 4 , may
lie c o n t in u e d b e y o n d J u n e 1 , 1 9 3 6 , o n s u c h te rm s a s th e
C om m ission may b y r u l e s a n d r e g u l a t i o n s p r e s c r i b e a s n e c e s ­
s a r y o r a p p r o p r i a t e f o r th e p r o t e c t i o n o f i n v e s t o r s o r
to p r e v e n t e v a s i o n o f th e p u r p o s e s o f th e A c t. Ho e x p i r a ­
t i o n d a t e s h o u ld e x p r e s s l y b e s e t , brut th e C om m ission s h o u ld
c o n t in u e to h a v e p o w e r to b r i n g a b o u t th e t e r m i n a t i o n o f
t h i s s i t u a t i o n i n p a r t o r a s a w h o le .
( b ) T h at s e c u r i t i e s th e i s s u e r o f w h ic h h a s d u ly r e g i s t e r e d
a n y s e c u r i t y on a n y e x c h a n g e p u r s u a n t to s e c t i o n 12 m ay,
d u r in g t h e p e r i o d w hen s u c h o t h e r r e g i s t r a t i o n i s e f f e c t i v e ,
b e a d m i t t e d t o t r a d i n g on m y e x c h a n g e i n a c c o r d a n c e w i t h
s u c h te r m s an d c o n d i t i o n s a s t h e C om m ission may b y r u l e s
and r e g u la tio n s p r e s c r ib e a s n e c e s s a ry o r a p p r o p r ia te f o r
th e p r o t e c t i o n o f i n v e s t o r s an d t o p r e v e n t e v a s i o n o f th e
E x change A c t.
2 . The C om m ission s h o u ld th e r e u p o n p r o c e e d e x p e d i t i o u s l y t o p e r ­
f e c t r e g u l a t i o n s a n d a p ro g ra m o f a d m i n i s t r a t i o n d e s ig n e d t o
make e f f e c t i v e f o r a l l s e c u r i t i e s t r a d e d o n a n u n l i s t e d b a s i s
on e x c h a n g e s r e q u i r e m e n t s c o n c e r n in g a d e q u a c y o f p u b l i c d i s ­
t r i b u t i o n , d e g r e e o f l o c a l t r a d i n g a c t i v i t y , minimum in f o rm a ­
t i o n to b e s u p p l i e d , a n d o t h e r r e q u ir e m e n t s n e c e s s a r y to a s s u r e
a p r o p e r f u n c t i o n i n g o f t h e m a rk e t o n s u c h e x c h a n g e s f o r s u c h
s e c u ritie s .
Such a p ro g ra m c o u ld b e p u t i n t o e f f e c t p u r s u a n t
to s e c t i o n 6 ( a ) , s e c t i o n 12 ( f ) a n d s e c t i o n 19 ( b ) o f th e
S e c u r i t i e s E x ch an g e A c t o f 1934.
3 . The e x i s t i n g p o w er o f t h e C om m ission to b r i n g a b o u t a d e q u a te
r e p o r t i n g b y i s s u e r s o f s u b s t a n t i a l s i z e , w h o se s e c u r i t i e s h a v e
a w id e p u b l i c d i s t r i b u t i o n , s h o u ld b e p e r f e c t e d to e n d t h a t
t h e r e be i n f o r m a t i o n s u p p l i e d b y t h e s e i B s u e r s c o m p a ra b le to
t h a t now f u r n i s h e d b y t h o s e s h o h a v e r e g i s t e r e d t h e i r s e c u r i t i e s
on an ex ch an g e.
U xat e n d b e i n g a t t a i n e d , th e C om m ission s h o u ld
th e n h e em pow ered t o p r e s c r i b e te rm s a n d c o n d i t i o n s u n d e r w h ic h
th e s e c u r i t i e s o f -these i s s u e r s s h o u ld b e p e r m i t t e d t o e n jo y
a n e x c h a n g e m a r k e t, w h e re th e p u b l i c i n t e r e s t , n o t s u b j e c t e d
t o th e c o n t r o l o f m a n ag em e n t, w o u ld b e f u r t h e r e d b y t h e c r e a ­
ti o n o f a n exchange m a rk e t. (2 0 )
As a r e s u l t o f t h e s e re c o m m e n d a tio n s , s e c t i o n 12 ( f )
S e c u r i t i e s E xchange A c t h a s b e e n m a t e r i a l l y am ended.
o f th e
A t p re s e n t,
a n y s e c u r i t y w h ic h w as a d m i t t e d t o u n l i s t e d t r a d i n g p r i v i l e g e s b e f o r e
M arch 1 , 1934 may b e p e r m i t t e d t o c o n t in u e o n t h i s b a s iB .
20
Beport on Trading in U h llste d S e c u r itie s , P t. IV, p . 24.
U n lis te d
-98-
t r a d i n g p r i v i l e g e s may "be e x te n d e d t o a n y s e c u r i t y l i s t e d a n d r e ­
g is te re d
on a n o t h e r n a t i o n a l s e c u r i t i e s e x c h a n g e , a n d t h e s e may
h e c o n t in u e d so lo n g a s s u c h s e c u r i t y r e m a in s l i s t e d .
They may
l i k e w i s e h e e x te n d e d t o a n y s e c u r i t y c o n c e r n in g w h ic h i n f o r m a t i o n
i s a v a i l a b l e w h ic h c o n fo rm s t o
th e r e q u i r a n e n t s o f t h e S e c u r i t i e s
A ct o f 1933 o r th o s e o f th e S e c u r i t i e s E x ch an g e A c t — th e l a t t e r
c a l l s f o r r e g i s t r a t i o n a n d p e r i o d i c r e p o r t s s i m i l a r to t h o s e i n t h e
case o f l i s t e d
s e c u ritie s .
A p p l i c a t i o n s to e x t e n d u n l i s t e d
tra d in g
p r i v i l e g e s u n d e r t h e S e c u r i t i e s E x ch an g e A c t c a n h e a p p ro v e d o n ly
a f t e r n o t i c e and o p p o r t u n i t y f o r h e a r i n g .
The a p p l i c a n t m u s t s a t i s ­
f y th e C om m ission t h a t t h e r e i s a s u f f i c i e n t d i s t r i b u t i o n o f th e
s e c u r ity in
q u e s t i o n w i t h i n a r e a s o n a b l e v i c i n i t y o f th e e x c h a n g e
o n w h ic h i t s e e k s u n l i s t e d t r a d i n g p r i v i l e g e s ,
in te re s t.
to h e i n th e p u b l i c
A p p lic a tio n c a n n o t h e a p p ro v e d u n le s s th e c o n d itio n s
a r e such th a t th e i s s u e r s h a l l h e s u b je c te d , a lo n g w ith th e o f f i c e r s ,
d i r e c t o r s , an d p r i n c i p a l s to c k h o ld e rs ( th o s e h o ld in g over te n p e r
c e n t ) to d u t i e s o f a p p r o x im a te ly th e sam e c h a r a c t e r a s t h o s e a r i s i n g
th r o u g h l i s t i n g a n d r e g i s t e r i n g on a n a t i o n a l s e c u r i t y e x c h a n g e i n
21
t h e r e g u l a r w ay.
In a l l p u b lic a tio n s o f q u o ta tio n s by i n s t i t u t i o n s
c o n n e c te d w i t h th e e x c h a n g e s , an d b y th e e x c h a n g e s th e m s e lv e s , a
c l e a r d i f f e r e n t i a t i o n m u st h e m ade b e tw e e n th o s e s e c u r i t i e s w h ic h
a re
f h l l y l i s t e d an d th o s e w h ic h h a v e b e e n a d m itt e d t o u n l i s t e d
22
tra d in g p riv ile g e s .
The G e n e r a l R u le s a n d R e g u l a t i o n s o f th e A c t p r o v i d e t h a t an y
21
E x c e p t t h a t th e C om m ission n e e d n o t co m p ly w i t h th e l a t t e r c o n d i t i o n s
i f i t a p p e a r s t h a t t h e p u b l i c i n t e r e s t i s b e s t s e r v e d b y n o t d o in g s o ,
22
.g q c u rltie g Exchange
a s amended, se c . 12 ( f ) , pp. 15-17.
-9 9 -
n a t i o n a l s e c u r i t i e s e x c h a n g e may make a p p l i c a t i o n f o r t h e c o n t in u a n c e
o r e x te n s io n o f u n l i s t e d tr a d in g p r iv ile g e s p u rs u a n t to
by f i l i n g in t r i p l i c a t e
th e t i t l e
i n th e p r e s c r i b e d
fo rm , i n f o r m a t i o n a s to
o f th f t s e c u r i t y , th e name o f th e i s x u e r ,
such s e c u r it y o u ts ta n d in g ,
s e c t i o n 12,
th e am ount o f
th e p u b l i c d i s t r i b u t i o n o f th e s e c u r i t y
i n t h e v i c i n i t y o f t h e e x c h a n g e , and th e volum e o f p u b l i c t r a d i n g
i n th e
s e c u r i t y d u r i n g th e p r e c e d in g tw e lv e c a l e n d a r m o n th s , s t a t i n g
th e s o u r c e o f s u c h i n f o r m a t i o n .
re a d y lis te d , and r e g is te r e d ,
I f th e s e c u r i t y i s o n e w h ic h i s a l ­
th e name o f th e e x c h a n g e m u s t be g iv e n ,
a l s o t h e nam es o f a n y f o r e i g n e x c h a n g e s w h e re t r a d i n g t a k e s p l a c e
in i t ,
i f s u c h i n f o r m a t i o n i s a v a i l a b l e , a n d i n f o r m a t i o n c o n c e r n in g
th e m o n th ly p r i c e r a n g e f o r e a c h o f t h e p r e c e d i n g tw e lv e c a l e n d a r
m o n th s.
I f th e s e c u r i t y i s l i s t e d
o r a d m itt e d to u n l i s t e d t r a d i n g
p r i v i l e g e s on o t h e r n a t i o n a l s e c u r i t i e s e x c h a n g e s , t h e p r i c e r a n g e s
on e a c h o f t h e s e e x c h a n g e s m u st be g iv e n .
If
th e a p p l i c a t i o n i s
f i l e d p u r s u a n t t o s e c t i o n 12 ( f ) ( 3 ) , a l i s t o f r e g i s t r a t i o n
s ta te ­
m e n ts p e r i o d i c r e p o r t s an d o t h e r d a t a , w h ic h h a v e b e e n s u b m itte d
i n a c c o r d a n c e w i t h th e S e c u r i t i e s A c t o f 1933 o r th e S e c u r i t i e s
E xch an g e A c t, m u s t b e s u b m it te d to s u p p o r t th e c o n t e n t i o n t h a t t h e r e
i s i n f o r m a t i o n a v a i l a b l e w h ic h i s s u b s t a n t i a l l y e q u i v a l e n t to t h a t
a v a i l a b l e i n th e c a s e o f s e c u r i t i e s r e g u l a r l y l i s t e d an d r e g i s t e r e d .
!Ehe r u l e s a l s o c a l l f o r a n y o t h e r i n f o r m a t i o n w h ic h th e C om m ission
23
may s e e f i t t o a s k f o r .
O v e i v t h e - c o u n t e r M a rk e ts
As h a s b e e n p o i n t e d o u t , a n d a s th e f r a m e r s o f th e S e c u r i t i e s
23
G e n e r a l B a le s a n d E e g u l a t i o n s , r u l e X -1 2 F -1 , p p . 1 2 2 8 -1 2 3 0 .
-1 0 0 -
E x ch an g e A c t Baw, t r a d i n g I n u n l i s t e d s e c u r i t i e s i s o n ly a p a r t o f
t h e l a r g e r p ro b le m o f c o n t r o l l i n g th o s e s e c u r i t i e s w h ic h a r e n o t
s u b je c t to th e d i s c i p l i n e
o f th e e x ch a n g e m ech an ism .
I n p r o v i d i n g a d e q u a te s a f e g u a r d s a g a i n s t a b u s e s i n u n l i s t e d
s e c u r i t i e s w h ic h a r e
tr a d e d o n e x c h a n g e s , th e C om m ission w as
c o n s ta n t ly c o n f r o n te d w ith .th e d i f f i c u l t i e s in v o lv e d i n c o n t r o l
o f o v e r - th e - c o u n te r m a rk e ts .
In f a c t,
i n t h e m in d s o f th e i n v e s t i g a t o r s ,
th e two p r o b le m s w e re a t m any p o i n t s two d i f f e r e n t a s p e c t s o f th e
sam e t h i n g .
I n o r d e r t h a t t h e C om m ission s h o u ld be i n a p o s i t i o n
t o h a n d le th e p ro b le m o f u n l i s t e d t r a d i n g p r i v i l e g e s i n a p o s i t i v e
m a n n e r , i t a p p e a r e d t o b e a b s o l u t e l y n e c e s s a r y t o g iv e th o B e s e c t i o n s
of
th e A c t ito ic h d e a l w i t h o v e r - t h e - c o u n t e r m a r k e ts a d e f i n i t e
r e a l i t y in o p e ra tio n .
o f u n lis te d tra d in g
By t h e s a n e r e a s o n in g w h ich c a l l e d f o r c o n t r o l
p riv ile g e s ,
i t w as deem ed d e s i r a b l e to b r i n g
s e c u r i t i e s t r a d e d i n on o v e r - t h e - c o u n t e r m a r k e ts u p to th o s e s t a n d a r d s
w h ic h th e C om m ission deem ed d e s i r a b l e f o r s e c u r i t i e s t r a d e d on ex­
ch an g es.
S e c t i o n 15 o f t h e A c t p r o v id e d th e C o n m iss io n w i t h c e r t a i n
24
p o w e r s , b y m eans o f w h ic h s u c h c o n t r o l m ig h t be b r o u g h t a b o u t .
The
o r i g i n a l d r a f t o f th e A c t to o k c o g n iz a n c e o f o n ly a p a r t o f t h e
d i f f i c u l t y I n v o lv e d i n c o n t r o l o f o v e r - t h e - c o u n t e r m a r k e t s , a n d h a s
b e e n s u b j e c t t o c o n s i d e r a b l e am endm ent.
B e fo re d i s c u s s i n g i t ,
how­
e v e r , a b r i e f summary o f t h e s i z e a n d th e s i g n i f i c a n c e o f o v e r - t h e c o u n t e r m a r k e ts i s I n o r d e r .
On J a n u a r y 1 , 1 9 3 6 , 5 ,0 8 8 o v e r - t h e - c o u n t e r b r o k e r s a n d d e a l e r s
w e r e r e g i s t e r e d u n d e r s e c t i o n 15 o f t h e A c t.
I n 1 9 3 2 , 1 1 ,8 1 5 c o r -
24
Beport on Trading i n U n lis te d S e c u ritie s . P t. I l l , p. 17.
-101-
p o r a t i o n s w i t h c a p i t a l i z a t i o n s o f $ 1 ,0 0 0 ,0 0 0 o r m ore w e re r e g i s ­
t e r e d w i t h t h e D e p a rtm e n t o f I n t e r n a l R ev en u e, o f w h ic h o n ly 1 ,8 0 0
w e re r e g i s t e r e d "under s e c t i o n
12 o f t h e A c t, id i ic h p r o v i d e s f o r
r e g i s t r a t i o n o f s e c u r i t i e s tra d e d on n a tio n a l s e c u r i t i e s exchanges.
W h ile some o f th e r e m a in in g w e re d o u b t l e s s c o r p o r a t i o n s o f n h ic h
t h e s e c u r i t i e s w e re c l o s e l y h e l d , m any o f them imiBt h a v e h a d m ore
th a n o n e c l a s s o f s e c u r i t y o u t s t a n d i n g .
tr a d e d o v e x ^ th e -c o u n te r.
A l l o f t h e s e w e re p r e s w n a b ly
A f u r t h e r in d i c a ti o n o f th e s iz e o f th e
o v e r - t h e - c o u n t e r m a r k e ts m ay b e h a d fro m th e q u o t a t i o n s o f th e
N a t i o n a l Q u o ta t io n s B u re a u ( i n 1 9 3 5 ) w h ic h r e p o r t e d o v e r - t h e - c o u n t e r
q u o t a t i o n s on a b o u t 9 0 ,0 0 0 i s s u e s o f s e c u r i t i e s ,
E ven a f t e r d e ­
d u c t i o n h a s b e e n made f o r l i s t e d an d u n l i s t e d i s s u e s t r a d e d on ex­
c h a n g e s ( w h ic h a m o u n te d to 6 ,2 6 0 aB o f D ecem ber 5 ,1 9 3 5 ) th e t o t a l
25
1 b s t i l l v ery la r g e .
S e c t i o n 15 o f t h e o r i g i n a l S e c u r i t i e s E x ch an g e A ^ o f 1934
p r o v i d e d t h a t i t w as -u n la w fu l f o r a l l b r o k e r s and d e a l e r s t o u s e
th e m a ils o r o th e r i n s t r u m e n t a l i t i e s o f i n t e r s t a t e
commerce i n
m a k in g o r c r e a t i n g m a r k e t s f o r s e c u r i t i e s , o r t o u s e t h e f a c i l i t i e s
o f a n y s u c h m a rk e t i n t h e c o n t r a v e n t i o n o f s u c h r u l e s an d r e g u l a t i o n s
w h ic h th e C om m ission m ig h t m ake.
tio n o f a l l tra n s a c tio n s ,
S u ch r u l e s m ig h t r e q u i r e r e g u l a ­
r e g i s t r a t i o n o f a l l s e c u r i t i e s in v o lv e d ,
an d r e g i s t r a t i o n o f b r o k e r s th e m s e lv e s .
At th e o u ts e t m o st p la n s
t o b r i n g a b o u t r e g i s t r a t i o n o f s e c u r i t i e s w e re b a s e d u p o n th e n o t i o n
o f p e n a l i z i n g th e i s s u e r f o r n o n - r e g i s t r a t i o n .
r e l u c t a n t a n d th e m a r k e t f o r h i s
I f th e i s s u e r w e re
s e c u r i t i e s w as d e s tro y e d ,
th e
e f f e c t w o u ld b e t o p e n a l i z e th e i n v e s t o r s whom th e A c t v a s d e s ig n e d
25
Boport on Trading in U n liste d S e c u ritie s , P t. I l l , p p .17-18.
-1 0 2 -
to p ro te c t.
P r e s s u r e e x e r te d , o n "b ro k ers to b r i n g a b o u t r e g i s t r a t i o n
o f is s u e r s bad l i t t l e
p o i n t , a s t h e b r o k e r s w e re o f t e n w i t h o u t
c o n t r o l o v e r th e i s s u e r .
F u r th e r m o r e , i f b r o k e r s w e re r e q u i r e d to
f i l e n e c e s s a r y i n f o r m a t i o n , w h ic h w as th e p r im a r y o b j e c t o f r e g i s ­
t r a t i o n , th e r e s u l t o b t a i n e d w o u ld be p r e c i s e l y th e same a s i n th e
c a s e o f s e c u r i t i e s a d m i t t e d to u n l i s t e d
haB
b e e n n o te d ,
t r a d i n g on e x c h a n g e s .
As
th e s t a t u s o f s e c u r i t i e s a d m i t t e d to u n l i s t e d
t r a d i n g p r i v i l e g e s c o n s t i t u t e d an u n d e s i r a b l e
s itu a tio n in i t s e l f .
I t w as a t one tim e s u g g e s te d t h a t t h e F e d e r a l R e s e r v e B o a rd , u n d e r
i t s R e g u l a ti o n " T " , e x te n d some c r e d i t o n s e c u r i t i e s r e g i s t e r e d
an d d e n y i t on th o s e w h ic h w e re n o t .
As p r e c i s e l y t h e same r e s u l t s
c o u ld b e o b t a i n e d i f a n i s s u e r r e g i s t e r e d o n a n e x c h a n g e , th e Com26
m i s s i o n saw l i t t l e v i r t u e i n t h i s s u g g e s t i o n .
The m o st w o rk a b le schem e seem ed t o b e t h e
s u g g e s tio n t h a t
th e Se c u r i t i e s A c t o f 1 9 3 3 b e a d a p t e d so t h a t i t w o u ld b e a r l e s s
r i g o r o u s l y on t h o s e i s s u e r s who h a d r e g i s t e r e d u n d e r t h e S e c u r i t i e s
E xch an g e A c t, w h i l e th e l a r g e r i s s u e r s o f u n r e g i s t e r e d s e c u r i t i e s
m ig h t b e f o r c e d t o f i l e p e r i o d i c i n f o r m a t i o n u n d e r th e S e c u r i t i e s
A c t o f 1933 s i m i l a r t o t h a t r e q u i r e d f o r r e g i s t r a t i o n u n d e r th e
S e c u r i t i e s E x c h a ig e A c t.
I t w a s f i n a l l y s u g g e s te d t h a t incom e t a x
r e t u r n s o f l a r g e c o r p o r a t i o n s w h ic h r e f u s e d t o r e g i s t e r m ig h t b e
m ade p u b l i c a s an a l t e r n a t i v e t o t h e i r f u r n i s h i n g
fo m a t io n .
th e r e q u i r e d i n ­
A t th e tim e a t w h ic h th e C om m ission made i t s
u n l i s t e d tra d in g p r iv i le g e s ,
s tu d y o f
i t s m in d w as s t i l l o p en on t h i s m a t t e r ,
a n d i t p r e s e n t e d i t s r e p o r t t o C o n g re s s on J a n u a r y 3 , 1 9 3 6 , 11 i n th e
26
R e p o rt on T r a d in g i n U n l i s t e d
-H oa, p p .
1 9 -2 0 .
-103-
h o p e t h a t p u b l i c d i s c u s s i o n o f th e o e s u g g e s t i o n s w o u ld make ju d g ­
m e n t a s t o th e d e s i r a b i l i t y o f o n e a g a i n s t t h e o t h e r , b o th b y
27
C o n g re s s an d t h e C o m m issio n , m o re c e r t a i n . "
The r e g i s t r a t i o n o f b r o k e r s a n d d e a l e r s , w h ile i n v o l v i n g no
s u c h p ro b le m a s th e r e g i s t r a t i o n o f s e c u r i t i e s , h a s n o t b e e n a l to g e th e r w ith o u t tr o u b le .
W h ile d o u b t l e s s t h e v a s t m a j o r i t y
o f b r o k e r s an d d e a l e r s r e g i s t e r e d w i t h o u t c a u s i n g a n y p a r t i c u l a r
d i f f i c u l t y , t h e h e a r i n g s b e f o r e th e C om m ission w h ic h a r e a v a i l a b l e
show t h a t many b r o k e r s h av e r e s o r t e d t o f a l s i f i c a t i o n o f t h e i r
r e g i s t r a t i o n s ta te m e n ts .
T h is h a s b e e n p a r t i c u l a r l y t r u e w i t h r e ­
l a t i o n to t h e i r b u s in e s s a d d r e s s e s .
In f a c t,
t h e s e c a s e s a r e fo u n d
m o re f r e q u e n t l y th a n a n y o t h e r one ty p e i n th e h e a r i n g s .
I t m ig h t
Appear t h a t r e g i s t r a t i o n i s o p e r a t i n g e f f e c t i v e l y a g a in B t th e fly v 28
b y - n ig h t d e a le r o f q u e s tio n a b le i n t e g r i t y .
I n May 1936 a n d J u n e
19 3 8 , C o n g re s s made s u b s t a n t i a l am endm ents t o s e c t i o n 15 o f t h e S e c u r i ­
t i e s E x ch an g e A c t o f 1 9 3 4 .
P e r h a p s one o f t h e m o s t I m p o r ta n t
c h a n g e s w as t h a t u n d e r t h e new law i t becam e t h e n a t u r e o f th e
b r o k e r 1 s b u s i n e s s r a t h e r th a n th e ty p e o f s e c u r i t y i n w h ic h h e d e a l t ,
w h ic h f u r n i s h e d th e b a s i s f o r h i s r e g i s t r a t i o n .
I n o r d e r to a v o id
r e g i s t r a t i o n , h i s b u s in e s s m ust be e x c lu s iv e ly i n t r a s t a t e .
im p o r t a n t th a n a n y c h a n g e s w h ic h w e re m ade i n t h i s
More
s e c t i o n o f th e
A c t, h o w e v e r, w e re th e a d d i t i o n s , w h ic h a c c u r a t e l y an d c o m p re h e n 29
e i v e l y d e f i n e a n d e x t e n d th e p u r p o s e s o f th e o r i g i n a l a c t .
27
H o n o rt on T r a d in g i n U n l i s t e d S e c u r i t i e s , p p . 2 0 - 2 1 .
28
S ee JL S .E .C . a n d 2 S .E .C . . P a r t I , c a s e s u n d e r s e c . 15 o f th e S e c u r i ­
t i e s E x ch an g e A c t o f 1 9 3 4 .
29
See S e c u ritie s Exchange
a s amended, p p .19 f f ,
-104-
A t p re s e n t,
s in c e tl»
p a s s a g e o f th e s o - c a l l e d M alo n ey ame n d -
30
m e n t, t h e S e c u r i t i e s E x ch an g e A ct p r o v i d e s a r a t h e r w e l l f o r m u l a te d
p ro g ra m f o r h a n d l i n g t h e o v e r - t h e - c o u n t e r s i t u a t i o n .
I t ap p ea rs
t h a t s e c t i o n 15 now h a s a fram e w o rk th o r o u g h ly e s t a b l i s h e d f o r c o n t r o l o f o v e r - t h e - c o u n t e r m a r k e ts a n d may he th o u g h t o f a s a n i n ­
t e g r a l p a r t o f t h e e s t a b l i s h e d m a c h in e ry o f th e C o m m issio n .
She e x i s t i n g law p r o v i d e s f o r th e r e g i s t r a t i o n o f b r o k e r s and
d e a l e r s th r o u g h t h e i r f i l i n g w i t h th e C om m ission o f an a p p l i c a t i o n ,
w h ic h s e t s f o r t h i n c o n s i d e r a b l e d e t a i l a l l o f th e i n f o r m a t i o n c o n ­
c e r n i n g th e a p p l i c a n t a n d t h o s e who a r e d i r e c t l y o r i n d i r e c t l y
i n c o n t r o l o f h im , o r c o n t r o l l e d b y him , an d a n y o n e u n d e r d i r e c t
o r i n d i r e c t common c o n t r o l w i t h h im , w h ic h th e C om m ission may f e e l
i s n e c e s s a r y f o r t h e p r o t e c t i o n o f i n v e s t o r s o r i n th e p u b l i c I n ­
te re s t.
B B g i s t r a t i o n s h a l l becam e e f f e c t i v e w i t h i n t h i r t y d a y s
fro m t h e d a t e o f f i l i n g o f th e a p p l i c a t i o n .
B ie C o m n ls s lo n may
d e n y r e g i s t r a t i o n to a n y b r o k e r o r d e a l e r a f t e r n o t i c e a n d o p p o r­
t u n i t y f o r h e a r i n g , i f i t f i n d s t h a t su c h r e g i s t r a t i o n w o u ld b e
c o n t r a r y to th e p u b l i c i n t e r e s t .
She g ro u n d s o n w h ic h r e g i s t r a ­
t i o n may be d e n i e d a r e c l e a r l y s e t f o r t h .
Any b r o k e r o r d e a l e r
( i n c l u d i n g d i r e c t l y o r i n d i r e c t l y c o n t r o l l e d p e r s o n s e t c . ) may
b e d e n i e d r e g i s t r a t i o n i f h e h a s made a s t a t e m e n t i n h i s a p p l i c a t i o n
o r a n y docu m en t s u p p o r t i n g i t w h ic h , in th e l i g h t o f th e c irc u m ­
s t a n c e s u n d e r w h ic h i t w a s m ad e, i s f a l s e w i t h r e s p e c t to a n y ma­
t e r i a l fa c t.
I f h e h a s b e e n c o n v i c t e d o f a n y f e l o n y o r m isd e m e a n o r
30
See pp.
f f . below.
-1 0 5 -
ln v o lv in g th e p u rc h a se o r s a le o f an y s e c u r it y , o r a r i s i n g o u t
o f h i s b u s in e s s a s b ro k e r o r d e a l e r , w ith in a p e rio d o f te n y e a rs
31
p r i o r t o h i s a p p l i c a t i o n , h e m ay b e d e n i e d r e g i s t r a t i o n .
The C om m ission te n d s t o
ta k e i n t o a c c o u n t, h o w e v e r,
th e co n­
d u c t o f th e p e r s o n a f t e r s u c h c o n v i c t i o n a s a f a c t o r i n d e t e r m in i n g
32
i t s co u rse o f a c tio n .
L ik e w is e , b r o k e r s a r e r e f u s e d r e g i s t r a t i o n
i f t h e y a r e e n j o i n e d , e i t h e r t e m p o r a r i l y o r p e r m a n e n tly fro m e n ­
g a g in g i n a n y c o n d u c t o r p r a c t i c e i n c o n n e c tio n w i t h p u r c h a s e o r
s a le o f any s e c u r ity ,
" b y o r d e r , ju d g m e n t o r d e c r e e o f a n y c o u r t
o f c o m p e te n t j u r i s d i c t i o n e n t e r e d w i t h i n t e n y e a r s p r e c e d in g t h e
f i l i n g o f su ch r e g i s t r a t i o n s ta te m e n t.
. . "
They a r e c o n s i d e r e d
c o n v e i c t e d i f th e y h a v e c o n f e s s e d i n o p o n c o u r t o r a v e r d i c t o f
g u i l t y h a s b e e n fo u n d a g a i n s t them e v e n th o u g h s e n te n c e may h a v e
33
b een su sp en d ed .
The C o n m iss lo n i s n o t em pow ered to r e f u s e r e g i s t r a t i o n on
a c c o u n t o f a n i n j u n c t i o n w h ic h w as n o t i n e f f e c t a t th e tim e a t
w h ic h h i s r e g i s t r a t i o n w as f i l e d , a l t h o u g h r u l e UA 5 p r o v id e s
34
a d e q u a te g r o u n d s f o r i t s r e v o c a t i o n .
F u r th e r m o r e , no b r o k e r may
b e r e g i s t e r e d i f h e h a s w i l l f u l l y v i o l a t e d t h e p o v i s i o n s o f th e
S e c u r itie s A ct o f 1933.
F in a lly ,
t h e S e c u r i t i e s E xch an g e A ct
p r o v i d e s f o r th e p r o h i b i t i o n o f th e u s e o f d e c e p t i v e d e v i c e s on
th e p a r t o f o v e r - th e - c o u n te r d e a l e r s .
Ho d e c e p t i v e d e v i c e s h a l l
b e u s e d , no d e c e p t i v e a c t s h a l l b e c o m m itte d an d o v e r - t h e - c o u n t e r
31
S e c u r i t i e s E x ch an g e A c t , a s am ended, s e c . 15 ( b ) .
32
1 S .E .C . 8 5 8 , I n th e m a t t e r o f C ly d e B e a l l M i t c h e l l .
33
B u ie s f o r t h e R e g u l a ti o n o f O v e r - t h e - c o u n t e r M a r k e ts , A p p en d ix Q - l ,
( B e p o r t on t h e F e a s i b i l i t y and A d v i s a b i l i t y o f th e C o m plete S e g re g a t i o f i o f th e F u n c ti o n s o f B r o k e r an d D e a l e r ) , B u ie MA-4,(a)3f ( c ) , p . 173.
34
1 S - E - n , , 4 1 6 , I n th e M a tte r o f G e r a ld Owens.
- 1
0
6
-
b r o k e r s a n d d e a l e r s m u st o p e r a t e i n a l l w ay s a c c o r d in g t o r u l e s
35
p r o m u lg a te d b y th e C o m m issio n .
The M alo n ey Amendm ent, w h ic h w as a p p r o v e d on J u n e 2 5 ,1 9 3 8
p r o v i d e s f o r th e f o r m a t i o n o f b r o k e r s ' a s s o c i a t i o n s .
T h ese a r e o f
tw o ty p e s w h ic h a r e te rm e d N a ti o n a l S e c u r i t i e s A s s o c i a t i o n s a nd
A f f ili a te d S e c u r itie s A s s o c ia tio n s .
T h ese a s s o c i a t i o n s a r e o f s u c h
c h a r a c t e r a s t o p l a c e t h e i r m e m b ersh ip u n d e r th e c o n t r o l o f th e
C om m ission I n a m a n n e r s i m i l a r to t h o s e o f N a t i o n a l S e c u r i t y Ex­
ch an g es.
T hey m u st f u r n i s h s u c h i n f o r m a t i o n c o n c e r n in g t h e i r
m e m b ersh ip e n d r u l e s o f p r o c e d u r e a s th e C o m m issio n may r e q u i r e ,
a n d a n y o t h e r i n f o r m a t i o n w h ic h may b e deem ed n e c e s s a r y b y th e Com­
m is s io n .
They m u s t f t i r n i s h c o p i e s o f t h e i r c o n s t i t u t i o n s , c h a r t e r s ,
o r a r t i c l e s o f in c o r p o r a tio n o r a s s o c ia t io n , w ith a l l e x i s t i n g b y 36
la w s a n d r u l e s .
An a p p l i c a n t a s s o c i a t i o n may becom e r e g i s t e r e d a s a n a t i o n a l
s e c u r i t i e s a s s o c i a t i o n , i f b y r e a s o n o f t h e num ber o f i t s m em bers,
th e sc o p e o f t h e i r t r a n s a c t i o n s , and t h e i r g e o g r a p h i c a l d i s t r i b u t i o n ,
it
i s p o s s i b l e f o r s u c h a s s o c i a t i o n to co m p ly w i t h t h e p r o v i s i o n s
37
o f th e law ; a n d i f th e a s s o c i a t i o n I t s e l f i s so o r g a n iz e d .
The r u l e s o f t h e a s s o c i a t i o n m u s t p r o v i d e t h a t an y b r o k e r o r
d e a l e r who m ak es u s e o f t h e m a i l s o r i n s t r u m e n t a l i t i e s o f i n t e r ­
s t a t e com m erce i n c o n n e c t i o n w i t h a s e c u r i t y b u s i n e s s w h ic h i s n o t
35
S e c u r i t i e s E x ch a n g e A c t , a s am ended, s e c , 15 ( c ) , ( l ) ,
(2 ) and ( 3 ) ,
36
I b i d . . s e c . 15 A ( a ) ( l )
and ( 2 ) , p . 22.
37
I b i d . . The f o l l o w i n g d e s c r i p t i o n o f t h e r u l e s o f an a p p l i c a n t
a s s o c i a t i o n i s b a s e d on s e c . 15 A ( b ) ( l ) - ( 1 0 ) , p p . 2 3 -2 5 .
-107-
t r a n s a c t e d th r o u g h a n a t i o n a l s e c u r i t i e s e x c h a n g e , may becam e a
m em ber.
The a s s o c i a t i o n m ay, h o w ev er, r e s t r i c t i t s m em b ersh ip on
a g e o g r a p h i c a l b a s i s , o r on a b a s i s o f ty p e o f b u s i n e s s d o n e , o r
i n a n y o t h e r way w h ic h 1 b c o n s i s t e n t w i t h th e p u b l i c i n t e r e s t .
T h ere a r e a l s o c e r t a i n p r e s c r i b e d c o n d i t i o n s u n d e r w h ic h b r o k e r s
may b e r e f u s e d o r e x p e l le d fro m m e m b e rsh ip .
No p e r s o n may becom e
amember o f a n a t i o n a l s e c u r i t i e s a s s o c i a t i o n who h a s b e e n e x p e l l e d
o r s u sp e n d e d fro m a n a t i o n a l s e c u r i t i e s e x c h a n g e , o r who lia s b e e n
e x p e l l e d o r s u sp e n d e d from an y o t h e r n a t i o n a l s e c u r i t i e s a s s o c i a t i o n
o f a ffilia te d
s e c u r i t i e s a s s o c ia tio n f o r co n d u ct in c o n s is te n t w ith
j u s t and e q u ita b le p r i n c i p le s o f tr a d e .
L ik e w is e , no p e r s o n may
b e a d m itt e d who i s s u b j e c t to a n o r d e r o f th e C o ra n issio n w h ich d e n i e s
o r r e v o k e s h i s r e g i s t r a t i o n u n d e r s e c t i o n 15 o f th e A c t, o r e x p e l l s
him fro m a n a t i o n a l s e c u r i t i e s ex c h a n g e o r n a t i o n a l s e c u r i t i e s a s s o c i ­
a t i o n , o r who i s th e
c a u s e o f an y su c h e x p u l s i o n o r s u s p e n s io n o r d e r
i n c o n n e c tio n w i t h a
b ro k e r o r d e a le r .
The r u l e s o f th e a s s o c i a t i o n m u st assum e a f a i r r e p r e s e n t a t i o n
o f i t s members i n th e a d o p t io n o f a n y r u l e s o r am endm ents, i n th e
s e l e c t i o n o f o f f i c e r s and d i r e c t o r s , an d i n a l l o t h e r p h a s e s o f th e
a d m in is tra tio n o f i t s a f f a i r s .
The r u l e s m u s t a l s o p r o v id e f o r an
e q u i t a b l e a l l o c a t i o n o f d u e s among i t s m em bers f o r d e f r a y i n g r e a s o n ­
a b le c o s ts o f a d m in is tra tio n .
The r u l e s o f th e a s s o c i a t i o n m u st f u r t h e r b e d e s ig n e d to p r e ­
v e n t f r a u d u l e n t an d m a n ip u la t iv e p r a c t i c e s , t o p r o v id e s a f e g u a r d s
a g a i n s t u n r e a s o n a b le
p r o f i t s and u n r e a s o n a b l e r a t e s o f c o ra n is s io n .
T h e ir aim m u st b e t o
p e r f e c t t h e m echanism o f a f r e e an d o p en
- 1 0 8
m a r k e t a n d to p r o t e c t I n v e s t o r s .
They m u s t n o t "be d e s ig n e d t o p e r ­
m i t u n f a i r d i s c r i m i n a t i o n b e tw e e n p a r t i e s in v o l v e d .
B u ie s muBt a l s o p r o v i d e f o r a p p r o p r i a t e d i s c i p l i n e b y s u s p e n ­
s i o n o r e x p u l s i o n o r o t h e r f i t t i n g p e n a l t i e s f o r th e v i o l a t i o n o f
t h e r u l e s o f th e a s s o c i a t i o n .
The p r o c e s s o f d i s c i p l i n i n g and
d e n y in g a d m itt a n c e to th e a s s o c i a t i o n m u s t b e c o n d u c te d i n a n o r ­
d e r ly fa s h io n .
I n th e d e t e r m i n a t i o n o f d i s c i p l i n a r y m e a s u r e s ,
s p e c i f i c c h a r g e s m u s t b e b r o u g h t a g a i n s t th e m ember in v o l v e d .
He
m u s t be g i v e n a n o p p o r t u n i t y f o r h e a r i n g a n d a c h a n c e to d e fe n d
h im s e lf.
R e c o rd s m u s t b e k e p t o f a l l su c h p r o c e e d i n g s .
A s ta te ­
m e n t m u s t be made w h ic h s e t s f o r t h a n y a c t o r p r a c t i c e w h ic h th e
m ember i s a l l e g e d to h a v e i n d u l g e d i n , o r w h ic h h e h a s n e g l e c t e d
to p e r f o r m .
A s ta t e m e n t m u st a l s o b e made o f t h e s p e c i f i c r u l e s
o f th e a s s o c i a t i o n w h ic h he i s c h a r g e d w i t h h a v in g v i o l a t e d , an d
w h e th e r o r n o t s u c h v i o l a t i o n s c o n s t i t u t e c o n d u c t i n c o n s i s t e n t
w ith J u s t and e q u ita b le p r i n c i p l e s o f tr a d e .
F u r th e r m o r e , th e
p e n a l t y w h ic h i s im p o se d m u st b e B e t f o r t h i n s ta t e m e n t fo rm .
In
p r o c e e d i n g s to d e n y m em b ersh ip to a b r o k e r o r d e a l e r s i m i l a r r e ­
q u ir e m e n ts a r e im p o se d .
The b r o k e r m u s t b e n o t i f i e d an d g iv e n a n
o p p o r t u n i t y f o r h e a r i n g o n th e s p e c i f i c g r o u n d s o n w h ic h h i s
m e m b e rs h ip i s d e n i e d .
T h ese p r o c e e d in g s m u s t b e r e d u o e d t o s t a t e ­
m e n t fo rm a n d k e p t i n th e r e c o r d s .
I n o r d e r to b r i n g th e s m a l l e r g r o u p s o f b r o k e r s an d d e a l e r s
u n d er c o n tro l,
o f a ffilia te d
th e M alo n ey am endm ent p r o v i d e s f o r th e e s t a b l i s h m e n t
s e c u rity a s s o c ia tio n s .
Such a s s o c i a t i o n s may b e r e ­
g i s t e r e d a s a f f i l i a t e d a s s o c i a t i o n s b y c o m p ly in g w i t h th e r u l e s
-1 0 9 -
g o v e r n in g n a t i o n a l s e c u r i t i e s a a B o c i a t i o n s , e v e n th o u g h th e a s s o c i ­
a t i o n i t s e l f i s n o t o f s u f f i c i e n t g e o g r a p h i c a l sco p e o r n u m e r ic a l
s i z e w i t h r e g a r d to m e m b e rs h ip , to h e e l i g i b l e f o r r e g i s t r a t i o n a s
a n a tio n a l s e c u r itie s a s s o c ia tio n .
S u c h 'a s s o c i a t i o n s
m ust he a f ­
f i l i a t e d w ith a n a tio n a l s e c u r i t i e s a s s o c ia t io n , and i t s
re q u ire ­
m e n ts f o r m e m b e rsh ip m u s t n o t h e l e s s s t r i c t th a n th o s e o f th e
a s s o c i a t i o n w i t h w h ic h i t i s a f f i l i a t e d .
a s s o c ia tio n f a i l s to a f f i l i a t e
a s s o c ia tio n , i t s
If,
f o r any re a s o n ,
such
i t s e l f w ith a n a tio n a l s e c u r it ie s
r e g i s t r a t i o n i s rev o k ed .
S h o u ld th e n a t i o n a l
s e c u r i t i e s a s s o c i a t i o n , w i t h w h ic h a n a f f i l i a t e d a s s o c i a t i o n i s
j o i n e d , w ith d ra w i t s r e g i s t r a t i o n ,
a te i s a u to m a tic a lly c a n c e lle d .
t h e r e g i s t r a t i o n o f th e a f f i l i ­
E ith e r a n a tio n a l o r an a f f i l i a t e d
a s s o c i a t i o n m ay w ith d ra w i t s r e g i s t r a t i o n u p o n r e a s o n a b l e n o t i c e
38
s e r v e d u p o n th e C o m m issio n .
lik e w is e ,
t h e C o m m issio n may r e v o k e th e r e g i s t r a t i o n o f a n y
a s s o c i a t i o n w h e th e r a f f i l i a t e d o r n a t i o n a l , o r s u s p e n d s u c h r e g i s ­
t r a t i o n f o r a p e r i o d n o t e x c e e d in g tw e lv e m o n th s,
may a l s o
tlhe C om m ission
s u s p e n d o r e x p e l a n y member o f a r e g i s t e r e d s e c u r i t i e s
a s s o c ia tio n i f ,
a f t e r o p p o rtu n ity f o r
h as v io la te d any o f i t s r u le s ,
h e a rin g , i t f in d s th a t he
o r t h a t h e h a s b e e n p a r t y to a
t r a n s a c t i o n w i t h a n y p e r s o n so d o in g , o r i f h e h a s o p e r a t e d i n a
s i m i l a r m anner w ith r e s p e c t to th e S e c u r i t i e s A ct o f 1933.
L ik e ­
w is e , an y o f f i c e r o r d i r e c t o r o f a r e g is t e r e d s e c u r i t i e s a s s o c ia tio n
m ay b e rem o v ed b y th e C o m m issio n i f i t f i n d s t h a t he h a s f a i l e d
w i l l f u l l y to e n f o r c e t h e r u l e s o f th e a s s o c i a t i o n , o r h a s a b u s e d
38
S e c u r i t i e s E x ch an g e A c t, a s am en d ed , s e c . 15A, ( c ) ,
p p . 25—2 6 .
(d),(e),(f),
-H O -
39
h is a u th o rity .
D ie C om m ission f u r t h e r r e g u l a t e s th e o p e r a t i o n o f r e g i s t e r e d
s e c u r i t i e s a s s o c i a t i o n s th r o u g h a p r o v i s i o n i n t h e A c t w h ic h r e n d e r s
a l l d i s c i p l i n a r y a c t i o n b y s u c h a s s o c i a t i o n s s u b j e c t t o r e v ie w
b e fo re i t .
The law a l s o p r o v i d e s t h a t th e C onxnission may i n s t i t u t e
a c t i o n f o r r e v ie w o n I t s own I n i t i a t i v e .
If.
a f t e r n o tic e and
o p p o r t u n i t y f o r h e a r i n g , t h e C o in n iss io n f i n d s t h a t i t c o n c u r s w ith
t h e r e g i s t e r e d a s s o c i a t i o n , t h e a c t i o n i s d is m i s s e d , u n l e s s t h e
C om m ission s e e s f i t t o m o d if y th e p e n a l t y p r e s c r i b e d b y th e a s s o c i ­
a t i o n on g ro u n d s t h a t i t I s e x c e s s iv e o r c o n tr a r y to th e p u b lic
in te re s t.
The C o s m is s io n m ay a l s o d e te r m in e w h e th e r o r n o t t h e
a c t s o r p r a c t i c e s o f t h e i n d i v i d u a l in v o l v e d a r e I n c o n s i s t e n t w i t h
J u s t and e q u ita b le p r in c i p le s o f tr a d e .
If,
on t h e o t h e r h a n d , th e
C om m ission f i n d s t h a t th e p r a c t i c e s e n g a g e d i n b y th e i n d i v i d u a l
i n q u e s t i o n a r e n o t i n v i o l a t i o n o f t h e r u l e s o f th e a s s o c i a t i o n ,
i t may s e t a s i d e t h e v e r d i c t o f th e a s s o c i a t i o n .
The C om m ission
h a s th e seme p o w er i n t h e c a s e o f d e n i a l o f m e m b ersh ip b y a r e g i s ­
te re d a s s o c ia tio n .
I t m ay, a f t e r n o t i c e an d o p p o r t u n i t y f o r h e a r in g *
r e v ie w t h e r e c o r d o f th e a s s o c i a t i o n a n d o t h e r e v i d e n c e , an d d e t e im i n e
w h e th e r o r n o t th e s i t u a t i o n i s
s u c h a s to w a r r a n t th e e x c l u s i o n o f
a p e r s o n a p p l y i n g f o r m e m b e rsh ip .
I f i t f i n d s t h a t th e c h a r g e s on
w h ic h h e i s e x c lu d e d a r e u n w a r r a n te d , i t may r e c ju ir e th e r e g i s t e r e d
e x c h a n g e t o a d m it h im .
P u r th e r m o r e , t h e C om m ission p r e s c r i b e s s p e c i f i c r u l e s w h ic h
may b e a d o p t e d b y th e r e g i s t e r e d a s s o c i a t i o n .
The r e g i s t e r e d
39
S e c u ritie s Exchange Act a s amended, se c . 15 A, ( 1 ) , p . 28.
-1 l i ­
a s s o c ia tio n s
m ay
a d o p t r u l e s w h ic h "bind m em bers to d e a l w i t h n o n -
member b r o k e r s o n ly on th o s e te rm s w h ic h a r e a c c o r d e d to t h e g e n e r a l
p u b lic .
N onnnem ber b r o k e r s w i t h i n t h e m e a n in g o f t h e la w , in c l u d e s
a l l b r o k e r s who u s e th e i n s t r u m e n t a l i t i e s o f i n t e r s t a t e com merce
and th e m a i l s f o r d e a l i n g i n s e c u r i t i e s , n o t th r o u g h n a t i o n a l
s e c u r i t i e s e x c h a n g e s , a n d who a r e n o t m em bers o f a n y r e g i s t e r e d
s e c u r itie s a s s o c ia tio n .
T h is d o e s n o t a p p l y to th o s e who d e a l ex>*
c l u a i v e l y i n b a n k e r * s a c c e p t a n c e s , c o m m e rc ia l p e p e r , an d co m m e rc ia l
b llle .
On t h e o t h e r h a n d , a n y member o f a r e g i s t e r e d s e c u r i t i e s
a s s o c i a t i o n may g r a n t a n y m em ber o f a n o t h e r r e g i s t e r e d s e c u r i t i e s
40
a s s o c i a t i o n d e a l e r ’ s d i s c o u n t s a n d o t h e r s p e c i a l te r m s .
E ach r e g i s t e r e d a s s o c i a t i o n i s r e q u i r e d to f i l e c o p i e s o f e a c h
c h a n g e i n o r a d d i t i o n to i t s r u l e s and r e g u l a t i o n s w ith t h e C om m ission,
an d s u c h o t h e r i n f o r m a t i o n a s i s r e q u i r e d to k e e p i t s r e g i s t r a t i o n
s ta t e m e n t u p to d a t e .
C h an g es o r a d d i t i o n s i n r u l e s a n d r e g u l a t i o n s
c a n n o t be e f f e c t i v e u n t i l t h i r t y d a y s a f t e r th e y a r e f i l e d w i t h th e
C om m ission, u n l e s s th e C o m m issio n g r a n t s p e r m i s s i o n p r i o r to t h a t
tim e , an d i n th e e v e n t t h a t th e C om m ission f i n d s t h a t s u c h c h a n g e s
o r a d d i t i o n s a r e i n c o n s i s t e n t w i t h i t s r e q u i r e m e n t s , i t may d i s ­
a p p ro v e o f th em .
L i k e w i s e , t h e C om m ission i s em pow ered t o a b r o g a t e
any r u l e of a r e g i s t e r e d s e c u r i t i e s a s s o c ia t io n i f i t
f i n d s t h a t su c h
a c o u r s e i s n e c e s s a r y t o a s s u r e f a i r d e a l i n g b y i t s m em bers, o r to
a s s u r e f a i r r e p r e s e n t a t i o n o f th e m e m b e rsh ip i n th e c o n d u c t o f i t s
a f f a i r s o r f o r th e p r o t e c t i o n o f i n v e s t o r s .
I t may a l s o a c t I n an
a f f i r m a t i v e m a n n er i n t h a t i t may a s k a r e g i s t e r e d a s s o c i a t i o n , a f t e r
40
Secii r i UflB Eichanga A c t, a s amended, s e c .15 A., ( g ) , ( h ) , p p .26-27.
-112-
n o ti c e and o p p o rtu n ity f o r h e a rin g ,
to a d o p t a n y r u l e w h ic h i t may
f i n d a p p r o p r i a t e f o r c a r r y i n g o u t t h e p r o v i s i o n s o f t h e la w .
m ay c h a n g e t h e p r o c e d u r e f o r a d m is s io n a n d d i s c i p l i n i n g
It
t h e m em bers,
t h e m e th o d s em p lo y ed i n a d o p t in g new r u l e s a n d r e g u l a t i o n s , o r th e
41
a f f i l i a t i o n b e tw e e n s u c h a s s o c i a t i o n s .
In o rd e r to f a c i l i t a t e
t h e f o r m a t io n o f t h e s e a s s o c i a t i o n s , t h e C o n n ie s i o n c o n d u c te d c o n ­
f e r e n c e s w i t h b r o k e r s i n v a r i o u s p a r t s o f th e c o u n t r y , w h ic h w e re
o p e n to a l l I n t e r e s t e d p a r t i e s , i n o r d e r t h a t i t m ig h t o b t a i n th e
v ie w p o in ts o f b ro k e rs a n d d e a l e r s .
T h is w o rk w as c a r r i e d o n th r o u g h
a S e c u r i t i e s A s s o c i a t i o n u n i t u n d e r th e T r a d in g a n d E x ch an g e D i v i s i o n
o f t h e C om m ission.
The o b j e c t i v e o f t h i s a c t i v i t y w as t o b r i n g a b o u t
a n o r g a n i z a t i o n w h ic h w o u ld b e s u p p o r te d b y th e b e t t e r e le m e n t o f
b r o k e r s a n d d e a l e r s th r o u g h o u t th e c o u n t r y .
On J u l y 2 0 ,1 9 3 9 ,
th e I n v e s tm e n t B a n k e rs C o n f e r e n c e , w h ic h h a d
b e e n c o o p e r a t i n g w i t h th e C om m ission f o r B e v e r a l y e a r s i n a n en ­
d e a v o r to Im prove th e s t a n d a r d s o f t h e o v e r - t h e - c o u n t e r b u s i n e s s ,
r e c o n s t i t u t e d i t s e l f aB th e N a t i o n a l A s s o c i a t i o n o f S e c u r i t y D e a l e r s ,
I n c . , a f t e r am en d in g i t s by-lscw s a n d r u l e s o f f a i r p r a c t i c e ,
file d
a p p l i c a t i o n w i t h th e C o n m isa lo n .
I t s a p p l i c a t i o n w as g r a n t e d b y
th e C om m ission on A u g u st 7 ,1 9 3 9 .
M em b ersh ip i n t h i s a s s o c i a t i o n
i s o p e n to a l l o v e r - t h e - c o u n t e r b r o k e r s a n d d e a l e r s e x c e p t t h o s e
who h a v e d i s q u a l i f i e d th e m s e lv e s b y t h e i r p r e v i o u s c o n d u c t.
B o th
t h e C om m ission a n d t h e A s s o c i a t i o n f a v o r t h e g r o u p in g o f t h e m o re
s p e c i a l i z e d ty p e s o f b r o k e r s a n d d e a l e r s , s u c h a s t h o s e who d e a l
42
in o i l r o y a ltie s , in s e p a ra te a s s o c ia tio n s .
41
42
.f if lc a r ltia f l B ag h m g e A & l, a s am ended s e c . 15 A , ( l ) , ( j )
SsBeC. 5 t h A n im al B e p o r t, p . 58
( k ) ,p .2 7 .
-1 1 3 -1 3 1 -
W h ile t h e M alo n ey Amendment d o e s n o t c o m p el o v e r - t h e - c o u n t e r
b r o k e r s a n d d e a l e r s t o fo rm a s s o c i a t i o n s , i t
i s n e v e rth e le s s a
s t e p i n th e d i r e c t i o n o f b r i n g i n g th e o v e r - t h & - c o u n t e r m a r k e ts
u n d e r a d i s c i p l i n e s i m i l a r to t h a t w h ic h e x i s t s i n t h e c a s e o f
th e n a tio n a l s e c u r ity exchanges.
m e n t,
W ith th e p a s s a g e o f t h i s amend­
th e m e ch an ism b y m ean s o f w h ic h th e s e c u r i t i e s b u s i n e s s a s
a w h o le may b e b r o u g h t u n d e r F e d e r a l c o n t r o l , i s e s s e n t i a l l y
c o m p le te .
I n o r d e r t h a t th e a s s o c i a t i o n s w h ic h may becom e r e g i s ­
t e r e d h a v e a s l a r g e a r e g u l a t o r y f u n c t i o n a s p o s s i b l e , t h e Com­
m i s s i o n h a s r e f r a i n e d fro m a n p l i f y i n g s u b s t a n t i a l l y i t s r u l e s r e g a r d i i ^ o v e r - t h e —c o u n t e r m a r k e ts ; t h e r e a r e m any r e g u l a t i o n s w h ic h
w e re i n t e n d e d b y th e M alo n ey A ct w h ich h a v e n o t b e e n assu m ed b y
th e a s s o c ia tio n s .
U i i s i s o f m in o r im p o r ta n c e , h o w e v e r, s i n c e
t h e C o m n issio n f u l l y r e c o g n i z e s i t s
d u ty to e l i m i n a t e p r a c t i c e s
o f an a b u s iv e c h a r a c t e r w h ic h a r e b e y o n d th e r e a c h o f th e r e g i s te re d a s s o c ia tio n s .
am endm ent, w h ic h w e re
[Che
present
published
r u l e s an d r e g u l a t i o n s u n d e r t h i s
on J u l y 13, 1 9 3 9 , c o n t a i n p r o v i s i o n s
w h ic h a r e v e r y s i m i l a r t o th o s e p r e s c r i b e d f o r n a t i o n a l s e c u r i t y
43
exchanges.
43
S .E .C . S e c u r i t i e s E x ch an g e A ct o f 1 9 3 4 . Be l e a s e No. 2 1 8 1 .
CHAPTER V
ORGANIZATION OF THE SECURITIES
AND EXCHANGE COMMISSION
The S e c u r i t i e s Exchange A ct o f 1934 was p a s s e d , " t o p ro v id e
f o r th e r e g u l a t i o n o f s e c u r i t y exchanges and o v e r - t h e - c o u n t e r
m ark ets o p e r a t i n g i n i n t e r s t a t e and f o r e i g n commerce and th ro u g h
th e m a i l s , t o p r e v e n t i n e q u i t a b l e and u n f a i r p r a c t i c e s on such
1
exchanges and m a r k e ts , and f o r o t h e r p u r p o s e s ."
The n e c e s s i t y
f o r th e r e g u l a t i o n o f exchanges i s d e s c rib e d i n th e Act a s due
to t h e f o llo w in g f a c t o r s : ( l ) t h e volume and d i f f u s i o n , th ro u g h
i n t e r s t a t e commerce, o f s e c u r i t y t r a n s a c t i o n s among t h e g e n e r a l
p u b l i c ; (2) t h e e f f e c t o f t h e p r i c e s e s t a b l i s h e d th ro u g h such
t r a n s a c t i o n s upon p r i c e s o f s e c u r i t i e s e lse w h e re , upon the amount
o f c e r t a i n F e d e r a l and s t a t e t a x e s , and upon th e v a lu e o f c o l l a t e r a l
f o r bank lo a n s : C®) t h e s u s c e p t i b i l i t y o f s e c u r i t y p r i c e s t o mani­
p u l a t i o n , which g iv es r i s e t o e x c e s s iv e s p e c u l a t i o n , a f f e c t s th e
volume o f c r e d i t a v a i l a b l e f o r i n t e r s t a t e commerce, and p re v e n ts
a f a i r a p p r a i s a l o f t h e v a lu e o f th e s e c u r i t i e s ; and (4) th e p r e ­
c i p i t a t i o n and p ro lo n g in g o f n a t i o n a l em ergencies by m a n ip u la tio n
2
and e x c e s s iv e s p e c u l a t i o n .
1
73rd Cong., P u b li c No. 291, H.R. 9323, S e c u r i t i e s Exchange Act
o f 1954. pream ble, p . l .
2
I b i d . , T i t l e I , s e c . 2, pp. 1 -2 .
-1 3 5 -
The C om m ission-set-up and p e r s o n n e l
To p ro v id e f o r e f f e c t i v e r e g u l a t i o n o f b o th s e c u r i t y exchanges
and o v e r - t h e - c o u n t e r m a rk e ts, th e Act p r o v id e s f o r th e c r e a t i o n
o f a S e c u r i t i e s and Exchange Commission.
T h is Commission i s com­
posed o f f i v e members a p p o in te d by t h e p r e s i d e n t , w ith t h e ad v ice
and co n sen t o f t h e S e n a te .
Not more
t h a n t h r e e may be members o f t h e same p o l i t i c a l p a r t y and members
o f d i f f e r e n t p a r t i e s s h a l l be a p p o in te d a l t e r n a t e l y , as n e a r l y
as i s p r a c t i c a b l e •
bach r e c e i v e s a s a l a r y o f * 1 0 ,0 0 0 a y e a r , may
enrage i n no o th e r b u s i n e s s , and h o ld s o f f i c e f o r a p e r io d o f
fiv e y ears.
In t h e case o f t h e i n i t i a l ap p o in tm en ts, hov/ever, i t
-was p rov id ed t h a t o n ly one commissioner sho uld be a p p o in te d f o r
f i v e y e a r s ; t h r e e were t o hold o f f i c e f o r f o u r , t h r e e , and two
y e a r s r e s p e c t i v e l y ; and one f o r one y e a r .
3
On June 30, 1934 .P resid en t R o o sev elt a p p o in te d t h e fo llo w ­
ing Commissioners:
COMMISSIOKERS
Joseph P . Kennedy
George C. Matthews
J an es LI. Landis
R obert E. Healy
F erd in a n d P ecora
STATE
HUMBER OF YEARS
Hew York
W isconsin
M a ssa c h u se tts
Vermont
Hew York
5
4
3
2
1
The f i r s t m eeting o f th e Commission was h e ld on J u ly 2, 1934,
a t which Joseph P. Kennedy was chosen as chairm an.
The a p p o in t­
ment o f t h e s e com m issioners was confirm ed by t h e S en ate on
Jan u ary 16, 1935.
Four days l a t e r Mr. F erdinand P e c o r a 's r e s i g n a ­
t i o n became e f f e c t i v e , and on O ctober 5 th o f t h a t y e a r he was r e ­
p la c e d by Mr. J . D. Ro3S, o f t h e S t a t e o f W ashington, who was
a p p o in te d f o r a p e r io d o f f i v e y e a r s .
On September 23, 1935,
Mr. Joseph P. Kennedy r e s ig n e d as chairm an and com m issioner, a t
w hich tim e Mr. Landis was e l e c t e d chairm an o f t h e Commission.
On Jan u ary 21, 1936 Mr, W illiam 0 . Douglas was a p p o i n t e d t o t h e
3
S e c u r itie s Exchange A ct, T it l e I , s e c . 4 ( a ) , p . 5.
-135-
Commission f o r the term ending June 5, 1939.
Upon th e re s ig n a tio n
o f Commissioner James M. L a n d is , e f f e c t i v e September 15, 1957, Mr.
Douglas was e l e c t e d chairman o f th e Commission,
When on A p r il 16,
1939, Mr. W illiam 0 . Douglas r e s ig n e d as chairm an and commissioner
t o a c c e p t an appointm ent as J u s t i c e o f t h e U nited S t a t e s Supreme
C o u rt, he was succeeded as chairman by Mr. Jerome M. F ra n k , who had
been a p p o in te d commissioner on December 20, 1937, to r e p l a c e Mr.
4
James M. L a n d is . As o f June 30, 1940, t h e com m issioners were as
f o llo w s :
COMMISSIONERS
Jerome N, Frank
R o b ert E. Healy
Sumner P ik e
Edward C, E ic h e r
Leon Henderson
STATE
New York
Vermont
Maine
Iowa
New J e r s e y
TERM EXPIRES
1942
1941
1943
1940
1944
Scope o f . j u r i s d i c t i o n o f the Commission
At p r e s e n t , t h e S e c u r i t i e s and Exchange Commission a d m in is te r s
n o t o n ly th e S e c u r i t i e s Exchange A ct o f 1934, b u t t h e S e c u r i t i e s
Act o f 1933, and th e P u b lic U t i l i t y H olding Company A ct o f 1935 a s
w ell.
S in ce th e a d o p tio n o f th e amended Bankruptcy Act by Congress
on Ju n e 22, 1938, th e Commission a l s o e x e r c i s e s d u t i e s w ith r e s p e c t
t o c o r p o r a t e r e o r g a n i z a t i o n s under C h ap ter X o f t h i s A ct; t h e T r u s t
5
I n d e n tu r e A ct o f 1939 has lik e w is e been e n t r u s t e d to th e Commission.
The S e c u r i t i e s Act o f
4
F o r changing p e r s o n n e l o f th e Commission, see S .E .C ., 1 s t Annual
R e p o r t. P t . 1 , p . l ; 2nd Annual R e p o r t. P t . I , p . 2; 3 rd Annual
R e p o r t, p . l j 4 t h Annual R e p o rt. I n t r o d u c t i o n , p . 3; 5 th Annual R e p o rt.
I n t r o d u c t i o n , p p .R -4 .
5
5 th Annual R e p o r t . I n t r o d u c t i o n , p . l and n . l . The In v e stm e n t Company
Act o f 1940 i s a l s o a d m in is te r e d by the Commission.
1933 was a d m in is te r e d by t h e F e d e ra l Trade Commission from
May 27, 1933 when i t '.ms e n a c te d , u n t i l September 1, 1934,
a t which tim e s i t s a d m i n i s t r a t i o n was t r a n s f e r r e d to t h e
6
S e c u r i t i e s and Exchange Commission.
The purposes o f th e
S e c u r i t i e s Act o f 1933 a r e , " t o p re v e n t t h e e x p l o i t a t i o n o f
t h e p u b lic by t h e s a l e o f unsound, f r a u d u l e n t and w o r th le s s
s e c u r i t i e s th ro ug h m i s r e p r e s e n t a t i o n ; t o p la c e ad eq u ate and
t r u e in fo r m a tio n b e f o r e t h e i n v e s t o r ; t o p r o t e c t h o n e s t e n t e r ­
p r i s e , seek in g c a p i t a l by h o n e s t p r e s e n t a t i o n , a g a i n s t com peti­
t i o n a f f o r d e d by d i s h o n e s t s e c u r i t i e s o f f e r e d to t h e p u b lic
th ro u g h crooked prom otion; t o b r in g i n to p r o d u c tiv e channels
o f i n d u s t r y and development c a p i t a l which has grown tim id to
th e p o i n t o f h o a rd in g ; and to a id i n p ro v id in g employment and
r e s t o r i n g buying and consuming power .
7
The P u b lic U t i l i t y h o ld in g Company Act o f 1935 charged t h e
S e c u r i t i e s ‘ and Exchange Commission w ith i t s enforcem ent and
came under t h e . j u r i s d i c t i o n o f th e Commission as soon as i t
became law.
e
i t s pu rpo se i s t o b r in g th o s e gas and e l e c t r i c
h o ld in g company systems w hich a r e in v o lv ed in i n t e r s t a t e commerce
u nd er t h e c o n t r o l o f th e S e c u r i t i e s and Exchange Commission.
"T h is r e g u l a t i o n ex tend s t o t h e s a l e o f u t i l i t y s e c u r i t i e s ,
u t i l i t y a s s e t s , and i n t e r e s t s i n o t h e r b u s in e s s e s ; t h e sim­
p l i f i c a t i o n and l i m i t a t i o n o f h o ld in g company system s, i n t e r ­
company t r a n s a c t i o n s ; s e r v i c e s a l e s and c o n s tr u c t i o n c o n t r a c t s ;
6
S .E .C ., JJat A nnual i R e p o r t , P a r t 1, p . 8, and S e c u r i t i e s Exchange
Act o f 1954, T i t l e I I , Amendments t o S e c u r i t i e s Act o f 1933, s e c .
210, pp . 4 3 f .
7
iinrl Annual !- l R e p o rt, P a r t I , p . 1.
a
I b i d . , P a rt I , p . 1.
-137
and th e m aintenance o f accounts and subm ission o f re p o rts as
req u ired .
This Act a l s o p ro v id e s f o r t h e s i m p l i f i c a t i o n o f
9
uneconomic h o ld in g company s t r u c t u r e s .
A d m in is t r a t i v e m achinery o f t h e Commission
------------ I't was bu ' aifcum plislr ' th e mtnt ii t J t r u c io n o f th e above
m entioned a c t s t h a t t h e a d m i n i s t r a t i v e m achinery o f t h e S e c u r i­
t i e s and Exchange Commission was c o n s t r u c t e d .
At t h e o u t s e t
t h e Commission e s t a b l i s h e d t e n a d m i n i s t r a t i v e u n i t s which con­
s i s t e d o f:
(l)
Legal D i v i s i o n , (2 ) R e g i s t r a t i o n D i v is io n , (3)
T rading and Exchange D iv i s i o n , (4 ) S e c r e t a r y , (5) D ir e c to r o f
P r o t e c t i v e Committee S tudy, (6 ) T e c h n ic a l A d v iso r, (7) Economic
A d v is o r, (8) Employment R esearch , (9) R egional S u p e r v is o r , and
(10) S u p e r v is o r o f I n fo rm a tio n R e search .
During t h e f i r s t y e a r
o f o p e r a t i o n i t became n e c e s s a r y t o r e a r r a n g e t h e a d m i n i s t r a t i v e
s e t- u p i n many p a r t i c u l a r s .
The t e c h n i c a l a d v i s o r 's u n i t and
t h a t o f t h e r e g i o n a l s u p e r v i s o r were dropped and fo u r new ad­
m i n i s t r a t i v e u n i t s were added, namely:
( l ) P u b lic U t i l i t i e s
D i v i s i o n , (2 ) C h ief A c c o u n ta n ts ' D i v i s i o n , (3 ) Research D iv is io n
and { 4 ) Forms and R e g u la tio n s D i v is io n .
The Forms and R e g u la tio n
D iv is io n was i n t u r n a b o lis h e d on June 9, 1939, and i t s f u n c tio n s
vrer e
t r a n s f e r r e d to a new Forms and R e g u la tio n s U nit under th e
R e g i s t r a t i o n D iv is io n .
As a r e s u l t o f i t s assum ption o f d u t i e s
d e a l i n g v/ith r e o r g a n i z a t i o n problems under C hapter X o f th e
Bankruptcy A ct, t h e Commission e s t a b l i s h e d a new d i v i s i o n , t h e
R e o r g a n iz a tio n D iv is io n , d u rin g t h e f i s c a l y e a r ending June 1939. 10
9
B .R .C .,
Annual 1 R e p o r t, P a r t I , p . 2, and 74th Cong., P u b lic
h o. 333, 8 . 2796, P u b lic U t i l i t y Act o f 1935, T i t l e I , s e c . 11, pp. 2 0 f f .
10
S .E .C ., -ltfc-Annua j. R e p t. , P t . I , p p. 3 -9 , and 5th-A nnual i \ e p t .,
In tro d ., p. 4 .
-I3 H -
These u n i t s , which have been developed w ith a view to e f f i c i e n t
a d m i n i s t r a t i o n o f t h e v a r io u s Acts under t h e Commission, a r e ,
w it h a few e x c e p tio n s , concerned w ith no p a r t i c u l a r a c t but
a r e o r g a n iz e d v/ith r e f e r e n c e t o t h e ty p e o f work to be done.
The Legal D iv is io n con cern s i t s e l f w ith r e n d e rin g a d v ic e to
t h e Commission and r e n d e r in g i n t e r p r e t a t i o n s o f s t a t u t e s en­
fo rc e d by t h e Commission in re sp o n se to i n q u i r i e s from i n t e r e s t e d
p a rtie s,
i t conducts a l l h e a r in g s ex cep t i n c a s e s where o t h e r
u n i t s have . j u r i s d i c t i o n , r e p r o s e n t s t h e Commission i n a l l
j u d i c i a l p r o c e e d in g s .
C rim in al c a s e s which a re r e f e r r e d t o th e
Department o f J u s t i c e a r e p re p a re d by t h e Legal D epartm ent, and
i t c o l l a b o r a t e s w ith o t h e r d i v i s i o n s o f t h e Commission i n p re ­
p a rin g r e p o r t s f o r Congress under th e t h r e e A cts.
The T rading and Exchange D i v i s i o n , t h e a c t i v i t i e s o f which
b e a r most d i r e c t l y on t h e r e g u l a t i o n o f s e c u r i t y exchanges, has
f i f t e e n sep arate but i n t e r r e l a t e d r e s p o n s i b i l i t i e s .
They a re as
fo llo w s :
"1.
The exam in ation o f r e g i s t r a t i o n s ta te m e n ts f i l e d
by exchanges f o r r e g i s t r a t i o n as n a t i o n a l s e c u r­
i t y exchanges and t h e exemption o f exchanges from
re g istra tio n ;
2.
t h e f o rm u la tio n o f r u l e s f o r th e r e g u l a t i o n o f
f l o o r t r a d i n g by members, f o r th e p r e v e n tio n
o f e x c e s s iv e t r a d i n g by members o f f th e f l o o r
o f exchanges, and f o r t h e l i m i t a t i o n o f d e a l­
in g s by s p e c i a l i s t s and o d d - lo t d e a l e r s ;
3.
t h e d e t e c t i o n o f e x c e s s iv e t r a d i n g and unlaw­
f u l p r a c t i c e s on exchan ges, in c lu d in g wash
s a l e s , matched o r d e r s , po ol o p e r a t i o n s , th e
d i s s e m in a tio n o f f a l s e and m is le a d in g inform a­
t i o n co n cern in g s e c u r i t i e s and o th e r manipu­
l a t i v e d e v ic e s ;
-1 3 9 -
4.
t h e re-view of f i e l d i n v e s t i g a t i o n s i n t o t r a d ­
in g a c t i v i t i e s ;
5.
t h e f o rm u la tio n o f r u l e s f o r t h e r e g u l a t i o n o f
p eg g in g , f i x i n g , and s t a b i l i z i n g o p e r a tio n s
on exchanges and i n o v e r - t h e - c o u n t e r m ark ets;
6.
t h e f o rm u la tio n o f r u l e s f o r t h e r e g u l a t i o n o f
p u t s , c a l l s , s t r a d d l e s , and o t h e r o p tio n s both
on exchanges and o v e r - t h e - c o u n t e r ;
7.
th e f o rm u la tio n o f r u l e s f o r t h e r e g u l a t i o n o f
s h o r t - s e l l i n g , and s t o p - l o s s o r d e r s ;
8.
t h e s tu d y o f t h e e f f e c t o f t h e F e d e ra l Reserve
Margin R e g u la tio n s on t r a d i n g i n s e c u r i t i e s ;
9.
t h e f o rm u la tio n o f r u l e s r e l a t i n g t o t h e borrow­
in g s o f exchange members, b r o k e r s , and d e a l e r s ;
10.
t h e s tu d y o f exchange r u l e s and t h e fo rm u la tio n
o f r u l e s governing m is c e lla n e o u s exchange
p rac tic e s;
11.
th e f o rm u la tio n o f r u l e s w ith r e s p e c t to
"when and i f is s u e d " t r a d i n g ;
12.
t h e f o rm u la tio n o f r u l e s f o r t h e r e g u l a t i o n o f
o v e r - t h e - c o u n t e r m a r k e ts , in c lu d in g r u l e s pro­
v id in g f o r t h e r e g i s t r a t i o n o f b ro k e rs and
d e a l e r s i n o v e r - t h e - c o u n t e r m ark ets and f o r th e
e l i m i n a t i o n o f th e u n f i t , r u l e s r e g u l a t i n g t r a d ­
ing p r a c t i c e s and d e a lin g s i n o v e r - th e - c o u n te r
m a rk e ts, r u l e s t o i n s u r e t o i n v e s t o r s i n ov ert h e - c o u n t e r m arkets p r o t e c t i o n comparable to
t h a t p ro vid ed in t h e c a se o f n a t i o n a l s e c u r i t y
exchanges, r u le s f o r t h e r e g u l a t i o n o f s e c u r i t i e s
s&leBinen employed by o v e r - t h e - c o u n t e r houses and
r u l e s f o r t h e r e g u l a t i o n o f in v estm en t co u n sel;
13.
t h e f o rm u la tio n o f r u l e s and r e g u l a t i o n s govern­
ing t h e c o n tin u an ce or e x te n s io n o f u n l i s t e d
t r a d i n g p r i v i l e g e s on n a t i o n a l s e c u r i t y ex­
changes, o f r u l e s governing t h e w ith d ra w al and
removal o f s e c u r i t i e s from such u n l i s t e d t r a d ­
in g p r i v i l e g e s , and o f r u l e s governing t h e del i s t i n g from n a t i o n a l s e c u r i t y exchanges of
s e c u r i t i e s f u l l y l i s t e d and r e g i s t e r e d th e r e o n ;
14.
t h e exam ination o f a p p l i c a t i o n s f o r th e con­
t i n u a n c e , e x t e n s io n , w ith d ra w a l, o r removal
o f s e c u r i t i e s from u n l i s t e d t r a d i n g p r i v i l e g e s
-1 4 0 -
and t h e ex am in atio n o f a p p l i c a t i o n s f o r th e
d e l i s t i n g o f s e c u r i t i e s l i s t e d and r e g i s t e r e d
on n a t i o n a l s e c u r i t y exchanges;
15.
t h e conduct o f h e a r in g s b e fo re t h e Commission
o r an o f f i c e r o f th e Commission h e ld on such
a p p l i c a t i o n s . " -11
The S e c r e ta r y o f t h e Commission i s t h e c h i e f a d m i n i s t r a t i v e
o f f i c e r o f th e Commission.
He has s u p e r v i s io n o v e r ( l ) Recording
S e c r e t a r y , who p r e p a r e s , m a in ta in s and in d ex es o f f i c i a l m inutes
o f th e Commission and t h e d r a f t i n g o f v a r io u s memoranda t o t h e
d i v i s i o n h e a d s, and {%) t h e A d m in is tr a tiv e D i v is i o n , t h e f u n c tio n s
o f which a r e , ( a ) a l l s e r v i c e a c t i v i t i e s , (b) p r e p a r a t i o n o f
do ck ets and r e c o rd s and t h e m aintenance o f c e n t r a l f i l e s , ( c )
m aintenance o f t h e p u b lic r e f e r e n c e room and th e d is s e m in a tio n
o f in f o r m a tio n , ( d ) m ain ten ance o f a p p r o p r i a t e a c c o u n tin g
r e c o r d s , ( e ) conduct o f g e n e r a l co rresp on dence o f a n o n - te c h n i c a l c h a r a c t e r , and {f ) t h e exam ination and a c t i o n on a l l
a p p l i c a t i o n s f o r adm ission t o p r a c t i c e b e fo re t h e Commission as
a t t o r n e y o r a g e n t.
The P u b lic U t i l i t i e s D iv is io n m ainly con cerns i t s e l f v d th
t h e a d m i n i s t r a t i o n o f t h e p u b lic u t i l i t y a c t s , b u t c o l l a b o r a t e s
w ith o th e r d i v i s i o n s i n t h e p r e p a r a t i o n o f r u l e s r e g a rd in g ho ld ­
in g company a c t i v i t i e s .
The C h ief A ccountant r e n d e rs a d v is o r y s e r v i c e t o t h e
Commission i n c o n n e c tio n w i t h ac c o u n tin g m a tt e r s f o r t h e conduct
o f s tu d i o s and t h e p ro m u lg a tio n o f a c c o u n tin g r u l e s and r e g u la ­
t i o n s , and s u p e r v is e s p ro m u lg a tio n and a d m i n i s t r a t i v e r u l e s ro ­
ll
S .E .C ., 2nd Annual R ep o rt, p p .4 -5 .
-141-
g ard ing uniform systems o f a c c o u n ts .
E is o f f i c e lik e w i s e
e s t a b l i s h e s p ro ced u res f o r ac c o u n tin g i n v e s t i g a t i o n s , re n d e rs
a d v is o r y o p in io n s i n h i g h ly t e c h n i c a l ac c o u n tin g q u e s tio n s t o
members o f t h e f i e l d f o r c e , and makes a c c o u n tin g b r i e f s f o r t h e
Commission in co n n e c tio n w ith t h e enforcem ent o f t h e v a r io u s
A cts.
The R esearch D iv is io n c o l l e c t s in f o r m a tio n b e a rin g on
c u r r e n t developm ents in t h e s e c u r i t i e s m ark ets and o bserves th e
f i n a n c i a l p o l i c i e s o f t h o s e c o r p o r a t i o n s which a r e under th e
j u r i s d i c t i o n o f t h e Commission.
I t m a in ta in s s t a t i s t i c a l and
a n a l y t i c a l in fo r m a tio n on t h e s e and o t h e r s u b j e c ts o f i n t e r e s t
to t h e Commission.
I t keeps r e c o r d s o f th e Commission's a c t i ­
v i t i e s and a d v is e s i t on m a t t e r s which f a l l w i t h i n i t s sco p e.
The Economic A dvisor i s ch arg ed w ith co n d u ctin g c e r t a i n
economic s t u d i e s f o r use by t h e Commission i n e s t a b l i s h i n g
g e n e r a l p o l i c i e s and r e n d e r in g a d v ic e r e g a rd in g t h e economic
a s p e c ts o f t h e S e c u r i t i e s Act o f 1933 and th e S e c u r i t i e s Exchange
Act o f 1934.
The S u p e r v is o r o f In fo r m a tio n R esearch i s a u n i t which
e x i s t s to comply w ith t h e law under which th e Commission o p e r a t e s .
This u n i t makes p u b lic t h e a c t i v i t i e s o f t h e Commission th ro u g h
p r e s s r e l e a s e s and m a ilin g l i s t s .
The R e g i s t r a t i o n D iv is io n i s r e s p o n s ib le f o r ex am ination o f
a l l r e g i s t r a t i o n s ta te m e n ts c o v e rin g p u b lic o f f e r i n g s o f s e c u r i t i e s
under t h e S e c u r i t i e s Act o f 1933, and th o s e c o v e rin g r e g i s t r a t i o n
o f s e c u r i t i e s under th e S e c u r i t i e s Exchange Act o f 1954,
I t is
■142—
a l s o r e s p o n s i b le f o r a l l r e p o r t s co n cern in g s e c u r i t y ownership
o f p r i n c i p l e sto c k h o ld e rs under b o th t h e S e c u r i t i e s Exchange
Act o f 1934 and th e P u b lic U t i l i t y H olding Company Act o f 1935.
I t h a n d le s n o t only i n i t i a l r e p o r t s , but p e r i o d i c r e p o r t s and
a l l i e d m a t e r i a l as w e l l ,
i t makes i n v e s t i g a t i o n s , conducts
h e a r in g s on s to p o rd e r p ro ceed in g s in m a t t e r s o f r e g i s t r a t i o n ,
and a f t e r t h e Commission has a c te d p r e p a r e s th e l e t t e r ' s o r d e r s .
Since June 9 , 1939, th e f u n c t i o n s o f t h e form er Forms and
R e g u la tio n s D iv is io n have been perform ed by a Forms and R e g u la tio n s
U n it under t h e R e g i s t r a t i o n D i v i s i o n .
This U nit subm its r u l e s ,
r e g u l a t i o n s , and forms t o t h e Commission.
I t conducts r e s e a r c h
f o r t h e development o f f a c t s , p o l i c i e s , and customs
o f th o s e i n ­
d u s t r i e s w hich a re t o be a f f e c t e d by i t s r u l e s , r e g u l a t i o n s , and
form s,
i t conducts c o n feren c es and in te rv ie w s w ith a c c o u n tin g
and l e g a l s o c i e t i e s , sto c k exchange o f f i c i a l s , and o t h e r s , t o
got o p in io n s on proposed form s, r u l e s , and r e g u l a t i o n s .
It
fu rth e rm o re p re p a re s l e g a l o p in io n s and i n t e r p r e t a t i o n s con cerning
t h o s e r u l e s and r e g u l a t i o n s .
This v/ork in v o lv e s th e p r e p a r a t i o n
o f r u l e s f o r sto ck exchanges, t h e f l o t a t i o n o f new s e c u r i t i e s ,
and t h e r e g i s t r a t i o n o f s e c u r i t i e s l i s t e d on e x c h a n re s.
The Employment Research D iv is io n concerns i t s e l f w ith a l l
p e rso n n e l m a tte r s f o r t h e Commission.
I t m a in ta in s p e r s o n n e l
r e c o r d s , in te rv ie w s a p p l i c a n t s , promotes and demotes and c l a s s i ­
f i e s work.
The F r o te o t i v e Study D iv is io n was formed to i n v e s t i g a t e
t h e o p e r a tio n o f p r o t e c t i v e com m ittees i n o o n n ectio n w ith
c o r p o r a te r e o r g a n i z a t i o n s .
This work v/as com pleted i n
J a n u a ry , 1936, and r e o o r t s to Congress were d r a f t e d on t h e sub12
je c t.
The K eo rg a n iz a tio n D iv is io n was e s t a b l i s h e d in Washington
and a l s o has u n i t s i n s e v e r a l r e g i o n a l o f f i c e s .
I t s purp ose i s
t o perform th e d u t i e s o f t h e Commission under C hapter X o f th e
Bankruptcy A ct.
bnder t h i s c h a p te r t h e Commission m ust, upon t h e
r e q u e s t o f th e ju d g e , o r may, upon i t s own i n i t i a t i v e , i f approved
1
by t h e ju d g e , appear i n any b an kru ptcy p ro ceed in g as a p a r t y i n
i n t e r e s t , and as such has a r i g h t t o be h eard i n a l l m a t t e r s which
may a r i s e .
I t a l s o f u n c tio n s i n an a d v is o r y c a p a c i t y w ith re g a rd
to re o rg a n iz a tio n p la n s.
I f t h e in d e b te d n e s s o f an i n s o l v e n t
firm in v o lv e s o v er ^ 3 ,0 0 0 ,0 0 0 , t h e jud ge must subrrdt any r e ­
o r g a n i z a t i o n p la n to th e Commission f o r e x a m in a tio n .
I f th e
in d e b te d n e s s i s l e s s th a n t h i s amount, t h e judge may do s o .
V/hen
t h e judge h a s s u b m i t t e d such a p la n t o t h e Commission, he must
n o t approve i t u n t i l t h e Commission has f i l e d i t s r e p o r t , un­
l e s s t h e l a t t e r g iv es n o t i f i c a t i o n t h a t i t w i l l n o t do s o , o r
p e r m its t h e tim e l i m i t s e t by t h e jud g e t o l a p s e ,
duch r e p o r t s
must be t r a n s m i t t e d t o c r e d i t o r s and s to c k h o ld e r s who a r e being
asked t o v ote on th e p la n ; t h e r e p o r t s a r e a d v is o r y i n c h a r a c t e r ,
and a r e designed t o re n d e r e x p e r t and i m p a r t i a l a s s i s t a n c e to
t h e c o u r ts and o t h e r s co n cern ed .
The R e o rg a n iz a tio n D iv is io n i s
12
i o r a com plete d e s c r i p t i o n o f t h e f u n c t io n s o f t h e v a r io u s
d i v i s i o n s see S .L .C ., 2nd A n nu al, k e p t . , P t . I , pp . 3 - 9 .
re s p o n sib le fo r th e drawing up and f i l i n g of th e se r e p o r ts , and
f o r a l l o t h e r d u t ie s o f th e Commission i n co n n e c tio n w ith t h e
15
Bankruptcy A ct, as d e s c rib e d above.
For th e e f f e c t i v e a d m i n i s t r a t i o n o f th e S e c u r i t i e s Act
o f 1953, t h e S e c u r i t i e s Exchange Act o f 1934, and t h e -Public
U t i l i t y Holding Company Act o f 1935, t e n r e g i o n a l o f f i c e s have
been e s t a b l i s h e d .
These s e rv e t h e g e n e r a l and i n v e s t i n g p u b lic
w i t h i n t h e zones o f t h e i r r e s p e c t i v e j u r i s d i c t i o n s .
They a ls o
a i d r e g i s t r a n t s and a c c o u n tin g , l e g a l and in v estm en t fir m s i n
complying w ith th e s e s t a t u t e s and r u l e s and r e g u l a t i o n s which
a re a d m in is te re d and en fo rced b / th e Commission.
; ach r e g i o n a l
o f f i c e i s su p e rv is e d by a r e g i o n a l a d m i n i s t r a t o r who i s r e s p o n s i b l e
f o r a l l a d m i n i s t r a t i o n , i n v e s t i g a t i o n , and enforcem ent o f a c t i v i 14
t i e s o f t h e Commission w i t h in h i s p a r t i c u l a r zone o f j u r i s d i c t i o n .
P ow er8 o f i n v e s t i g a t i o n an d p r o s e c u t i o n
As t h e lav/- p ro v id e s t h a t t h e Commission may a c t o n ly a f t e r
n o t i c e and o p p o r tu n ity f o r h e a r i n g , r u l e s have been fo rm u la te d
which a t once give o r d e r to th e p ro c e e d in g s and p ro v id e con­
s i d e r a b l e e l a s t i c i t y in p ro c e d u re ,
as c o n s i s t i n g o f two main ty p e s :
h e a r in g s may be th o u g h t o f
( l ) th o s e f o r t h e purpose o f
talcing ev id e n c e , and (2) th o se which weigh f a c t s and re n d e r
d e c is io n s .
The form er a r e e s s e n t i a l l y i n v e s t i g a t i o n s from ‘which
t h e a d v i s a b i l i t y o f f u r t h e r a c t i o n may be d eterm in e d .
13
o .i- .C ., 5 t h Annual KejJt., P t . 1, pp. 7 -2 1 .
14
b . ^ . C . , 2nd Annual. K ep t. , P t . X, pp . 9-10, and 5 t h Annu a l % e p t. ,
X ntrod. , p . 4 .
i
-145-
These i n v e s t i g a t i o n s ’nay be i n s t i t u t e d whenever t h e
Commission b e l i e v e s t h a t any s e c t io n o f t h e a c t o r i t s r u l e s
and r e g u l a t i o n s have been v i o l a t e d .
I t may r e q u i r e any p e r ­
son t o f i l e a s ta te m e n t i n w r i t i n g , under o a th o r o th e r w is e ,
co n cerning a l l f a c t s and circu m stan ces t o be i n v e s t i g a t e d .
I t may p u b lis h in fo rm a tio n con cerning v i o l a t i o n s , p r a c t i c e s ,
o r c o n d i ti o n s e x i s t i n g , a t i t s d i s c r e t i o n .
I t i s empowered,
th ro u g h i t s members o r t h e i r r e p r e s e n t a t i v e s , to subpoena
-w itn esses, compel t h e i r a tte n d a n c e , t a k e e v id e n c e , and r e q u i r e
any m a t e r i a l f o r purposes o f evidence from any p la c e i n t h e
U nited S t a t e s .
In th e ev en t o f r e f u s a l o f I n d iv i d u a l s to obey
a subpoena o f th e Commission, i t may invoke t h e a id o f any
c o u r t o f t h e U nited S t a t e s .
Such c o u rts may i s s u e an o r d e r
com pelling t h e i n d i v i d u a l t o comply and may p u n ish f a i l u r e
on grounds o f contem pt.
Any p erso n v/ho, w ith o u t cau se, f a i l s
t o produce d e s ir e d evidence o r t o t e s t i f y , i s c o n s id e re d g u i l t y
o f a misdemeanor and may be f in e d n o t mere th a n a thousand
d o l l a r s o r s e n t to p r is o n f o r a term o f n o t more th a n one y e a r ,
or b o th .
I n d iv i d u a l s who a r e com pelled to t e s t i f y a r e n o t p e r ­
m i t t e d t o be excused on t h e ground t h a t t h e i r te s tim o n y may
i n c r im i n a t e them.
They a r e exempted from p r o s e c u t i o n , hov/ever,
f o r t h a t which t h e y a r e com pelled to d iv u lg e a f t e r t h e y have
claim ed t h e i r p r i v i l e g e a g a i n s t s e l f - i n c r i m i n a t i o n .
This
exemption does n o t in c lu d e any a c t o f p e r j u r y v/hich th e y may
15
cojmrdt i n g iv in g te s tim o n y .
*
15,
S e c u ritie s Exchange Act, se c . 21, ( a ) , ( b ) , ( c ) , and ( d ) , pp. 3 2 f f ,
-146-
An i n v e s t i g a t i o n i s n o t a h e a r in g i n any p e r t i n e n t s e n s e ,
n o r i n any sen se an a d v e r s a r y p ro c e e d in g , b u t i s m erely a p r e ­
lim in a r y i n q u i r y by th e Commission,
F u rth erm o re, any o f f i c e r
o f t h e Commission who p r e s i d e s a t a p r e l im i n a r y h e a r in g i s m erely
an employee o f t h e Commission and any memorandum which he may
7hake t o t h e Commission i s p u r e ly a d v is o r y i n c h a r a c t e r and i n no
way binds t h e Commission.
A f te r such an ex am in atio n , a d e c i s io n
o f t h e Commission t h a t form al p ro ceed in g s a r e n e c e s s a r y , in v o lv e s
i n no Yfay a q u e s ti o n o f t h e m e r it s o f t h e c a se under c o n s i d e r a t i o n .
Such i n v e s t i g a t i o n s may be p r i v a t e l y co n du cted , t h e p a r t y in ­
v e s t i g a t e d may be r e p r e s e n t e d by c o u n s e l, i t may be a g reed t h a t
t e s tim o n y o f w i t n e s s e s , p r o p e r l y a d m itte d , i n t h e i n v e s t i g a t i o n
m ight be c o n s id e re d as evidence in su bsequent h e a r i n g s , and y e t
16
t h e i n v e s t i g a t i o n l e g a l l y m a in ta in s i t s p r e l im i n a r y c h a r a c t e r .
Any i n d i v i d u a l may ap p ear b e f o re t h e Commission on h i s
own b e h a l f , a member o f a p a r t n e r s h i p may r e p r e s e n t i t , and on
o f f i c e r o f a c o r p o r a t i o n , t r u s t , o r a s s o c i a t i o n may r e p r e s e n t
them.
L ik ew ise, an o f f i c e r o f a s t a t e commission, s t a t e d e p a r t ­
m ent, o r p o l i t i c a l s u b - d i v i s i o n o f any s t a t e may r e p r e s e n t h is
o r g a n i z a t i o n i n any p r o c e e d in g s .
I f a p erso n i s r e p r e s e n t e d by
a t t o r n e y , however, such a t t o r n e y must have been a d m itte d to
p r a c t i c e b e f o re t h e U nited S t a t e s Supreme C o u rt, t h e h i g h e s t
c o u r t o f any s t a t e o r t e r r i t o r y o f t h e United S t a t e s , th e Court
o f A p p eals, o r t h e U nited S t a t e s D i s t r i c t Court o f t h e D i s t r i c t o f
Columbia.
16
1 .3 .
Any p e rso n ap p e a rin g b e fo re t h e Commission i n a r e p r e C ., 574, (.White, Weltf, & Co., e t a l . ) . .
.
s e n t a t i v e c a p a c i ty may be r e q u i r e d to f i l e power o f a t t o r n e y w ith
it.
The Commission may d i s q u a l i f y anyone who i s found to be la c k ­
in g i n t h e n e c e s s a r y q u a l i f i c a t i o n s , la c k in g i n c h a r a c t e r o r in ­
t e g r i t y , o r t o have engaged i n u n e t h i c a l o r im proper p r o f e s s i o n a l
17
co n d u ct.
P r a c t i c e b e f o re t h e Commission i s c o n s tru e d t o cover
t h e p r e p a r a t i o n o f any s ta te m e n t by a t t o r n e y , e n g in e e r,
a c c o u n ta n t, o r o t h e r e x p e r t , f i l e d w ith th e Commission.
This
r u l e a p p l i e s t o t h e f i l i n g o f r e g i s t r a t i o n s ta te m e n ts a s w e l l
Id
as o t h e r documents.
N o tic e s o f h e a r in g s a re s e n t t o i n t e r e s t e d p a r t i e s which
s t a t e t h e tim e , p l a c e , and s u b j e c t m a t t e r o f t h e h e a r i n g , by
p e r s o n a l s e r v i c e , r e g i s t e r e d m a il, o r confirm ed t e l e g r a p h i c
n o tic e ,
N o tic e , under re q u ire m e n ts o f t h e Act (as under th o s e
o f due p r o c e s s ) has been c o n s tru e d by t h e Commission t o mean
t h a t t h e p e rso n a l l e g e d t o have v i o l a t e d a s t a t u t e be inform ed
t o t h a t deg ree which i s n e c e s s a r y t o e n a b le him t o p r e p a re a
defense.
I t does n o t r e q u i r e a d e t a i l e d s ta te m e n t, b u t u s u a l l y
19
fo llo w s t h e language o f t h e law.
17.
i'he term "im proper p r o f e s s i o n a l conduct" has been c o n s tru e d to
mean conduct im proper t o members o f th e b a r , "When t h e r u l e s
o f p r a o t i c e were amended i n 1938, t h i s term was i n t e r p r e t e d
i n t h e l i g h t o f t h e Canons o f P r o f e s s i o n a l E th ic s o f t h e American
Bar A s s o c i a t i o n . I t was s i m i l a r l y re g a rd e d by Mr. C h e ste r T. Lane
in 1939, when he had o c c a s io n to comment on i t . See S .E .C .,
k o le a s e No. 2066, under S ec. Exch. A ct, A p r il 5 , 1939.
18
a . i i . C . , Ilules o f P r a c t i c e as amended t o Dec. 1, 1939, p p . 1 -2 .
19
l o i d . , p p . 2—3, and 1 S.. E.. C, 2S8,
l o h a e l J . Hochfyi)
The Commission may i s s u e subpoenas f o r both p erso n s and
documentary e v id e n c e .
W itn esses s h a l l be e n t i t l e d t o f e e s equ al
t o t h o s e p a id by c o u r t s .
Except a s p ro v id e d by law, th e
Commission may ex ten d th e tim e l i m i t o f anv h e a r i n g , o r may
20
c o n tin u e o r a d jo u rn i t .
The Commission i s a p p a r e n t l y w i l l i n g to conduct h e a r in g s
i n any p a r t o f t h e U nited S t a t e s when t h e r e i s a bona f i d e
re a so n f o r doing s o , and t o g r a n t change o f venue when h a rd 21
3hip s a r e l i k e l y t o be worked upon i n d i v i d u a l s who must a t t e n d .
There i s e v id e n c e , however, t h a t i t would p r e f e r t o h e a r im­
p o r t a n t c a s e s i n "Washington, or i n some p la c e where i t i s e a s i l y
p o s s i b l e f o r members t o a t t e n d , e s p e c i a l l y when t h e s u b je c t
m a t t e r i s i m p o r ta n t, o r i f i t ap p ears t h a t a r e q u e s t f o r change
22
o f venue i s a ru se on t h e p a r t o f a l l e g e d v i o l a t o r s .
In t h e ev ent t h a t t h e Commission f e e l s t h a t a v i o l a t i o n
i s about t o be com m itted, i t may b r in g an a c t i o n in any U nited
S t a t e s F e d e ra l C ourt t o e n j o i n 3uch v i o l a t i o n s .
The Commission
may a l s o t r a n s m i t ev id en ce t o t h e A tto rn e y G en eral, who may
i n s t i t u t e c r i m i n a l p ro c e e d in g s a g a i n s t v i o l a t o r s .
S im ila rly ,
t h e Gommission may a p p ly t o any F e d e ra l c o u r t f o r a mandamus
ciC)
t o f o r c e com pliance w ith t h e p r o v is i o n s o f t h e A ct.
20
S . k . C . , iiu les o f P r a c t i c e , amended, pp. 4 - 5 .
21
l . S * E . C ., ‘ 5 6 o ; ( . C h a r l i s X . W r ig f tt, e t a l , ) .
.
22
1 S; E. C ,, 258. >
-
•
•
2 3 ..................
S e c u r i t i e s Exchange A c t, a « 0 . 21 (e ) and ( f ) , p . 34.
-I4S*R ig h t s o f a p p e a l t o t h e c o u r t s .
Aggrieved persons may o b t a i n a rev iew o f o r d e rs o f th e
Commission i n t h e C i r c u i t Court o f A p p eals, o r t h e Court o f
A ppeals o f t h e d i s t r i c t o f Columbia.
P e t i t i o n s must be sub­
m i t t e d w i t h i n s i x t y days a f t e r t h e i s s u a n c e o f t h e o rd e r i n
q u e s ti o n ,
llo o r d e r , however, may be c o n s id e re d by a c o u r t u n t i l
a f t e r p e t i t i o n has been made t c t h e Commission; and th e f in d in g s
o f t h e Commission con cern ing f a c t , i f su p p o rte d by s u b s t a n t i a l
e v id en ce, i s c o n s id e re d c o n c l u s iv e .
The f i n d in g s o f th e c o u r t
a r e c o n s id e re d f i n a l , u n le s s avipeal i s made t o t h e Supreme
24
Court o f th e U n ited S t a t e s .
E f f e c t o f t h e S e c u r i t i e s E x ch a n g e A o t on e x i s t i n g la w .
R igh ts and rem edies under t h e S e c u r i t i e s E x change
Act o f 1934 a r e i n a d d i t i o n t o th o s e which a r e a l r e a d y in
e x i s t e n c e i n law and e q u i t y .
This does n o t mean, however, t h a t
a p e rso n v/ho may b r in g a c t i o n under th o p r o v is i o n s o f th e Act
may r e c o v e r more t h a n t h o s e damanges which have o c c u rre d on
accou nt o f th e a c t o f which he has com plained.
The Act does
n o t m odify e x i s t i n g law r e g a r d in g r e l a t i o n s h i p s between members
o f exchanges and t h e exchange a u t h o r i t i e s i n t h e s e tt le m e n t o f
d i s p u t e s between members, o r an;/ p erso n who has agreed t o bind
h im s e lf to such a c t i o n .
N e i t h e r does i t change t h e b in d in g
e f f e c t o f t h e exchange a u t h o r i t i e s i n any d i s c i p l i n a r y a c t i o n
f o r v i o l a t i o n s o f r u l e s o f t h e exchanr-e, so long as th e r u le s
26
do n o t c o n f l i c t w i t h t h e p r o v is i o n s o f t h e A c t.
24
S e c u r i t i e s Exchange A ct, s<so. 25, (fi.) and ( b ) , pp. 36 f.
25
i b i d . , a e c . 20, (a ) and ^ b ), p . 37.
-150-
The S e c u r i t i e s Exohange Act, fu rtherm ore, i n v a li d a t e s a l l
o o n tra o ts between in d iv id u a ls whioh a r e made i n o o n f lio t w ith i t s
p r o v is io n s .
I t voids a l l r i g h t s o f in d iv id u a ls who have performed
under suoh o o n tra o ts and th o se who have i n t e r e s t s in such con­
t r a c t s , provided t h a t suoh i n t e r e s t was aoquired w ith a know­
ledge t h a t t h e c o n tr a c t was made i n v i o l a t i o n of th e Act.
It
does n o t, however, a f f e c t th e v a l i d i t y o f any loan o r extension
o f o r e d i t made e i t h e r b efo re o r subsequent to th e passage o f
t h e Act, u n le ss a t th e tim e a t whioh i t was made th e p a r t i e s
involved were aware t h a t t h e i r a c ts were in co n trav en tio n o f
th e law.
The Act cannot be co n stru ed as a defense a g a in s t th e
o o lle o tio n o f any d eb t whioh has been o o n tra o te d or aoquired
by any person i n good f a i t h and w ith o u t knowledge t h a t th e
p ro v isio n s o f th e Aot had been v i o l a t e d .
In connection, however,
w ith c o n tr a c ts made between b ro k ers and customers through th e
means o f d ecep tiv e or m an ip u lativ e o r fra u d u le n t devioes, or
a c t s , n o tio n s must be brought w ith in one year i f o o n tra o ts are
t o be v o i d e d . ^
Power t o p rev en t f l i g h t o f s e c u r i t i e s .
In o rd er t o give th e Commission power t o prevent th e f l i g h t
o f domestio s e c u r i t i e s from exchanges in th e United S t a t e s , th e
Aot provides t h a t i t i s unlawful f o r any b rok er or d e a le r to
use t h e m ails and i n s t r u m e n t a l i t i e s o f i n t e r s t a t e commeroe to
t r a n s a o t b u s in e s s in s e o u r i t i e s o f c o rp o ra tio n s whioh are
r e s i d e n t s o f t h e United S t a te s or a r e organized under th e laws
26
S e o u ritie s Exohange Aot, seo. 29, ( a ) , (b), and (o), pp. 37f.
-151-
o f t h e U nited S t a t e s i n any p la c e where t h e U n ited S t a t e s govern­
ment has j u r i s d i c t i o n , u n le s s i t i s done i n accord an ce v /ith t h e
p r o v is i o n s o f t h e S e c u r i t i e s
Exchange A ot.
. The
law does n o t
apply# however, to b u s in e s s i n s e c u r i t i e s w hich i s t r a n s a c t e d
e n t i r e l y o u t s i d e o f t h e U nited S t a t e s and n o t u sin g t h e i n s t r u m e n t a l ­
i t i e s o f i n t e r s t a t e commerce and t h e m a i l s .
Such b u s in e s s i s
s u b je c t o n ly t o such r u l e s and r e g u l a t i o n s as t h e Commission may
see f i t t o p r e s c r i b e t o p re v e n t ev asio n s o f t h e law.
This pro ­
v is i o n has s u c c e s s f u l l y p re v e n te d a f l i g h t o f s e c u r i t i e s to
exchanges o u t s i d e t h e U nited S t a t e s .
I t h as n o t been n e c e s s a r y
f o r t h e Commission t o f o rm u la te r u l e s and r e g u l a t i o n s t o cope
27
w ith t h e problem and a t t h e p r e s e n t tim e none e x i s t .
P e n a l t i e s u n d e r t h e S e o u r i t i e s E xo h an g e A o t.
The Act p ro v id e s f o r p e n a l t i e s which a r e s u f f i c i e n t l y
d r a s t i c t o make v i o l a t i o n s o f i t s p r o v is i o n s r a t h e r c o s t l y .
Any v i o l a t i o n o f t h e p r o v i s i o n s o f t h e Act or i t s r u l e s and
r e g u l a t i o n s , may be p u nish ed by a f i n e o f n o t more t h a n Tl0,000
o r im prisonm ent o f n o t more t h a n two y e a r s , o r b o th .
I f th e
p erso n in v o lv e d i s a s to c k exchange member, a f i n e may be im­
posed up t o ^ 5 0 0,00 0.
ho p e rso n , however, may be f in e d or
im prisoned i f he i s a b le t o pro ve t h a t he had no knowledge o f
th e re q u ire m e n ts o f t h e Act o r i t s r u l e s and r e g u l a t i o n s w ith
r e f e r e n c e t o t h e m a t t e r i n q u e s ti o n .
These p r o v is i o n s ap ply n o t
o n ly t o t h e r u l e s prom ulgated and t o t h e Act i t s e l f , b u t t o t h e
27
S e c u ritie s Exchange A ct, a e c . 30, (a ) and ( b ) , p . 33.
-1 5 2
—
f i l i n g o f in fo r m a tio n under t h e re q u ire m e n ts o f s e c t i o n 15
o f th e A ct.
F a ls e or m i s le a d in g s ta te m e n ts a re p u n ish e d in
t h e same manner as any o t h e r v i o l a t i o n and f a i l u r e t o f u r n i s h
in fo r m a tio n r e q u i r e d by s e c t i o n 14 (d) i s p e n a l i z e d by a f o r ­
f e i t u r e o f itlOO p e r day f o r e v e ry day d u rin g which r e q u ir e d
in fo r m a tio n i s n o t f i l e d .
These p r o v is i o n s a p p ly t o a l l
s e c t io n s o f t h e Act and i t s r u l e s and r e g u l a t i o n s , e x c e p t
s e c t i o n 15 (c ) (3 ) which a r e concerned w ith t h e f i n a n c i a l
r e s p o n s i b i l i t y o f o v e r - t h e - c o u n t e r b ro k e rs and d e a l e r s .
Here,
however, exemption does n o t extend to t h e use o f d e c e p tiv e
d ev ices and th e r u l e s d e s c r i b e d e c e p tiv e d e v ic e s i n such a way
t h a t t h e exemptions a r e n o t im p o rta n t from a p u b lic p o i n t o f view.
CHAPTER VI
REGULATION OF CREDIT
P r o v i s i o n s o f th e A c t r e g u l a t i n g c r e d i t e x t e n s i o n
W h ile c r e d i t i s n e c e s s a r y f o r m any o p e r a t i o n s i n t h e s e c u r i t y
m a r k e t s , i t s u n r e s t r a i n e d u s e m ay r e s u l t i n s e r i o u s d i s l o c a t i o n s
o f s e c u rity p ric e s .
S in c e in v e s t m e n t i n v o l v e s r e l a t i v e l y l i t t l e
u s e o f b o rro w e d f u n d s , c r e d i t te n d s t o b e u s e d i n a u g m e n tin g th e
p u r c h a s i n g pow er o f s p e c u l a t o r s i n b u l l i s h o p e r a t i o n s , w i t h t h e
r e s u l t t h a t p r i c e s a r e u n d u ly r a i s e d .
On th e o t h e r h a n d , when
s p e c u l a t o r s o v e r - e x t e n d th e m s e lv e s , t h e r e s u l t may b e a c o l l a p s e
o f t h e m a rk e t d u e to f o r c e d l i q u i d a t i o n .
To c o p e w i t h t h i s s i t u a ­
tio n ,
t h e f r a m e r s o f th e S e c u r i t i e s E x ch an g e A ct o f 1 9 3 4 i n s e r t e d
1
s p e c if i c p r o v is io n s r e g a rd in g th e e x te n s io n o f c r e d i t .
Among o t h e r t h i n g s , t h e s e p r o v i s i o n s p r e s c r i b e m a rg in r e ­
q u ir e m e n ts w h ic h a r e r e g u l a t e d b y th e S o a r d o f G o v e rn o rs o f t h e
F e d e r a l R e s e rv e S y stem a l t h o u g h th e S e c u r i t i e s a n d E x ch an g e Com­
m i s s i o n i s c h a r g e d w i t h t h e a c t u a l e n f o r c e m e n t o f t h e B o a r d 's
re g u la tio n s .
The A c t c o n t a i n s a s ta t e m e n t o f th e b a s i s o n w h ic h
2
th e B o a rd i s
su p p o se d to b a s e i t s c a l c u l a t i o n s . A c c o r d in g t o
s e c t i o n 7 ( a ) o f th e A c t, c r e d i t c a n b e e x t e n d e d o n s e c u r i t i e s
i n a n am ount n o t g r e a t e r t h a n :
1 , 56 p e r ce n tu m o f th e c u r r e n t m a r k e t p r i c e o f th e
s e c u rity , o r
1
7 3 r d C o n g ., P u b l i c . f la .2 2 1 , £ . £ • 3 3 2 2 , S e c u r itiB H B u c h a n A f i l
o f 1 5 3 4 , a s am ended t o J u n e 3 5 , 1 9 3 8 , s e c . 7 a n d 8 , p p . 7 - 1 0 .
2
3he B o a rd o f G o v e rn o rs h a s m o d i f ie d t h e s e r e q u i r e m e n t s to s u i t
t h e c o n d i t i o n o f th e m a r k e t s .
F u r th e r m o r e , t h e e x c h a n g e s o r member
f i r m s m ay r e q u i r e c a s h a d v a n c e s i n e x c e s s o f t h e s e r e q u ir e m e n t s i f
t h e y w is h to do s o .
2 . 100 p e r c en tu m o f th e lo w e s t m a r k e t p r i c e o f t h e s e c u r i t y
d u r i n g t h e p r e c e d i n g t h i r t y - s i x c a l e n d a r m o n th s , h u t n o t
m ore th e n 7 5 p e r ce n tu m o f t h e c u r r e n t m a rk e t p r i c e .
T h ese p r o v i s i o n s a r e m ade f o r t h e p u r p o s e o f m a k in g i t p o s s i b l e
t o e x t e n d c r e d i t when s e c u r i t i e s a r e low an d c u r t a i l i n g i t when
th e y advance i n p r ic e .
When a s e c u r i t y i s a t i t s
l o w e s t m a rk e t
p r i c e , t h e e x t e n s i o n m ig h t b e 100 p e r c e n t , e x c e p t f o r th e p r o ­
v i s i o n t h a t c r e d i t may n o t b e e x te n d e d b e y o n d 75 p e r c e n t o f th e
c u r r e n t m a rk e t p r i c e .
As t h e s t o c k g o e s u p , 100 p e r c e n t o f th e
lo w e s t ip a r k e t p r i c e b eco m es l e s s t h a n 55 p e r c e n t o f th e c u r r e n t
m a rk e t p r i c e .
F o r e x a m p le , a s t o c k s e l l i n g a t 60 w h ic h h a s h a d a
low o f 20 w i t h i n t h e t h i r t y - s i x p r e c e d i n g c a l e n d a r m o n th s , w ould
b e s u b j e c t to a c r e d i t e x t e n s i o n o f o n ly tw e n ty d o l l a r s u n d e r
p r o v i s i o n 2 , b u t m ig h t r e c e i v e a n e x t e n s i o n o f t h i r t y t h r e e
d o ll a r s u n d er p ro v is io n 1.
As e i t h e r p r o v i s i o n m ay b e u s e d , p r o ­
v i s i o n 1 w m ild g o v e r n w hen a g i v e n s t o c k h a d r e a c h e d a h e i g h t
s u f f i c i e n t to r e n d e r i t s u s e m ore a d v a n ta g e o u s to th e p e r s o n
s e e k in g c r e d i t .
By t h i s m ean s th e maximum c r e d i t e x te n d e d a t
p e e k s o f th e m a rk e t i s l i m i t e d to 5 5 p e r c e n t , w h ile when th e
m a r k e t i s m a k in g lo w s , i t may b e i n c r e a s e d t o 75 p e r c e n t .
It
s h o u ld b e n o te d t h a t t h e s e p r o v i s i o n s a r e g u i d i n g p r i n c i p l e s s e t
f o r t h f o r th e b e n e f i t o f th e B o a rd o f G o v e rn o rs r a t h e r t h a n r i g i d
r e q u i r e m e n t s w h ic h m u s t be c a r e f u l l y a d h e r e d t o .
S e c tio n 7 (b )
s t a t e s t h a t , " N o t w i th s ta n d i n g t h e p r o v i s i o n s o f s u b s e c t i o n
o f th is s e c tio n ,
th e B o ard o f
(a)
-1 5 5 -
G o v e rn o rs o f t h e F e d e r a l R e s e r v e S y s te m , m ay, fro m tim e t o t i m e ,
w ith r e s p e c t to a l l o r s p e c if ie d s e c u r i t i e s o r tr a n s a c tio n s , o r
c l a s s e s o f s e c u r i t i e s , o r c la s s e s o f t r a n s a c t i o n s by su ch r u l e s
an d r e g u l a t i o n s (1 ) p r e s c r i b e s u c h lo w e r m a rg in r e q u i r e m e n t s f o r
t h e i n i t i a l e x t e n s i o n o r m a in te n a n c e o f c r e d i t a s i t deem s n e c e s ­
s a r y o r a p p r o p r i a t e f o r t h e acco m m o d a tio n o f com m erce an d i n d u s ­
t r y , h a v in g d u e r e g a r d t o t h e g e n e r a l c r e d i t s i t u a t i o n i n t h e
c o u n t r y , a n d (2 ) p r e s c r i b e s u c h h i g h e r m a rg in r e q u i r e m e n t s f o r
t h e i n i t i a l e x t e n s i o n o r m a in te n a n c e o f c r e d i t a s i t may deem
n e c e s s a i y o r a p p r o p r i a t e to p r e v e n t t h e e x c e s s i v e u s e o f c r e d i t
to fin a n c e tr a n s a c tio n s in s e c u r i t i e s ."
C o n t r o l o v e r c r e d i t g o e s much f a r t h e r t h a n a m ere p r e s c r i b ­
i n g o f m a rg in r e q u i r e m e n t s .
The A c t p r o v i d e s f o r a c a r e f u l r e g u ­
l a t i o n o f a l l i m p o r t a n t c r e d i t t r a n s a c t i o n s a n d m akes i t u n la w f u l
f o r b ro k e rs an d d e a le r s to o p e ra te e x c e p t i n a c c o rd a n c e w ith i t s
r u l e s an d th o s e p r o m u lg a te d by t h e F e d e r a l R e s e r v e B o a rd o f Gov­
e rn o rs.
R u le s c o v e r o p e r a t i o n s n o t o n l y b e tw e e n b r o k e r s a n d c u s ­
t o m e r s , b u t b e tw e e n b r o k e r s a n d b e tw e e n b r o k e r s a n d b a n k s a s w e l l .
T h ese r u l e s a r e b a s e d upon p r o v i s i o n s o f t h e A ct w h ic h g iv e
t h e F e d e r a l R e s e rv e B o ard o f G o v e rn o rs an d t h e S e c u r i t i e s an d Ex­
ch a n g e C om m ission w id e s u p e r v i s i o n o v e r t h e u s e o f c r e d i t i n s e ­
c u rity tra n s a c tio n s .
I t i s now u n la w f u l f o r a m em ber, b r o k e r , o r
d e a l e r t o b o rro w , i n t h e o r d i n a r y c o u r s e o f h i s b u s i n e s s , o n an y
s e c u r i t y w h ic h i s r e g i s t e r e d on a n a t i o n a l s e c u r i t y e x c h a n g e (u n ­
l e s s t h e s e c u r i t y i s ex em p ted ) fro m an y b a n k w h ic h i s n o t a member
-15G -
o f t h e F e d e r a l R e s e r v e S y s te m , u n l e s s s u c h b a n k h a s f i l e d a n
a g r e e m e n t w h e re b y i t a g r e e s t o co m p ly w i t h th o s e p r o v i s i o n s
o f t h e B a n k in g A ct o f 1933 an d t h o s e o f t h e am ended F e d e r a l
R e s e r v e A ct w h ic h a r e a p p l i c a b l e t o member b a n k s , a n d w h ic h
r e l a t e to th e e x te n sio n o f c r e d i t f o r p u rp o se s o f fin a n c in g
s e c u r i t i e s , an d t o o p e r a t e a c c o r d in g t o w h a te v e r r u l e s an d
r e g u l a t i o n s may be p r e s c r i b e d b y t h e B o a rd o f G o v e r n o r s .
It
i s l i k e w i s e u n la w f u l f o r b r o k e r s o r d e a l e r s t o b o rro w fro m
e a c h o t h e r e x c e p t i n a c c o r d a n c e w i t h r u l e s p r o m u lg a te d by t h e
F e d e r a l. R e s e r v e B o ard o f G o v e rn o rs i n o r d e r t h a t e m erg en cy
n e e d s may be m e t.
F u r th e r m o r e , b r o k e r s a n d d e a l e r s m u st n o t
p e r m i t t h e i r t o t a l in d e b te d n e s s t o e x c e e d l i m i t s w h ic h t h e S e ­
c u r i t i e s a n d E xchange C om m ission may f i x a n d i n no c a s e m u s t
t h e i n d e b t e d n e s s e x c e e d 2 ,0 0 0 p e r c e n t o f t h e i r n e t c a p i t a l .
I n t h e c o m p u ta tio n o f t h i s p e r c e n t a g e , i n d e b t e d n e s s o n exemp­
t e d s e c u r i t i e s i s e x c lu d e d ,
b u t f i x e d a s s e t s and th e v a lu e o f
e x c h a n g e m e m b e rsh ip s a r e e x c lu d e d a s a s s e t s .
In d e b te d n e s s to
c u s to m e r s i n t h e fo rm o f c r e d i t b a l a n c e s a r e c o u n t e d a s a p a r t
2
o f in d e b te d n e s s .
T h e re i s a l s o a p r o v i s i o n t o c o r r e c t a b u s e s w h ic h h ad p r e ­
v i o u s l y e x i s t e d i n c o n n e c tio n w ith t h e u s e o f c u s to m e rs * s e c u r ­
i t i e s b y b r o k e r s an d d e a l e r s t o h y p o t h e c a t e o r a r r a n g e f o r t h e
h y p o t h e c a t i o n o f an y s e c u r i t i e s c a r r i e d f o r t h e a c c o u n t o f a
c u s to m e r i n s u c h a way t h a t t h e s e c u r i t i e s w i l l becom e com -
2
S e c u r itie s Exchange Act as amended, s e c . 8 (a) and (b)
-II; 7 -
m in g le d w i t h t h e s e c u r i t i e s o f o t h e r s w i t h o u t h i s w r i t t e n c o n ­
s e n t , o r t h a t t h e y w i l l be s u b j e c t e d t o a n y l i e n o r c l a im on
t h e p a r t o f a p le d g e e f o r t h e sum g r e a t e r t h a n t h e i n d e b t e d 3
n e s s o f t h e c u s to m e r t o t h e b r o k e r o r d e a l e r .
W h ile t h i s p r o ­
v i s i o n i s s u b j e c t to s u c h r u l e s an d r e g u l a t i o n s a s t h e Commis­
s i o n may p r e s c r i b e , no r u l e s an d r e g u l a t i o n s h av e a s y e t a p ­
p e a re d on th e s u b je c t.
The po w er t o f o r m u l a t e r u l e s on t h e p a r t o f b o th t h e Com­
m i s s io n a n d t h e B o a rd o f G o v e rn o rs o f t h e F e d e r a l R e s e r v e S y s­
te m , i s d e r i v e d fro m s e c t i o n 23 (a ) o f t h e S e c u r i t i e s E x ch an g e
A c t, w h ic h s t a t e s t h a t , "The C om m ission an d t h e B o ard o f G o v er­
n o r s o f t h e F e d e r a l R e s e r v e S y stem s h a l l e a c h h a v e p o w er t o make
s u c h r u l e s a n d r e g u l a t i o n s a s may b e n e c e s s a r y f o r t h e e x e c u t i o n
o f t h e f u n c t i o n s v e s t e d i n them by t h i s t i t l e ,
p u rp o s e c l a s s i f y i s s u e r s ,
an d may f o r s u c h
s e c u r i t i e s , e x c h a n g e s , an d o t h e r p e r ­
s o n s o r m a t t e r s w i t h i n t h e i r r e s p e c t i v e j u r i s d i c t i o n s . 11
I n m at­
t e r s r e l a t i n g t o t h e e x t e n s i o n o f c r e d i t , t h e C om m ission h a s b e e n
c o m p a r a ti v e ly i n a c t i v e .
I t h a s f o r m u l a t e d no r u l e s on t h e s u b j e c t
b ey o n d th o s e n e c e s s a r y t o p e r m i t s e c u r i t i e s w h ic h a r e ex e m p te d o r
w h ic h a r e t r a d e d i n o n ex em p ted e x c h a n g e s t o r e c e i v e c o n s i d e r a t i o n
fro m a c r e d i t s t a n d p o i n t , t h e same a s t h a t w h ic h a c c r u e s t o s e c u r i -
4
t i e s w h ic h a r e r e g u l a r l y t r a d e d i n o n n a t i o n a l s e c u r i t i e s e x c h a n g e s .
3
S e c u r i t i e s E xch an g e A c t . . s a c . 8 ( c ) a n d ( d ) .
4
S . E . C . , G e n e r a l R u le s an d R e g u l a t i o n s u n d e r t h e S e c u r i t i e s E x ch an g e
A c t o f 193-4* a s am ended t o F e b . -15,. -1940,r u l e X -7 C 2 -1 , p . 7 0 l . ■'-•
158I t I s th r o u g h R e g u l a ti o n s "T ” a n d •■U8 , w h ic h h a v e h e e n p r o m u lg a te d
b y t h e F e d e r a l B e s e rv e B o a rd o f G o v e rn o rs ,
t h a t th e d e t a i l s o f
5
c r e d i t c o n t r o l i n th e s e c u r i t y b u s i n e s s a r e e s t a b l i s h e d *
A n a ly s is o f
B e g u l a t i o n " T " , w h ic h iB i s s u e d w i t h p a r t i c u l a r r e f e r e n c e
t o s e c t i o n s 7 an d 8 ( a ) o f th e S e c u r i t i e s E x ch an g e A c t, f o r m u l a t e s
r u l e s w h ic h g iv e p r e c i s i o n to
th e o p e r a t i o n o f th e c r e d i t m ech an ism
w i t h r e l a t i o n to s e c u r i t y t r a n s a c t i o n s .
B ro k e ra g e a c c o u n t s w i t h
c u s to m e r s a r e d i v i d e d i n t o two t y p e s , g e n e r a l a n d s p e c i a l , f o r
p u rp o ses o f r e g u la tio n .
The g e n e r a l a c c o u n t c o n s i s t s o f a l l f i n ­
a n c i a l r e l a t i o n s b e tw e e n c r e d i t o r s an d c u s to m e r s
w h ic h a r e n o t
6
s u b j e c t t o th e r e g u l a t i o n s f o r s p e c i a l a c c o u n t s .
5
B o a rd o f G o v e rn o rs o f th e F e d e r a l B e s e rv e S y stem , E x te n s io n a n d
M a in te n a n c e o f C r e d i t b y B r o k e r s . D e a l e r s , a n d M embers o f t h e Na­
t i o n a l S e c u r i t i e s E x c h a n g e s . R eg u latio n "JE * a s am ended to M ay,2 2 ,
1939.
B B g u la tio n “ T* f i r s t becam e e f f e c t i v e on O c t. 1 , 1 9 3 4 ;
i t a p p e a r e d I n i t s o r i g i n a l fo ira i n t h e F e d e r a l B e s e rv e B u l l e t i n
o f t h a t m o n th , t o g e t h e r w i t h i n t e r p r e t a t i o n s o f c e r t a i n r u l i n g s .
S u b s e q u e n t r u l i n g s u n d e r t h e B B g u la tio n m ade b y th e F e d e r a l B e s e rv e
B o a rd w e re i n c o r p o r a t e d i n t h e r e v i s e d B e g u l a ti o n o f J a n . , 1938 an d
i n th e S u p p lem en t t o B e g u l a ti o n *T ", i s s u e d a t t h a t tim e . ( S e e F ed .
R e s . B u l l . , F e b . 1 9 3 8 , p p .8 7 f f . ) Beo am endm ents h a v e s i n c e b e e n
m ade t o t h e r e v i s e d B e g u l a ti o n - th e f i r s t becam e e f f e c t i v e on M arch
2 1 , 1 9 3 8 , ( s e e F e d . B e s . B u l l . , A p r. 1 9 3 8 , p . 2 6 0 ) , an d t h e s e c o n d
o n May 2 2 , 1939 (F e d . B es. B u l l . , A p r. 1 9 3 9 , p . 2 5 3 ) .
B o a rd o f G o v e rn o rs o f t h e F e d e r a l R e s e r v e S y ste m , L o an s b y B anks
f o r th e P u r p o s e o f P u r c h a s in g o r C a r r y in g S to c k s R e g i s t e r e d on a
N a t i o n a l S e c u r i t i e s E x c h a n g e . R e g u l a t i o n "U ", a s am ended to S e p t. 1 ,
1937.
R e g u l a t i o n "tJ* becam e e f f e c t i v e on May 1 ,1 9 3 6 ; i t m ay b e
f o u n d i n i t s o r i g i n a l fo im i n th e F e d . B e*. B u l l , f o r A p r i l o f t h a t
y e a r ( p p .2 5 -2 5 3 ).
The B e g u l a ti o n w as am en d ed a s o f J u l y 1 , 1936
( s e e F e d . B es. B u l l . , J u l y 1 9 3 6 , p . 5 5 0 ) , a n d a g a i n a s o f S e p t . l ,
1 9 3 7 ( F e d . B es. B u l l . Nov. 1 9 3 7 , p . 1 0 7 5 ).
6
" C r e d i t o r 8 i s d e f i n e d a s m e a n in g a n y m em ber o f a n a t i o n a l s e c u r i t i e s
e x c h a n g e o r a n y b r o k e r o r d e a l e r who t r a n s a c t s b u s i n e s s i n s e c u r i t i e s
th r o u g h th e medium o f a n y s u c h member - F e d . B e s . B o a rd , R e g u l a t i o n
"T ". sec. 2, p .l.
-1 6 9 -
The g e n e r a l r u le p r o v id e s t h a t no c r e d it o r may e f f e c t a
tr a n s a c t io n w ith any custom er in a g e n e ra l a cco u n t w hich in
com bin ation w ith o th er tr a n s a c tio n s e f f e c t e d on th e same day,
b rin g h i s (th e c u sto m e r 's) a d ju ste d b a la n ce in e x c e s s o f th e
maximum lo a n v a lu e o f th e s e c u r i t i e s in h i s a c c o u n t, or w hich
in c r e a s e s an e x i s t i n g e x c e s s , u n le s s a d e p o s it o f e it h e r cash
or s e c u r i t i e s i s r e c e iv e d a s soon a s p o s s ib le ( a t m ost no lo n g ­
e r th an th r e e b u s in e s s days) w hich vri.ll eq u a l or ex ceed th e e x 7
i s t i n g e x c e s s . S im ila r ly , w ithdraw al o f cash or s e c u r i t i e s may
ta k e p la c e o n ly when no d e p o s it i s n e c e s s a r y due t o t r a n s a c t io n s
o f a p r e ce d in g day, or when such w ithdraw al d oes n o t c r e a te a
d e b it b a la n c e w hich i s in e x c e s s o f th e maximum lo a n v a lu e o f
S
th e rem ainin g s e c u r i t i e s . In th e ev en t t h a t th e r e q u ir e d de­
p o s i t i s n o t r e c e iv e d w ith in th e th r e e day p e r io d s p e c i f i e d ,
s e c u r i t i e s must be s o ld or o th er liq u id a t in g t r a n s a c tio n s e f ­
f e c t e d b e fo r e th e e x p ir a tio n o f t h i s p e r io d , t o an e x te n t w hich
7
In d eterm in in g w hether or n o t an e x c e s s o f d e b it b a la n ce e x i s t s
over th e lo a n v a lu e o f s e c u r i t i e s , com nutations are made on a
b a s is o f a l l tr a n s a c t io n s e f f e c t e d on th e g iv e n d a y , e x c lu s iv e
o f any d e p o s it o f cash or s e c u r i t i e s , c o v e r in g tr a n s a c t io n or
liq u id a t io n which has tak en p la c e a s a r e s u l t o f o p e r a tio n s on
a p r e v io u s day.
The amount t o be in c lu d e d in th e a d ju ste d d e b it b a la n ce o f a
g e n e r a l a cco u n t a s margin req u ired on a lo n g commitment o f un­
is s u e d s e c u r i t i e s must be th e cu r re n t market v a lu e o f the un­
is s u e d s e c u r i t i e s , l e s s th e maximum lo a n v a lu e v/hich th e y would
have i f th e y w ere is s u e d and h eld i n th e a c c o u n t. The amount
re q u ir e d f o r a s h o r t commitment must be t h a t margin which would
be r eq u ir ed i f t h e y were is s u e d and s o ld sh o r t i n th e a c co u n t.
No margin i s r e q u ir e d f o r a sh o r t commitment in u n issu e d s e ­
c u r i t i e s , how ever, i f s e c u r i t i e s are h e ld in th e a cco u n t on a
b a s is o f w hich th e u n issu e d s e c u r i t i e s are to be is s u e d .
g
R egulation 11T11, sec. 3, (a) and (b ) , p . 2 ,
-ItiO -
com pensates f o r th e r e q u ir e d d e p o s it .
There a r e tim e s , how ever,
■when a r e g u l a r l y c o n s ti t u t e d com m ittee o f a n a tio n a l s e c u r i t i e s
exch an ge, which has j u r i s d i c t i o n over th e b u s in e s s condu ct o f i t s
members, may, upon a p p lic a t io n , exten d th e p e r io d d u rin g v/hich
th e r e q u ir e d d e p o s it may be made, provided t h a t i t i s convinced
9
t h a t th e c irc u m sta n c es are e x c e p t io n a l.
Maximum lo a n v a lu e in a g e n e r a l accou n t i s d e sc r ib e d a s th e
sum o f th e maximum lo a n v a lu e s o f th e in d iv id u a l s e c u r i t i e s i n
th e a c c o u n t, in c lu d in g s e c u r i t i e s w hich have been bought bu t
w hich have n o t y e t been d e b ite d t o th e a c co u n t, b u t e x c lu d in g
s e c u r i t i e s v/hich have been s o ld fo r th e a c c o u n t, and u n issu e d
s e c u r itie s .
The maximum lo a n v a lu e o f th e in d iv id u a l s e c u r i­
t i e s , b u t fo r a few e x c e p tio n s to be noted l a t e r , i s p r e sc r ib e d
by th e Board o f G overnors.
No c o l l a t e r a l o th e r than r e g is t e r e d
s e c u r i t i e s or exempted s e c u r i t i e s h a s any lo a n v a lu e in a g e n e r a l
a c co u n t.
W arrants or r ig h t s to su b sc r ib e to s e c u r i t i e s e x p ir in g
w ith in n in e t y days have no lo a n v a lu e in a g e n e r a l accou n t u n le s s
th e y a r e accom panied by th e s e c u r i t i e s which have been th e b a s is
o f th e is s u e o f such w arran ts and r i g h t s , t h e i r v a lu e may be add­
ed t o th e c u r re n t v a lu e o f th e s e c u r i t i e s f o r p u rp oses o f c a l c u l ­
a t in g maximum lo a n v a lu e .
In c a lc u la t in g th e cu r re n t market v a lu e
o f a s e c u r it y on v/hich c r e d it i s t o be e x ten d ed , th e c r e d it o r must
u se th e t o t a l c o s t or -the n e t p ro ceed s o f s a l e , a s th e c a s e may be$
or i f no pu rchase or s a le i s in v o lv e d , i t i s p e r m is s ib le t o u se th e
c lo s in g p r ic e o f th e p reced in g day as p u b lish e d in a r e l i a b l e quo­
ta tio n s e r v ic e .
9
In th e absence o f a q u o ta tio n o f t h i s k in d , i t i s
I t sh o u ld be n o te d t h a t th e exchanges have ad o p ted r u l e s to p re ­
v e n t " f r e e r id in g " v/hich supplem ent th e r u l e s prom ulgated by th e
F e d e ra l R eserve B o a rd -see S .E .C , 3rd Annual R e p o rt, p . 6 9 .
-16 Im­
p e r m is s ib le t o u s e "any r ea so n a b le e stim a te o f th e market v a lu e
10
o f such s e c u r it y . . . "
T h e 'h d u jste d d e b it b a la n ce" , v/hich i s used f o r th e c a lc u ­
l a t i o n o f c r e d i t f o r th e g e n e ra l a c co u n t, i s c a r e f u l l y d e s c r i­
bed w ith a view t o th e e x c lu s io n o f a l l ite m s w hich do n o t pro­
p e r ly form a b a s i s fo r th e e x te n s io n o f c r e d i t .
The " a d ju sted
d e b it balance" i s computed by adding t o th e n e t d e b it b a la n c e ,
i f any, in th e a c c o u n t, (1 ) th e t o t a l c o s t o f any s e c u r i t i e s
v/hich have been bought (o th e r th a n exempted s e c u r i t i e s ) and v/hich
have n ot a t th e tim e of c a lc u la t io n been d e b ite d t o th e a c c o u n t,
(2 ) th e market v a lu e o f any s e c u r i t i e s so ld sh o r t p lu s such am­
ou n ts a s th e Board p r e s c r ib e s from tim e t o tim e a s m argin f o r
s h o r t s a le s ( t h i s l a t t e r need not be in c lu d e d i f s e c u r i t i e s are
h e ld in th e a cco u n t v/hich a re exch angeable or c o n v e r t ib le in t o
th e s e c u r i t i e s v/hich have been s o ld s ; o r t ) , (3 ) th e s p e c if ie d
amount o f margin f o r a l l u n issu e d s e c u r i t i e s h e ld i n th e a c co u n t,
p lu s a l l r e a li z e d l o s s e s and minus a l l u n r e a liz e d p a in s (n o t e x ­
c eed in g th e r e q u ir e d margin) on each commitment in u n l is t e d se ­
c u r i t i e s , (/+) th e amount o f margin r eq u ir ed by th e c r e d it o r in
c o n n e c tio n vrith any p u t, c a l l , o p tio n , endorsem ent, or guaran­
te e .
From t h i s i s su b tr a c te d any n e t c r e d it b a la n ce v/hich may
e x i s t and th e n e t p roceed s o f any s a le a s s e c u r i t i e s v/hich has
taken p la c e and f o r which th e account has n o t been c r e d it e d .
T h is method o f c a lc u la t io n ten d s to e lim in a te elem en ts i n th e
e x te n s io n o f c r e d i t v/hich have no r e a l c o l l a t e r a l v a lu e , and
11
t o fo r c e u n ifo r m ity in c a lc u la t io n s f o r c r e d it e x t e n s io n s .
10
R e g u la tio n "T'j s e c . 3 ( c ) , p . 3 .
11
I b i d . , sec . 3
( d ) , pp. 3 r 4 .
•
-1 6 2 S p e c i a l a c c o u n t s a r e c l a s s i f i e d a s f o ll o w s !
S p e c i a l o m n ib u s
a c c o u n ts , s p e c ia l c a s h a c c o u n ts , s p e c ia l a r b it r a g e a c c o u n ts , s p e c ia l
co m m o d ity a c c o u n t s , a n d s p e c i a l m i s c e l l a n e o u s a c c o u n t s .
E ach s p e c ia l
a c c o u n t m u s t he r e c o r d e d s e p a r a t e l y a n d m u s t h e c o n f i n e d to s u c h
o p e r a tio n s a s a r e p r e s c r ib e d f o r e a c h p a r t i c u l a r ty p e .
The s p e c i a l o m n ib u s a c c o u n t 1 b a n a c c o u n t i n w h ic h t h e c u s to m e r
i s a b r o k e r o r d e a l e r r a t h e r th a n a m ember o f t h e p u b l i c .
The c u s to m e r
m u s t s u b m it a s i g n e d s t a t e m e n t t o th e e f f e c t t h a t h e i s e i t h e r su b ­
j e c t t o t h e p r o v i s i o n s o f E e g u l a t i o n "T” o r t h a t he h a s o f f i c e s o n ly
in fo re ig n c o u n trie s .
A d u p l i c a t e o f t h i s s t a t e m e n t m u st b e f i l e d
w i t h th e s e c u r i t i e s e x c h a n g e o f w h ic h th e c a r r i e r o f t h e a c c o u n t
i s a m em ber.
I n a n a c c o u n t o f t h i s ty p e no s e c u r i t i e s h a v e a l o a n
v a l u e , a n d no s h o r t s a l e s c a n b e made e x c e p t u p o n a s ig n e d s ta t e m e n t
o f t h e c u s to m e r t h a t h e h a d e n t e r e d I n t o I d e n t i c a l co m m itm en ts w i t h
h i s c u s to m e r s .
The l o a n v a l u e s on s e c u r i t i e s u n d e r s u c h c irc u m ­
s t a n c e s a r e s u b j e c t t o s p e c i a l p r e s c r i p t i o n b y t h e B o a rd , a s a r e
l i k e w i s e t h e m a r g in s f o r s h o r t s a l e s .
T h ese l o a n v a l u e s a r e sam e-
12
w h a t h i ^ i e r th a n i n th e c a s e o f th e g e n e r a l a c c o u n t.
some l e n i e n c y i s
F u r th e r m o r e ,
shown i n th e c a s e o f s p e c i a l o m n ib u s a c c o u n t s ,
w h ic h i 8 n o t e v i d e n t i n t h a t o f g e n e r a l a c c o u n t s .
I f t h e maxtnrnm
l o a n v a l u e o f s e c u r i t i e s h e l d i n a s p e c i a l o m n ib u s a c c o u n t i s
e q u a l t o , o r g r e a t e r th a n , i t s
a d j u s t e d d e b i t b a l a n c e on a n y one
o f th e t h r e e d a y s ( d u r i n g w h ich a d e f i c i e n c y m u s t b e m ade u p i n
t h e c a s e o f a g e n e r a l a c c o u n t) l i q u i d a t i o n o r c o v e r i n g t r a n s a c t i o n
n e e d n o t ta k e p l a c e .
18
F e d e r a l B s s e r v e B o a rd , S u p p le m e n t to B e g u l a tl o n
J a n u a ry 1 , 1936.
e ffe c tiv e
-1 6 3 L ikew ise, th e req u irem en ts concerning th e w ithdraw al o f cash or
s e c u r i t i s e , w h ic h a r e fo u n d i n c o n n e c tio n w i t h g e n e r a l a c c o u n t s ,
13
do n o t o p e r a t e w i t h r e f e r e n c e to s p e c i a l om nibus a c c o u n t s .
The s p e c i a l c a s h a c c o u n t i s c l a s s i f i e d a n d r e g u l a t e d w ith a
v ie w t o s e g r e g a t i n g t r a n s a c t i o n s w h ic h a r e e s s e n t i a l l y f o r c a s h
fro m t h o s e w h ic h o p e r a t e on a b a s i s o f c r e d i t .
th e s e a c c o u n ts ,
I n th e c a s e o f
th e c r e d i t o r m ay s e l l a n y s e c u r i t y f o r a n y c u s ­
to m e r , p r o v id e d t h a t t h e s e c u r i t y i s h e l d i n t h e c u s t o m e r 's
a c c o u n t , o r t h a t th e c r e d i t o r i s a s s u r e d t h a t th e c u s to m e r ( o r
h i s p r i n c i p a l )ow ns a n d w i l l d e l i v e r p r o m p tly a n y s e c u r i t y w h ic h
i s s o ld .
& may l i k e w i s e b u y a n y s e c u r i t y f o r a n y c u s to m e r e i t h e r
f o r c a s h h e ld i n h i a a c c o u n t, o r i n r e l i a n c e upon an ag re e m e n t
t h a t p ay m en t w i l l b e made p r o m p tly , a n d t h a t th e c u s to m e r d o e s n o t
c o n te m p la te s e l l i n g i t b e f o r e paym ent i s m ade.
C r e d i t o r s may d e a l
w i t h c u s to m e r s fro m t h e i r own h o l d i n g s o n t h e same b a s i s .
c u s to m e r s e l l s a s e c u r i t y ,
t h e r e i s no tim e l i m i t o n i t s
If a
d e liv e ry ;
a r e g u l a t i o n s h l c h f o r m e r l y l i m i t e d t h e tim e i n w h ic h d e l i v e r y
14
m ig h t b e made w as r e p e a l e d o n U ay
22$ 1939.
D e la y e d d e l i v e r i e s
i n a c a s h a c c o u n t a r e n o t c o n s id e r e d s h o r t s a l e s b y th e f e d e r a l
Be s e r v e B o a rd ,
I f a c u s to m e r p u r c h a s e s a s e c u r i t y a n d d o e s n o t
m ake f u l l c a s h p ay m e n t w i t h i n s e v e n d a y s , h i s a c c o u n t m u s t be
l i q u i d a t e d , u n l e s s th e t r a n s a c t i o n i s o f t h e ty p e i n w h ic h th e s e c u ­
r i t y i s t o b e d e l i v e r e d a g a i n s t p a y m en t, when th e tim e l i m i t i s
fiv e d ay s.
The l i m i t i s
th irty -
s e v e n d a y s i n c a s e s w h ere t h e c u s to m e r
13
B a e u la tio n
*J*, s e c . 4 ( b ) , p . 6 .
14
B o a rd o f G o v e rn o rs o f th e F e d e r a l R e s e rv e S y stem , A n n o u n cem en t.
Uay 14, 1939.
-
164 -
has purchased a s e c u r it y and so ld i t a g a in w ith o u t pa:dag f o r
i t w ith in a p e r io d o f n in e t y d ays.
Furtherm ore, i t i s p o s s ib le
t o d isr eg a r d th e se r e s t r i c t i o n s i f a p ro p erly a u th o rized com­
m itte e o f a n a tio n a l s e c u r i t i e s exchange i s s a t i s f i e d th a t both
custom er and c r e d ito r are a c tin g in good f a it h and th a t un usual
circu m stan ces e x i s t .
Under such circum stances e x te n s io n s may
be granted b y a com m ittee o f an exchange fo r a p erio d s u f f i c i ­
en t t o render payment p o s s i b l e .
Such a p erio d may be r e - e x t e n -
ded i f c o n d itio n s appear to warrant i t .
Moreover, i f the s e c u r ­
i t y in v o lv e d in r e g is t e r e d or exempted, th e tr a n s a c tio n may be
tr a n s fe r r e d to a genera] account or a s p e c ia l omnibus a cco u n t,
15
a s th e c a se may demand.
S p e c ia l a r b itr a g e acco u n ts seg r e g a te t h i s type o f b u sin e s s
from o th e r .
They a re acco u n ts which handle tr a n s a c tio n s which
a re fo r th e purposes o f talcing advantage o f p r ic e d if f e r e n c e s
betw een m arkets and betw een s e c u r i t i e s .
Through th e se accou n ts
s e c u r i t i e s a re purchased in one market and so ld in another a t
ap p roxim ately the same tim e , or one ty p e o f s e c u r ity i s bought
.vhich i s c o n v e r tib le in t o another ty p e , w ith which an o f f s e t t i n g
s a le may y i e l d a p r o f i t .
There are no s p e c ia l r e g u la tio n s r e ­
garding th e s e a cco u n ts beyond th a t which r e q u ir e s th a t o f f s e t t i n g
p u rch ases and s a le s are made 'w ithin a time which does not rob th e
tr a n s a c tio n o f i t s assumed c h a r a c te r .
T ra n sa ctio n s in com m odities are a ls o seg reg a ted in se p a ra te
accou n ts in which c r e d it o r s may ca rry out tr a n s a c tio n s fo r c u s -
16
tom ers in com m odities o n ly .
18
16
R egu lation ” T*, s e c . 4- ( c ) , pp. 6 -8 .
X b i d . , s e c . 4 ( d ) ’an d ( e ) , p . 8 .
-lfi'5 —
The s p e c ia l m is c e lla n e o u s a cco u n t i s an account w hich a cco ­
modates cu stom ers in th o s e ways w hich are n o t p o s s ib le under th e
r e g u la t io n s imposed upon th e v a r io u s o th er ty p e s o f a c c o u n ts .
In
th e s e a c co u n ts a c r e d it o r may, w ith th e p e r m issio n o f a d u ly a u th or­
iz e d com m ittee o f a n a t io n a l s e c u r i t i e s , exch an ge, make and main­
t a i n lo a n s t o m eet th e emergency no ’ds o f any c r e d it o r .
L ikevo.se,
w ith th e p e r m issio n o f th e proper com m ittee o f an exch an ge, a c r e ­
d it o r may make and m a in ta in lo a n s t o any p a rtn er o f any fir m which
i s a member o f a n a t io n a l s e c u r i t i e s exch ange, in order t h a t a
p a rtn er can make a c o n tr ib u tio n o f c a p ita l, t o th e fir m , p rovid ­
ed t h a t th e borrower and le n d e r a re both e it h e r members o f th e
same fir m or o f th e same exch an ge.
The com m ittee must be con­
v in c e d , how ever, th a t th e lo a n i s o u ts id e o f th e ord in ary course
o f th e b u s in e s s o f th e le n d e r , and t h a t i t has not been made in
c o n tr a v e n tio n o f any r u le o f th e exch an ge.
Furtherm ore, i t must
be d eterm in ed d e f i n i t e l y th a t th e lo a n i s n o t f o r th e purpose o f
en a b lin g th e b orrow er’ s firm to in c r e a s e t h e i r d e a lin g s i n secu r­
itie s .
I t i s through t h i s ty p e o f accou n t th a t brokers ca rry on
b u s in e s s f o r each o th e r .
I t i s p ro v id ed t h a t through t h i s medium
a c r e d it o r may pu rchase or s e l l any s e c u r it y fo r a custom er who
i s a b rok er or d e a le r , so lo n g a s th e c r e d it o r i s a c tin g in good
f a i t h and payments o f cash and d e liv e r y o f sto ck take p la c e in
accordan ce w ith th e a c ce p ted custom s o f th e b u s in e s s .
O d d -lot d e a le r s may be fin a n c e d through th e s p e c ia l m is c e l­
la n eo u s a c c o u n t.
Any c r e d it o r may fin a n c e th e tr a n s a c tio n s o f
an o d d -lo t d e a le r who i s a member o f th e exchange, or e n te r in t o
any arrangem ent o f t h i s typ e where a l l p a r t ic ip a n t s o th er than
- Inu­
tile c r e d it o r a r e r e g is t e r e d o d d -lo t d e a le r s .
LikeiTi.se, th e ac­
t i v i t i e s o f u n d erw ritin g and d is t r ib u t in g s y n d ic a te s are r e c o r ­
ded through t h i s a cco u n t, p ro v id ed t h a t th e s e c u r i t i e s in v o lv e d
are n ot to be d is t r ib u t e d through t h e medium o f a n a t io n a l s e ­
c u r i t i e s exch an ge, or t h a t th e d is t r ib u t io n has th e approval
o f a d u ly a u th o r is e d com m ittee o f a n a t io n a l s e c u r i t i e s ex ­
change .
F i n a l l y , th e s p e c ia l m is c e lla n e o u s a cco u n t p ro v id es a me­
dium by means of w hich th e c o l l e c t i o n and exchange o f s e c u r i t i e s
may tak e p la c e vrhich are n o t o f th e c h a r a c te r o f pu rch ases and
s a le s .
In t h i s c o n n e c tio n , money p aid o r/a n d r e c e iv e d , and s e ­
c u r i t i e s c o l l e c t e d or d e liv e r e d a r e reco rd ed in t h i s account*
F oreign exchange tr a n s a c tio n s fo r custom ers a re lik e w is e r e ­
cord ed .
C r e d it, w ith or w ith o u t c o l l a t e r a l , f o r pu rp oses o th er
than tr a d in g in or c a r r y in g s e c u r i t i e s , w hich i s p erm itted un 17
d cr th e la w , a ls o i s record ed i n t h i s a c c o u n t.
S e c tio n 5 o f R e g u la tio n "T" f o ll o w s c l o s e l y s e c t io n S (a )
o f th e A c t, and p r o h ib it s borrow ing by b rokers or d e a le r s e x ­
c e p t from member banks o f th e F ed era l R eserve System , or from
«
non-member banks w hich have f i l e d agreem ents ivith th e F ed era l
R eserve Board, or from o th er s o u r c e s , t o th e e x te n t to which
13
such lo a n i s co n sid e re d an emergency n eed .
S e c tio n 6 o f th e R e g u la tio n s e t s f o r t h c e r t a in p r o v is io n s
which are d e sig n e d t o a f f e c t c o n tr o l over th o se a s p e c ts o f se ­
c u r it y d e a lin g w hich cannot be r e g u la te d by m erely r e s t r i c t i n g
17
18
« "
, ,
R e g u la tio n T , s e c . A ( f ) , p r . 8 -9 .
Cf» pp. 1® -156 above.
-167-
a c t i v i t i e s w ith in th e accou n t i t s e l f .
I f a g e n e r a l accou n t i s
th e a ccou n t o f a p a r tn er or c r e d it o r a c a lc u la t io n o f th e ad­
ju s te d d e b it b a la n ce must n o t in c lu d e any o f th e p a r tn e r ’ s r e ­
l a t i o n s w ith th e fir m , a s th e s e a r e r e f l e c t e d in c a p i t a l and
drawing a c c o u n ts .
In c a se th e c r e d it o r i s a p a r ty t o a j o i n t
v en tu re in a g e n e r a l a c c o u n t, th e a d ju s te d d e b it b a la n ce o f
th e a ccou n t must c o n ta in th e amount by w hich th e c r e d i t o r ' s
c o n tr ib u tio n t o th e j o i n t v e n tu r e s e x c e e d s th e amount w hich
would have been n e c e s s a r y t o e n t i t l e him m erely t o a p ro p o rtd o n a te sh are o f th e p r o f i t s .
In t h i s 'way i t i s made impos­
s i b l e fo r a c r e d it o r t o evade th e law through p e r so n a l p a r t i­
c ip a t io n in g e n e r a l a c c o u n ts .
G uaranteed a c co u n ts a r e l i k e ­
w is e s u b je c t to r e s t r i c t i o n s , w hich a re d e sig n e d to e lim in a te
th e p o s s i b i l i t y o f abuse through e x c e s s iv e c r e d it based uoon
th e guarantee o f an oth er p e r so n .
I f th e guarantee i s e x ec u ted
i n ~uch a way th a t th e c r e d it o r h as an u n r e s t r ic t e d r ig h t t o
u se funds and s e c u r i t i e s from th e g u a r a n to r ’ s a cco u n t t o c a r r y
th e guaranteed a c co u n t, i f th e gu aran tor i s n o t a c r e d it o r , and
i f a copy o f th e gu aran tee i s f i l e d w ith th e n a t io n a l s e c u r i t i e s
exchange o f vrhich th e c r e d it o r i s a member, th e c r e d it o r may a t
h i s o p tio n deduct from th e a d ju s te d d e b it b a la n ce o f th e custom­
e r ' s accou n t an amount which i s n o t g r e a te r than th e e x c e s s lo a n
v a lu e o f s e c u r i t i e s in th e g u a r a n to r 's accou n t over i t s a d ju ste d
b a la n c e .
I f , how ever, b eca u se o f th e gu aran tee o f a g e n e r a l a c ­
co u n t, a tr a n s a c tio n ta k e s p la c e vrhich would n o t have been p o s­
s i b l e w ith o u t th e e x is t e n c e o f th e g u a r a n tee , th e g u a r a n to r 's a c ­
count i s s u b je c t t o th e a d d itio n o f a sum e q u a l to th e amount which
-168
th e c r e d it o r may have dedu cted from th e a d ju s te d b a la n ce o f th e
accou nt vrhich i s gu a ra n teed .
Furtherm ore, no r e d u c tio n can be
made in th e amount o f th e d e d u c tio n from th e guaranteed a cco u n t,
nor can any a d d itio n be made t o th e a d ju s te d d e b it b a la n ce o f *
th e g u a r a n to r 's a c c o u n t, u n le s s th e a d ju s te d d e b it b -la n c e o f
th e guaranteed a c c o u n t, a f t e r a l l tr a n s a c t io n s are reco rd ed fo r
th e day o f th e d e c r e a s e , does not ex ceed th e lo a n v a lu e o f th e
s e c u r i t i e s i n th e gu aran teed a c c o u tn .
L ik e w ise , i f th e guaran­
t e e i s term in ated or red u ced , th e d e b it b a la n ce on. th e day o f
r e d u c tio n o r te r m in a tio n , a f t e r a l l tr a n s a c t io n s have ta k en p la c e ,
must n o t exceed th e lo a n v a lu ed o f th e s e c u r i t i e s in th e a c c o u n t.
P r o v is io n i s a ls o made fo r c o n t in u it y in a c co u n ts which have
been tr a n s fe r r e d from one c r e d it o r t o a n o th e r.
Under th e s e c i r ­
cum stances th e g e n e r a l a cco u n t i s tr e a te d a s though i t had been
m ain tained by th e t r a n s f e r e e from th e d a te o f i t s o r i g in ,
^’he
t r a n s fe r e e a c c e p ts a sta te m e n t in good f a i t h t h a t no cash or s e ­
c u r i t i e s need be t r a n s fe r e d t o th e a cco u n t b eca u se o f any tr a n s ­
a c tio n which has r r e v io u s ly tak en p la c e in th e a c c o u n t.
In th e
e v en t t h a t such a sta te m e n t i s n ot a v a i l a b l e , th e tr a n s f e r e e may
a c c e p t a sig n e d sta te m e n t from th e custom er to t h i s e f f e c t .
S im ila r ly , i f a g e n e r a l a cco u n t i s tr a n s fe r r e d from one cu s­
tomer t o an o th er, i t may be tr e a t e d by th e c r e d it o r a s though i t
had been in th e name o f th e tr a n s f e r e e s in c e th e d a te o f i t s o r i 20
g in .
In th e c a se o f r e o r g a n iz a t io n s , a c r e d it o r may exchange s e ­
c u r i t i e s f o r any cu stom er, f o r th e purpose o f p a r t ic ip a t in g in
•^ R e g u latio n 11! 1,1 se c. 6 ( a ) , ( b ) , and ( c ) , p. 11.
^ Ib id .., se c . 6, ( d ) , p p . 1 1-1 2 .
-IG 9-
th e r e o r g a n iz a tio n in w hich t h e s e c u r it y i s in v o lv e d .
I f , as a
r e s u l t o f r e o r g a n iz a tio n , th e custom er comes in t o p o s s e s s io n o f
a s e c u r it y vrhich i s n e it h e r r e g is t e r e d nor exem pted, he cannot
w ithdraw e i t h e r th e s e c u r it y or th e p ro ceed s o f i t s s a le from
h i s accou n t fo r a p e r io d o f s i x t y d a y s, beyond th e e x te n t to
21
vrhich t h i s m ight be done i n th e c a se o f a r e g is t e r e d s e c u r it y .
A cts w hich c o n s t it u t e th e d e liv e r y o f s e c u r i t i e s and th e
r e c e ip t o f fu n d s and th e tim e a t vrhich th e y are assumed t o ta k e
p la c e , a r e d e f i n i t e l y s e t f o r t h in th e s e r e g u la t io n s .
T h is ap­
p ears t o have been done w ith a v ie w to g iv in g d e f i n i t e n e s s t o
th e fo r m u la tio n o f a r e c e ip t or d e liv e r y w ith o u t in tr o d u c in g
elem en ts w hich m ight in t e r f e r e w ith th e o p e r a tio n o f b u s in e s s .
A check or a d r a ft on a bank vrhich i s p a y a b le in th e r e g u la r
cou rse o f b u s in e s s , i s c o n sid e r e d payment upon i t s r e c e i p t .
Any order on a s a v in g s bank t o vrhich a passbook i s a tta c h e d i s
a ls o c o n sid e re d payment when i t i s r e c e iv e d .
A shipm ent o f s e ­
c u r i t i e s w ith a s ig h t d r a f t a tta c h e d which has been undertaken
in good f a i t h , i s view ed a s c o n s t it u t in g payment o f th e amount
o f th e d r a f t .
In th e c a s e o f s p e c ia l omnibus a c co u n ts in vrhich
th e custom er i s n o t lo c a t e d in th e same c i t y , a w r it t e n or t e l e ­
grap h ic n o t ic e t o th e e f f e c t th a t money or s e c u r i t i e s have been
shipped may be t r e a te d by th e c r e d it o r a s c o n s t it u t i n g payment on
th e d a te o f r e c e ip t o f such o r d e r .
There i s n o th in g in th e r u le s ,
how ever, vrhich p r e v e n ts th e c r e d it o r from b e in g more e x a c tin g than
22
th e s e r e g u la t io n s r e q u ir e .
21
R e g u la tio n * T?', s e c . 6 ( e ) , p . 1 2 .
22
I b i d . , se c . 6 ( f ) , p . 12.
-170-
Therc i s no r e s t r i c t i o n on th e payment o f i n t e r e s t c h a r g e s,
communication c h a r g e s, sh ip p in g c h a r g e s , premiums on s e c u r i t i e s
borrowed f o r sh o r t s a l e s , and o th e r s e r v ic e c h a r g e s , in th e gen­
e r a l a c c o u n t, but such ite m s must be ta k en in t o c o n s id e r a tio n in
c a lc u la tin g the a d ju s te d d e b it b a la n ce i n such a c c o u n ts .
A c r e d i­
to r may pay t o or fo r cu stom ers a l l cash i n t e r e s t or d iv id e n d s
which he may have c o l l e c t e d fo r a g e n e r a l a c c o u n t , w ith o u t regard
fo r th e p r o v is io n s o f t h e r e g u la t io n s , so lo n g a s such payment i s
made w ith in t h i r t y - f i v e days a f t e r th e day on w hich i t u s u a lly i s
done, p rovided t h a t th e c r e d it "which has accrued t o th e accou nt
b e fo r e such payment has n o t been u se d in th e pu rchase o f s e c u r i 23
t i e s which o th e r w ise c o u ld n o t have been p u rch a sed .
Borrowing and le n d in g s e c u r i t i e s may ta k e p la c e f r e e from
any r e g u la t iv e s u p e r v is io n .
T /ithout reg a rd fo r th e r e g u la tio n s
any person may d e p o s it cash f o r th e purpose o f borrow ing s e c u r i­
t i e s t o s e l l s h o r t, in th e ev en t t h a t he i s o b lig e d t o d e liv e r
s e c u r i t i e s which he has n o t r e c e iv e d .
He may lik e w is e le n d s e ­
c u r i t i e s f o r th e so p u rp oses a g a in s t d e p o s it .
L ik e w ise , c r e d it
e x te n s io n s f o r a p a r t o f a day fo r th e purpose o f c le a r in g se ­
c u r i t i e s on a n a t io n a l s e c u r i t i e s ex ch a n g e, w hether th e c l ' a r ance ta k e s p la c e betw een members or through th e medium o f an
o r g a n iz a tio n employed by them, i s n o t s u b j e c t to r e g u la t io n .
F oreign currency vrhich i s p a y a b le i n th e cu rren cy
o f th e
U nited
S t a te s may be taken by a c r e d it o r in a g e n e r a l accou n t su b je c t
o n ly t o th e custom s o f th e b u s i n e s s . ^
^"R eg u la tio n “I1. s e c . 6 ( g ) , pp . 1 2 -1 3 .
24
I b i d . , s e c . 6 ( h ) , ( i ) , arid ( j ) , p . 13.
-1 7 1 -
R eg u la tio n "T" c o n ta in s c e r t a in m is c e lla n e o u s p r o v is io n s
vrhich are d e sig n e d to make th e c o n tr o l o f th e Board o f Gover­
n ors o f the F e d era l R eserve System over th e u se o f c r e d it fo r
s e c u r it y tr a n s a c tio n s more c o m p le te .
I t i s p ro v id ed th a t a
c r e d it o r may arran ge a lo a n f o r a custom er w ith a n o th er per­
son on term s vrhich a re in accordan ce w ith th e r e g u la t io n s ,
bu t he i s n o t p e r m itted t o arran ge lo a n s on any e th e r term s.
T his a p p lie s in a l l c a s e s e x c e p t th o s e in vrhich a bank i s i n ­
v o lv e d as le n d e r , w hich i s s u b je c t t o r e g u la t io n "Tin o f th e
Board o f G overnors o f th e F ed e ra l R eserve System . 25
In th e i n t e r e s t o f custom er p r o te c tio n i t i s provid ed th a t
c r d i t vrhich h s been i n i t i a l l y extended i n accordance vrith r u le s
and r e g u la tio n s may be m ain tain ed w ith o u t reg a rd fo r changes in
market p r ic e s o f th e s e c u r i t i e s in v o lv e d .
I t may be m aintained
r e g a r d le s s o f any changes in lo a n valu ed or m argin req uirem en ts
vrhich th e Board may su b se q u e n tly p r e s c r ib e .
L ik e w ise , tlw f a c t
th a t a s e c u r it y c e a s e s to be r e g is t e r e d or exempted d o es n o t a f­
f e c t th e m aintenance o f c r e d it once e x te n d e d .
The c r e d it o r , hovr-
e v e r , may a c c e p t f o r h i s own p r o te c tio n any a d d it io n a l c o l l a t e r a l
26
vrhich may be a v a ila b le , in c lu d in g r e g is t e r e d s e c u r i t i e s .
S u b -s e c tio n ( c ) under s e c t io n 7 p la c e s th e r e s p o n s i b i l i t y
fo r r e p o r tin g th e u s e t o vrhich c r e d it i s p u t sq u a r e ly upon th e
borrow er.
Every e x te n s io n o f c r e d it on r e g is t e r e d s e c u r i t i e s
i s co n sid e re d fo r t h e purpose o f c a rr y in g s e c u r i t i e s , u n le s s th e
custom er makes a sta te m e n t o f th e u se t o vrhich th e extended e r e -
R e g u la tio n " t " , s e e . 7. (a ),- p p .1 3 -1 4 .
25
:
I b id ., se c . 7 (b ), p . 14.
-1 7 2 d i t i s t o be p u t, and s p e c i f i c a l l y s t a t e s t h a t i t i s n o t to be
used f o r th e p u rp o se o f tr a d in g o r c a r r y in g s e c u r i t i e s , n o r f o r
th e purpose o f e v ad in g r e g u l a t i o n s .
The c r e d i t o r has m erely to
r e l y upon th e w r i t t e n s ta te m e n t a f t e r hav in g tak en such p re c a u ­
ti o n s to d is c o v e r f a l s i t y as would become a p ru d e n t man o f r e a s o n 27
a b le d i l i g e n c e .
W hile R egiiL ation "T" p r e s c r ib e s a d e f i n i t e framework and de­
f i n i t e l i m i t s w ith in w hich th e c r e d i t mechanism m ust work, i t
does n o t ro b exchanges o r c r e d i t o r s o f any k in d o f t h e i r i n i t i a t i v e
i n o p e ra tin g w ith in th e framework w hich has been l a i d down.
There
i s n o th in g i n t h i s r e g u la tio n which p re v e n ts any exchange from
a d o p tin g and e n fo rc in g any r u le which f u r t h e r r e s t r i c t s c r e d i t ,
o r which r e s t r i c t s th e tim e and manner i n w hich i t s members m ust
o b ta in a d d i t i o n a l m argin i n c u sto m e rs' a c c o u n ts .
The exchanges
may a ls o r e q u ir e h ig h e r m argins th a n th e Board r e q u i r e s , i f th e y
so d e s i r e , and r e s t r i c t c r e d i t w ith o u t p e rm is sio n o f th e Board.
The r i g h t s o f c r e d i t o r s to e n fo rc e r e s t r i c t i o n s which th e y may
deem n e c e s s a ry a r e a l s o p e r m itte d .
The r i g h t o f any c r e d i to r
to r e q u ir e more s e c u r i t y f o r th e m aintenance o f a lo a n th an th e
r e g u l a t io n p r e s c r i b e , t o r e f u s e t o ex ten d c r e d i t a lto g e t h e r , o r to
28
s e l l any c o l l a t e r a l w hich th e y may h o ld , i s l e f t unhampered.
Banking A cts o f 1955 and 1955
The r o le o f th e banking s tr u c t u r e in th e e x te n s io n o f c re ­
d i t f o r s e c u r i t y t r a n s a c t i o n s , as w e ll as i n o th e r a c t i v i t i e s connec­
te d w ith th e s e c u r i t i e s b u s in e s s , was b ro u g h t o u t i n s tro n g
27
R e g u la tio n nT ", s e c . 7 ( c ) , p . 14
28
I b i d . . se c . 7 ( e ) , p . 14.
-173-
r e l i e f vdth th e crash o f 1929 and th e subsequent d e p r e s s io n .
The
attem p t o f commercial banks to make an e n tr y i n t o ‘th e in v estm en t
b u s in e s s in th e l a t e 1 9 2 0 's gave r i s e to what became known a s th e
" s e c u r ity a f f i l i a t e " .
These c o r p o r a tio n s w ere h e ld la r g e l y by th e
la r g e com m ercial banks, and t h e ir fu n c tio n s w ere s im ila r t o th o se
performed by in v e stm e n t banks g e n e r a lly .
In some in s ta n c e s th e s e
c o r p o r a tio n s were con n ected t o th e p a ren t bank through th e d e v ic e
o f havin g one sto c k c e r t i f i c a t e on which was p r in te d th e sto ck o f
both th e p aren t bank and th e a f f i l i a t e d c o r p o r a tio n . ,nhe c lo s e
c o n n e c tio n betw een th e two made fo r e x te n s iv e u se o f th e parent
b an k 's funds in th e s e c u r it y b u s in e s s .
vrith th e p a ssa g e o f th e G la ss—S t e a g a ll A c t, w hich was ap­
proved on June 1 6 , 1 9 3 3 , member banks o f th e F e d e r a l R eserve Sy­
stem w ere fo r b id d e n to have a s a f f i l i a t e s "any c o r p o r a tio n , b u s i­
n e ss t r u s t or s im ila r o r g a n iz a tio n which engaged p r in c i p a ll y in
th e b u s in e s s o f th e i s s u e , f l o t a t i o n , u n d e rw r itin g , p u b lic s a l e ,
or d is t r ib u t io n a t w h o le s a le or r e t a i l through sy n d ic a te p a r t i c i ­
p a tio n , o f s t o c k s , bond d e b e n tu r e s, n o te s or o th e r s e c u r i t i e s ."
( V io la t io n s became p u n ish a b le b y a f i n e o f 3 1 ,0 0 0 per day fo r each
day a f t e r June 1 6 , 1 934, on w hich v i o l a t i o n s m ight c o n t in u e .)
The
u n if ic a t io n o f s to c k c e r t i f i c a t e s became i l l e g a l on th e same d a te ,
except
in th e c a se o f c o r p o r a tio n s which h e ld bank p rem ises .
therm ore, e x te n s io n s t o a f f i l i a t e s w ere s e v e r e ly r e s t r i c t e d .
Fur­
Loans
t o a f f i l i a t e s , s e c u r i t i e s purchased under rep u rch ase agreem en ts, in ­
v estm en ts in c a p it a l s to c k bonds or o th er o b lig a t io n s o f a f f i l i a t e s ,
-174.-
and s to c k s , bon ds, and o th e r o b lig a t io n s o f an a f f i l i a t e a c c e p te d
as c o l l a t e r a l f o r an advance to any p e r so n , became lim it e d t o 10
p er cen t o f th e c a p it a l sto c k and su r p lu s o f th e member bank i n th e
case o f any one a f f i l i a t e , and to 20 per c e n t f o r a l l o f them .
Such
lo a n s as might be made under th e s e p r o v is io n s had t o be secu red by
c o l l a t e r a l o f a t l e a s t 20 per c e n t more v a lu e th a n th e amount o f
th e lo a n , e x c e p t when th e c o l l a t e r a l was composed o f o b lig a t io n s
o f any s t a t e or p o l i t i c a l s u b d iv is io n , in w hich c a s e o n ly 10 per
c e n t a d d it io n a l v a lu e was r e q u ir e d .
O b lig a tio n s o f the U n ited
S t a te s Government and c e r t a in government c o r o o r a tio n s were e x 29
empted from t h i s p r o v is io n .
Under th e G la s s - S t e a g a ll A c t, d e a lin g s in in v estm en t s e c u r i­
t i e s b y member banks became r e s t r i c t e d to pu rchase and s a le o f s e ­
c u r i t i e s fo r cu sto m ers.
A ll p u rch a ses f o r th e ir own accou n t a re
s u b je c t t o such l i m i t a t i o n s a s th e C om p troller o f Currency m ight
p r e s c r ib e .
In no c a se co u ld t h e i r h o ld in g s ex ceed 10 per cen t o f
anjr one is s u e u n le s s th e t o t a l amount o f th e i s s u e w ere l e s s than
■
3 100,000 and n o t i n e x c e s s o f 50 per c e n t o f th e c a p it a l o f th e
bank.
In no c a se co u ld th e t o t a l exceed 15 p e r cen t o f th e amount
o f c a p it a l s to c k a c t u a l l y p a id i n and 25 p er c e n t o f i t s unim pair­
ed s u r p lu s .
The law a l s o p r o /id e d th a t no i n s t i t u t i o n w hich is s u e d , s o ld ,
d is t r ib u t e d or o th e r w ise engaged in th e s e c u r i t i e s b u s in e s s might
r e c e iv e d e p o s it s .
T h is p r o v is io n i s o p e r a tiv e in th e c a se o f s t a t e
ch a rtered and p r iv a te banks a s w e ll a s member b a n k s.
20
Trurtherm ore,
73rd Cong. 1 s t S e s s io n , H.It. 5 6 6 1 , Banking A ct o f 1933 ( G la s s S t e a g a ll A c t s e c . 5, 1 3 7 1 5 , 1 2 , 2 0 , 2 1 , 3 2 , 33*
-175o o rresp o n d en t r e l a t io n s h i p s "between banks o f d e p o s it and i n s t i t u ­
t io n s engaged in th e s e c u r ity b u sin e ss were made i l l e g a l .
It
was f i n a l l y p ro v id e d t h a t in te r lo c k in g d i r e c t o r a t e s between banks
and i n s t i t u t i o n s d e a lin g in s e c u r i t i e s o r le n d in g money f o r th e
purpose o f making lo a n s secu re d by sto ck and bond c o l l a t e r a l are
p r o h ib ite d .
The Banking Act o f 1935 e la b o r a te d th e p ro v is io n s
o f th e 1933 A ot, and made c e r ta i n r e v is io n s which were deemed
n e c e s sa ry to c a rry o u t th e purpose o f th e e a r l i e r a c t in an
o r d e rly fa sh io n . 30
To th e s tu d e n t o f s e c u r i t i e s exchange r e g u la tio n , th e s e two
a c ts a re o f i n t e r e s t beaause th e y r e p r e s e n t an a tte m p t to se g re g a te
th e s e c u r i t i e s b u s in e s s from t h a t of d e p o s it banking, and th e re b y
b rin g th e c r e d i t o p e ra tio n s o f banks w ith r e l a t i o n to th e s e c u r i­
t i e s b u sin e ss under more e f f e c t iv e c o n tr o l.
While i t may be
s a id t h a t th e y s e g re g a te d th e in v estm en t banking b u sin e ss from i t s
so u rces o f funds in an in c o n v e n ie n t way, i t m ight be p o in te d o u t
t h a t th e fo u n d a tio n was l a i d fo r a mechanism whereby b o th d e p o s it
and in v estm en t banking m ight be b ro u g h t under s u p e rv is io n in a
manner whioh made i t p o s s ib le t o d e a l s t r i n g e n t l y w ith c r e d it ex­
te n s io n s on s e c u r i t y o p e ra tio n s by th e fo rm er, w h ile th e l a t t e r
were l e f t w ith t h a t d egree o f freedom which i s n e c e s sa ry in th e
b u s in e s s o f in v estm en t banking.
From a c o n tr o l p o in t o f view
such s e g re g a tio n was a p r a o t ic a l n e c e s s it y .
R e g u la tio n " U”
R e g u la tio n ” U” o f th e Board of G overnors, whioh was promul­
g ated p u rsu a n t to s e c tio n 7 o f th e S e c u r itie s Exchange Act o f 1934,
d e a ls e x c lu s iv e ly w ith
30
7 4th Cong., H.R. 7617, Banking Aot o f 1935.
-176-
banking o p e ra tio n s f o r th e purchase and c a rry in g of s e c u r i t i e s .
I t does n o t in any way r e s t r i c t th e r i g h t o f banks t o extend c r e ­
d i t f o r p u rp o ses o f th e accom odation o f a g r i c u l t u r e , commerce or
in d u s tr y , r e g a r d le s s o f w h ether o r n o t such c r e d i t i s secu red by
s to c k s , bonds, o r s im i l a r c o l l a t e r a l .
F u rth erm o re, i t does n o t
r e s t r i c t th e r i g h t o f banks to demand c o l l a t e r a l on lo an s t o an
e x te n t g r e a t e r th a n t h a t p ro v id e d f o r in th e law , or to handle
any lo an as th e bank may see f i t w ith in th e scope o f th e p r o v i­
s io n s .
The r e g u la tio n s th em selv es m erely c o n s tr u c t a framework
i n w hich th e c r e d i t o p e ra tio n s o f banks w ith r e l a t i o n to s e c u r i t y
tr a n s a c tio n s m ust f u n c tio n . 31
I t i s p ro v id e d t h a t no bank may make lo a n s on s to c k f o r th e
purpose o f c a r r y in g any s to c k r e g i s t e r e d on a n a tio n a l s e c u r i t i e s
exchange beyond th e maximum lo a n v a lu e w hich th e Board may p re ­
s c r ib e from tim e to tim e .
Banks are a ls o bound to e x e r c is e good
f a i t h in d e te rm in in g th e v alu e o f c o l l a t e r a l o th e r th an s to c k s f o r
t h i s p u rp o se .
The r e g u la tio n p r e s c r ib e s t h a t th e e n t i r e in d e b te d ­
n ess o f any b o rro w e r, in c u r r e d f o r th e p u rc h a sin g or c a rry in g o f
sto c k r e g i s t e r e d on a n a tio n a l s e c u r i t i e s exchange p r io r to May 31,
1936, th e d a te
on w hich t h i s r e g u la tio n becomes e f f e c t i v e , must be
t r e a t e d as a s in g le lo a n , and a l l th e c o l l a t e r a l se c u rin g i t m ust
be ta k e n in to c o n s id e r a tio n in d e te rm in in g w hether o r n o t th e loan
i s in acco rd an ce w ith r e g u la tio n s .
At no tim e must a bank p e rm it
lo a r d o f G overnors o f th e F e d e ra l R eserv e System, R e g u la tio n "U",
e x p la n a to ry fo rew o rd .
-1 7 7 -
tlie w ithdrawal o f c o l l a t e r a l from any loan fo r the purchase or car­
ryin g o f s e c u r it ie s which would cause th e loan valu e o f th e remain­
in g c o l l a t e r a l to be l e s s than th e amount o f the lo a n , o r , i f th ere
i s an a lr e a d y e x is t in g d e fic ie n c y o f t h is ch a ra cter, i t must not be
in c r e a se d by w ith draw als.
The amount o f the lo a n , however, may be
in c r e a s e d , provided th a t th ere i s s u f f i c ie n t a d d itio n a l c o ll a t e r a l
32
added t o equal the amount o f th e in c r e a s e .
There are many e x c e p tio n s to t h i s r u le , which have been made
in the in t e r e s t o f f a c i l i t a t i n g th o se tr a n sa c tio n s which are not
o f a t;"pe th a t i s l i k e l y t o be su b jec t to .-douse.
Loans to fo r e ig n
banking i n s t it u t io n s are exempted, as are loan s o f under "'1,000 in
amount.
Loans to brokers and d e a le r s fo r th e purpose o f fin a n c in g
th e d is t r ib u t io n o f s e c u r i t ie s through mediums other than a n a tio n a l
s e c u r i t i e s exchange are a ls o exempted from th e p r o v isio n s o f th e r e ­
g u la t io n .
A bank may a ls o ig n o re them in the event th a t a broker or
d e a le r i s in an cmev' ency s it u a t io n ,
are not members o f
h e a lin g s between persons who
n a tio n a l s e c u r it ie s exchanges or o th erw ise in
th e s e c u r ity b u sin e.-s, are exempted from the operation o f th e r e ­
g u la t io n .
A ll temporary advances fo r fin a n cin g th e purchase and
s a le o f s e c u r it ie s or fo r carryin g s e c u r it ie s in t r a n s it vrhich v d .ll
be s e t t le d in th e ordinary course o f b u sin ess are a ls o exempted.
Loans rep aid on th e same calen d ar day on which th ey are made, are
w ith ou t r e s t r ic t io n ; th ose made fo r purposes o f a ffo c tin " ‘ a r b itr a g e
tr a n s a c tio n s , and those fo r the purpose o f fin a n cin g o d u -lo t tr a n s ­
a c tio n s o f members o f n a tio n a l s e c u r it ie s exchanges f a l l o u tsid e
32
Regulation "U", sec. 1, General Rule, p. 1*
-
178-
th e scope o f th e r e g u l a t io n , a s do lo an s made o u ts id e o f th e
f o r t y - e i g h t S ta te s o r th e D i s t r i c t o f Columbia.
33
Banks may a o e e p t a s ta te m e n t as to th e p urpose o f a lo a n ,
w hich has been sig n e d by an o f f i c e r o f th e bank o r by th e b o rro w er,
as s u f f i c i e n t ev id e n ce to e s t a b l i s h th e use t o which th e extend ed
c r e d i t i s t o be p u t .
No lo a n need be t r e a t e d a s a lo a n f o r th e
p u rp o se o f c a r r y in g s to c k , r e g a r d le s s o f how i t may be s e c u re d ,
u n le s s i t s p u rp o se i s to r e t i r e in d e b te d n e ss which was o r i g i n a l l y
in c u r re d in th e p u rch ase o f s e c u r i t i e s .
In c a se th e b o rro w er i s
a d e a l e r , o n ly lo a n s to c a r r y s e c u r i t i e s f o r custom ers need be so
tre a te d .
Renewals o r e x te n s io n s o f lo an s a r e n o t re g ard ed a s new
lo a n s , u n le s s th e amount o f th e lo a n i s in c re a s e d beyond th e a c c r u a l
o f i n t e r e s t and o th e r s e rv io e c h a rg e s .
Banks may a c c e p t th e t r a n s ­
f e r o f lo a n s from o th e r banks o r t r a n s f e r lo a n s between b o rro w ers
w ith o u t re g a rd f o r th e p r o v is io n s o f th e R e g u la tio n , i f th e lo a n
i s n o t in c re a s e d and th e c o l l a t e r a l v a lu e o f th e s e c u r i t i e s
p led g ed i s n o t changed.
A f te r th e lo an has been t r a n s f e r r e d , any
s u b s t i t u t i o n s o r w ith d ra w a ls o f c o l l a t e r a l may ta k e p la c e t h a t
would have been p e rm itte d t o th e borrow er I f th e lo an had been
made by th e bank in v o lv e d .
S e o u r itie s which a r e h eld by a bank
in i t s c a p a c ity o f c u s to d ia n need n o t be c o n sid e re d as c o l l a t e r a l
i f th e bank had n o t o r i g i n a l l y r e l i e d upon i t i n making th e
l o a n . 34
33
R e g u la tio n "U” , s e c . 2, E x cep tio n s to G eneral R ule, p p . 1 -2 .
I b i d . , Sec. 3, ( a ) , ( b ) ,
( d ) , ( e ) , ( f ) , ( g ) , ( h ) , and ( i ) , pp. 2-3,
-179Supplem ents t o th e R e g u la tio n s
On November 1, 1937, th e Board s e t 60 p e r c e n t o f m arket
v a lu e a s th e maximum lo a n v a lu e o f any s to c k , w hether o r n o t i t
i s r e g i s t e r e d on a n a ti o n a l s e o u r ity exchange.
In th e c a s e o f
b ro k e rs and d e a le r s , however, th e lo a n v a lu e s were s e t a t 75 p er
c e n t o f o u r re n t m ark et v a lu e , on c o n d itio n t h a t such b o rro w er sub­
m it a s ta te m e n t t h a t he i s s u b je c t to th e p r o v is io n s o f Regu­
l a t i o n *'Tm o r ex ten d s c r e d i t in accordance w ith i t s p r o v is io n s , and
t h a t th e s e c u r i t i e s whioh a r e h y p o th ecated t o s e c u re th e lo an a r e
c a r r i e d f o r th e a c c o u n t o f h is custom ers o th e r th a n h is p a r tn e r s .* ^
On Jan u a ry 1, 1938, th e Board is s u e d a supplem ent t o Regu­
l a t i o n "T" whioh s e t th e maximum lo an v a lu e s on r e g i s t e r e d s e c u r i ­
t i e s f o r g e n e ra l a c c o u n ts a t 60 p e r c e n t.
For s p e c ia l omnibus
ac c o u n ts a maximum lo a n v a lu e o f 75 p e r c e n t was s e t .
These lo a n
v a lu e s , whioh c o rre sp o n d w ith th o s e o f R eg u latio n “ U11, b r in g
p r e s s u re from b o th d i r e c t io n s upon th e s e o u r i t i e s w ith r e l a t i o n
to c r e d i t e x te n s io n .
A t th e same tim e th e Board r u le s t h a t an
a d ju s te d d e b it b a la n c e in a g e n e ra l acco u n t m ust be 50 p e r c e n t o f
th e c u r r e n t m arket v a lu e o f any s e o u r ity s o ld s h o r t, and in s p e c ia l
omnibus acco u n ts 35 p e r c e n t m ust be r e t a in e d .
F u rth e r stu d y o f th e c r e d i t problem
Y/hile th e Board o f G overnors i s charged w ith th e d u ty o f
fo rm u la tin g c r e d i t p o l i c i e s under R e g u la tio n s "T" and “ U", th e
S e o u r itie s and Exchange Commission i s re s p o n s ib le f o r th e a c tu a l
c a r r y in g o u t o f th e s e p o l i c i e s .
For t h i s reaso n th e Commission
h as c o o p e ra te d o lo s e ly w ith th e Board from th e b e g in n in g .
35 Board o f G overnors o f th e F e d e ra l R eserve System , Supplem ent to
R e g u la tio n "U".
® loard o f G overnors o f th e F e d e ra l R eserve System , Supplem ent to
R e g u la tio n "T ".
-180At th e o u t s e t th e Commission made many s u g g e s tio n s to th e Board i n
c o n n e c tio n w ith th e fo rm u la tio n o f R e g u la tio n "T ".
I n o rd e r to sup­
plem ent th e work o f th e Board a u n it was s e t up f o r th e purpose o f
ch eck in g m argin a c c o u n ts , n o t o n ly to a s c e r t a i n w hether o r n o t b ro k e rs
were com plying w ith th e p r o v is io n s o f th e law , b u t a ls o t o s tu d y th e
e f f e c t o f i t s o p e r a tio n upon th e e x te n s io n o f c r e d i t on r e g i s t e r e d
s e c u ritie s .
D uring th e f i r s t y e a r o f th e o p e r a tio n o f R e g u la tio n
"T" 197 firm s w ere exam ined.
The r e s u l t s o f th e s e ex am in atio n s were
made a v a i l a b l e to th e Board o f G overnors f o r s tu d y .
D uring th e f o l ­
low ing y e a r th e Commission was r e p re s e n te d a t c o n fe re n c e s w ith mem­
b e r s o f th e Board o f G overnors i n o rd e r to a s s i s t i n th e fo rm u la tio n
o f R e g u la tio n "U ".
D uring t h i s y e a r p e rso n n e l was a s s ig n e d to
37
r e g io n a l o f f i c e s t o s tu d y th e o p e ra tio n o f R e g u la tio n "T".
The e x p e rie n c e w hich th e Commission has g ain ed th ro u g h stu d y
o f th e o p e r a tio n o f R e g u la tio n s "T" and "U" has e n ab led i t to a s s i s t
th e Board o f G overnors i n making r e v is io n s o f th e s e r u l i n g .
One o f
th e m ost f r e q u e n t ty p e s o f v i o l a t i o n which has been en co u n tered i s
e v a s io n o f th e p r o v is io n s o f R e g u la tio n "T" th ro u g h l i q u i d a t i n g un­
m argined a c c o u n ts w ith in th r e e d ay s, in s te a d o f p u ttin g up m argin as
th e law r e q u i r e s .
As a r e s u l t o f co n fe re n c e s betw een r e p r e s e n t a t i v e s
o f ex ch an g es, th e Commission, and th e B oard, p r a c t i c a l l y a l l n a tio n a l
s e c u r i t i e s Exchanges have adopted r u le s which p r o h ib i t t h e i r members
from p e r m ittin g cu sto m ers t o av o id m argin re q u ire m e n ts th ro u g h l i q u l 38
d a tin g commitments w ith in th r e e d ay s.
37
S .E .C ., 1 s t Annual R e p o rt. P t. I I , p p .1 6 -1 7 , and 2nd Annual R e p o rt
P t. I I , p .16.
38
3 rd Annual R e p o rt. p .6 9 - c f . pp.
above. On F eb. 2 4 ,1 9 3 7 , th e
Commission a ls o s e n t a s e t o f r u le s to th e New York S tock Exchange and
to th e New York Curb Exchange w hich p r o h ib ite d " d a y lig h t tr a d in g " by
r e q u i r i n g t h a t a c c o u n ts o f members o f exchanges, exchange f ir m s , and
t h e i r p a r t n e r s be f u l l y m argined a t a l l tim e s.
-1 8 1 -
L im ita tio n s o f p e r so n n e l have made i t im p o s s ib le fo r th e Com­
m is s io n t o c a r r y ou t i t s in s p e c t io n s and i n v e s t i g a t ons t o th e de­
g ree vrhich i t f e e l s i s n e c e s s a r y .
N e v e r th e le s s , i t has co n tin u ed
i t s vrork and has broadened the scope o f i t .
A fte r th e r e v i s i o n o f
R e g u la tio n "T" r e p r e s e n t a t iv e s v i s i t e d th e o f f i c e s o f s e c u r it y d e a l­
e r s in s e le c t e d v i c i n i t i e s throughout th e co u n try t o r e v ie w t h e i r
methods o f d oin g b u s in e s s .
As a r e s u l t th e Commission has been a b le
to ren d er c o n s id e r a b le a s s is t a n c e to numerous d e a le r s in g a in in g an
u n d erstan d in g o f t h e s e and. oth er r e g u la t io n s .
A ccounts o f non-mem­
b er b rokers and d e a le r s s u b je c t to P e c u la tio n "T" a l s o r e c e iv e such
in s p e c t io n a s p e r so n n e l lim it a t io n s p e r m it.
Such v i o l a t i o n s a s have
been found have been turned over to th e v a r io u s ex ch a n res f o r t i o 39
c ip lin a r y a c t io n .
As y e t no v i o l a t i o n s have been uncovered v.-hich
are o f such c h a r a c te r a s t o w arrant t h e i r b ein g tu rn ed over to th e
Commission f o r a c t i o n ,
39
4-th Ann. Ren11 . , p . 8 0 .
CHAPTER VII
SHORT SALES AND MANIPULATIVE DEVICES
A. SHORT SALES
D e s c r ip tio n o f s h o r t s e l l i n g
S h o rt s e l l i n g has been s u b je c t t o so much d is c u s s io n t h a t
any tre a tm e n t o f th e s u b je c t sh o u ld b e g in w ith a d e s c r i p t io n
o f th e p ro c e s s and i t s p o s s ib le r e s u l t s .
S h o rt s e l l i n g i s i n tim a te ly co n n ected w ith s to c k b o rro w in g .
I n o r d e r to make a s h o r t s a le i t i s n e c e s s a ry t o borrow s to c k from
someone who i s w i l l in g to le n d i t i n r e t u r n f o r a money lo a n .
The borrow ed s to c k i s s o ld a t th e m ark et and th e p ro c e e d s c r e d ite d
t o th e s e l l e r ' s a c c o u n t.
The s e l l e r th e n owes n o t a s t i p u l a t e d
money v a lu e b u t a s p e c i f i c nunber o f s h a re s o f s to c k .
A t some
l a t e r d a te th e r e q u ir e d nvmber o f s h a r e s a r e a c q u ire d i n th e
m ark et and r e tu r n e d to th e le n d e r and th e money lo a n c o l l e c t e d .
Such lo a n s o f s to c k may be made " f l a t " o r a t a premium depending
on w h eth er o r n o t th e s to c k i s i n s u p p ly .
I f th e v a lu e p e r
s h a re o f th e s to c k borrowed d e c re a s e s betw een th e tim e th e
borrow ed s to c k i s s o ld i n th e m arket and th e tim e i t i s re p u r­
c h a se d , a p r o f i t a c c ru e s to th e s e l l e r .
I f , on th e o th e r hand,
th e s to c k r i s e s i n v a lu e , i t m ust be p u rch a se d and d e liv e r e d a t a
lo s s .
The su p p ly o f s to c k i n t h i s l a t t e r c a se i s u s u a lly so
sm a ll t h a t exp en ses in v o lv ed in m a in ta in in g a s h o r t p o s it io n make
su ch a p o s it i o n u n te n a b le .
-
i s
?
-
S h o r t s e l l i n g may b e t h o u g h t o f a s h a v in g tw o p o s s i b l e
e le m e n ts o f a b u s e i n h e r e n t i n i t s
e x e c u tio n :
(1 ) d e m o r a li­
z a t i o n o f t h e m a rk e t th r o u g h d e p r e s s i o n o f p r i c e s , a n d (2 )
m is u s e o f s t o c k h e l d i n t h e a c c o u n t s o f b r o k e r s th r o u g h l e n d ­
in g i t .
The f i r s t i s d i r e c t a n d im m e d ia te , a n d s h a l l b e t h e
s u b je c t o f f i r s t c o n s id e ra tio n .
D em o ra liz atio n o f th e m arket th ro u g h s h o r t s e l l i n g .
I t I s g e riS F a H y t r u e t h h t s h o r t s e t l i n g i s a T > o o l w h e re ­
b y t h e i n d i v i d u a l c l o s e t o t h e m a r k e t t a k e s a d v a n ta g e o f o v e r ­
b ought p o s itio n s in s e c u r itie s .
F o r t h i s r e a s o n , i t i s th o u g h t
o f a s a d e v i c e w h ic h i s o f a d v a n ta g e t o a s m a l l g ro u p a n d op­
p o sed to th e p u b lic i n t e r e s t .
I t s h o u ld a l s o b e n o t e d t h a t
o p i n i o n e x p r e s s e d b y e x a m in e r s i n t h e h e a r i n g s b e f o r e t h e
S e n a te C om m ittee o n B an k in g a n d C u r r e n c y seem ed t o i n d i c a t e
t h e v ie w t h a t d i s p r o p o r t i o n a t e p r i c e r i s e s w e re due t o t h e
f a c t t h a t a s m a l l g ro u p o f s p e c u l a t o r s
w h ip p e d u p " s p e c u ­
l a t i o n on th e p a r t o f th e p u b lic and t h e r e a f t e r u se d s h o r t
s e l l i n g a s a d e v i c e by m eans o f w h ic h t h e m a r k e t w as d e m o r a l1
iz e d and th e p u b lic e x p lo ite d .
One m ig h t s u s p e c t a l s o t h a t
a f e e l i n g e x i s t e d t h a t d e s t r u c t i o n o f v a l u e s w as i n I t s e l f
a b a d t h i n g , r e g a r d l e s s o f w h e th e r o r n o t s u c h v a l u e s w ere
sound.
C o n s id e ra tio n s o f t h i s s o r t p la c e d s h o r t s e l l i n g
b e f o r e t h e m inds o f l e g i s l a t o r s n o t i n t h e l i g h t o f a n a c ­
t i o n m e c h a n ic a lly t h e r e v e r s e o f a l o n g p o s i t i o n a n d e q u a l ­
l y j u s t i f i a b l e , b u t i n t h e l i g h t o f a t o o l b y m eans o f w h ic h
^"See s e c t i o n o n s h o r t s e l l i n g i n a n a l y s i s o f S e n a te H e a r in g s
i n C h ap . I I , p p . 5 6 -5 8 .
-
184 -
a s m a l l g ro u p m ig h t e x p l o i t t h e p u b l i c a n d d e s t r o y v a l u e s
f o r s e l f i s h en d s*
I t -was, t h e r e f o r e , t h e s u b j e c t o f much
d is c u s s io n .
D e s p ite a rg u m e n ts t o t h e c o n t r a r y , w h ic h w e re a d v a n c ­
e d i n te s t im o n y b e f o r e t h e C o m m ittee on B a n k in g a n d C u r r e n c y ,
t h e p ro b le m o f " b e a r r a i d i n g " was o n e w h ic h h a d b e e n a m a t t e r
o f c o n c e r n t o t h e G o v e rn o rs o f t h e New f o r k S to c k E xchange
f o r some t i m e .
T h is i s i l l u s t r a t e d b y t h e f a c t t h a t t h e
c o n s t i t u t i o n o f t h e New Y ork S to c k E x c h a n g e , u n d e r S e c t i o n s
f o u r a n d s e v e n o f A r t i c l e X V II, p r o h i b i t e d t h e d e m o r a liz a ­
t i o n o f t h e m a rk e t t h r o u g h b e a r r a i d i n g p r i o r t o t h e p a s ­
s a g e o f t h e S e c u r i t i e s E x ch a n g e A c t o f 1 9 3 4 .
On May 2 3 th
o f 1 9 3 2 , t h e G o v e rn in g C o m m ittee b r o u g h t c h a r g e s a g a i n s t
D a n ie l McKeon t o th e e f f e c t t h a t h e h a d "m ade o f f e r s t o
s e l l s e c u r i t i e s f o r th e p u rp o se o f u p s e ttin g th e e q u i l i ­
b r iu m o f t h e m a r k e t, a n d b r i n g i n g a b o u t a c o n d i t i o n o f d e ­
m o r a l i z a t i o n i n w h ic h p r i c e s w o u ld n o t f a i r l y r e f l e c t m ar­
k e t v a l u e s , an d t h e r e b y w as g u i l t y o f c o n d u c t i n c o n s i s t e n t
w ith j u s t and e q u ita b le p r i n c i p l e s o f t r a d e ."
Even th o u g h
t h e o f f e r s made b y McKeon w e re n o t a c c e p t e d a n d no a c t u a l
d e m o r a l i z a t i o n o f t h e m a r k e t r e s u l t e d , h e w as s u s p e n d e d fro m
2
m em b ersh ip f o r a p e r i o d o f o n e y e a r .
A s h o r t s a le i s d e fin e d ( f o r p u rp o se s o f re g u la tio n )
a s " a n y s a l e o f a s e c u r i t y w h ic h t h e s e l l e r d o e s n o t own o r
an y s a l e w h ic h i s consum m ated b y t h e d e l i v e r y o f a s e c u r i t y
2
New York Stock Exchange " Announcement". key 26, 1932,
-1 8 5 5
b o rro w e d b y , o r f o r t h e a c c o u n t o f , t h e s e l l e r .
t o own a s e c u r i t y i f
(l)
"A p e r s o n I s deem ed
he o r h i s a g e n t h a s t i t l e
t o i t ; o r (2 ) h e
h as p u rc h a se d i t o r h as e n te r e d i n t o an u n c o n d itio n a l c o n t r a c t,
b in d in g on b o th p a r t i e s , t o p u rc h a se i t b u t h as n o t y e t re c e iv e d
it;
(3 ) o r he owns a s e c u r i t y c o n v e r t i b l e i n t o i t o r e x c h a n g e a b le
f o r i t an d h a s t e n d e r e d s u c h s e c u r i t y f o r c o n v e r s io n o r e x c h a n g e ;
o r (4 ) he h a s a n o p t i o n t o p u r c h a s e o r a c q u i r e i t a n d h a s e x e r c i s e d
s u c h o p t i o n ; o r ( 5 ) he h a s r i g h t s o r w a r r a n t s t o s u b s c r i b e t o i t
4
an d h a s e x e r c i s e d s u c h r i g h t o r w a r r a n t s . "
He i s n o t c o n s id e r e d
s p e c i f i c a l l y a s ow n in g a s e c u r i t y e v e n th o u g h he may h a v e a s e c u r i t y
c o n v e rtib le in to i t ,
o r o p tio n s , r i g h t s o r w a rra n ts to p u rc h a s e i t ,
u n le s s th e y have b een e x e r c is e d .
F u r th e r m o r e , o w n in g a s e c u r i t y
i s c o n s t r u e d t o mean a n e t lo n g p o s i t i o n i n a s e c u r i t y .
I f a p e r­
so n i s a t o n c e s h o r t a n d lo n g o f a p a r t i c u l a r s e c u r i t y t o t h e
same am o u n t, a s a l e i n s u c h a s e c u r i t y m u st be c o n s i d e r e d a s h o r t
s a l e w i t h i n t h e m e a n in g o f t h e r u l e .
S e c t i o n 10 ( a ) o f t h e S e c u r i t i e s E x ch an g e A c t p r o v i d e s t h a t
i t i s u n la w f u l t o e f f e c t a s h o r t s a l e on a n y n a t i o n a l s e c u r i t i e s
e x c h a n g e e x c e p t i n a c c o r d a n c e w i t h r u l e s p r e s c r i b e d b y t h e Com­
m i s s io n .
To p r o t e c t t h e m a r k e t a g a i n s t " b e a r r a i d s " by s h o r t
s e l l e r s t h e C om m ission h a s p r e s c r i b e d
3
S . E . C . , G e n e r a l R u le s an d R e g u l a t i o n s u n d e r th e S e c u r i t i e s Ex­
ch an g e A c t o f 1 9 5 4 . a s am ended t o F e b . 1 5 , 1 9 4 0 , r u l e x - 3 B - 5 , p . 3 0 2 .
4
O f f i c e o f t h e S e c r e t a r y , New Y ork S to c k E x c h a n g e , c i r c u l a r C -6 4 4 S .
( c i r c u l a r i s s u e d t o m em bers) F e b . 5 ,1 9 3 8 .
-last h a t i t i s u n la w fu l t o e f f e c t a s h o r t s a le a t a p r ic e below
th e l a s t s a l e , " r e g u la r way41, w hich had ta k e n p la c e on th e
exchange.
Such s h o r t s a le can be made a t a p r ic e e q u a l to
th e l a s t p r ic e o n ly i f i t h as been p re c e d e d by a low er p r ic e ,
5
" r e g u la r way".
I t i s f u r t h e r p ro v id e d t h a t each o rd e r must be marked
"lo n g " o r " s h o r t" i n o rd e r t h a t s h o r t s a le s may be e a s i l y r e ­
c o g n iz e d .
I t i s f u r t h e r p r e s c r ib e d t h a t no”s e l l " o rd e r may
be marked "lo n g " by a member u n le s s th e acco u n t f o r which
th e t r a n s a c t i o n i s e x e c u te d h as i n i t th e s e c u r i t y to be de­
l i v e r e d a f t e r th e s a l e has been e f f e c t e d , o r u n le s s such mem­
b e r has been in fo rm ed t h a t h i s c l i e n t i s th e owner o f such
s e c u r i t i e s and w i l l d e l i v e r them as soon a s p o s s ib le w ith 6
o u t undue in c o n v e n ie n c e .
I n o r d e r t h a t th e s e r e g u la t io n s may n o t i n t e r f e r e w ith
t r a n s a c t i o n s w hich a re t e c h n i c a l l y s h o r t b u t n o t r e a l l y s h o rt
i n c h a r a c t e r , th e r u l e s p ro v id e f o r v a r io u s e x c e p tio n s .
S a le s
" a g a in s t th e bo x ” a r e p e r m itte d th ro u g h th e exem ption o f t r a n s ­
a c tio n s w hich a r e made by any p e rso n f o r an acco u n t i n which
he h as no i n t e r e s t , o r b y a n y p e rso n so lo n g a s he owns th e
s e c u r i t y s o ld and w i l l make d e liv e r y a s soon as i s co n v e n ie n t­
ly p o s s ib le .
I n o r d e r to av o id th e n e c e s s ity o f b r o k e r s '
g a th e r in g in fo rm a tio n c o n c e rn in g th e s t a t u s o f each s a l e ,
i t i s p e r m is s ib le f o r them to e n t e r i n t o w r itte n agreem ents
5
O en eral R u les and R e g u la tio n s . r u l e X -lO A -l(a).
6
I b i d . . r u le s X-10A-1 (b) and ( c ) .
-IB 7 -
w ith custom ers to th e e f f e c t t h a t th e l a t t e r w i l l d e s ig n a te
s h o rt s a le s a s su ch .
I n th e e v e n t t h a t a s a le i s marked
"lo n g 11 and th e s e c u r ity i s n o t d e liv e r e d , th e b ro k er may a s ­
sume t h a t th e custom er owns th e s e c u r i ty and w i l l d e liv e r i t
7
as soon a s p o s s ib le w ith o u t undue inconvenience or expense.
At th e o u ts e t odd l o t d e a le r s were f r e e d from th e s e r e ­
q u irem en ts re g a rd in g s h o r t s e l l i n g , which were a p p lic a b le to
th e round l o t tr a n s a c tio n s o n ly ..
I n January 1938 th e Com­
m is s io n 's r u le s s t i l l p ro v id e d t h i s exem ption.
I n May o f
t h a t y e a r , however, th e New York Stock Exchange announced
a r u l i n g o f i t s own to be e f f e c t i v e June 1 , which extended
th e r u l e to cover s h o rt s e l l i n g i n odd l o t 3 , ex cep t i n th o se
sto c k s i n which th e odd l o t d e a le r was r e g is te r e d .
The em­
p h a s is i n t h i s r u li n g i s on th e p r ic e a t which a s h o rt s a le
may be made, which s u g g e sts t h a t th e aim o f th e New York
Stock Exchange was to e lim in a te any advantage which m ight
accru e to odd l o t d e a le r s i n " s h o r t" o r d e rs , g e n e ra lly be­
cause o f an exem ption w hich had been g ra n te d to them be­
cause o f th e p a r t i c u l a r n e c e s s i t i e s o f t h e i r type o f b u s i8
n ess.
S h o rt s a le s may a ls o be a u th o riz e d by n a tio n a l se c u r­
i t i e s exchanges f o r th e purpose o f e q u a liz in g p r ic e s between
two exchanges w ith o u t re g a rd f o r th e r e g u la tio n s .
S h o rt s a le s
7
New York S to ck Exchange, C ir c u la r C-6443.
8
New York Stock Exchange, P u b lic R e la tio n s D epartm ent, R elease
Wednesday, Kay 25, 1938*
-188-
in s p e c ia l a r b itr a g e a c co u n ts a r e lik e w is e exempted when th e
c a r r ie r o f th e accou nt owns a s e c u r it y by v ir t u e o f which he
w i l l be e n t i t l e d to a c q u ir e s e c u r i t i e s o f th e same c la s s as
th o s e so ld *
Such r ig h t must be one which has been extended
to a l l s e c u r it y h o ld e r s o f any c la s s o f s e c u r i t i e s o f th e i s ­
su er or one w hich was o r i g i n a l l y a tta c h e d t o , or rep re sen ted
by, an oth er s e c u r it y .
A ll t r a n s a c tio n s o f t h i s ty p e must be
fo r th e purpose o f p r o f it in g by p r ic e d if f e r e n c e s betw een th e
two s e c u r i t i e s in v o lv e d in o rd er to be exem pted.
L ik ew ise,
s a l e s o f t h i s ty p e may be made in in t e r n a t io n a l a r b itr a g e a c ­
c o u n ts, p rovided th e s e l l e r knows or has reason t o b e lie v e
th a t he w i l l be a b le to a c q u ir e s e c u r i t i e s in a fo r e ig n mar­
k e t to co v er th e tr a n s a c t io n and p la n s to a cq u ire them.^
M isuse o f custom ers 1 sto o k through le n d in g by b r o k e r s.
S in ce s to c k le n d in g i s an in t e g r a l p art o f a sh o r t s e l l ­
in g t r a n s a c t io n , s h o r t s e l l i n g cannot be co n sid ered w ith o u t
c o n s id e r a tio n o f t h i s p r a c t ic e .
In a d d itio n to th e p o s s ib le
i l l e f f e c t s upon th e p r ic e s tr u c tu r e o f th e m arket, th e m is­
use o f custom ers 1 stock s was a s u b je c t o f i n v e s t ig a t io n by
th e S en ate Committee on Banking and Currency.
The charge was
made t h a t th e brokers used th e sto c k o f t h e i r custom ers whose
s to c k had been borrow ed.
I t was f e l t t h a t th e custom ers did
not have proper c o n tr o l over t h e i r sto o k , and were th e r e fo r e
tak en advantage o f .
The New York Stock Exohange, w h ile d e-
§ e n e r a l R ules and R e g u la tio n s , r u le X-10A-I (d)
fe n d in g i t s p r a c t i c e s b e f o re th e Committee on Banking and Cur­
re n c y , a p p a r e n tly had c e r t a i n m isg iv in g s co n cern in g i t s e s ta b ­
l i s h e d p r a c t i c e s i n t h i s c o n n e c tio n , s in c e as e a r ly as F ebru­
a r y 1 8 , 1932, i t s G overning Committee is s u e d a c i r c u l a r to i t s
members re g a rd in g th e m a tte r .
T h is c i r c u l a r p o in te d o u t to
th e members o f th e exchange t h a t i n some in s ta n c e s th e cus­
to m ers d id n o t a p p r e c ia te t h a t th e u s u a l form o f c u s to m e rs '
agreem ent p e r m itte d th e b ro k e r to le n d c u sto m e rs' s e c u r i t i e s
w hich had been p u rc h a se d on m arg in , nor d id th e y know t h a t
th e y had th e r i g h t to rev o k e t h i s p e rm is sio n a t a ry tim e .
The Committee r e s o lv e d t h a t a f t e r A p ril 1 , 1932, members
o f th e exchange sh o u ld n o t le n d s to c k s h e ld on m argin f o r
cu sto m ers w ith o u t s e p a ra te a u th o r iz a tio n i n w r itin g from th e
cu sto m er t o do s o .
c o u n ts .
T h is r e s o l u t i o n a p p lie d to a l l new a c ­
I t was a l s o r e s o lv e d , how ever, t h a t th e Committee
on B u sin e ss Conduct m ight r e q u i r e members to c a l l c u s to m e rs '
a t t e n t i o n t o t h e i r r i g h t to rev o k e any a u th o r iz a tio n f o r th e
le n d in g o f s e c u r i t i e s w hich had been p r e v io u s ly g iv e n . T h is
m ig h t be done a t such s t a t e d p e r io d s as th e Committee m ight
10
deem d i s c r e e t .
T his s o lu tio n i s i n many r e s p e c ts s im i la r to th e p ro ­
v is io n s o f s e c t io n e i g h t o f th e S e c u r i ti e s Exchange A ct,
11
w hich have b een d is c u s s e d i n a p re v io u s c h a p te r ,
except
t h a t s e c t io n e i g h t s p e c i f i c a l l y p ro v id e s t h a t s e c u r i t i e s
10
New York S to ck Exchange, C ir c u la r C-4873, F e b . . 18, 1932.
11
See Chap* VI, pp. 155--157 above.
-190-
m ust n o t be l e n t to a sum beyond th e a c tu a l in d e b te d n e s s o f
th e custom er Tilth r e s p e c t to such s e c u r i t i e s .
The R ules and
R e g u la tio n s under th e A ct w hich r e g u la te s h o r t s e l l i n g (u n d er
s e c tio n 10) f u r t h e r r e g u la te th e conduct o f b ro k e rs w ith r e ­
l a t i o n t o le n d in g s e c u r i t i e s .
A member o f a n a tio n a l s e c u r ­
i t i e s exchange i s f o rb id d e n to le n d or a rra n g e f o r th e lo a n
o f s e c u r i t i e s i f he knows o r b e lie v e s t h a t th e s a le f o r th e
co v erag e o f w hich th e s e c u r i t y i s r e q u ir e d has been marked
" lo n g 11.
He m ust n o t f a i l t o make d e liv e r y o f a s e c u r ity on
th e d a te on w hich d e liv e r y i s due i f he knows t h a t th e s a le
h as been s im i l a r l y m arked.
By th e s e means th e Commission
hopes to b rin g p r e s s u r e t o b e a r to p re v e n t c ircu m v en tio n o f
i t s ru le s .
I f , how ever, a member has been inform ed b y th e
s e l l e r t h a t th e s e c u r i t y needed has been sh ip p ed o r t h a t i t
i s owned, b u t can n o t be c o n v e n ie n tly d e liv e r e d a t th e moment
w ith o u t undue in c o n v e n ie n c e , th e s e p r o v is io n s do n o t a p p ly ;
n o r do th e y a p p ly to lo a n s o f s e c u r i t i e s by one member to
a n o th e r member, o r t o any lo a n o r o th e r arrangem ent i f ,
p r i o r to i t s e x e c u tio n , th e exchange on which i t i s a r ­
ra n g e d f in d s t h a t th e s a le r e s u l t e d from a m istak e i n good
fa ith .
They need n o t a p p ly i f th e c o n d itio n o f th e m arket
a t t h e tim e th e m istak e was d isc o v e re d i s such t h a t undue
h a rd s h ip w ould r e s u l t th ro u g h c o v e rin g a t r a n s a c t io n w ith
a p u rc h a se by c a sh .
I n a l l c a s e s , due d ilig e n c e must have
12
b e en u se d i f exem ption from th e r u le s i s t o be claim ed.
12
G eneral Rules and R e g u la tio n s, ru le X-1GA-2 (a) and (b ).
-2 9 1 -
I n c o n c lu s io n i t m ight be s a id t h a t th e s e r u l e s a r e ab o u t
a s d r a s t i c as c o u ld be d e v is e d w ith o u t unduly ham pering th e l e ­
g itim a te p r a c t i c e s w hich depend upon s to c k le n d in g f o r t h e i r
e x e c u tio n .
I t w ould ap p ear t h a t th e y make i t im p o s s ib le f o r
a b u ses to ta k e p la c e w ith r e f e r e n c e to s to c k le n d in g u n le s s
th e p a r t i c i p a n t s a r e w i l l i n g to ru n th e r i s k in v o lv e d i n
dow n rig h t m is r e p r e s e n ta tio n o f t h e i r p o s itio n s .
W ith th e con­
t a c t s betw een th e exchanges and th e Commission d ev elo p ed as
th e y a r e , a tte m p ts a t e v a s io n would ap p ear to be e x tre m e ly
ris k y .
I t rem ain s t o be seem, however, w hether o r n o t i t
may be p o s s ib le f o r th o s e who w ish to v i o la te th e r u l e s to
c o n tr iv e e f f e c t i v e m ethods o f e v a sio n .
L ik ew ise, th e d egree
to whioh th e s e r u l e s w i l l s ta n d th e t e s t o f tim e from th e
p o in t o f view o f p r a c t i c a l o p e r a tio n , i s s t i l l a m a tte r
w hich can n o t be f u l l y a p p r a is e d a t t h i s tim e .
B,
MANIPUIATIVE DEVICES
The problem o f th e use o f m a n ip u la tiv e d e v ic e s i s one
w hich h a s d e f ie d exchange a u t h o r i t i e s f o r maiy y e a r s .
As
su g g e ste d i n C h ap ter I , m a n ip u la tiv e d e v ic e s ap p ear to have
ta k e n form a s soon a s th e grow th o f m ark ets became s u f f i c i ­
e n t l y advanced to p ro v id e a f i e l d f o r t h e i r o p e r a tio n .
Re­
g a r d le s s o f th e s ta n d a rd s o f exchanges c o n cern in g m anipula­
t i v e p r a c t i c e s , t h e r e ap p ear t o have been tim es a t w hich i t
h a s become n e c e s s a ry f o r th e exchanges th em selv es to s te p i n
and cu rb th e a c t i v i t i e s o f m a n ip u la to rs .
There h a s n e v e r been
-192
an open d e fe n se o f m a n ip u la tio n o r d e c e p tio n by exchange au­
t h o r i t i e s ex co p t t o th e e x te n t which m arket mt'.klng o r p r ic e
p eg g in g h s s been r e s o r t e d to n s a p a r t o f th e r o u tin e o f d is ­
t r i b u t i n g new s e c u r i t i e s .
Methods o f m a n ip u la tio n have v a r ie d
from tim e to t i n e depending upon th e n a tu r e o f th e m ark ets i n
w hich th e y have been u se d .
There a p p e a rs to have been s u b s ta ­
n t i a l agreem ent between th e Senate Committee on Banking and
C urrency end th e r e p r e s e n ta t iv e s o f th e New York S tock Ex­
change c o n ce rn in g th e o b je c tio n a b le n a tu re o f m a n ip u la tiv e
p ra c tic e s .
M a n ip u la tio n i n g e n e r a l .
lithile m a n ip u la tiv e p r a c t i c e s , a s th e y were d is c o v e re d
by th e Com m ittee, v a ry somewhat i n d e t a i l , t h e r e a re mcny
c h a r a c t e r i s t i c s w hich a re common to them e l l which have
t i w i r r o o t s i n th e s t r u c t u r e o f th e s e c u r i t i e s m a rk e ts.
These c h a r a c t e r i s t i c s may be b r i e f l y s t a t e d .
In o rd er th a t
a m a n ip u la tiv e o p e r a tio n may be conducted, th e r e must be
s to c k a v a i l a b l e a t a p r ic e below which i t could be 3 o lc , i f
m a n ip u la tiv e a c t i v i t y i n t h a t 3tock were r e s o r te d t o .
For
th e purpose o f r a i s i n g th e p r i c e , such s to c k a p p e a rs to have
been found i n tho hands o f in d iv id u a ls o r c o r p o ra tio n s i n
su ch q u a n tity t h a t th e y could n o t r e a d ily d isp o s e o f i t
w ith o u t r e s o r t t o m a n ip u la tio n ,
Such a s i t u a t i o n would r e n ­
d e r th e h o ld e r am enable t o s u g g e s tio n s c o n cern in g i t s d i s ­
p o s a l,
O r, i f such s to c k were n o t a v a il a b le in la r g e b lo c k s ,
i t m ig h t be a c q u ire d by th e m a n ip u la to rs th em selv es a t f a v ­
o ra b le p r i c e s .
I n any c a s e , I t would be t o th e ad v an tag e o f
m a n ip u la to rs n o t to a c q u ire th e s to c k o u t r ig h t b u t to o b ta in
i t th ro u g h o p tio n s which m ight be ta k e n up i f t h e i r o p e r a tio n s
w ere s u c c e s s f u l.
Having s to c k a v a i la b le , th e n e x t s te p i n ­
v o lv ed was to in f lu e n c e th e p r ic e , so t h a t th e s to c k m ight
be ta k e n down u n d er th e o p tio n s and p r o f i t a b l y d is p o s e d o f .
The p e rs o n n e l in v o lv e d o f te n c o n s is te d o f a co m b in atio n o f
p r o f e s s io n a l o p e r a to r s , b ro k erag e f ir m s , s p e c i a l i s t s and
som etim es in v e stm e n t s e r v ic e s .
Each o f th e s e h e ld a p o s i­
t i o n w hich would make i t p o s s ib le f o r him t o r e n d e r s e r v ic e s
v a lu a b le t o th e o p e r a tio n ,
A common method o f s t a r t i n g o p e ra ­
t i o n s was to c r e a t e a c t i v i t y i n th e p a r t i c u l a r s to c k th ro u g h
t r a n s a c t i o n s betw een members o f th e co m b in atio n .
T h is m ight
be done by m erely b u ying and s e l l i n g enough o f th e s to c k to
c r e a te th e im p re ssio n o f a c t i v i t y i n i t .
I t was n o t e s s e n ­
t i a l t h a t th e o p e r a to r s buy a s u f f i c i e n t amount o f th e s to c k
t o p u t up th e p r ic e m a t e r ia lly .
p u b lic t o do.
T h is th e y r e l i e d upon th e
W hile t h i s p ro c e ss which h as been d e s c rib e d
as "ch u rn in g " was g o in g o n, th e b ro k erag e house in v o lv e d
m ight i s s u e m arket l e t t e r s a d v is in g i t s custom ers to p u r ­
ch ase th e s to c k on one ground o r a n o th e r.
L ik ew ise, o th e r
in v e stm e n t s e r v ic e s m ig h t g iv e s im ila r a d v ic e .
At th e same
tim e th e s p e c i a l i s t who d e a l t i n th e s to c k was i n a p o s it i o n
to see t h a t o p e r a tio n s were b ein g c a r r i e d on i n th e b e s t
p o s s ib le m anner, and had th e advantage o f in fo rm a tio n co n -
c e m in g th e s to c k in v o lv e d , which was n o t a v a ila b le to o u t­
s id e rs .
As th e 3tock advanced i n p r i c e , p r e v io u s ly a c q u ire d
o p tio n s were ta k e n up and th e sh a re s which were th e re b y ac­
q u ire d were s o ld a t a p r o f i t to th e o p e r a to r s .
I f , by th e
p r o c e s s , th e s to c k had advanced to a h ig h p r ic e , i t m ight be
s o ld s h o r t , r e s u l t i n g i n a d d itio n a l p r o f i t s , b u t i t was n o t
e s ta b lis h e d t h a t p o o ls had o p e ra te d on th e s h o r t s id e o f th e
13
m arket in t h i s manner.
C o ntrol o f m a n ip u la tiv e p r a c tic e s by th e Hew York Stook Exchange.
R e g u la tio n o r p r o h ib itio n o f m an ip u la tiv e o p e ra tio n s ap­
p e a rs to have been c e n te re d around th e se p r a c t i c e s .
P r io r to
th e p assag e o f th e S e c u r itie s Exchange Act o f 1934, th e ex­
change a u t h o r i t i e s to o k s te p s to b rin g t h i s problem under con­
tro l.
As e a r l y as September 29, 1932, th e Governing Committee
o f th e New York S tock Exchange r u le s t h a t , "No member a c tin g
as a s p e c i a l i s t and no p a r tn e r of such a member and no firm
i n w hich such a member i s a g e n e ra l o r s p e c ia l p a r tn e r s h a l l ,
d i r e c t l y o r i n d i r e c t l y , be i n t e r e s t e d i n a p o o l d e a lin g o r
tr a d in g in s to c k i n which such a member i s a s p e c i a l i s t , nor
s h a l l a ry such member, p a r tn e r , or firm , d i r e c t l y o r i n d i r e c t ­
l y a c q u ire o r g r a n t, i n co n n ectio n w ith a p o o l o p e r a tio n , an
o p tio n to buy o r s e l l o r to r e c e iv e o r d e liv e r s h a re s o f sto c k
14
i n w hich such a member i s a s p e c i a l i s t . "
I n June 1933, The Governing Committee prom ulgated a r u le
which made i t n e c e s sa ry f o r a member o f a firm is s u in g a m ar^ S e e Chap. I I above, pp. 60 f f .
^N ew York Stock Exchange, O ffic e o f th e S e c r e ta r y , C irc u la r C -5007,
September 29 , 1932.
I t should be n o te d , however, t h a t t h i s r u le was n o t adopted
i n f i n a l form u n t i l Feb. 14, 193(5 j See N.Y. Stock Exchange,
Committee on P u b l i c i t y , P re ss R elease o f t h a t d a te .
k e t l e t t e r t o en d o rse i t p e r s o n a lly .
The name o f th e w r i te r
o f th e l e t t e r had t o be in c lu d e d i n th e endorsem ent, and a
copy o f i t was r e q u ir e d to be k e p t on f i l e f o r a t l e a s t th r e e
y ears.
On August 2 , 1933, th e Committee on B u sin ess Conduct
is s u e d a c i r c u l a r t o members r e q u ir in g t h a t members made week­
l y r e p o r t s o f a l l p o o ls , s y n d ic a te s , and j o i n t ac c o u n ts which
w ere o p e r a tin g i n th e m a rk et.
These r e p o r t s were r e q u ir e d to
c o n ta in th e names o f th e s e c u r i t i e s tra d e d i n , th e amounts o f
com m ittm ents e x i s t i n g , th e p e rso n s p a r t i c i p a t i n g , and t h e i r r e ­
s p e c tiv e i n t e r e s t s .
L ik e w ise, a l l o p tio n s i n which th e members
w ere i n t e r e s t e d d i r e c t l y o r i n d i r e c t l y , o r o f which th e y had a c ­
q u ire d knowledge th ro u g h t r a n s a c tio n s which th e y had e x ecu ted
w ere r e q u ir e d to be r e p o r te d .
Commenting upon th e S e c u r it ie s Exchange Act p r io r t o i t s
p a s s a g e , Mr. W hitney, th en P r e sid e n t o f th e New York S tock Ex­
ch an ge, made th e f o llo w in g sta tem en t:
"In g e n e r a l, th e b i l l
i s aimed a t e lim in a t io n from th e s to c k market o f m a n ip u la tiv e
p r a c t ic e s w hich m igh t u n f a ir ly in f lu e n c e th e cou rse o f p r i c e s .
I t a ls o attem p ts to p r e v en t e x c e s s iv e s p e c u la tio n .
For many
y e a r s th e exch an ge, by changing i t s r u l e s , has sought to ac­
co m p lish th e same r e s u l t .
For in s t a n c e , we have r u le s p r o h ib it ­
in g f i c t i t i o u s tr a n s a c t io n s and 'wash s a l e s ' and a ls o matched
ord ers.
The r u le adopted tod ay in regard to m a n ip u la tiv e p ra c­
t i c e s s tr e n g th e n s th e p r o v is io n o f th e c o n s t it u t io n w hich pro­
h i b i t s members p a r t i c i p a t i n g i n tr a n s a c t io n s in te n d e d to b r in g
ab o u t a c o n d itio n i n w hich p r ic e s would n o t f a i r l y r e f l e c t mar­
k e t v alu e s*
The d is s e m in a tio n o f rum ors by members o f th e Ex­
change has lo n g been fo rb id d e n , and we have c o n s id e re d th e i s ­
suance o f f a l s e o r m isle a d in g sta te m e n ts to in d u c e th e p u rc h a se
o r s a le o f s e c u r i t i e s a s n o th in g s h o r t o f f r a u d .
We h a v e, l i k e ­
w is e , fo rb id d e n a l l paym ents f o r th e p u rp o se o f s e c u rin g i n s p i ­
r e d p u b l i c i t y , and have n o t o n ly p r o h ib ite d c o r n e rs b u t have
v e s te d i n th e G overning Committee o f th e Exchange power t o f i x
th e p r i c e a t w hich c o n tr a c ts a f f e c te d by a c o rn e r sh o u ld be l i ­
q u id a te d .
W hile we have n o t p r o h ib ite d o p tio n s , e x c e p t when
g ra n te d to o r a c q u ire d by a s p e c i a l i s t , we have f o r many y e a r s
p r o h ib ite d members tr a d in g i n 'p u t s ' and ' c a l l s ' , w hich a r e th e
commonest form o f o p tio n .
" I n e f f e c t , t h e r e f o r e , most o f th e p r o v is io n s a g a in s t th e
m a n ip u la tio n o f s e c u r i t y p r i c e s , c o n ta in e d i n s e c tio n 8 o f th e
15
b i l l , a r e a lr e a d y r u l e s o f th e Exchange."
I n a p p r a is in g th e v a lu e o f r e g u la tio n s g o v ern in g m anipula­
t i v e p r a c t i c e s which were prom ulgated by th e New York S tock Ex­
ch an g e, i t m ust be r e c a l l e d t h a t th e case a g a in s t th e exchanges
in v o lv e d n o t o n ly th e m a tte r o f th e adequacy o f t h e i r r u l e s , b u t
a ls o th e e f f e c t i v e n e s s w ith which th e r u l e s were a d m in is te re d .
I n any e v e n t, i t was n e c e s s a iy to in c o r p o ra te p r o v is io n s a g a in s t
m a n ip u la tiv e p r a c t i c e s i n t o th e law , i n o rd e r to g iv e them th e
^N ew York S to ck Exchange, P re ss R e le a s e . F eb ru ary 1 4 , 1934
I n th e f i n a l d r a f t o f th e S e c u r iti e s Exchange A ct o f 1934,
s e c t io n 9 r a t h e r th a n s e c tio n 8 d e a ls w ith m a n ip u la tiv e
p ra c tic e s .
-1 9 7 d e s ir e d f o r c e .
W ith th e p a s s in g o f th e S e c u r i t i e s Exchange A ct
o f 1954, t h a t w hich had been a mere b re a c h o f s to c k exchange r u le s
became v i o l a t i o n o f th e law .
F u rth e rm o re , a lth o u g h th e S e c u r i ti e s
Exchange A ct c o n ta in s many p r o v is io n s r e g a rd in g
m a n ip u la tiv e
p r a c t i c e s w hich a r e s im ila r t o th o se found i n th e r u l e s o f th e
New York S to ck Exchange, i n g e n e r a l, i t s p r o v is io n s te n d to be
more s p e c i f i c and f a r r e a c h in g .
P r o h ib itio n s a g a i n s t m a n ip u la tio n under th e S e c u r i t i e s Exchange
A ct o f 1954
"C hurning”th e m arket, t h a t i s , c r e a tin g an im p re s sio n o f
t r a d in g a c t i v i t y in p a r t i c u l a r s to c k s th ro u g h making o f f - s e t t i n g
p u rc h a se s and s a l e s , has been s t r i c t l y p r o h ib i te d .
u n law fu l f o r any p e rso n
I t has become
to e f f e c t a tr a n s a c t i o n i n a s e c u r i t y
which in v o lv e d no change i n b e n e f i c i a l o w n ersh ip , o r to e n te r
o r d e rs f o r p u rc h a se o r s a le w ith the knowledge t h a t o f f - s e t t i n g
o rd e rs have been p la c e d by a n o th e r p e rso n a t s u b s t a n t i a l l y th e
same tim e and a t th e same p r i c e .
F u rth e rm o re , i t i s now u n law fu l
f o r any b ro k e r o r d e a le r t o d iss e m in a te in fo r m a tio n i n th e o rd in a ry
co u rse o f h i s b u s in e s s to th e e f f e c t t h a t th e p r ic e o f a s e c u r i ty
16
i s l i k e l y t o r i s e o r f a l l as a r e s u l t o f m arket o p e r a tio n s .
I t was a l s o p ro v ided t h a t no p erso n m ig h t, f o r pay from a
b ro k e r o r d e a l e r , d isse m in a te in fo rm a tio n o f t h i s c h a r a c te r f o r
th e purpose o f b r in g in g about a r i s e o r f a l l .
T h is p r o v is io n
was d esig n e d t o e lim in a te " s e r v ic e s " and"m arket” l e t t e r s w r itte n
l y s o - c a l l e d e x p e r ts i n th e pay o f p o o l o p e r a to r s .
B ro k ers were
16
S e c u r itie s Exchange A ct, se c . 9 (a) ( l ) , ( £ ) , and ( 3 ).
-190f u r t h e r r e s t r i c t e d i n t h a t under th e Act i t became u n law fu l f o r
them to g iv e o u t any in fo rm a tio n w hich, in th e l i g h t o f th e c i r ­
cum stances in w hich i t was g iv e n , was f a l s e o r m is le a d in g w ith
r e s p e c t to any m a te r ia l f a c t .
These p r o v is io n s were aimed a t th e
main f a c t o r s i n p o o l o p e ra tio n w hich were commonly p r a c ti s e d to in d u ce
p u b lic p a r t i c i p a t i o n .
I t should be r e c a l l e d t h a t p u b lic p a r t i c i p a ­
t i o n was a d m itte d by b ro k e rs t e s t i f y i n g b e fo re th e S en ate Commit17
te e as a v i t a l l y n e c e s s a ry f a c to r i n th e s u c c e s s f u l o p e r a tio n o f p o o ls .
Extrem e c a re was n e c e s s a ry i n fram in g t h i s l e g i s l a t i o n i n th e
i n t e r e s t o f b r in g i n ab o u t d e s ir e d r e s u l t s , a s i t had been found
t h a t in fo rm a tio n which was b o th tr u e and u n tru e c o u ld o p e ra te to
th e b e n e f i t o f p o o l o p e r a to r s , i f d iss e m in a te d p u b lic l y a t th e
18
p ro p e r tim e .
The problem o f p r i c e s t a b i l i z a t i o n
One o f th e m ost d i f f i c u l t o f th e problem s w ith w hich th e
Commission has a tte m p te d to d e a l i s th e c o n tr o l o f p ric e -p e g g in g
or s ta b iliz a tio n .
As advantage m ight o f te n a c c ru e to p o o l o p e r a to r s
th ro u g h t h i s p r o c e s s , i t was f e l t t h a t th e r e sh o u ld be some r e s t r i c ­
t i v e l e g i s l a t i o n i n t h i s co n n e c tio n .
On th e o th e r hand, s t a b i l i z i n g
o p e r a tio n s i n c o n n e c tio n w ith th e is s u in g o f new s e c u r i t i e s c o u ld
n o t be re g a rd e d a s e s s e n t i a l l y c o n tr a ry to th e p u b lic i n t e r e s t .
P eg g in g o f th e p r ic e s o f new s e c u r it y is s u e s d u rin g th e p e r io d o f
t h e i r d i s t r i b u t i o n i s a lo n g e s ta b lis h e d p r a c t i c e , and one which
has been c o n s id 17
See Chap. I I ab o v e, pp.
18
ff.
. .
S e c u r i t i e s Exchange A c t, s e c . 9 (a ) 4 and 5.
-19P-.
ered an i n t e g r a l and n e c e s s a r y p a r t o f th e d is t r ib u t in g p r o c e s s .
P r o h ib itio n o f t h i s and a l l i e d p r a c t ic e s m ight e a s i l y have an
ad verse e f f e c t upon th e flo w o f c a p it a l in t o in d u s tr y .
For
t h i s rea so n th e Commission has been r e lu c t a n t t o fo rm u la te
s p e c i f i c r u le s on th e s u b j e c t.
P u rsu a n t to s e c tio n s 9 (a) (6} and 10 (b) o f th e A ct, th e
Commission began a c a r e f u l su rv ey t o d eterm in e th e d egree to
w hich p eg g in g , f i x i n g , o r s t a b i l i z i n g i s c o n s is te n t w ith th e
p u b lic i n t e r e s t .
The f i r s t s te p in v o lv e d was th e g a th e rin g
o f a v a i l a b l e h i s t o r i c a l d a ta co n cern in g th e s e o p e r a tio n s i n
an a tte m p t t o g a in p e r s p e c tiv e co n cern in g t h e i r ad v an tag es and
d is a d v a n ta g e s , and th e o p p o r tu n itie s f o r t h e i r ab u se.
D uring
th e p e r io d from 1935 to 1939, th e Commission conducted a s e r i e s
o f c o n fe re n c e s w ith r e p r e s e n ta ti v e s o f th e in v e stm e n t ban k in g
and b ro k e ra g e b u s in e s s , drew up s e v e r a l t e n t a t i v e d r a f t s o f r u l e s ,
r e v is e d them on th e b a s is o f s u g g e s tio n s made by banks, i n v e s t­
ment b a n k e rs, s to c k exchange members, t h e exchanges th e m se lv e s,
and by th e In v e stm e n t Bankers A s s o c ia tio n , th e In v estm en t Bankers
C onference I n c . , and th e New York S e c u r ity D ealers A s s o c ia tio n and
conducted f u r t h e r stu d y in an a ttem p t to embrace s t a b i l i z a t i o n
19
o p e r a tio n s on both o v e r -th e -c o u n te r m arkets and ex ch a n g es.
F i n a l l y on F e b ru a ry 9 , 1939, two r u le s were ad o p ted by th e Com­
m is s io n .
The f i r s t was r u le no. 827, adopted u n d er th e S e c u r i t­
i e s A ct o f 1933J i t p ro v id e s t h a t when s t a b i l i z a t i o n o f a new
i s s u e i s c o n te m p la te d , th e p ro sp e c tu s and r e g i s t r a t i o n
must
^ l s t Ann. R e p 't. , p . 1 5 , 2nd Ann, R e p 't. p . 1 5 , 3 rd Ann. R ep 't
P* 7 3 , 4 th Ann. R ep»t. . p. 9 1 .
-2 0 0 c o n ta ln a sim p le s ta te m e n t to t h i s e f f e c t .
The second, r u le
X-17A-2, a d o p ted under th e S e c u r i ti e s Exchange A ct o f 1934,
r e q u ir e s t h a t any u n d e rw rite r o r o th e r b ro k e r who s t a b i l i z e s
a s e c u r i t y m ust subm it d a i l y r e p o r t s to th e Commission, showing
a l l t r a n s a c t i o n s f o r s t a b i l i z a t i o n p u rp o se s .
These r u le s do n o t
a tte m p t a c t u a l l y to r e g u la te s t a b i l i z i n g a c t i v i t i e s , b u t m erely
to make them known to th e p u b lic , and to p ro v id e th e Commission
w ith in fo r m a tio n which may a s s i s t them in th e fo rm u la tio n o f r u le s
20
to govern th e s e p r a c t i c e s .
A f u r t h e r r u le which r e g u la te s s t a b i l i z a t i o n p r a c t i c e s in
c o n n e c tio n w ith "m arket o f f e r in g s " , became e f f e c t i v e F eb ru a ry
21
1 5 , 1940, under th e S e c u r i ti e s Exchange A c t. T h is new r u le
p r o h ib i t s th e m arking up o f p r ic e s ; and s in c e t h e r e a re r i g i d
r e s t r i c t i o n s on p u rc h a s e s , s t a b i l i z e r s can do l i t t l e more th a n
m a in ta in an o r d e r ly m ark et.
They may n e i t h e r s u p p o rt th e mar­
k e t n o r p r o f i t by i t s in d ep en d en t r i s e a t any p r ic e more th a n
a p o in t above t h a t a t which s t a b i l i z a t i o n commenced.
F u r th e r ­
more, s t a b i l i z a t i o n may n o t ta k e p la c e i n p r ic e s w hich have
been a t t a i n e d by p re v io u s m a n ip u la tio n .
T h is l a t e s t r u lin g
co v ers o n ly a sm all p a r t o f th e problem o f s t a b i l i z a t i o n , and
can h a r d ly be c o n s id e re d a c o n c lu s iv e s te p i n th e d i r e c t i o n o f
c o n tr o l.
I t i s s t i l l a d m itte d ly t e n t a t i v e in c h a r a c te r and may
be th o ro u g h ly r e v is e d i n th e f u tu r e .
F u rth e rm o re , i t s a d o p tio n
20
5 th A nnual R e p o rt.p . 117 and n o te ; r u le 827 a p p e a rs i n th e G en eral
Rulew and R e g u la tio n s under th e S e c u r i ti e s A ct of 1933, a s amended
to F eb. 1940; r u l e X-17A-2 ap p ears i n th e G e n e ra l R u les and R egula­
t i o n s under th e S e c u r i t i e s Exchange A ct o f 1934, a s amended t o Feb.
1940, p . 1701-1702.
S .E .C ., R e le a se No. 2446 under th e S e c u r i t i e s Exchange A c t. Mar.
1 8 ,1 9 4 0 , p p .1 2 -1 4 .
-201b ro u g h t v ig o ro u s d i s s e n t from Commissioner H ealy, who approved
n e i t h e r th e r u le i t s e l f n o r th e p o lic y o f th e Commission w ith r e l a t i o n to s t a b i l i z a t i o n .
22
At th e p r e s e n t w r itin g , c o n tr o l o f
s t a b i l i z a t i o n and a l l i e d p r a c tic e s s t i l l rem ains an u nsovled problem .
R e g u la tio n o f th e use o f o p tio n s .
S in ce th e use o f o p tio n s has p lay ed an im p o rta n t p a r t in th e
p ro c e ss o f m a n ip u la tio n , r u le s were fo rm u la te d w hich r e g u la te th e
use o f o p tio n s o f a l l k in d s .
Any tr a n s a c t i o n whereby a perso n
a c q u ire s any " p u t" , " c a l l " , " s tr a d d le " o r o th e r o p tio n w hereby he
may a c q u ire a r i g h t to p u rch ase o r s e l l a s e c u r ity w ith o u t b e in g
bound to do so, can be e f f e c te d only f o r purposes w hich a re n o t a
p a r t o f pool o p e r a tio n s .
T ra n s a c tio n s made by any p erso n in con­
n e c tio n w ith a s e c u r i t y w ith r e l a t i o n t o which any o p tio n has been
a c q u ire d a re lik e w is e s u b je c t to r e g u l a tio n .
F u rth erm o re, no t r a n s ­
a c tio n may be e f f e c t e d ex cep t a cco rd in g to r u le s , where th e p erso n
e f f e c t i n g th e t r a n s a c t i o n knows o r has reaso n to b e lie v e t h a t th e
p erso n f o r whom i t i s e f f e c te d has any such o p tio n .
T his l a t t e r
p r o v is io n iB presum ably d esig n e d to e lim in a te th e s e r v ic e s o f
s p e c i a l i s t s and o th e r f lo o r t r a d e r s , which had been v a lu a b le to mar­
k e t o p e r a to rs i n c a r r y in g on pool o p e r a tio n s .
I t i s a ls o p ro v id ed
t h a t no one may e n d o rse o r g u a ra n te e th e perform ance o f any o p tio n
in any s e c u r i t y e x c e p t a s p r e s c r ib e d by th e Commission.
The i n t e n t
o f th e Commission in t h i s in s ta n c e i s to make b o th buyer and s e l l e r
o f th e o p tio n e q u a lly l i a b l e and th e re b y in c r e a s e th e r i s k s in v o lv ed
in e v a sio n o f th e A ct.
23
^ S . E . C . , R elea se No. 2446, p. 19.
23
S e c u r i t i e s and Exchange A ct, s e c . 9 (b ) and (o), p . 11.
- 2 0 Si-
F u rth e r sa fe g u a rd s a g a i n s t m a n ip u la tiv e p r a c t i c e s .
As a f u r t h e r s a fe g u a rd a g a in s t m a n ip u la tiv e p r a c t i c e s ,
th e r u l e s u n d er th e A ct p ro v id e t h a t i t i s u n la w fu l f o r a ry
p e rso n who i s p a r t i c i p a t i n g o r i s o th e rw ise f i n a n c i a l l y i n ­
t e r e s t e d in th e d i s t r i b u t i o n o f any s e c u r i t y , to u se th e
m a ils , o th e r i n s t r u m e n t a l i t i e s o f i n t e r s t a t e commerce, o r
th e f a c i l i t i e s o f a iy n a t i o n a l s e c u r i t i e s exchange, i n c e r ­
t a i n ways w hich would f a c i l i t a t e th e d i s t r i b u t i o n o f s e c u r i­
tie s .
Such p e rso n m ust n o t pay any second p e rso n f o r s o l i c i t ­
in g o th e r s to p u rch ase o r s e l l such a s e c u r i t y , o r any o th e r
s e c u r i t y o f th e same i s s u e r .
T h is r u le exem pts o n ly th o s e
paym ents w hich a r e i n th e form o f s a l a r i e s t o r e g u l a r l y em­
p lo y e d p e rso n s whose d u t i e s in v o lv e th e s o l i c i t a t i o n o f o r 24
d e rs f o r e x e c u tio n on a n a t i o n a l s e c u r i t i e s exchange.
F i n a l l y , i n t r e a t i n g s p e c i f i c a l l y m a n ip u la tiv e d e v ic e s ,
th e r u l e s p ro v id e f o r p o s s ib le developm ents i n the f u tu r e by
s t a t i n g t h a t " m a n ip u la tiv e , d e c e p tiv e , o r o th e r f ra u d u le n t
d e v ic e o r c o n triv a n c e " in c lu d e s a n y th in g which th e Commission
may choose t o d e fin e a s su ch.
T his should make i t p o s s ib le
f o r th e Commission to in c lu d e under t h i s h ead in g any combina­
t i o n which m ight be u sed to accom plish m a n ip u la tiv e r e s u l t s i n
th e f u t u r e .
These r u l e s a r e d e sig n e d to in c lu d e n o t o n ly s e ­
c u r i t i e s which a r e r e g i s t e r e d on n a tio n a l s e c u r i t i e s exchanges
25
b u t a ls o th o se which have been exempted from r e g i s t r a t i o n .
The p r o v is io n s o f th e Act and i t s r u l e s a r e given "teeth ."
th ro u g h th e allo w an ce o f rem edy a t law to anyone who i s e f f e c ­
te d by any o p e r a tio n s w hich a re fo rb id d e n i n th e A ct o r s u b je c t
^^Ge n e r a l R u les and R e g u la tio n s , r u le X-10B-2, pp. 1003-1004.
25I b i d . / r u le X-lQB^3 and - 4 .
-2 0 3 -
t o r e g u la tio n u n d er i t .
Anyone who o p e r a te s i n c o n tra v e n ­
t i o n o f th e Act o r i t s r u le s i s l i a b l e to any p e rso n who may
buy o r s e l l th e s e c u r i t y w hich h as been a f f e c t e d by h i s o p e ra ­
tio n s .
The i n j u r e d p a r t y may sue a t law i n arry c o u r t o f com­
p e te n t j u r i s d i c t i o n , and th e c o u r t may a s s e s s re a s o n a b le c o s ts
a g a in s t e i t h e r p a r t y to th e s u i t ,
Aiy p e rso n who becomes l i ­
a b le u n d er t h i s p r o v is io n may r e c o v e r, as i n c a s e s o f c o n tr a c t ,
from o th e r p a r t i e s who, i f jo in e d in th e o r i g i n a l s u i t , would
have been l i a b l e to make th e same paym ent.
Such a c t io n m ust,
how ever, be b ro u g h t w ith in a y e a r a f t e r th e d is c o v e ry o f th e
26
f a c t s , and w ith in th r e e y e a r s a f t e r th e v i o l a t i o n .
26
S e c u r i ti e s Exchange A ct, s e c . 9 ( e ) , p . 11
CHAPTER V III
THE SECURITIES EXCHANGE ACT OF 1 9 5 4
IN OPERATION
A. ROLE AND INSTRUMENTS OF THE COMMISSION
A side from th e p r o h ib it io n o f c e r t a i n p r a c t ic e s by law ,
th e S e c u r i t i e s Exchange A ct o f 1934 p ro v id ed two v e ry d i r e c t
a id s to th e s e c u r i t y buying p u b lic .
F i r s t , i t made a v a il a b le a
g r e a t d e a l o f in fo r m a tio n co n cern in g s e c u r i t i e s and s e c u r i t i e s
m a rk e ts , w hich p r i o r to i t s p assag e had been e i t h e r u n a v a ila b le
o r n o n - e x is te n t i n u s a b le form .
S econdly, i t s tre n g th e n e d th e
p o s itio n o f th e p u b lic a t law by p ro v id in g c e r t a i n rem edies i n
a d d itio n to th o se w hich had h i t h e r t o e x is te d .
S e c tio n s 12 and 13 o f th e A ct, which p ro v id ed f o r th e
r e g i s t r a t i o n o f s e c u r i t i e s on exchanges, r e q u ir e d th e f i l i n g
o f a l l in fo rm a tio n w hich th e Commission c o n sid e re d n e c e s s a ry
1
f o r th e p u b lic i n t e r e s t and th e p r o te c tio n o f i n v e s t o r s . While
c o r p o ra tio n s were exem pted from p u b lic ly d is c lo s in g in fo rm a tio n
w hich would be d e tr im e n ta l to t h e i r b u s in e s s , such a s th e d is ­
c lo s u r e o f t r a d e s e c r e t s , th e y were re q u ire d t o f i l e w ith th e
Commission a l l in fo rm a tio n demanded by th e A ct.
The Commission
m ight th en d e te rm in e what p a r t s o f t h i s in fo rm a tio n sh o u ld be
made p u b lic .
I t was assumed by th e fram ers o f th e A ct t h a t
a c o r p o ra tio n may have v e ry co g en t re a so n s f o r w ith 1
In fo rm a tio n f i l e d u n d er s e c tio n s 12 and 13 o f th e S e c u r i t i e s Ex­
change Act o f 1934 in fo rm s th e p u b lic re g a rd in g s e c u r i t i e s which a re
tra d e d on ex ch an g es. The S e c u r i ti e s A ct o f 1933 g iv e s s im ila r i n ­
fo rm a tio n c o n c e rn in g new is s u e s o f s e c u r i t i e s .
-2O T -
h o ld in g c e r t a i n in fo r m a tio n , which may n o t be im m ed iately ob­
v io u s .
For t h i s re a so n a c o rp o ra tio n may f i l e o b je c tio n s t o
p u b lic d is c lo s u r e o f c e r t a i n ite m s ; th e s e o b je c tio n s a r e
s tu d ie d by th e Commission and g ra n te d o r d en ied a s c o n d itio n s
ap p ear to w a r r a n t.
F a ilu r e to d is c lo s e r e q u ire d in fo rm a tio n
i n i t s e n t i r e t y c o n s t i t u t e s adequate reaso n f o r s t r i k i n g a
2
s e c u r i t y from l i s t i n g on th e exchanges on which i t i s r e g i s t e r e d .
F u rth erm o re, s to c k t r a n s a c t i o n s by d i r e c t o r s , o f f i c e r s , a n d p r i n ­
c i p a l s to c k h o ld e rs o f c o r p o r a tio n s , which w ere once re g a rd e d a s
s e c r e t s , a r e now m a tte r s o f p u b lic re c o rd .
The p u b lic h as a ls o
been a id e d th ro u g h p u b lic a tio n of th e names o f b r o k e rs and
d e a l e r s who have been r e g i s t e r e d under th e A c t.
Tfhile such
r e g i s t r a t i o n does n o t i n i t s e l f g u a ra n te e th e cu sto m er a g a in s t
u n f a i r tr e a tm e n t, i t a t l e a s t makes i t p o s s ib le f o r him to d i s ­
c r im in a te betw een th o s e who a r e o p e ra tin g w ith th e a p p ro v a l o f
th e Commission and th o s e who a r e unable to p ro c u re i t s a p p ro v a l
o r who sim p ly choose t o v i o l a t e th e law .
I n a d d itio n t o m a te r ia l which i s made p u b lic u n d er th e
above m entioned s e c tio n s o f th e A ct, th e Commission h as g a th e re d
a g r e a t d e a l o f in fo rm a tio n co n cern in g s e c u r i t i e s and m a rk e ts in
2
In a l l in s ta n c e s th e Commission has made i t c l e a r t h a t th e f u l ­
f i l l i n g of r e g i s t r a t i o n re q u ire m e n ts and su b seq u en t r e g i s t r a t i o n
o f a s e c u r i t y on an exchange in no way im p lie s t h a t th e Commission
has p a sse d on th e v a lu e o f th e s e c u r ity , and s e c tio n 26 o f th e A ct
makes I t u n law fu l f o r anyone in th e s e c u r i t i e s b u s in e s s to make
such r e p r e s e n t a t i o n s t o a custom er.
c o n n e c tio n w ith i t s a d m in is tr a tio n o f th e A ct; t h i s i s lik e w is e
a v a i l a b l e t o th e p u b lic i n th e r e fe r e n c e rooms o f th e Commission,
o r may be o b ta in e d g r a t i s o r a t a sm all c o s t from th e p u b lic a tio n s
u n i t o r from th e S u p e rin te n d e n t o f Documents.
The in fo rm a tio n made a v a ila b le by th e S e c u r i ti e s Exchange
A c t, i f p r o p e r ly ta k e n ad v an tag e o f by th e p u b lic , sh o u ld do
much to overcome p u b lic ig n o ra n c e i n co n n ectio n w ith s e c u r i t i e s
and s e c u r i t i e s m a rk e ts .
I t should be added t h a t t h e S e c u r i ti e s
A ct o f 1933 and th e P u b lic U t i l i t y H olding Company A ct o f 1935
lik e w is e h e lp to s tre n g th e n th e p u b lic p o s iti o n in t h i s r e s p e c t .
There can now be l i t t l e v a l i d re a so n f o r co m p lain t on th e p a r t
o f th e p u b lic to th e e f f e c t t h a t a n y th in g has been w ith h e ld from
i t which m ight p r o p e r ly have been d iv u lg e d .
F u rth e rm o re , th e
In v e stm e n t A d v ise rs A ct o f 1940, e f f e c t i v e November 1 , 1940, r e ­
q u ir e s th e r e g i s t r a t i o n o f a l l in v e stm e n t a d v is o r s who r e c e iv e
com pensation f o r t h e i r s e r v i c e s .
The p u b lic h e n c e fo rth w i l l be
p r o te c te d from a b u ses w hich have a r is e n from t h i s s o u rc e .
3
Not o n ly d id th e S e c u r i ti e s Exchange A ct p ro v id e th e
custom er w ith more a d e q u a te in fo rm a tio n w ith re g a rd to s e c u r i t i e s
and m a rk e ts; i t a l s o p ro v id e d means o f a s s u r in g him t h a t t h e i n ­
fo rm a tio n was a c c u r a te , o r , i n th e e v e n t t h a t i t was n o t, made
re c o v e ry a t law p o s s ib le f o r th e damaged p e rs o n .
S e c tio n 18
o f th e A ct made i t p o s s ib le f o r anyone who r e l i e d upon f a l s e o r
m isle a d in g in fo r m a tio n , and in c u r r e d l o s s , to sue i n any c o u r t
o f com petent j u r i s d i c t i o n , and to re c o v e r l o s s e s .
The o n ly
5,S.E .C ., In v e stm e n t Company A ct o f 1940, R elea se No. 1, S e p t. 23,
1940.
l i m i t a t i o n s im posed w ere t h a t th e a c t i o n m ust b e b ro u g h t w ith in
one y e a r a f t e r th e d is c o v e r y o f f a c t s w hich c o n s t i t u t e t h e cau se
f o r a c t i o n , and w i t h i n t h r e e y e a r s a f t e r th e c a u s e f o r a c t i o n
h ad ta k e n p l a c e .
F u r th e r p r o t e c t i o n f o r th e c u sto m e r a r i s e s o u t
o f s e c t io n 29 o f th e A c t, w hich p r o v id e s t h a t no c o n t r a c t which
i s made c o n t r a r y t o th e p r o v is io n s o f th e A ct s h a l l be v a l i d o r
b in d in g .
I t i s made c l e a r i n th e A c t, how ever, t h a t t h i s p ro ­
v i s i o n c a n n o t be u sed e i t h e r on th e p a r t o f th e b r o k e r o r o f th e
cu sto m e r f o r th e p u rp o s e o f ev ad in g c o n t r a c t s w hich w ere e n te r e d
i n t o v rith th e know ledge t h a t th e p r o v is io n s o f th e A ct w ere b ein g
v io la te d .
A c tio n a g a i n s t a b ro k e r
tr y
a cu sto m er m ust be b ro u g h t
w i t h i n one y e a r a f t e r th e d is c o v e r y o f th e f a c t s and w ith in th r e e
y e a r s a f t e r th e c a u s e f o r a c ti o n h a s o c c u r re d , a s i n t h e c a s e o f
damage from f a l s e o r m is le a d in g in f o r m a tio n .
T h is s e c t i o n n o t
o n ly m akes p o s s i b l e r e c e o v e r y by a cu sto m er who h a s been damaged
th ro u g h v i o l a t i o n o f th e A c t, b u t a l s o makes th e l e g a l s t r u c t u r e
upon w hich a c o n t r a c t made i n c o n tr a v e n tio n o f th e A ct may r e s t
so q u e s tio n a b le a s t o make an y v i o l a t i o n a r i s k y p ro c e d u re i n
an y c a s e .
F i n a l l y , i t sh o u ld be p o in te d o u t t h a t th e e x i s t e n c e
o f th e Com m ission b e f o r e w hich th e p u b lic may p l a c e i t s com­
p l a i n t s i s o f v a s t im p o rta n c e in s tr e n g th e n in g th e p u b l i c p o s i t i o n .
As a r e s u l t o f th e s e p r o v is io n s th e p u b lic a p p ro a c h e s th e
s e c u r i t i e s m a rk e ts much s tr e n g th e n e d ; a s a r e s u l t o f o t h e r s e c tio n s
o f th e A c t, th e m a rk e t h a s b e e n c o n s id e r a b ly m o d ifie d and c o n t r o l l e d
i n th e p u b lic i n t e r e s t , th ro u g h a fram ew ork which h a s b e e n d e s c r ib e d
-208i n C h a p te rs IV, V, V I, and VTI above.
I t i s th e p u rp o se o f t h i s
c h a p te r to s tu d y th e o p e ra tio n o f th e Commission u n d er th e
v a r io u s s e c tio n s o f th e A ct, and to d e p ic t b o th th e r e s u l t s o f
i t s o p e r a tio n s and th e -neans by w hich th e s e r e s u l t s a r e b ein g
acco m p lish ed .
For p u rp o se s of enforcem ent o f th e A ct, th e Commission i s
p ro v id e d w ith s e v e r a l e f f e c t i v e t o o l s :
f i r s t , i t may o b ta in i n ­
ju n c tio n s from th e c o u r ts to r e s t r a i n v i o l a t o r s ; se c o n d ly , i t
may r e f e r v i o l a t i o n s to th e D epartm ent o f J u s tic e f o r c r im in a l
p ro c e e d in g s; t h i r d l y , i t may invoke s e c tio n 19 o f th e A ct a g a in s t
v io la to rs .
S e c tio n 19 g iv e s th e Commission power to d e a l v ig o r ­
o u s ly w ith ex ch an g es, members o f exchanges, and l i s t e d co rp o ra ­
tio n s .
Under i t s p r o v is io n s th e Commission has power t o suspend
o r rev o k e th e r e g i s t r a t i o n of a n a tio n a l s e c u r i t i e s exchange; i t may
suspend o r e x p e l any member o f a n a tio n a l s e c u r i t i e s exchange; i t
may suspend o r s t r i k e from r e g i s t r a t i o n any s e c u r i t y w hich i s
l i s t e d on a n a t i o n a l s e c u r i t i e s exchange.
In o v e r - th e - c o u n te r
m arkets i t may, u n d er s e c tio n 15 o f th e A c t, suspend o r revoke th e
r e g i s t r a t i o n o f any b ro k e r o r d e a le r who has v i o l a t e d any p ro ­
v is io n o f th e A ct.
'While i t s powers in o v e r - th e - c o u n te r m ark ets
a r e n o t as w e ll d ev elo p ed as i n th e case o f th e s to c k exch an g es,
th e p a ssa g e o f th e Maloney amendment and th e fo rm a tio n o f th e
N a tio n a l A s s o c ia tio n o f S e c u r ity D e a le rs, I n c . , prom ise t o b rin g
ab o u t a c o n tr o l o v e r th e s e m ark ets s im ila r t o t h a t e x e r c is e d in
th e c a s e o f th e s to c k exchanges th em se lv e s.
-209-
Since i t i s p ro v id ed in s e c tio n 19 t h a t th e Commission may
p r e s c r ib e r u le s which must be adopted by n a tio n a l s e c u r i t i e s ex­
changes i f th e y re fu s e to make changes which have been su g g ested ,
i t h as been p o s s ib le f o r th e Commission to compel th e ad o p tio n
o f v a rio u s r u l e s by th e exchanges, th e re b y p a s sin g th e r e ­
s p o n s i b i l i t y f o r t h e i r enforcem ent on to th e l a t t e r .
L ikew ise,
sin c e th e Commission i s in a p o s itio n to impose such r u le s and
r e g u la tio n s a s may be n e c e s sa ry to e n fo rc e th e p r o v is io n s o f
th e A ct, i t i s a b le to e x e r t p re s s u re upon exchanges and o th e r
members o f th e b ro k erag e community to b rin g ab o u t th e d e s ire d
re fo rm s th ro u g h a c tio n on t h e i r p a r t , r a t h e r th a n on th e p a r t
o f th e Commission.
T his p re ss u re has brought a b o u t a s it u a t i o n
which has been d e s ig n a te d " c o -o p e ra tio n " , between th e exchanges
and r e l a t e d p a r t i e s and th e Commission, which h a s been h e lp f u l
to a l l .
From th e p o in t o f view o f th e exchanges and th e
bro k erag e community i t i s advantageous to u n d ertak e s e lf - re f o r m
i n th e i n t e r e s t o f ap p easin g th e Commission, b ecau se i t i s
th e re b y p o s s ib le to accom plish th e d e s ire d ends a lo n g l i n e s
m ost f a v o ra b le to th e fo rm er.
In many in s ta n c e s , th e Commission
has asked f o r th e c o -o p e ra tio n of th e exchanges and o th e rs i n
fram ing new r u l e ? .
T his h as u s u a lly been g iv en w i l l i n g l y sin c e
an o p p o rtu n ity i s a f fo r d a d f o r th o se to be a f f e c te d to 3 ta te t h e i r
case c l e a r l y and i n some m easure to a d a p t th e r u le s to t h e i r
d e s ir e s i n th e m a tte r .
The Commission b e n e f i ts from t h i s
arrangem ent s in c e i t i s p o s s ib le f o r them to a v a i l th em selv es of
—210 —■
c o n ta c t w ith th o se who have had lo n g e x p e rie n c e i n such a f f a i r s ;
i t a l s o p u ts them, i n c lo s e r touch w ith th e r e a l i t i e s o f th e
f i n a n c i a l community th a n m ight o th e rw ise be th e case*
As a
r e s u l t o f t h i s ty p e o f c o -o p e ra tio n i t has n o t o n ly been p o s s ib le
f o r th e Commission t o b rin g a b o u t rem edies f o r s p e c i f i c a b u s e s,
b u t a l s o t o b r in g a b o u t an e x te n s iv e r e o r g a n iz a tio n o f th e New
York S tock Exchange, which w i l l be th e s u b je c t o f a su b seq u en t
c h a p te r .
S in ce th e r o l e o f th e Commission i s p r e v e n tiv e a s w e ll a s
p u n i t i v e , i t h a s ta k e n f u l l advantage o f th e powers o f in v e s tig a t io n
bestow ed upon i t by th e A ct to g a th e r and a n a ly z e a l l m a te r ia l which
may en a b le i t t o fo rm u la te p re v e n tiv e p ro g ram s.
Y/hile i t h a s
d e a l t r ig o r o u s ly w ith o f f e n d e r s , i t h a s a t th e same tim e s tr i v e n
t o remove th o s e c o n d itio n s which i n v i t e v i o l a t i o n s o f th e A ct o r
make them p o s s i b l e .
A side from th e f a c t o r s which have been enum erated, th e r e
a r e o th e r s w hich te n d tow ard making th e p o lic y o f th e Commission
c o - o p e ra tiv e and e v o lu tio n a ry i n c h a r a c te r .
Some s e c tio n s o f th e
Act a r e sim p le and obvious p r o h ib iti o n s o f p a r t i c u l a r k in d s o f
a c t i v i t y , w h ile o th e r s te n d to em phasize d e s ir e d r e s u l t s , o r t o
in v o lv e i n t e r p r e t a t i o n s o f sequences o f e v e n ts , i n w hich l a t t e r
c a s e s th e Commission i s c o n fro n te d Tfith S u b s ta n tia l problem s o f
i n t e r p r e t a t i o n and a d m in is tr a tio n .
F u rth erm o re, s e v e r a l s e c tio n s
o f th e Act a r e o f such c h a r a c te r t h a t t h e i r enforcem ent m ight
s e r i o u s ly i n t e r f e r e w ith th e e s s e n t i a l f u n c tio n s o f th e m a rk e ts,
u n le s s a p p lie d th ro u g h th e u se o f c a r e f u l l y worked o u t r u l e s , th e
-211f o rm u la tio n o f w hich n e c e s s i t a t e s lo n g and c a r e f u l s tu d y .
T h e re fo re , th e p r e s e n t c h a p te r i s n o t o n ly a s tu d y o f ad m in is­
t r a t i o n and i n t e r p r e t a t i o n o f p r o v is io n s o f th e la w , b u t one o f
broad p o lic y fo rm u la tio n w ith r e l a t i o n to th e s e c u r i t i e s m arket
a s a w h o le.
B.OPERATION OF P R O V IS IO N S FOR EA.QT r
CONTROL OF FXCHA’T ’1-S.
S E C U R IT IE S .
ARE BROKERS
R e g is tr a tio n o f Exchanges
S e c tio n s 5 and 6 o f th e A ct, which p ro v id e f o r th e r e g i s t r a ­
t i o n o f s e c u r i t i e s exchanges as n a t i o n a l s e c u r i t i e s exchanges and
make i t u n law fu l f o r exchanges t o o p e ra te w ith o u t r e g i s t r a t i o n un­
l e s s t h e i r b u s in e s s i s o f sm all volume and e s s e n t i a l l y l o c a l in
c h a r a c te r , have p r e s e n te d l i t t l e d i f f i c u l t y f o r th e Commission.
The ex ch an g es, fa c e d w ith th e a l t e r n a t i v e of r e g i s t r a t i o n o r
d i s s o l u t i o n , have made l i t t l e c o m p lain t; and, s in c e th e A ct i s
b ased upon th e u se o f i n s t r u m e n t a l i t i e s o f i n t e r s t a t e commerce,
t h e r e h a s been no s e r io u s problem in v o lv ed in d e te rm in in g which
exchanges sh o u ld be r e g i s t e r e d and which exem pted.
C e r ta in changes,
which have been n o te d i n C hapter IV, have tak en p la c e in th e l i s t
o f n a t i o n a l s e c u r i t i e s exchanges, b u t th e r e h as been l i t t l e
ev id en ce o f f r i c t i o n o f any k in d i n th e m a tte r.
R e g is tr a tio n o f S e c u r i t i e s
The s i t u a t i o n has been v e ry d i f f e r e n t in th e case o f th e
l i s t i n g o f s e c u r i t i e s on exchanges.
In t h i s c o n n e c tio n th e
Commission i s c o n fro n te d n o t o n ly w ith th e problem o f e n fo rc in g
-2 l a ­
th e p r o v is io n s o f th e A ct, b u t o f m a in ta in in g th e k in d o f m arket
which i t c o n s id e rs in th e p u b lic i n t e r e s t and f o r th e p r o te c tio n
o f in v e s to rs .
C ases coming b e fo re th e Commission have a r is e n a s a r e ­
s u l t o f th e c o n f l i c t i n g i n t e r e s t s o f th e is s u in g c o r p o r a tio n ,
th e s to c k - h o ld e r , and th e exchange.
In th e c a s e o f A lle n
I n d u s t r i e s , I n c . , th e c o rp o ra tio n a p p lie d t o th e Commission f o r
p e rm issio n t o w ithdraw th e sto c k from l i s t i n g on th e C lev elan d
and D e tr o it Stock Exchanges; r e g i s t r a t i o n o f th e s to c k on th e
Hew York Curb had become e f f e c t iv e s e v e ra l m onths p r e v io u s ly .
O b je c tio n >vas e n te re d by th e C lev elan d Stock Exchange to th e
e f f e c t t h a t s t r i k i n g th e sto ck o f t h i s company from l i s t i n g
was i n c o n s i s t e n t w ith th e p u b lic i n t e r e s t and sh o u ld , th e r e f o r e ,
be p r o h ib i t e d .
T h is o b je c tio n c a lle d f o r a s ta te m e n t o f p o s itio n
on th e p a r t o f th e Commission w ith re g a rd to i t s power o v er
d e lis tin g of s e c u ritie s .
The Cammission h e ld t h a t th e r i g h t o f
an i s s u e r t o change i t s p la c e o f l i s t i n g had alw ays been and
s t i l l was a m a tte r which was p r im a r ily in th e hands o f th e
i s s u e r , s u b je c t o n ly to th o s e p r o v is io n s which w ere n e c e s s a ry
in th e p u b lic i n t e r e s t and s u b je c t t o th e r u l e s o f th e exchanges
in such m a t t e r s .
In t h a t n o th in g had been proved b e fo re th e
Commission t o i n d i c a t e t h a t a d e f i n i t e t h r e a t to th e p u b lic i n ­
t e r e s t e x i s t e d , and due to th e f a c t t h a t th e r e was n o t any com­
p l a i n t from s to c k h o ld e rs which in d ic a te d t h a t th e y w ere b e in g
i n ju r e d , th e Commission r u le d t h a t i t had no power t o deny th e
a p p lic a tio n p re s e n te d by th e i s s u e r f o r w ith d ra w a l from th e
-213C leveland Stock Exchange.
F urtherm ore, i t was ru le d t h a t th e
I s s u e r had th e r i g h t to w ithdraw from l i s t i n g even though r u le s
o f th e exchange i n q u e s tio n had n o t been com plied w ith from a
fo rm a l s ta n d p o in t.
I t was a ls o p o in te d o u t t h a t l i s t i n g was n o t
a c o n t r a c t i n th e sen se t h a t i t was e n fo rc e a b le by an exchange
4
a g a in s t an i s s u e r .
The ca se o f th e C o n n e c tic u t R ailw ay and L ig h tin g Company
which came b e fo re th e Commission a ro s e from a c o m p lain t from
s to c k h o ld e r s re g a rd in g d e l i s t i n g .
The i s s u e r had a p p lie d f o r d e -
l i s t i n g on th e grounds t h a t th e s to c k o f th e company no lo n g e r
had v a lu e .
S to c k h o ld e rs , on th e o th e r hand, f e l t t h a t i t had v alu e
and t h a t th e y would be harmed by te r m in a tio n o f l i s t i n g .
In th i s
in s ta n c e th e Commission f e l t t h a t i t was n o t i n a p o s it i o n to re n d e r
an o p in io n c o n c ern in g th e v a lu e o f a s e c u r i t y .
I t u n dertook an
i n v e s t i g a t i o n , however, o f th e p o s s i b i l i t y o f c o llu s io n betw een th e
i s s u e r and th e New York Stock Exchange i n th e i n t e r e s t o f d e p r e s s in g
th e p r ic e o f th e s to c k , to th e d e trim e n t o f th e s to c k h o ld e r s , b u t
no such s i t u a t i o n was found to e x i s t .
The f i n a l d e c is io n o f th e
Commission was to th e e f f e c t t h a t , b ecau se th e s to c k had ceased
to be o f an in v e stm e n t c h a r a c te r , and becau se th e p o s s i b i l i t y t h a t
th e m ark et p r ic e s m ight se rv e a s an i n d i c a t o r o f f a i r v a lu e was
n o n - e x i s t e n t , d e l i s t i n g should be p e r m itte d .
These c a s e s , and such
o th e r s a s have been h eard b e fo re th e Commission, in d i c a t e t h a t th e
Commission le a v e s as much
4
2 S .E .C ., 14 f f . The r e c e n t c o n tro v e rs y o v e r " m u ltip le tra d in g "
d e m o n stra te s th e d eg ree to which t h e Commission view s I t s e l f a s b e in g
l im ite d t o a c tin g o n ly I n th e p u b lic i n t e r e s t . When th e N.Y. S tock
Exchange d ec id e d t o e n fo rc e a r u le p r o h ib i t i n g members from d e a lin g
on o th e r exchanges in s e c u r i t i e s l i s t e d on th e N.Y. Exchange, th e Com­
m iss io n ask ed th e Exchange to p o stp o n e a c tio n u n t i l i t could in v e s ­
t i g a t e and a t th e same tim e i t q u e s tio n e d i t s own power to a c t i n a m a tte r
o f t h i s ty p e ._______________________
-2 .1 4 -
d i s c r e t i o n w ith th e i s s u e r as i s c o n s is te n t w ith th e p u b lic i n ­
t e r e s t , and i s i n t e r e s t e d o n ly i n m a in ta in in g f a i r v a lu e s on
th o se s e c u r i t i e s which a r e l i s t e d on th e ex ch an g es, and i n p r o t e c t i n g th e p u b lic .
In c a s e s where th e a p p lic a tio n f o r d e l i s t i n g i s made by
a s e c u r i t y exchange, th e Commission p u rsu e s a s im i la r p o lic y ,
so lo n g a s th e a p p lic a tio n i s unopposed by o th e r i n t e r e s t e d
p a rtie s .
In th e case o f th e Hupp K otor Car C o rp o ra tio n , how ever,
th e Commission d e f i n i t e l y s ta te d i t s r i g h t to g r a n t o r to deny
th e a p p l i c a t i o n o f an exchange f o r d e l i s t i n g a ^ s e c u r i t y . ( I n t h i s
case th e s e c u r i t y vra.s te m p o ra rily l i s t e d . )
Those i n c o n tr o l o f
th e Hupp Motor Car C o rp o ra tio n had made c o n tr a c t s w ith th e
c o rp o ra tio n which in th e o p in io n of th e New York S tock Exchange
were in e x c u s a b le .
These c o n tr a c ts w ere f o r management s e r v ic e s ,
and p ro v id e d t h a t th e managers were to g e t l a r g e p r o f i t s and
sto c k o p tio n s w hich w ere u n lim ite d i n tim e , r e g a r d le s s o f th e
r e s u l t s o f t h e i r management.
F or t h i s re a so n th e New York Stock
Exchange ask ed to have th e sto ck of th e Hupp M otor Car C o rp o ra tio n
s tr i c k e n from th e l i s t .
W ithout p r e ju d ic e t o th e exchange’ s
r i g h t s w ith r e s p e c t to d e l i s t i n g s to c k s p erm an en tly r e g i s t e r e d ,
th e Commission h e ld t h a t th e exchange sh o u ld n o t s t r i k e th e
sto c k from th e l i s t .
I t was p o in te d o u t t h a t , i n c o n s id e rin g
w h eth er o r n o t a s e c u r i t y should be d e l i s t e d , n o t o n ly m ust th e
p u b lic i n t e r e s t be tak en in to a c c o u n t, b u t a ls o th e p r o te c tio n
of in v e s to rs .
In t h i s case i t was f e l t t h a t th e s to c k h o ld e rs o f
IIupp M otors w ould s u f f e r unduly from th e d e l i s t i n g o f t h i s
6
2 T, E. C . , 21 f f .
-2156
s e c u r it y .
In th e m atter o f Mother Lode C o a lit io n Mines Company,
th e
Commission h eld t h a t i t had no r ig h t t o deny an a p p lic a t io n made
by an exchange in accordance w ith i t s r u l e s , b u t t h a t i t had o n ly
th e a u t h o r ity to p r e sc r ib e such term s a s are c o n s is t e n t w ith th e
p u b lic i n t e r e s t , and f o r th e p r o te c tio n o f in v e s t o r s .
I t a ls o
p o in te d ou t t h a t , when an exchange a s s e r t s t h a t c o n tin u e d l i s t i n g
o f a s e c u r it y on an exchange would m isle a d th e p u b lic , an a p p li­
c a t io n to s t r id e from l i s t i n g should be g r a n te d .
I t sh o u ld be
n o ted t h a t t h i s ca se d i f f e r s from t h a t o f th e Hupp Motor Car
C orp oration n o t o n ly in th a t th e s to c k was perm anently r e g is t e r e d
b u t a l s o t h a t th e m atter in v o lv e d d e f i n i t e s to c k exchange r u lin g
and p r e c e d e n t.
The sto c k o f th e company in q u e s tio n was b e in g
bought and s o ld when In f a c t th e company was no lo n g e r i n e x i s t 7
ence as a g o in g con cern .
F in a lly ,
in th e c a s e s where th e r e g i s t r a n t has f a i l e d t o
conform t o th e p r o v is io n s o f th e S e c u r i t i e s Exchange A c t, th e
Commission h old s th a t i t i s n e c e s s a r y fo r th e p r o te c tio n o f th e
in v e s t o r s and in th e p u b lic i n t e r e s t , to withdraw r e g i s t r a t i o n
8
o f th e s e c u r it y . I t sh ou ld be p o in te d o u t t h a t s in c e th e reg u ­
l a t i o n s o f th e Act are In co rp o ra ted a s a p a r t o f th e r u le s o f
6
2 S .E .C ., 505 f f .
7
5 S .E .C ., 280 f f .
8
1 S .E .C ., 879, and o th e rs .
-21Cth e sto c k ex ch a n g es, and s in c e th e r u le s and r e g u la t io n s o f th e
exch an ges th em se lv e s a r e s u b je c t t o th e ap p ro v a l o f th e Commis­
s io n , v i o l a t i o n o f th e r u le s o f th e sto c k exch anges and o f th e
r u le s o f th e Commission amount to v i r t u a l l y th e same t h i n g .
D if f e r e n c e s o f o p in io n betw een th e exch anges and th e Commission
a r e l i k e l y t o a r i s e o n ly i n th o s e c a s e s where m a tte r s o f d i s c r e ­
t i o n a r e in v o lv e d , and where th e i n t e r e s t s o f th e Commission and
th o se o f th e exchanges are n o t i d e n t i c a l .
U n lis te d Trading P r iv ile g e s
As in th e c a se o f l i s t i n g o f s e c u r i t i e s on ex ch a n g es, th e
c o n tr o l o f u n lis t e d tr a d in g p r i v i l e g e s I n v o lv e s c o n s id e r a b le
p o l i c y fo r m u la tio n and in t e r p r e t a t io n o f th e law on th e p a r t o f
th e Commission.
The g u id in g p r in c ip le th rou ghout has been th e
m aintenance o f such m arkets a s v / i l l conduce to th e p u b lic i n ­
t e r e s t and th e p r o te c tio n o f in v e s t o r s .
I n t e r e s t e d p a r t i e s in v o lv e d in m a tte r s o f u n l i s t e d tr a d in g
p r i v i l e g e s a r e (1 ) i s s u e r s , (2 ) h o ld e r s o f s e c u r i t i e s , (3 ) ex­
changes on w hich s e c u r i t i e s a r e trad ed on an u n li s t e d b a s i s ,
(4 ) th o se exchanges w hich c o n s t it u t e prim ary m arkets f o r s e c u r i­
tie s ,
(5 ) b rok ers who sponsor s e c u r i t i e s w ith u n lis t e d tr a d in g
p r i v i l e g e s , and (6 ) th e Commission.
There a re in h e r e n t con­
f l i c t s o f i n t e r e s t among th e s e p a r t i e s .
The i s s u e r may d e s ir e
to m a in ta in i t s s e c u r i t i e s on an exchange when t h e i r m arket i s
o f such c h a r a c te r a s to be d e tr im e n ta l t o th e p u b lic i n t e r e s t .
On th e o th e r hand, i t may w ish t o remove them f o r v a r io u s r e a so n s
-2 1 7 -
when an adequate market f o r them s t i l l e x i s t s .
H o ld ers o f a
s e c u r it y may o b j e c t t o i t s b e in g removed from an exchange
where i t has en joyed u n li s t e d tr a d in g p r i v i l e g e s , when th ey
are to o few in number to c o n s t it u t e '*the p u b lic i n t e r e s t 1*
in any s i g n i f i c a n t s e n se , and when th e m arket i s so t h in a s
t o be dan gerous.
Exchanges on w hich s e c u r i t i e s are trad ed on
an u n lis t e d b a s is may w ish to m a in ta in them on t h i s b a s is
f o r th e revenue w hich th ey b r in g i n , r e g a r d le s s o f th e
c h a r a c te r o f th e market w hich th e y e n jo y .
Exchanges which
c o n s t i t u t e primary m arkets f o r s e c u r i t i e s would n o t encourage
e x te n s io n o f u n lis t e d tr a d in g p r i v i l e g e s in th o se s e c u r i t i e s
on o th e r exch an ges.
L ik e w ise , b rok ers who sponsor s e c u r i t i e s
w ith u n lis t e d tr a d in g p r i v i l e g e s may w ish t o have them main­
t a in e d or removed f o r r ea so n s o f t h e i r own, which may have
l i t t l e t o do w ith th e p u b lic, i n t e r e s t .
F i n a lly , b ro k ers who
d e a l in s e c u r i t i e s o v e r -th e -c o u n te r w hich a l s o en jo y u n l is t e d
tr a d in g p r i v i l e g e s may w ish to have th e s e p r i v i l e g e s te r m in 9
a te d in th e i n t e r e s t o f c u t t in g down c o m p e titio n .
Hence,
th e r e e x i s t s a s e r i e s o f f o r c e s which o p e r a te w ith o u t regard
f o r th e m aintenance o f th e b e s t p o s s ib le m arkets, and w hich
must be curbed or a t l e a s t c o n t r o lle d i f th e p u b lic i n t e r e s t
i s t o be se r v e d .
In co n n e c tio n w ith th e s e problem s th e Commission has
form u lated a s e t o f r a th e r d e f i n i t e p o l i c i e s .
In ca rr y in g
9 .
1 3 . E. C. , 909 f f .
* I t i s n o t o n ly a p o l i c y o f
th e Commission bu t a mandate o f th e s t a t u t e t h a t c o m p e titio n
betw een exchanges and o v e r -th e -c o u n te r m arkets be en cou raged .
Hence, so lo n g a s th e exchange f o r a s e c u r it y i s a d eq u a te,
i t i s r e ta in e d by t h a t body.
-2 1 8 —
them ou t i t has shown a marked tend en cy to d isr eg a r d the ad­
van tages o f th e p a r tic u la r a p p lic a n t in v o lv e d and t o adhere
rath er r i g i d l y to what i t c o n sid e r s th e in t e n t o f th e A ct.
The Commission view s th e A ct a s c a l l i n g f o r th e maintenance
o f u n lis t e d tr a d in g p r iv ile g e s in a l l s e c u r it ie s on a l l ex­
changes (1 ) where th e r e i s s u f f i c i e n t p u b lic d is tr ib u tio n o f
such s e c u r i t i e s in the v i c i n i t y o f th e exchanges to r ep re sen t
an a p p re c ia b le number o f p e o p le , (2 ) v/here th er e i s s u f f i c i e n t
tra d in g a c t i v i t y in such s e c u r i t i e s on th e exchanges to rep re­
se n t tru e m arkets, (3 ) where tr a d in g i s o f such ch a ra cter a s
t o r e p r e se n t th e p u b lic in th e v i c i n i t y o f th e exchanges r a th e r
than a few in t e r e s t e d p a rties.^ ®
There appears to be o n ly one group among th e " in te r e s te d
p a r tie s '1 p r e v io u s ly m entioned in Whose fa v o r th e Commission has
d e v ia te d from i t s p o l i c y , namely th e ex ch a n g es.
This d e v ia tio n
i s more apparent than r e a l , however, because i t has happened
on ly under circu m stan ces where th e exchanges vfere v i t a l l y de­
pendent upon revenue from u n lis t e d tr a d in g .
In th e se c a se s th e
Commission has f e l t th a t i t i s b e t t e r to m ain tain c e r ta in s e c u r i­
t i e s on such exchanges than to r is k th e p o s s i b i l i t y o f t h e i r having
10E. C„, 3 * f f . , a nd 450 f f . , and" V ic in ity o f the exchange" i s a g eo g ra p h ica l
concept w hich, in th e view o f th e Commission, r e p r e se n ts the area
in which the p u b lic regard s a p a r t ic u la r exchange as one o f the
n a tio n a l exchanges towards which i t would lo o k f o r a market.
" S u ffic ie n t tr a d in g a c t iv it y " i s thought o f n o t e n t ir e ly in a
q u a n tita tiv e sen ses th e Commission i s more concerned w ith s im ila r it y
between th e exchange market and th e o v e r -th e -c o u n te r market f o r a
p a r tic u la r s e c u r ity than w ith th e amount tr a d e d . "Character o f
tradin g" i s th ou gh t o f n o t a s a m eahstof d is tin g u is h in g between
a f a i r and r e p r e s e n ta tiv e market and one th a t may be s p e c u la tiv e
in ch a ra cterj even though th e market fo r a s e c u r it y may be both
f a i r and r e p r e s e n ta tiv e , th e f a c t th a t i t i s f o r the most p art
m aintained by d e a le r s has c o n s t it u t e d s u f f i c i e n t reason fo r
term in atin g u n lis t e d tr a d in g p r iv ile g e s in a s e c u r it y .
1 8 . E. C*, 923 f f . ,
3 8 . 2 C ., 81 f f . .
.
2 8.
-2 1 9 -
to d is s o lv e , so lo n g a s th e p u b lic i n t e r e s t was n o t s e r io u s ly
e ffe c te d .
11
Because o f th e g e o g ra p h ic a l c o n s tr u c tio n o f th e U nited
S t a te s , many s e c u r i t i e s are l i s t e d on more than one exchange,
and many which a re l i s t e d on one exchange en jo y u n lis t e d tra d in g
p r iv ile g e s on a n o th e r .
In some o f th e s e s e c u r i t i e s th ere i s
s u f f i c i e n t tr a d in g so th a t s o - c a lle d • independent market!! i s
e s t a b lis h e d , w h ile in o th e r s tr a d in g i s m ech a n ica lly geared to
th e ir primary m arket.
Some a re trad ed in odd l o t s o n ly w h ile
o th ers are trad ed i n both odd and round l o t s .
In such in s ta n c e s ,
th e Commission i s fundam en tally in t e r s te d in se e in g th a t th e
c o s t s to cu sto m ers, th e s e r v ic e s which th ey r e c e iv e , and th e
tri­
ces a t which t h e ir ord ers are ex ecu ted in no way put them a t a
disadvantage in com parison ’w ith primary m arkets.
In in s ta n c e s
where th ere i s n o t s u f f i c i e n t tr a d in g in a s e c u r it y to enable i t
t o have an independent market in round l o t s , th e Commission has
not seen f i t t o p erm it round l o t tr a d in g .
"Where th e r u le s o f th e
exchange are d esig n ed to promote an independent market, and where
such a market a c t u a ll y e x i s t s , i t i s encouraged by th e Commission,
sin c e i t i s f e l t th a t co m p etitio n betw een such markets i s h e a lth y
fo r them.
F i n a lly , u n lis t e d tr a d in g p r i v i l e g e s
primary markets are in
in
s e c u r it ie s whose
th e F a st i s p e r m itted on th e exchanges on
th e 7fest c o a s t n o t o n ly because th er e i s adequate p u b lic d i s t r i ­
bu tion and tr a d in g a c t i v i t y th e r e , b u t because th e d iffe r e n c e in
12
time g iv e s th e p u b lic g e n e r a lly b e t t e r a c c e s s to th e m arket.
11
•
2 8.' B. c f , 178 f * .
12 .
i t
,E. C . , 178 f f . ,
364 f f „ and 560 f f .
3. 8 . E.
c . , 2B4 f f . and 339 f f . , 4. 8. E. C. ,
-2 2 0 '-
P r o x ie s
In accordan ce w ith s e c t io n 14 o f th e A c t, th e Commission
has adopted r u le s and r e g u la t io n s g o v ern in g th e s o l i c i t a t i o n o f
p r o x ie s , c o n s e n ts , or a u t h o r iz a t io n s co n cern in g s e c u r i t i e s l i s t e d
on n a t io n a l s e c u r i t i e s ex ch a n g es.
7he o r i g i n a l r u le s w ere
adopted on September 2 4 , 1935 J on A ugust 1 1 , 1 9 3 8 , a r a th e r com­
p l e t e r e v is io n was p u b lish e d by th e Commission, and th e r e v is e d
r u le s were amended on February 1 5 , 1 9 4 0 .
These r u le s have been aimed r lir e c t ly a t the fundam ental
w eak n esses o f th e p r e - e x is t in g methods o f s o l i c i t a t i o n .
P r io r
to t h e i r en actm en t, s to c k h o ld e r s ‘were u s u a lly in th e dark con­
cern in g th e m o tiv es and i n t e r e s t s in v o lv e d in th e s o l i c i t a t i o n
and u se o f p r o x ie s ; th e s e 7/ere som etim es o f q u e s tio n a b le c h a r a c te r
and o fte n d i r e c t l y opposed to th e s to c k h o ld e r 's i n t e r e s t s .
F u rth er­
m ore, he was o f t e n unaware o f th e e x is t e n c e o f o p p o s itio n to
management p o l i c i e s on th e p a r t o f o th e r sto c k h o ld e r s w ith whom
h is i n t e r e s t m igh t be a l l i e d .
A lso th e sto c k h o ld e r was o fte n
in a d e q u a te ly inform ed a s t o what m a tte r s h i s proxy a u th o r ize d th e
s o l i c i t o r to v o te on, and a s to th e a c t io n w hich was to be ta k e n .
As a r e s u l t , sto c k h o ld e r s in g e n e r a l m erely sig n e d p r o x ie s a s a
kind o f d u ty or perhaps threw them away, w ith th e r e s u l t th a t th e
v o tin g sto c k o f a c o rp o ra tio n was a c t u a l l y in c o n tr o l o f a few
in t e r e s t e d p a r t i e s , and th e power which v/as t h e o r e t i c a l l y in th e
hands o f th e v o tin g s to c k h o ld e r s was i n f a c t n o n - e x is t e n t .
F in a lly
i t had been e x tr em e ly d i f f i c u l t f o r th e management to o b ta in an
e x p r e s s io n o f o p p o s itio n t o i t s p o l i c i e s , due t o i t s i n a b i l i t y to
s o l i c i t w id e ly s c a t te r e d s to c k h o ld e r s .
These shortcom ings in
-221-
th e system o f p roxy s o l i c i t a t i o n , w hich had been o f such lo n g
sta n d in g a s t o be tr e a t e d by many v /r ite r s a s i n e v i t a b l e , v/ere
s p e c i f i c a l l y a tta c k e d by th e r u lin g s o f th e Commission.
The r u le s a s o r i g i n a l l y d r a fte d p r e sc r ib e d i n g e n e r a l
th e p roced u re which v/as t o be c a r r ie d o u t in c o n n e c tio n w ith
s o lic ita tio n s .
Under them no proxy m ight be s o l i c i t e d through
th e m a ils or o th e r in s t r u m e n t a lit i e s o f i n t e r - s t a t e commerce,
u n le s s th o se s o l i c i t e d w ere a d e q u a te ly inform ed n o t o n ly a s t o
th e f a c t s o f th e m atter t o be v o te d on bu t a ls o a s t o th e back­
ground o f th e s it u a t io n and th e m o tiv es in v o lv e d .
I f a s o lic i­
t a t io n was i n i t i a t e d by any d ir e c t o r , o f f i c e r , em ployee, o r
com m ittee o f th e is s u e r i n h i s or i t s b u s in e s s c a p a c it y , i t was
requ"' red th a t th e s e c u r it y h o ld er be inform ed a s t o w hether or
n o t such s o l i c i t a t i o n was b e in g made on b e h a lf o f th e management.
L ik e w ise , i f o p p o s it io n t o s o l i c i t a t i o n by th e management e x is t e d
on th e p a r t o f any o f f i c e r or d ir e c t o r , and such o p p o s itio n had
been f i l e d by th e is s u e r n o t l e s s than tw en ty days p r io r t o th e
d a te o f s o l i c i t a t i o n , in fo r m a tio n to t h a t e f f e c t was req u ired
t o be in c lu d e d in th e s o l i c i t a t i o n .
I f such o p p o s itio n planned
t o s o l i c i t 25 p e r c e n t or more o f any c l a s s o f s e c u r i t i e s , a s t a t e ­
ment t o th a t e f f e c t lik e w is e had t o be in c lu d e d .
Furtherm ore,
i f s o l i c i t a t i o n w ere made o th e r w ise than on b e h a lf o f th e i s s u e r ,
i t was n e c e s s a r y t o in c lu d e i n th e sta tem en t th e names o f th e persons
i n i t i a t i n g th e s o l i c i t a t i o n , th e c l a s s or c la s s e s o f s e c u r i t i e s owned
by them , nnd th e sta tem en t o f th e a g g r eg a te amount o f each c la s s
o f s e c u r it y so owned.
I f a p erson was e s p e c i a l l y engaged f o r
com pensation t o s o l i c i t s to c k h o ld e r s , i t was n e c e s s a r y to in ­
form them to th a t e f f e c t and t o name th e p erso n s f o r whom
s o l i c i t a t i o n was b e in g made.
The sto c k h o ld er was a l s o e n t i t l e d
t o r e c e iv e a b r i e f d e s c r ip t io n o f th e m a tters w hich were t o be
p r e se n te d and a c te d upon in th e e x e r c is e o f th e p r o x y , and to
be inform ed o f th e a c t io n w hich was t o be tak en by th e p roxy
h o ld e r s con cern in g them .
P r o v is io n was made in th e r u le s t o a ff o r d s to c k h o ld e r s
more e f f e c t i v e means f o r e x p r e s s in g o p p o s itio n t o th e managementj
i t was provid ed th a t any s e c u r it y h o ld er o f record m igh t r e q u ir e
t h a t th e is s u e r m a il t o e v e r y sto c k h o ld er which th e management
had s o l i c i t e d any form o f p ro x y , vrith any sta te m e n ts or l e t t e r s
t h a t th e s to c k h o ld e r m igh t f u r n is h , w ith in f i f t e e n d a y s o f r e ­
c e i p t o f a p p lic a t io n .
The forms and l e t t e r s r e q u ir e d , a s w e l l as
th e e n v e lo p e s and p o s ta g e , were t o have been p a id b y th e s to c k ­
h o ld e r i n i t i a t i n g th e p ro x y .
He was a l s o req u ir ed t o pay f o r , or f u r ­
n is h s e c u r it y fo r r e a so n a b le c o s t o f m a ilin g . I t was s p e c i f i c a l l y
p r o v id e d , how ever, th a t th e is s u e r must n o t charge him more
than th e c o s t o f m a ilin g th e management* s own p r o x ie s , p ro v id ed
t h a t th e s e r v ic e was com parable.
I t was r e q u ir e d under th e s e r u le s th a t th e form o f th e
proxy and any a d d it io n a l r e la t e d m a tter be f i l e d n o t o n ly w ith
th e Commission b u t a ls o w ith th e n a tio n a l s e c u r i t i e s exchange on
w hich th e s e c u r it y m ight be r e g is t e r e d .
I t was n e c e s s a r y t h a t
t h i s be done n o t l a t e r th an th e d a te o f th e f i r s t s o l i c i t a t i o n ,
- 2 ,2 ? -
P e n a lt ie s f o r u se o f f a l s e or m is le a d in g in fo rm a tio n p la c e d
i r r e g u l a r i t i e s in c o n n e c tio n w ith p r o x ie s on th e same b a s is a s
any o th e r f a l s i f i c a t i o n under th e A c t.
A ll v i o l a t i o n s o f r u le s
reg a r d in g p r o x ie s ren d ered th e o ffe n d e r s u b je c t t o a l l p e n a l t i e s
a p p lic a b le f o r o th e r v i o l a t i o n s o f th e A c t.
I t was p ro v id ed ,
how ever, t h a t such v i o l a t i o n s did n o t in v a lid a t e th e proxy in ­
volved.'*’3
The r e v is io n o f August 1 1 , 1 9 3 8 , w ith i t s amendments o f
February 1 5 , 194-0, i s n o t a fundam ental dep artu re from th e aims
o f th e o ld r u l e s , w hich covered in a g e n e r a l way a l l o f th e
im p ortan t c o n s id e r a t io n s i n c o n n e c tio n w ith proxy s o l i c i t a t i o n ;
i t i s r a th e r an exp an sio n and e la b o r a tio n o f th e o r i g in a l pro­
v is io n s in an a ttem p t on th e p a r t o f th e Commission t o ren der
them more w orkable in th e l i g h t o f e x p e r ie n c e .
In t h e i r r e v is e d
form th e p r o v is io n s co n cern in g in fo rm a tio n t o be in c lu d e d in proxy
sta te m e n ts are more s p e c i f i c than th e form er o n e s , and are
supplem ented by sch ed u le A, w hich d e s c r ib e s in d e t a i l
which must be in c lu d e d in such a sta te m e n t.
th e ite m s
P r o v is io n i s made t h a t
proxy form s must c o n ta in sp aces on which s to c k h o ld e r s may s p e c i f y
th e a c t io n w hich th e y d e s ir e t o be taken and th e a u t h o r it y w hich
th ey w ish t o c o n fe r 'with regard t o each m a tte r .
L e g ib ility i s
a ls o a ssu r e d through p r o v is io n a s to th e s i z e o f ty p e to be used
in th e p r in t in g o f p ro x y s ta te m e n ts .
P r o v is io n s d e a lin g w ith th e
13.
S .E .C -, R u les and R e g u la tio n s under th e S e c u r i t ie s Exchange
A ct o f 1 9 3 4 . January 2 4 , 193&, r u le s LA 1 , 2 , 3 , 4 , 5 , 6 , and
7 , pp. 4 5 -4 8 .
-2 2 4 -
f i l i n g o f m a te ria l w ith th e Commission and th e exchanges, w ith
th e d u ty o f th e i s s u e r t o fu r n is h in fo rm a tio n a t th e r e q u e s t
o f th e s e c u r it y h o ld e r , w ith s o l i c i t a t i o n s to w hich th e r u le s
a re n o t a p p lic a b le , w ith f a l s e or m isle a d in g s ta te m e n ts , and
w ith d e f i n i t i o n s , a r e e x p r e sse d in c o n s id e r a b ly more d e t a i l
th an fo r m e rly and have been m o d ifie d w ith r e s p e c t t o c e r t a in
14
t e c h n i c a l i t i e s , b u t th e y are n o t m a t e r ia lly changed.
G e n e ra lly sp e a k in g , th e c o n tr o l o f p r o x ie s h a s n o t been
a s e r io u s problem f o r th e Commission, and w ith th e p a s s in g o f
tim e an
in c r e a s in g number o f is s u e r s
have su b m itted t h e ir
p r o x ie s t o th e Commission p r io r t o t h e i r b ein g s e n t t o s to c k ­
h o ld e r , i n ord er t o a s su r e th em se lv e s o f c o r r e c t n e s s .
It
should be p o in te d o u t, how ever, th a t th e nature o f th e v i o l a t i o n s
w hich have o ccu rred g iv e s ample j u s t i f i c a t i o n f o r th e r e g u la to r y
m easures w hich have been ta k e n .
For example, i n one in s ta n c e
p r o x ie s w ere is s u e d by a c o rp o ra tio n to a u th o r iz e a sto ck
o p tio n c o n tr a o t betvfeen th e c o rp o ra tio n and i t s p r e s id e n t .
T his c o n tr a c t p rovid ed f o r a s u b s t a n t ia l s a la r y fo r th e p r e s id e n t
and o p tio n s on sto c k to be purchased on a b a s is p r e sc r ib e d in th e
c o n tr a c t.
I t was a l s o r e q u e ste d t h a t app roval be g iv e n t o c e r t a in
p u rch ases by th e c o r p o r a tio n o f i t s own s to c k .
I t was n o t r e ­
v e a le d in th e proxy s o l i c i t a t i o n t h a t th e p r e s id e n t owned a lm o st
h a l f o f th e s to c k i n th e co rp o ra tio n and had v i r t u a l c o n tr o l o f i t
14,
S .E .C ., G eneral R u les and R e g u la tio n s under th e S e c u r i t i e s Ex­
change A ct o f 1 9 3 4 , a s amended to and in c lu d in g February 1 5 ,
1 9 4 0 , r e g u la tio n X -14, pp* 1 4 0 1 -1 4 1 6 .
s in c e no one on th e board o f d ir e c t o r s had any s to c k , and t h a t
a s a r e s u l t th e r e was no b a rg a in in g betw een th e p r e s id e n t and
the c o r p o r a tio n over th e term s o f th e c o n t r a c t .
I t was a ls o n ot
d is c lo s e d t h a t under th e o p tio n s th e p r e s id e n t was a b le t o a c q u ir e
the s to c k a t a p r ic e s u b s t a n t ia lly under th e m arket.
Nor w as i t
r e v e a le d t h a t some o f th e pu rch ases o f s to c k vrhich th e management
d e s ir e d t o have r a t i f i e d were made a t p r ic e s a s much a s 3 2 0 .0 0
above th e market v a lu e o f th e s to c k .
As a r e s u l t o f t h e s e f in d in g s
th e Commission r eq u ir ed th a t th e a d d it io n a l in fo r m a tio n be s e n t to
th e s to c k h o ld e r s and th a t a form f o r c o n fir m a tio n or r e v o c a tio n be
se n t t o them .
15
In a n o th er in s ta n c e th e management o f an in v e stm e n t company
s o l i c i t e d p r o x ie s fo r th e r e - e l e c t i o n o f d ir e c to r y two o f whom
were o r i g i n a l l y e le c t e d by in d iv id u a ls who l a t e r became in v o lv e d
in law s u i t s w ith the company.
I t vfas f a l s e l y s t a t e d th a t th e
r e s ig n a t io n o f th e se two d ir e c t o r s o r ig in a t e d w ith th e board o f
d ir e c t o r s .
Furtherm ore, th e b a la n ce s h e e t o f th e company la b e le d
i t s d e f i c i t "Earned Surplus" and c o r r e c te d t h i s e r r o r in s c a r c e ly
le g ib le i t a l i c s .
F u rth er, i t s ta te d a "quoted market value" fo r
th e company’ s s e c u r i t i e s , 70 p e r c e n t o f w hich r e p r e s e n te d s e c u r i­
t i e s f o r w hich th e r e w ere no q u o ta tio n s a v a ila b le and which had
been a c q u ir e d in o th e r than arm’ s le n g th t r a n s a c t io n s .
A lso th e
r ig h t o f th e i s s u e r in th e a s s e t s u n d e r ly in g th e s e s e c u r i t i e s was
open to some q u e s tio n .
F i n a ll y , th e s o l i c i t a t i o n m a te r ia l c o n ta in e d
a m essage from th e p r e s id e n t i n which he m entioned th e pending law
s u i t s b u t n e g le c t e d t o m ention th a t two o f th e c a n d id a te s f o r r e e l e c t i o n to th e board were con n ected w ith them.
15 •
S .E .C ., 4th Annual R ep o rt, pp. 69-70.
For th e s e r e a s o n s ,
-2 2 6 -
th e Commission req u ired th a t th e co rp o ra tio n send o u t r e v is e d
s o l i c i t i n g m a t e r ia l.
Tfhen t h i s m a te r ia l was f i l e d , i t was found
t h a t th e two d ir e c to r s i n q u e s tio n had re s ig n e d from th e board
and t h a t t h e i r p la c e s had been f i l l e d by o th e r p e rso n s o f u n q u e stio n e d i n t e g r i t y .
16
R e g is tr a tio n o f B rokers and D e a le rs
S ectio n 15 o f bne Act p ro v id e s f o r th e r e g i s t r a t i o n of
b ro k e rs and d e a le rs in o v e r-th e -c o u n te r m arkets and p r e s c r ib e s
th e term s under which r e g i s t r a t i o n may be g r a n te d .
V io la tio n s
o f t h i s s e c tio n may r e s u l t in suspension o r re v o c a tio n o f a
b r o k e r - d e a le r ’ s r e g i s t r a t i o n .
This s e c tio n may a ls o be invoked
a g a i n s t members o f a n a tio n a l s e c u r i t i e s exchange, b u t s in c e
th e r e a r e o th e r means by which exchange members may be d is c ip l in e d ,
i t s im p o rtan ce h as accrued through i t s o p e ra tio n a g a in s t o v e rth e - c o u n te r b ro k ers and d e a le r s .
The number o f v io la tio n s o f t h i s
s e c tio n has been v ery l a r g e , b u t, s in c e th e numcerof o v e r-th e -c o u n te r
b ro k e rs
and d e a le r s i s a ls o v e ry la y g e , th e se c a s e s do n o t in any
sen se r e p r e s e n t a s e rio u s problem to th e Commission, b u t th ey do
throw l i g h t upon th e ty p e s of p r e s s u re vmich give r i s e t o v i o l a t i o n .
L ik ew ise , th ey g iv e a p ic tu r e o f th e methods o f th e Commission and
o f th e way in vrhich i t i n t e r p r e t s s e c tio n 15 o f th e A c t.
Through
them , p re c e d e n ts have been e s ta b lis h e d which ap p ear to have become
c r y s t a l l i z e d to a c o n s id e ra b le d eg re e .
Cne o f th e most fre q u e n t ab u ses which a r o s e , p a r t i c u l a r l y
in th e e a r l y days o f th e Com m ission's o p e r a tio n , was f a i l u r e on
th e p a r t o f th e a p p lic a n t b ro k e r a n d /o r d e a le r to d is c lo s e h i s
c o r r e c t b u sin e ss a d d re s s .
Under such c ircu m stan ces i t became im -
S . E . C . , 5th Annual R eport, pp. 6 0 -6 1 .
~??7 •*
p o s s ib le t o n o t i f y th e a p p lic a n t o f h i s o p p o rtu n ity f o r h e a rin g
i n th e m a tte r .
ly r u le d
In c a s e s o f t h i s s o r t , th e Commission h as c o n s is te n t-
t h a t such m isin fo rm a tio n c o n s t i t u t e s concealm ent o f a
m a te r ia l f a c t w ith in th e m eaning o f r u le MA-i and r e g i s t r a t i o n
17
h a s been c o n s is t e n t l y r e fu s e d u n d er th e s e c irc u m s ta n c e s .
L ik ew ise, when r e g i s t r a t i o n has been g ra n te d and su p p le ­
m en tal in fo rm a tio n co n cerning th e a d d re s s o f th e r e g i s t r a n t has
n o t been f i l e d , th e Commission h a s seen f i t t o revoke such r e g i s ­
t r a t i o n u n d er r u le f.iA-5, which s t a t e s t h a t w ith h o ld in g o f m a te r ia l
f a c t s from th e Commission c o n s t i t u t e s grounds f o r r e v o c a tio n o f
r e g is tra tio n .
F or a r e g i s t r a n t to c o n tin u e to do h i s b u s in e s s
when th e Commission i s n o t i n p o s s e s s io n o f h i s c o r r e c t b u s in e s s
a d d re s s i s deemed a g a in s t th e p u b lic i n t e r e s t .
In th e e v e n t
t h a t th e a p p lic a n t can n o t be found o r t h a t he i s n o t i f i e d by
r e g i s t e r e d m ail accom panied by a r e t u r n r e c e i p t , due n o t i c e o f
h e a rin g i s c o n sid e re d t o have been g iv e n .
In c a s e s w here th e r e
i s la c k o f p e rs o n a l s e r v ic e , how ever, re v o c a tio n h as n o t been
18
made perm anent i n c h a r a c te r .
I t i s d i f f i c u l t to a c c o u n t f o r th e r e lu c ta n c e o f b ro k e rs
and d e a le r s to g iv e c o r r e c t a d d re s s e s e x c e ;t in term s which p la c e
such p e rso n s i n a q u e s tio n a b le l i g h t .
Lack o f w illin g n e s s to co­
o p e r a te w ith th e Commission seems to f u r n is h in a d e q u a te m otive f o r
such r e f u s a l .
I t h a rd ly a p p e a rs l i k e l y t h a t any d e a le r i n s e c u r i­
t i e s who co n d u cts a b u s in e s s o f any consequence w ould je o p a r d iz e
h i s p o s it i o n by such c o n d u c t.
17*
18-
See 1 *5. F,
t.'4j
One i s fo rc e d t o th e c o n c lu s io n
23G, 267 1 248, 247f find dthorg .
I b i d . , 4 8 9 .and 463.
?.?.a -
t h a t such b ro k e rs and d e a le r s a r e o f a f ly - b y - n ig h t c h a r a c te r ,
o r a r e f o r r a t h e r d e f i n i t e re a s o n s u n w illin g to fa c e th e p o s s i­
b i l i t y o f an i n v e s t i g a t io n o f t h e i r a f f a i r s by th e Commission.
Of ab o u t e q u a l e f f e c t n u m e ric a lly a r e th o s e c a s e s which
have come b e fo re th e Commission in v/hich th e r e g i s t r a n t h a s been
e n jo in e d by a c o u r t o f com petent j u r i s d i c t i o n w ith in te n y e a rs
p r i o r t o th e f i l i n g o f h i s a p p l i c a t i o n , o r in which in ju n c tio n
i s in e f f e c t a t th e tim e o f f i l i n g h i s a p p l i c a t i o n .
In th e
form er c a s e s th e Commission c o n s id e rs th e e n t i r e re c o rd o f th e
a p p lic a n t d u rin g th e te n y e a r p e r io d a s w e ll as th e p a r t i c u l a r
a c t which gave r i s e to th e i n j u n c t i o n .
The Commission, i s ,
fu rth e rm o re , concerned r; t h e r ‘b i t h th e re a so n s f o r which an i n ­
ju n c tio n a g a in s t a r e g i s t r a n t h a s been is s u e d th a n vd.th th e mere
f a c t o f i t s is s u a n c e .
In th e e v e n t t h a t a tem porary in ju n c tio n
h a s been is s u e d a g a in s t a r e g i s t r a n t , th e Commission, w h ile r e ­
fu s in g r e g i s t r a t i o n d u rin g th e l i f e o f th e in ju n c t i o n , may re c o n ­
s id e r i t s a c tio n s upon th e rem oval o f th e in j u n c t i o n .
YJhile
i t i s n o t c o n sid e re d t h a t an i n j u n c t io n f i l e d su b seq u en t to
th e d a te o f f i l i n g o f th e a p p l i c a t i o n i s grounds f o r th e r e f u s a l
o f r e g i s t r a t i o n , such i n ju n c tio n may c o n s t i t u t e grounds f o r
r e v o c a tio n , i f such re v o c a tio n i s i n th e p u b lic i n t e r e s t .
19
I n th o se c a s e s , how ever, where a perm anent in ju n c tio n
p r o h ib itin g , th e r p g i s t t a h t f r o m d e a lin g i n s e c u r i t i e s h a s been
is s u e d by a s t a t e c o u r t, th e Commission ta k e s th e view t h a t h i s
19
1^1.
C.jd. C-b<b8 . -
••
-2 2 3 -
r e g i s t r a t i o n sh o u ld be e i t h e r suspended o r rev o k e d .
In c a s e s o f
t h i s s o r t , a s in o t h e r s , th e Commission i s r e l u c t a n t to ta k e
perm anent a c tio n u n le s s p e r s o n a l s e r v ic e h as been made upon th e
a p p l i c a n t , b u t r a t h e r r e s o r t s t o tem porary su sp e n sio n s u n t i l
p e r s o n a l s e r v ic e can be made e f f e c t i v e .
A t such tim e th e
tem porary su sp en sio n i s e i t h e r made perm anent o r rev o k ed .
If,
how ever, i t sh o u ld be im p o ss ib le to re a c h th e r e g i s t r a n t , th e
Commission w i l l n o t h e s i t a t e to revoke r e g i s t r a t i o n .
In s ta n c e s
o f t h i s c h a r a c te r a r e u s u a lly found when ev id en ce a g a in s t th e
r e g i s t r a n t i s such t h a t th e r e s u l t o f a h e a rin g i s a fo reg o n e
c o n c lu sio n - — f o r exam ple, when th e d e fe n d a n t h a s l e f t h is
p la c e o f b u s in e s s w ith o u t le a v in g a fo rw a rd in g a d d r e s s , and when
th e re a s o n s f o r h i s le a v in g a r e o b v io u s.
Such in s ta n c e s a re most
common where th e r e g i s t r a n t h as been e n jo in e d p erm an en tly from
d e a lin g in s e c u r i t i e s in a p a r t i c u l a r s t a t e .
20
L ess numerous th a n r e f u s a l s because o f in ju n b tio n s ,
b u t r e v e a lin g w ith re g a rd to th e a t t i t u d e o f th e Commission,
a r e th o s e c a se s i n which r e f u s a l o f r e g i s t r a t i o n i s based
upon c o n v ic tio n o f crim es in v o lv in g th e s a le o f s e c u r i t i e s .
Such c rim e s, i f com m itted w ith in te n y e a r s p r i o r to th e f i l i n g
o f a p p l i c a t i o n , c o n s t i t u t e grounds f o r r e f u s a l o f r e g i s t r a t i o n .
As in th e case o f i n j u n c ti o n s , th e Commission does n o t r e f u s e
r e g i s t r a t i o n due to th e mere f a c t o f c o n v ic tio n ; su b seq u en t
b e h a v io r o f th e a p p lic a n t i s c o n s id e re d , and i f he h as com mitted
no o th e r a c ts which c o n s t i t u t e s t a t u t o r y grounds f o r a c tio n ,
th e Commission may ta k e t h i s in to a c c o u n t in d e te rm in in g w h eth er
20 •
2 3.
S. C*, 73d - . i i 7 4 0 .
' .
-2 3 0 -
o r n o t r e g i s t r a t i o n i s c o n s is te n t w ith th e p u b lic i n t e r e s t .
C o n v ictio n i n th e ey es o f th e Commission in c lu d e s a p le a o f
g u i l t y , and i s viewed a s such w h eth er o r n o t th e c o u r t im poses
s e n te n c e on th e d e fe n d a n t.
L ik e w ise , r e s t i t u t i o n made by
th e d e fe n d a n t d oes n o t a l t e r th e f a c t o f h i s c o n v ic tio n .
These
ele m e n ts, how ever, a r e c o n s id e re d i n d e te rm in in g w h eth er o r n o t
i t i s i n th e p u b lic i n t e r e s t to p e rm it r e g i s t r a t i o n .
F u r th e r ­
m ore, a f t e r r e g i s t r a t i o n h a s been r e f u s e d , i t i s p o s s ib le f o r
th e a p p lic a n t to r e - a p p ly , and t h e Commission may th e n rev iew
th e re c o rd and d e te rm in e , i n th e l i g h t o f any new c o n s id e ra tio n s
which may b e p r e s e n te d , w h eth er or n o t i t i s i n th e p u b lic
i n t e r e s t to p e rm it r e g i s t r a t i o n .
21
Crimes c o n n ected w ith th e s e c u r i t i e s b u s in e s s a r e viewed
by th e Commission in a b road s e n s e .
The term " s e c u r i t i e s " in
th e c a se o f L ouis Grew was c o n s tru e d t o in c lu d e o i l r o y a l t i e s
even though th e y w ere n o t deemed a s e c u ri t y u n d er th e law s o f
th e S ta te o f M a ss a c h u se tts , w here Grow was c o n v ic te d o f la rc e n y
i n c o n n ectio n w ith t h e i r s a l e .
F u rth erm o re, m isuse o f fu n d s
o b ta in e d from a c l i e n t f o r th e p u rp o se of p u rc h a s in g s e c u r i t i e s ,
i s lik e w is e c o n sid e re d a crim e i n c o n n e c tio n w ith th e s e c u r i­
t i e s b u s in e s s .
Tfhile t h e r e has n o t been s u f f i c i e n t a d ju d ic a tio n
o f c a se s o f t h i s s o r t t o d e f in e ’’crim es co n n ected w ith th e
s e c u r i t i e s b u s in e s s " i n a l l i t s r a m if i c a t i o n s , i t i s su g g e ste d
t h a t c o n s tr u c tio n w i l l be g iv e n t o t h i s term broad enough to
in c lu d e a l l crim es w hich have a s u f f i c i e n t l y c lo s e r e l a t io n s h i p
21.
1 G. E. C ., 858, and 2 3 . E. U ., 306.
-23].-
to th e s e c u r i t ie s b u sin e ss to make i t seem probable t h a t a
p e rso n cap a b le o f com m itting such crim es would be dangerous
t o th e p u b lic i f d e a lin g in s e c u r i t i e s .
C.
22
OPERATION OF TEARING REGULATIONS
F u n c tio n s o f B rokers and D e a le rs
S e c tio n 11 o f th e Act a tte m p ts to curb c e r ta in f u n c tio n s
o f b ro k e rs and d e a l e r s which have been c o n s id e re d e i t h e r harm ful
o r u n n e c e s sa ry .
T his s e c tio n p ro v id e s f o r th e r e g u la tio n o f
f l o o r tr a d in g by members o f n a tio n a l s e c u r i t i e s exchanges, e i t h e r
f o r t h e i r own a c c o u n t o r f o r d i s c r e t io n a r y a c c o u n ts , and to p r e ­
v e n t e x c e s s iv e t r a d in g by such members on th e exchanges b u t o f f
th e f l o o r .
I t p r o v id e s f o r th e r e g i s t r a t i o n o f s p e c i a l i s t s and
odd l o t d e a le r s and r e s t r i c t s t h e i r a c t i v i t i e s to l i m i t s which
a re n e c e s sa ry f o r th e perform ance o f t h e i r f u n c tio n s .
The
s p e c i a l i s t m ust n o t tr a d e f o r h i s own a c c o u n t beyond t h a t amount
v/hich i s n e c e s s a ry f o r th e m aintenance o f an o r d e rly m ark et,
vfhile th e o d d - lo t d e a le r i s r e s t r i c t e d to such tr a n s a c tio n s as
a re n e c e s s a ry f o r th e perform ance o f h i s f u n c tio n as an o d d -lo t
d e a le r.
On exchanges where t h e volume o f tr a d in g i s s u f f i c i e n t l y
l im ite d to make such r u le s i m p r a c tic a l, th e Commission may make
e x c e p tio n s , p ro v id e d such e x c e p tio n s a r e n o t in c o n s i s t e n t w ith
th e p u b lic i n t e r e s t .
I t has f u r t h e r been p ro v id e d t h a t a l l
p e rso n s a c tin g a s b ro k e rs and d e a le r s , w h eth er on n a tio n a l
s e c u r i t i e s exchanges o r o th e rw is e , a r e p r o h ib ite d from
22
1 E. K. C ., 843, and 2 S. h. C ., 306.
->272—
e f f e c t i n g t r a n s a c t i o n s in which th e y ex ten d o r a rra n g e t o ex­
te n d c r e d i t to cu sto m ers on s e c u r i t i e s in th e iss u a n c e o f
which th e y had p a r t i c i p a t e d a s members o f th e s y n d ic a te group
w ith in s i x m onths p r i o r to th e t r a n s a c t i o n .
F u rth erm o re, a l l
b ro k e rs and d e a le r s m ust d is c lo s e to t h e i r custom ers i n w r itin g
b e fo re th e co m p letio n o f a t r a n s a c t i o n w hether th e y a re a c tin g
a s b ro k e rs o r a s d e a le r s in th e t r a n s a c t i o n .
In some in s t a n c e s v i o l a t i o n s o f th e l a t t e r p r o v is io n s
o f th e A ct have been rem edied
hy: th e Commission through ob­
t a in in g in j u n c t io n s from th e c o u r t s .
These v i o l a t i o n s have
occu rred in c o n ju n c tio n w ith v i o l a t i o n s o f o th er s e c t io n s
o f th e A c t.
23
Those p r o v is io n s o f s e c tio n 11 which d e a l w ith th e
e x te n s io n o f c r e d i t by b r o k e r - d e a le r s t o custom ers f o r th e
p u rch ase o f s e c u r i t i e s in which th e y have had an i n t e r e s t
a s d i s t r i b u t o r s , and th o s e which p ro v id e t h a t th e b ro k e rd e a le r m ust d is c lo s e h i s f u n c tio n to th e custom er w ith -whom
he i s d e a lin g , a r e c o m p a ra tiv e ly sim p le and d e f i n i t e and need
l i t t l e e x p la n a tio n o r d e f i n i t i o n .
The problem o f enforcem ent
i s e s s e n t i a l l y one o f d e t e c ti o n .
Such i s n o t th e c a se w ith th e p r o v is io n s which attem p t
to r e g u la t e th e fu n c tio n o f th e b r o k e r -d e a le r in a more g e n e r a l
way and p r e s c r ib e th e l i m i t s o f h i s fu n c tio n on th e ex ch a n g es.
23
I n ju n c tio n s f i l e d in c o n n e c tio n w ith v io l a ti o n s of th e Act
a re t a b u la te d i n a p p e n d ic e s o f th e Annual R eports o f th e
Commission; see 2nd Annual R e p o rt, p . 136, in ju n c tio n
a g a in s t K. W. Todd & Co.
The c o m p le x ity o f th e problem o f r e v is in g th e fu n c tio n o f th e
broker and d e a le r was r ec o g n iz e d by the fram ers o f th e A ct and
p r o v is io n was made in the law i t s e l f f o r a stu d y o f th e b ro k erd e a le r fu n c tio n w ith a view t o s e g r e g a tin g th e s e two form s o f .
a c tiv ity .
T his stu d y has n o t been p r im a r ily concerned w ith
se g r e g a tio n a s an end in i t s e l f .
I n s te a d , i t has been concerned
w ith th e broader problem o f c o n t r o l o f exchange tr a d in g .
S egre­
g a tio n o f th e b r o k e r -d e a le r fu n c tio n h as been co n sid e re d a l o g i c a l
p o in t o f d ep artu re s in c e an ob v io u s c o n f l i c t o f i n t e r e s t may
occur betw een th e b r o k e r -d e a le r and h i s custom er b ecause o f
t h i s m u ltip le f u n c t io n .
As a p r e lim in a r y p a r t o f th e g e n e r a l program o f c o n t r o llin g
tra d in g on exch an ges, ev ery n a t io n a l s e c u r i t i e s exchange and e v e r y
exempted exchange 'was req u e sted by th e Commission on A p r il 16,
1935 t o a d o p t c e r t a i n r u le s re g a rd in g tra d in g a c t i v i t y .
These
r u le s were d e sig n e d to e lim in a te e x c e s s iv e tra d in g on exchanges
and " to d e l i n e a t e more c l e a r l y c e r t a i n o f th e f id u c ia r y o b li­
g a tio n s o f th e b ro k e r to h is custom er and to r e s t r i c t c e r ta in
p r a c t i c e s re g a rd e d a s d e tr im e n ta l to th e in v e s tin g p u b lic " .
24
The f i r s t r u le p r o h ib it s pu rch ases or s a l e s by
members o f exchanges or o f member fir m s which a re to o la r g e f o r
t h e ir f i n a n c i a l r e s o u r c e s , o r w hich may have a bad e f f e c t on
the m ark et.
IVhile t h i s r u le i s d esig n ed to p rev en t e x c e s s iv e
tr a d in g , i t p erm its members to tr a d e in m od eration ,
24.
S .E .C ., R e p o rt on th e F e a s i b i l i t y and A d v is a b ility o f th e
Complete S e g re g a tio n o f th e F u n c tio n s o f D ealer and B roker,
p . 61; see a ls o 1 s t Annua l R e p o r t, p p . 13-14-.
The second r u le d e a ls 'with j o i n t a cco u n ts in which members
or p a r tn e r s o f member fir m s a r e i n t e r e s t e d .
T his r u le p r o v id e s
t h a t no member w h ile on th e f l o o r can tra d e fo r an a cco u n t in
w hich he i s j o i n t l y in t e r e s t e d w ith any o th er p e r so n , e x ce p t
vrith th e ap p roval o f th e ex ch a n g e.
The e f f e c t o f t h i s r u le i s
t o red uce th e tr a d in g c a p a c ity o f a member t o th e r e s o u r c e s o f
h im s e lf , h i s fir m , and i t s p a r tn e r s .
As a r e s u l t a member
ca n n o t i n f l a t e h i s tr a d in g c a p a c ity by th e u se o f c a p i t a l o f
o u t s id e r s , and lik e w is e o u t s id e r s cannot g a in advantage in t h e ir
tr a d in g by team ing up w ith members.
The t h ir d r u le s t i p u l a t e s th a t no p a rtn er or firm may h old
a j o i n t acco u n t f o r exchange tr a d in g w ith o u t su b m ittin g th e f a c t
to th e exchange f o r a p p r o v a l.
I f i t i s approved, com prehensive
in fo rm a tio n must be g iv e n vreekly reg a rd in g t r a n s a c tio n s on b e h a lf
o f th e a ccou n t in w hich th e member p a r t ic ip a t e s or o f v/hich he
h as kn ow led ge.
T his makes i t p o s s ib le fo r th e Commission to
su rv ey p e r i o d i c a l l y th e o p e r a tio n s o f j o i n t a c c o u n ts.
"he fo u r th r u le p r o h ib it s th e e x e c u tio n o f d is c r e t io n a r y
o rd ers by members on th e f l o o r , t h a t i s , ord ers where th e r e i s
any d is c r e t io n beyond th a t w hich i s embodied in th e o rd in a ry
com m ission o r d e r .
T h is r u le a ls o p r o h ib its any member, fir m , or
p a r tn e r from a f f e c t i n g tr a n s a c tio n s f o r a d is c r e tio n a r y accou n t
Yfhich a re e x c e s s iv e in s i z e or freq u en cy in view o f th e r e s o u r c e s
o f th e a c c o u n t.
T h is p r o v is io n was i n s t i t u t e d t o p rev en t tr a d in g
by a member in d is c r e t io n a r y a cco u n ts because o f a d e s ir e to
in c r e a s e h i s com m ission s.
-2.o 5'-
The f i f t h r u le p r o h ib it s a broker from tr a d in g f o r h is
own accou n t w h ile he i s h o ld in g a cu sto m er's o r d e r , u n le s s he
i s w i l l i n g t o pay more or a c c e p t l e s s than th e p r i c e s s t ip u la t e d
in th e order o f such cu stom er.
The s ix t h r u le p r o v id e s th a t no member, fir m ,o r p a rtn er
w hether a c tin g as b rok er o r d e a le r s h a l l e x e c u te or cau se to be
ex ec u ted any order f o r th e pu rchase o f any s e c u r it y a t s u c c e s s ­
i v e l y h ig h e r p r ic e s or th e s a le o f s e c u r i t i e s a t s u c c e s s i v e l y
low er p r ic e s fo r th e purpose o f Indu cin g a f a l s e appearance o f
tr a d in g a c t i v i t y or un duly in f lu e n c in g th e market p r ic e o r
making a p r ic e w hich d o es n o t r e f l e c t the tr u e s t a t e o f th e
m arket.
The sev en th r u le p r o h ib it s any member w h ile tr a d in g on
th e f lo o r from e x e c u tin g any order f o r h is own a c co u n t in any
s e c u r it y in w hich he or any member o f h is firm h o ld s or h a s been
gra n ted an o p t io n .
T h is r u le -was d esig n ed to d isc o u r a g e f l o o r
tr a d in g by members h o ld in g or g r a n tin g o p t io n s , and on th e
o th e r hand t o d isc o u r a g e th e u se o f o p tio n s by members 'who
tr a d e w h ile on th e f l o o r .
The e ig h th r u le makes i t n e c e ssa r y f o r b ro k ers to keep
a proper r eco rd o f a l l o r d e rs tr a n sm itted t o th e f l o o r fo r
e x e c u t io n .
Every member who e x e c u te s o rd ers on th e f l o o r must
keep com plete r e c o r d s .
These r e c o r d s must in c lu d e th e name o f
th e s e c u r it y , th e amount, th e p r ic e and th e tim e when each
ord er was tr a n s m itte d .
The n in th , t e n t h , and e le v e n th r u le s have t o do -with
s p e c ia lis ts .
(The p r e ce d in g r u le s may, o f c o u r se , a l s o ap p ly
to s p e c ia l is t s .)
The n in th r u le p r e v en ts a broker from a c tin g
-£ .3 6 -
a s a s p e c i a l i s t in a s e c u r it y u n le s s he i s r e g is t e r e d a s a
s p e c i a l i s t in such s e c u r it y by th e exch ange.
The te n th r u le
p r o h ib it s s p e c i a l i s t s from making p u rch ases o r s a l e s i n th e
s e c u r it y in w hich he i s a s p e c i a l i s t , fo r any a cco u n t in which
h e , h i s fir m , or a p a r tn er i s i n t e r e s t e d , beyond th e amount
w hich i s n e c e s s a r y f o r th e m aintenance o f a f a i r and o r d e r ly
m arket.
T h is r u le a ttem p ts to e lim in a te th e d e a le r a c t i v i t i e s
o f s p e c i a l i s t s e x c e p t in s o f a r a s th e y a re u s e f u l t o th e m arket.
In v iew o f th e p a r t ic u l a r l y advantageous p o s it io n o f th e
s p e c i a l i s t , th e Commission f e l t i t v ery n e c e s s a r y t h a t he be
s u b je c te d to s t r in g e n t c o n t r o l.
The e le v e n t h r u le p r o h ib it s th e s p e c i a l i s t , h i s fir m ,
and h i s p a r tn e r s from p a r t ic ip a t in g in any j o i n t accou n t
which buys and s e l l s s to c k s in which he i s a s p e c i a l i s t .
The t w e lf t h r u le r e q u ir e s th a t th e s p e c i a l i s t keep
l e g i b l e r eco rd s o f a l l o rd ers p la ced Yfith him, and a ls o e x ­
e c u t io n s , m o d ific a tio n s and c a n c e lla t io n s o f such o r d e r s .
The t h ir t e e n t h r u le r e q u ir e s r e g is t r a t i o n o f o d d -lo t
d e a le r s .
The fo u r te e n th r u le p r o h ib it s any o d d -lo t d e a le r ,
h i s fir m , or h i s p a r tn e r s from p a r t ic ip a t in g in a j o i n t
acco u n t w ith a non-member, through w hich s e c u r i t i e s a r e bought
or s o ld in w hich he i s r e g is t e r e d a s an o d d -lo t d e a le r .
The f i f t e e n t h r u le p r o h ib its a s p e c i a l i s t , o r o d d -lo t
d e a le r , i n a sto c k (a lo n g w ith h i s firm or any p a r tn er in i t )
from a c q u ir in g , h o ld in g o r g ra n tin g an o p tio n in such s to c k .
The s ix t e e n t h p r o v id e s t h a t no member may u se any f a c i l i t y o f
-237an exchange to make a s h o rt s a le o f any s e c u r i t y below th e p r ic e
25
o f th e l a s t s a le o f such s e c u r ity .
I t was p o in te d o u t by th e Commission t h a t any la c k o f e f ­
f e c tiv e n e s s i n th e o p e ra tio n o f th e s e r u le s has n o t been due to
la c k o f c o o p e ra tio n by th e exchanges.
S in ce th e y have been th o u g h t
o f a s b ein g e v o lu tio n a ry i n c h a r a c te r th e Commission has n o t th o u g h t
26
i t n e c e s s a ry as y e t to re n d e r any d e f i n it e judgm ent on t h e i r e f f ic ie n c y .
S in c e s u b -s e c tio n (e ) of s e c tio n 11 c a lle d f o r an in v e s tig a tio n
w ith a view to s e g re g a tin g th e fu n c tio n
o f b ro k e r and d e a le r ,
a com prehensive stu d y was made o f th e problem which w ill be b r i e f l y
summarized h e r e .
T h is stu d y d is c lo s e d t h a t th e com bination o f th e
b r o k e r- d e a le r f u n c tio n was most f re q u e n tly found among commission
b ro k e rs , f l o o r b ro k e rs , and bond b ro k e rs and d e a le r s .
F lo o r t r a d e r s
o n ly o c c a s io n a lly a c te d as b ro k e rs , w hile o d d - lo t b ro k ers seldom
tra d e d f o r t h e i r own acco u n t.
a c te d as b r o k e rs .
O d d -lo t d e a le r s seldom , i f e v e r,
I n a c tiv e members u s u a lly e f f e c te d tr a n s a c tio n s
o n ly f o r th em selv es u n le ss th e y were connected w ith in v estm en t
b anking firm s i n which case th e y m ight a c t in e i t h e r c a p a c ity .
The
stu d y a tte m p te d to a n a ly se th e e f f e c t s o f th e s e v a rio u s ty p es o f
tr a d in g , w ith a view to a p p ra is in g th e v alu e o f each in m a in ta in in g
27
a f a i r and o r d e r ly m arket.
F lo o r tr a d in g was th e f i r s t ty p e to be c o n s id e re d , perhaps
b ecause i t s u s e fu ln e s s was open to th e most s e rio u s q u e s tio n .
25
R ep o rt on S e g re g a tio n . Appendix 0 -1 , pp. 166-170; f o r summary
o f r u le s and i n t e r p r e t a t i o n s o f th e T enth R u le , (is s u e d by th e
T rad in g and Exchange D iv is io n , March 3 0 ,1 9 5 7 ), see 3rd Ann. Rep1t . .
p p .75-70; f o r f u l l d is c u s s io n o f r e g u la tio n o f s h o r t s e ll i n g see
Chap. VII above.
26
I b i d . , p . 64
27 I b i d . , p p .3-10.
-2 sa­
l t was q u ite w e ll e s t a b lis h e d t h a t th e f l o o r tr a d e r had c e r ta in
ad van tages over th e g e n e r a l p u b lic :
(1 ) h i s c o s t s vrere found
t o be lo w e r , (2 ) he cou ld tr a d e e x t e n s iv e ly w ith l e s s c a p i t a l ,
(3 ) h i s p o s it io n on th e f l o o r made i t e a s i e r f o r him t o r e v is e
h i s market a p p r a is a ls than vrould be th e c a se vrLth o u t s id e r s .
It
was fu r t h e r e s t a b lis h e d th a t h i s tr a d in g Teas e s s e n t i a l l y o f an i n a n d -o u t v a r i e t y .
On th e w hole th e f l o o r tr a d e r s v/hose a c t i v i t i e s
xrere ob served tended to tr a d e w ith th e tren d and th u s a c c e n tu a te
f lu c t u a t io n s in p r ic e s during th e p erio d s t u d ie d .
I t was n o t
c l e a r , how ever, v/hether th e f lo o r tr a d e r s a c t u a l l y i n i t i a t e d tr e n d s
or m erely fo llo w e d tren d s which came about from o th e r c a u s e s .
I t appeared th a t f l o o r tr a d in g added somewhat to th e c o n t in u it y
and l i q u i d i t y o f th e m ark ets.
Most o f th e f l o o r tr a d in g , how ever,
appeared t o be co n cen tra ted in sto c k s w hich tend ed to be a c t i v e
in any c a s e .
In o n ly abou t a th ir d o f th e tim e under o b se r v a tio n
d id f l o o r tr a d in g ten d t o have a s t a b i l i z i n g in f lu e n c e upon the
m ark et. ^ 8
The s p e c i a l i s t lik ev d .se was found t o have c o m p e titiv e ad­
v a n ta g es o v er th e g e n e r a l p u b lic .
The volume o f tr a d in g w hich
he u s u a lly handled and th e p o s s e s s io n o f h i s book were found to
g iv e him p a r t ic u la r advan tages i n the s e c u r i t i e s in ydiich he
s p e c ia liz e d .
He vras a ls o found t o be in a p a r t i c u l a r l y ad­
v a n ta g eo u s p o s it io n t o engage in m a n ip u la tiv e p r a c t ic e s becau se
o f h i s e x c lu s iv e knowledge o f o r d e rs above and below th e m arket,
w hich he m ight o b ta in from h i s b ook .
28 .
Report on S e g re g a tio n . pp. 14-25.
S p e c i a l i s t s , d u rin g th e
—2’SB-
p eriod under o b s e r v a tio n , tra d ed a g a in s t th e tren d o f th e market
more o ft e n than w ith i t and i n t h i s way c o n tr ib u te d t o a con­
tin u o u s and o r d e r ly m arket.
The e f f e c t o f t h e i r tr a d in g w ith
t h e ir b o o k s, how ever, was t o in c r e a s e th e spread betw een b id
and asked p r ic e s and th u s d im in ish c o n t in u it y o f th e m arket.
In h i s b rok er c a p a c ity th e o p e r a tio n o f th e s p e c i a l i s t i n th e
e x e c u tio n o f lim it e d and s t o p - l o s s o r d e rs .vas found to perform
a u s e fu l s e r v ic e .
I t was n o t e s t a b lis h e d , how ever, a s had been
contended by s p e c i a l i s t s , th a t b ecau se o f h i s l i a b i l i t y fo r
e rr o r he must be a llo w ed to tr a d e fo r h i s own accou nt and make
up h i s l o s s e s .
S p e c i a l i s t s have an Im portant in c e n t iv e t o main­
ta in a f a i r and o r d e r ly m arket, s in c e through doing so t h e ir
com m ission b u s in e s s more than com pensates under o rd in a ry c i r ­
cum stances f o r th e l o s s e s w hich*they may in c u r in a ttem p tin g
29
t o do s o .
W hile on th e f lo o r o f th e New York Stock Exchange th e
s p e c i a l i s t and th e o d d -lo t d e a le r are se p a r a te in d iv id u a ls , th e
New York Curb Exchange has a system w hereby th e fu n c tio n s o f
th e s p e c i a l i s t and th e o d d -lo t d ea ler are combined.
T his
system te n d s to stren gth en fu r th e r th e p o s it io n o f th e s p e c i a l i s t
and t o m u ltip ly th e p o s s i b i l i t i e s fo r a b u s e s .
The argument in
fa v o r o f such a com bination has been t h a t i t i s n e c e s s a r y on
th e s n a lle r exchanges i f o d d -lo t s a le s a re t o be made a t p r ic e s
w hich v n .ll r e f l e c t f u l l l o t v a lu e s .
29 R eport on S eg reg a tio n , pp. 25-42.
I t i s fu r th e r argued t h a t ,
-240-
s in c e th e c o s t s o f sep a r a te system s a r e to o h ig h f o r th e sm a lle r
e x ch a n g es, i t I s p o s s ib le o n ly on th e Uevr York Stock Exchange
t o have th e s p e c i a l i s t and th e o d d -lo t d e a le r s e p a r a te d .
Y /hile
th e r e have been many c r i t i c i s m s o f th e odd l o t s p e c i a l i s t sy stem ,
th e r e seems to be no a lt e r n a t i v e w hich vrould n o t work in j u r y t o
th e sm a ll I n v e s t o r .
30
Trading by members o f f th e f l o o r 'was found to be l e s s o f
an in -a n d -o u t v a r ie t y than f lo o r tr a d in g .
Members in v o lv e d in
i t r e q u ir e d more c a p it a l than f l o o r tr a d e r s d id .
Y/hile th e s e
members d id n o t have some o f th e a d v a n ta g es o f th e f l o o r tr a d e r s ,
th e y d id have c e r t a in a d v a n ta g es, p a r t ic u l a r ly i n th a t th e y
could o p era te a t r a t e s low er than th o s e which are charged to th e
g e n e r a l p u b lic .
The tr a d in g by th e s e members was n o t , d u rin g th e
p e r io d s tu d ie d , predom in antly w ith o r a g a in s t th e tren d o f th e
m arket.
As in th e c a se o f the f l o o r tr a d e r s , t h i s tr a d in g d id
c o n tr ib u te somewhat t o th e l i q u i d i t y o f th e m arket, b u t i t s u s e ­
f u ln e s s -was im paired by the f a c t th a t i t tended to c e n te r in
s e c u r i t i e s wnich were a lr e a d y a c t i v e .
31
The sm a lle r exchanges p r e se n ted a problem v ery d i f f e r e n t
from t h a t o f th e la r g e r o n e s .
Y /hile on such exchanges a s th e
New York Curb Exchange, c o n s id e r a b le s p e c ia l iz a t io n o f fu n c tio n
had d ev elo p ed , on th e sm a lle r exch an ges th e s e tended t o d isa p p e a r .
In m ost c a s e s i t "was hard to d i f f e r e n t i a t e betw een one k in d o f
b rok er and a n o th e r , th e s p e c i a l i s t and th e o d d -lo t d e a le r ten d in g
30R eport on S e g r e g a tio n , pp. 4 3 -4 6 .
31-
I b i d . , pp. 46-50.
-2 4 1 -
to d isa p p ea r a lt o g e t h e r .
Furtherm ore, many o f th e members
o f th e sm a lle r exchanges tr a n s a c t a g r e a te r volume o f b u s in e s s
a s o v e r -th e -c o u n te r d e a le r s th an a s b ro k ers and
ex ch a n g es.
d e a le r s on
Furtherm ore, t h e i r o v e r -th e -c o u n te r o p e r a tio n s are
n ot lim it e d to s e c u r i t i e s w hich a re u n l i s t e d , b u t in c lu d e secu r­
i t i e s which are l i s t e d on th e ex ch a n g es.
I t i s one o f th e major
problem s o f th e sm a lle r exchanges t o in d u ce members to tr a d e on
them r a th e r than o v e r -th e -c o u n te r .
I t i s furtherm ore d i f f i c u l t
f o r th e sm a ller exchanges to fin d s e c u r i t i e s s u it a b le f o r l i s t i n g .
Eany is s u e r s appeared t o w ish t o a v o id l i s t i n g b eca u se o f th e
d is c lo s u r e p r o v is io n s o f th e S e c u r i t ie s Exchange A c t, w h ile many
o th e r s who d e s ir e d an exchange market tended to g r a v it a t e toward
th e la r g e r exch an ges.
The o p in io n p r e v a ils th a t i f s e g r e g a tio n
were en forced upon th e sm a lle r ex ch a n g es, th e members 'would
e l e c t th e d e a le r fu n c tio n and tr a d e o v e r - th e -c o u n t e r , th er e b y
32
c lo s in g th e ex ch a n g es.
In c o n c lu sio n i t was p o in te d o u t th a t th e com bination
o f th e fu n c tio n s o f broker and d e a le r in v o lv e d a c o n f l i c t o f
i n t e r e s t w hich was d e tr im e n ta l to th e f id u c ia r y r e la t io n s h ip
in h e r e n t in th e brokerage f u n c tio n .
33
I t was a l s o s t a t e d th a t a
typ e o f tr a d in g e x is t e d on th e exch anges w hich e x e r te d an
undue in f lu e n c e on p r ic e s , i n c i t e d s p e c u la tio n , le d to d i s ­
o r d e r ly m ark ets, and in t e r f e r e d w ith th e e f f e c t i v e f u l f i l l m e n t
o f th e brokerage fu n c tio n .
These e v i l s were n o t c o n sid e re d
32
Report on S e g r e g a tio n , p p . 51-53*
33
I b i d ., p . 109.
J>AZ-
o f s u f f i c i e n t im p o rtan ce im p o rtan ce t o c a l l f o r im m ediate l e g i s ­
la tiv e a c tio n .
I n s te a d , i t was su g g e ste d t h a t an a d m in is tr a tiv e
program be i n s t i t u t e d t o d e a l w ith th o se a s p e c ts o f th e problem
w hich were m ost u r g e n t, w h ile th e l e s s u rg e n t a s p e c ts of th e
m a tte r were t o be s tu d ie d f u r t h e r .
As a b eg in n in g i t was
su g g e ste d t h a t a c co u n ts o f members tr a d in g on o r o f f th e f l o o r be
f u l l y m argined a t a l l tim e s , and t h a t th e y should be f u n c tio n a lly
s e g re g a te d , e x c e p t f o r s p e c i a l i s t s in th e s to c k s i n w hich th e y
s p e c i a l iz e d .
I t was lik e w is e u rg ed t h a t r u l e s c o n c e rn in g ex­
c e s s iv e t r a d in g should be r i g i d l y o b serv ed , and t h a t commission
b ro k e rs c a rry in g m argin a c c o u n ts sh o u ld n e i t h e r engage in firm
tr a d in g n o r p e rm it t h e i r p a r tn e r s to do s o .
F u rth erm o re, need was
f e l t f o r s t r i c t r u le s re g a rd in g e x c e s s iv e tr a d in g i n d i s c r e t i o n a r y
ac c o u n ts and t r a d in g 'which o p e ra te d to th e d e trim e n t o f such
a c c o u n ts .
E x cessiv e tr a d in g by s p e c i a l i s t s f o r t h e i r own a c c o u n ts
was re g a rd e d a s a m a tte r f o r r i g i d r e g u la tio n and i t -was f e l t t h a t
th e c o n d itio n s under which a s p e c i a l i s t m ight tr a d e w ith h i s book
sh o u ld be r i g i d l y p r o s c r ib e d .
In th e m a tte r o f o v e r - th e - c o u n te r
m ark ets no d e f i n i t e c o n c lu s io n s co u ld be reach ed re g a rd in g
s e g re g a tio n ,
fu ch ev id en ce as was g a th e re d su g g e ste d t h a t seg­
r e g a tio n m ight s e r io u s ly h in d e r r a t h e r than h e lp th e b ro k e ra g e
f u n c tio n in th e s e m a rk e ts.
The im m ediate program , t h e r e f o r e ,
e n v isio n e d a c o n tin u e d e la b o r a tio n and enforcem ent o f p r o h ib itio n s
a g a in s t d e c e p tiv e and f r a u d u le n t tr a d e p r a c t i c e s , w ith i n s i s t e n c e
upon a c l e a r d is c lo s u r e to th e cu sto m ers o f th e
c a p a c ity in which
-PA'S--
b ro k e rs and d e a le rs may be a c tin g .
T his stu d y was regarded by th e
t i n c t l y p r e lim in a r y in c h a r a c te r .
ommlssion as b e in g d i s ­
I t vras f e l t th a t th e r e should
be fu r th e r stu d y n o t o n ly bjr th e Com m ission, bu t by th o s e in
th e s e c u r it y b u s in e s s and o t h e r s .
The stu d y has been co n tin u ed
v/ith th e co o p e ra tio n o f th e b r o k e r s and d e a le r s , b u t a t t h i s
v r ritin g has n o t reached a d e c i s i v e c o n c lu s io n .
The problem
o f se g r e g a tio n o f th e b r o k e r -d e a le r f u n c t io n , vrtiich was con­
s id e r e d one t o be s o lv e d by an e v o lu tio n a r y approach a t th e
o u t s e t , s t i l l c o n tin u e s to be one o f an e v o lu tio n a r y c h a r a c te r ,
th e u ltim a te s o lu t io n o f vrtiich w i l l depend upon th e j o i n t
e f f o r t s o f the Commission and th e ex ch a n g es.
Sh ort S a le s
Short s e l l i n g , which was brough t under th e c o n tr o l o f the
Commission by s e c tio n 10 o f th e A c t, has n o t been a problem o f
major im p ortan ce.
I t was one o f th e f i r s t m a tter s to come to
th e Commission’ s a t t e n t io n , a s I t had been w id e ly d is c u s s e d
d u rin g th e p ro ceed in g s which le d t o l e g i s l a t i o n , and th e exchanges
were asked to adopt a r u le fo r the c o n tr o l o f s h o r t s e l l i n g v e r y
35
soon a f t e r th e p assage o f th e A c t.
There has been no e v id e n c e ,
how ever, t h a t sh o r t s e l l i n g has been used e x t e n s iv e ly a s a t o o l
f o r m an ip u lation s in c e th a t tim e , and th e tren d o f th e market
h a s n ot been conducive to b e a r ish o p e r a tio n s .
34 •
R eport on S e g r e g a tio n , pp. 109-114*
35 •
S.B .C ., 1 s t Annual R ep o rt, p . 16.
The su b seq u en t r u le s ,
-2 4 4 w hich have been f u l l y d is c u s s e d i n C h ap ter V II, were fo rm u lated
a s a r e s u l t o f a s tu d y o f th e e f f e c t s o f s h o r t s a le s d u rin g a sh a rp
d rop i n p r ic e s i n Septem ber and O cto b er o f 1937 and a g a in d u rin g
36
th e p e rio d from M arch 21 t o A p r il 2 , 1938. Rumors co n cern in g
e v a sio n o f th e r u le 3 have been d is c u s s e d by members o f th e Com­
m ission* s s t a f f and exchange r e p r e s e n t a t i v e s , w ith th e r e s u l t
t h a t amendments have been made and r e p o r ts on c e r t a i n ty p e s o f
37
t r a n s a c tio n s have been r e q u ire d o f exchange members.
No fo rm al
c a s e s have come b e fo re th e Commission, however, and i n th e few
in s ta n c e s where v i o l a t i o n has o c c u r re d , in fo rm a l a c t io n o f an
e d u c a tio n a l and e x p la n a to r y c h a r a c te r has been ta k e n by th e
38
ex changes.
C o n tro l o f C r e d it
A f u l l d is c u s s io n o f R e g u la tio n s "T" and "IP1 has been p re ­
s e n te d i n C h ap ter V i.
I t was p o in te d o u t t h a t R e g u la tio n nUw
d e a ls w ith th e c o n tr o l o f c r e d i t w hich i s ex ten d ed by banks f o r
th e p urpose o f p u rc h a s in g and c a r r y in g s e c u r i t i e s ; t h i s r e g u la tio n
i s a d m in is te re d by th e Board o f G overnors o f th e F e d e r a l R eserve
System .
R e g u la tio n nTn d e a ls v d th c r e d i t ex ten d ed f o r th e same
p u rp o se , and w h ile th e Board fo rm u la te s p o l i c i e s under t h i s re g u ­
l a t i o n , i t s a d m in is tr a tio n i s l e f t to th e S e c u r i t i e s and Exchange
Commission.
36
S .E .C . , 4 th Annual R e p o rt, p p . 87-88; see p p .187 f f . above.
37
F i f t h Annual R e p o rt, p p .4 4 -4 5 .
38
P e rso n a l l e t t e r from C. MacCoy, A s s is ta n t D i r e c to r , D epartm ent
o f P u b lic R e la tio n s , New York S to ck Exchange, Septem ber 27,1940.
-245S in c e th e s e r e g u la t io n s have been in e f f e c t , m arket
c o n d itio n s have n o t been such as to p u t t h e i r w o r k a b ility to
a c o n c lu s iv e t e s t .
The Commission h as conducted I n v e s tig a tio n s
o f m argin a c c o u n ts o f member firm s from th e b eg in n in g and has
r e c e n t l y conducted in s p e c tio n s o f non-member firm s a s w e ll.
The
r e s u l t s o f th e s e i n v e s t i g a t i o n s have been tu rn e d o v e r to th e
Board o f G overnors o f th e F e d e ra l R eserve System , and in some in ­
s ta n c e s th e Board has asked th e exchanges t o ta k e d i s c i p l i n a r y
a c tio n .
I t a p p e a rs to have been th e p o lic y o f th e exchanges to
handle such c a s e s i n an in fo rm a l m anner, and a s a r e s u l t no d a ta
a re a v a i l a b l e .
The e x p e rie n c e o f th e New York S tock Exchange
seems to show t h a t p r a c t i c a l l y a l l o f th e c a s e s o f t h i s s o r t
which have been b ro u g h t to th e a t t e n t i o n o f th e Exchange have
proved upon i n v e s t i g a t i o n t o be th e r e s u l t o f ig n o ra n c e o r o f
m isu n d e rsta n d in g r a t h e r
39
th a n o f p u rp o s e fu l e v a sio n o f th e r u le s .
D. ADMINISTRATION OF REGULATION CONCERNING
MANIPULATION AND FRAUD
M an ip u la tiv e A c t i v i t i e s
S e c tio n 9 and 10 (b) o f th e A ct have been a d m in iste re d n o t
o n ly w ith a view t o p r o h ib itin g o r p u n ish in g s p e c i f i c a b u se s, b u t
a ls o t o th e w orking o u t o f a b ro a d e r program o f a p re v e n tiv e c h a ra c ­
te r.
Soon a f t e r th e p assag e o f th e A c t, t r a d in g a c t i v i t i e s on th e
m ost im p o rta n t exchanges were p u t under o b s e r v a tio n .
Through t h i s
means th e Commission sought
39
L e t t e r from C. MacCoy. I t sh o u ld be p o in te d o u t i n co n n ectio n w ith
t h i s s ta te m e n t t h a t , w h ile v i o l a t i o n s o f any new r u lin g a re l i k e l y
to o ccu r th ro u g h m isu n d e rsta n d in g o r ig n o ra n c e , th e p u b lic r e l a t i o n s
dep artm en t o f th e Exchange could n o t be ex p ected to em phasize th e
im p o rtan ce o f v i o l a t i o n s , and th e e x p la n a tio n g iv en would o f co u rse
c o n s ti t u t e a v e ry p la u s ib l e excuse f o r v i o l a t o r s under th e c irc u m sta n c e s .
n o t o nly to d is c o v e r u n u su a l m arket a c t i v i t y , b u t to d e te c t
"wash"
s a le s , m atched o r d e r s , tip p in g , d is s e m in a tio n o f f a ls e
in fo rm a tio n , and a c t i v i t y on th e p a r t o f s p e c i a l i s t s above t h a t
which was n e c e s s a ry f o r th e m aintenance o f f a i r and o r d e rly
m a rk e ts.
A system was in a u g u ra te d f o r accu m u latin g in fo rm a tio n
w ith r e l a t i o n t o p r ic e movements, which m ight be p u b lis h e d o r
c irc u la te d .
R e p o rts o f p r i n c i p a l b e n e f i c i a l owners o f r e g i s ­
te r e d s e c u r i t i e s , f i l e d under s e c tio n 16 o f th e A ct, have been
a n aly ze d to d e t e c t p o s s ib le m a n ip u la tio n by i n s i d e r s .
As a
p a r t o f th e p r e v e n tiv e program th e Commission lias in a u g u ra te d
what i t term s th e " f l y i n g q u iz z " , which i s d esig n e d to p re v e n t
m an ip u la tio n by im m ed iately in q u ir in g i n t o any u n u su al m arket
b e h a v io r.
In h a n d lin g th e s e m a tte rs th e Commission has h e ld
co n fe re n c e s w ith p u t and c a l l b ro k e rs and o th e r s w ith a view
to fo rm u la tio n o f e f f e c t i v e r u le s re g a rd in g th e u se of o p tio n s
and f o r o th e r p u rp o s e s .
T hroughout i t s s u r v e illa n c e o f tr a d in g
a c t i v i t y th e Commission i s on th e a l e r t f o r v io la t io n s o f o th e r
s e c tio n s o f th e A ct.
For rea so n s o f p o l i c y th e Commission h as kept con­
f i d e n t i a l th e f a c t t h a t tr a d in g in a s e c u r i t y i s under i n ­
v e s t i g a t i o n , s in c e such know ledge, i f made p u b lic , m ight have
a d e p r e ssin g e f f e c t on th e p r ic e o f i t .
D uring the co u rse o f
i n v e s t ig a t i o n s i t has o ft e n been n e c e s s a r y f o r th e Commission
t o r e s o r t to i t s power o f subpoena in ord er to o b ta in inform a­
tio n .
C om plaints from in d iv id u a ls reg a r d in g m a n ip u la tiv e
p r a c t ic e s have n o t proved r e l i a b l e b a se s f o r a c t io n .
I t has
-2 4 7 -
been th e p o li c y o f th e Commission t o in v e s t i g a t e a l l co m p la in ts
o f t h i s c h a r a c te r , b u t i t h as found t h a t many o f them a r e f a l s e
le a d s , i n i t i a t e d f o r p e rs o n a l re a s o n s and o n ly a few have le d
th e Commission t o th e un covering o f a c t u a l m a n ip u la tiv e a c t i 40
v itie s .
I t h a s been found th a t th e s e c u r i t i e s m arkets are n o t
cap ab le o f p o l i c i n g th e m se lv e s w ith r e l a t i o n t o m a n ip u la tiv e
a c tiv itie s .
For t h i s reason th e Commission has been fo r c e d ’to
tak e an a c t iv e p a r t i n th e m a tte r .
I t h as d e a lt w ith manipu­
l a t i v e c a s e s w ith a l l o f th e v a r io u s means a t i t s d is p o s a l.
In some in s t a n c e s , when i t appeared th a t th e Act was about t o
be v io la t e d , in j u n c t io n s have been ob ta in ed from th e c o u r ts .
In o t h e r s , v i o l a t o r s have been tu rn e d over to th e c o u r ts f o r
p r o s e c u tio n .
I n s t i l l o th e r s , s e c tio n 19 o f th e Act h as been
invoked and t h e v i o l a t o r s have been e x p e lle d from th e n a ti o n a l
s e c u r i t i e s exchanges o f which th e y w ere members.
I t i s in t h i s
l a t t e r group o f in s ta n c e s t h a t th e p o lic y o f th e Commission has
been p o r tr a y e d .
7 /h ile th e r e has been no h e s i t a t i o n on th e p a r t o f th e
Commission t o d e a l sum m arily w ith v i o l a t o r s when th e y have
d e l i b e r a t e l y a c te d c o n tr a r y to lav/1, th e r e h as been a marked
tendency to show le n ie n c y when th e v i o la tio n
h a s n o t been
s e rio u s and where th e p a r t p la y e d by th e v i o l a t o r was a m inor
onej t h i s h a s lik e w is e been th e c a s e where i t c o u ld be
e s ta b lis h e d t h a t th e v i o l a t o r was n o t c o m p le te ly c e r t a i n t h a t
40.
1 s t A nnual R e p o rt, p p . 1 4 -1 5 , 4-th Annual R e p o rt, p p . 8 1-83,
and 5 th Annual R e p o rt, p p . C 7 ff.
-2473-
he was v i o l a t i n g th e la w .
For t h i s reason i t appears p o s s ib le
fo r b rok ers t o a tte n d to t h e ir b u s in e s s w ith o u t fe a r t h a t some
a c t w hich th e y may u n w ittin g ly commit w i l l r e s u l t in s e r io u s
damage to them .
In th e c a s e o f ■'r. Ju n iu s R ich a rd s, th e v i o la t o r was
suspended from th e exch anges o f w hich he vans a member f o r o n ly
te n d a y s .
In t h i s in s ta n c e i t was n o t e s t a b lis h e d th a t
Mr. R ich ard s was c o g n iz a n t o f th e f a c t t h a t he was v i o l a t i n g
th e law in e x e c u tin g o rd ers f o r another who had plan ned to
m an ip u late th e m arket.
He a d m itte d , how ever, th a t the n atu re
o f th e t r a n s a c t io n s in v o lv e d sh ou ld have p u t him on n o t i c e , and
i t appeared t h a t h e was w i l l i n g in e v e r y way to h e lp th e Commission
41
w ith i t s i n v e s t i g a t i o n .
The c a se in v o lv e d an attem p ted m a n ip u la tio n o f th e s to c k
o f S im p lic it y P a tte r n s , I n c . , by a B r i t is h firm w hich had ob­
t a in e d o p tio n s on i t in t h i s c o u n try .
There i s no remedy a t lav/
a g a in s t fir m s as su ch , nor i s th e r e any way in w hich fo r e ig n
fir m s may be d is c ip lin e d f o r v i o l a t i o n s o f th e A c t.
The
Commission h a s secu red th e c o -o p e r a tio n o f s e v e r a l o f f i c i a l
and n o n - o f f i c i a l firm s in Canada, how ever, in curbing manip­
u l a t i v e p l o t s i n o r ig in a t in g th e r e .
There seems to be no
in d ic a t io n t h a t th e Commission has sought to d e a l s t r in g e n t ly
in such c a s e s w ith th e in d iv id u a l o ffe n d e r s who come under
t h e ir j u r i s d i c t i o n , w ith a v ie w t o making i t dangerous t o
j o in w ith o th e r s in such v e n tu r e s .
41 .
4 S. E. n . , 742-.
i t should be noted t h a t
-2.49-
in t h i s c a se th e a c t io n o f th e Commission was s u f f i c i e n t l y
q u ick t o p r e v e n t th e major p a r t o f th e contem plated m anipula­
t i v e a c t i v i t y from ta k in g p la c e .
S in c e a c t io n on m a n ip u la tiv e c a s e s by th e Commission
in v o lv e s in t e r p r e t a t io n o f r e la t io n s h ip s betw een s p e c i f i c a c t s
which in th em se lv e s m igh t be p e r f e c t l y l e g a l , i t seems ad­
v is a b le to r ev iew c e r t a in le a d in g c a s e s which have been d e c id e d ,
in order th a t l i g h t may b e s t be thrown on th e Commission1s
p o l i c y in such m a tte r s .
The f i r s t c a se chosen i s th a t o f l ’r . C h arles C. F r ig h t.
T h is c a se i s o f i n t e r e s t n o t o n ly b ecause i t g iv e s a r a th e r
com plete p ic tu r e o f th e p r o c e s s e s o f m a n ip u la tio n , bu t a ls o
i n d i r e c t l y b ecau se o f th e f a c t t h a t Hr. ’" r ig h t was one o f th e
s p e c i a l i s t s 7fho appeared b e fo r e th e Senate Committee on
Banking and Currency to defen d th e p r a c t ic e s o f th e Yew York
Btock exchange and to t e s t i f y a g a in s t th e F le tc h e r - Rayburn
b ill.
42
lir . ’F lig h t , a lo n g w ith two members o f th e firm o f A rnold
and Company, w ere charged vrith v i o l a t i o n o f s e c t io n 9 o f th e
S e c u r it ie s Exchange A c t.
The e v id e n c e v/hich came to l i g h t
du rin g th e in v e s t ig a t i o n showed th a t on Beptember 7 , 1935, an
o p tio n fo r 1 6 0 ,0 0 0 sh a r es o f P inner C orporation sto c k ’was
o b ta in e d from !.rr . R obert P o r te r , p r e s id e n t o f th e K inrer
C o rp o ra tio n .
T his o p tio n was n e g o t ia t e d through c o n fe r en ce s
42Bee Chapter I I , pp. 4 9 -5 0 ab ove.
-250-
w ith Mr. 7 /r ig h t, Mr. H erbert King, and Mr. Korman S t e m o f
A rnold and Company.
The o p tio n vras made o u t in th e name o f
Mr. A lb e r t King; th e p a r t i e s a c t u a lly in t e r e s t e d in th e o p tio n ,
how ever, were Mr. 7 /r ig h t, Mr. H erbert K ing, and Mr. S t e m .
Kinner C orporation was trad ed in on th e Los A n g eles
Stock Exchange, b u t th e market p r io r to the g r a n tin g o f th e
above-m entioned o p tio n was both q u ie t and t h i n .
Mr. 'F righ t
f i r s t made arrangem ents w ith Mervin Ash and Company, w hich had
o f f i c e s in both Los A n g eles and New York, whereby he would
be k ep t inform ed on th e market f o r K inner.
T h is firm was a ls o
used in th e e x e c u tio n o f subsequent o r d e r s.
During f i v e days
o f tr a d in g , from September 11 to September 1 5 , th e p r ic e r o se
from 46 c e n ts t o 75 c e n ts per share on a volume o f 1 2 7 ,7 0 0
s h a r e s , o f w hich 5 2 ,0 0 0 are a t t r ib u t a b le t o market a c t i v i t i e s
on th e p a r t o f ’F r ig h t, " te r n , and King.
During th e "mark-up*1
o f th e o p e r a tio n , 79 p e r c e n t o f a l l th e p u rch a ses o f Kinner
were made by Mr. ’F r ig h t.
Mr. '.Fright used s e v e r a l
a c co u n ts
b e s id e s h i s own in t h i s o p e r a tio n , namely th o s e o f Mrs. C harles
C . '.Fright, A lv in Richmond, Edward R. '.Thitehead, and Dorothy
M a c k a ill, a Hollywood a c t r e s s ; to th e s e a c co u n ts he a l lo c a t e d
sh a res w hich he had p u rch a sed .
In th e c a s e s o f Mrs. 'F righ t
and M iss M a c k a ill, Hr. " /rig h t had power o f a tto r n e y over t h e i r
a c co u n ts w ith o u t t h e ir know ledge.
On th e s e l l i n g s id e , w ith
the e x c e p tio n o f 9 ,0 0 0 sh a res w hich were so ld through th e
a ccou n t o f A lv in Richmond, a l l o th e r s a le s ( t o t a l l i n g 4 1 ,3 0 0
sh a r e s) w ere s o ld through an a cco u n t which Mr. 'F right had
opened f o r a Mr. .Stewart Haddock.
F orty thousand sh a r e s,
-251whioh were ta k e n down under th e o p tio n a t 45 c e n ts , were ta k e n in to
t h i s a c c o u n t.
There was ev ery ev id en ce t h a t th e purpose o f th e o p e ra tio n
was to m a n ip u la te th e s to c k .
When Mr. W right bought, he "reached"
f o r th e s to c k , th e re b y paying h ig h e r fo r i t th a n would have been
s e n s ib le i f he had been buying f o r in v estm en t p u rp o se s.
F u rth e r­
more, ev id en ce o f th e tr a n s a c tio n s and accompanying comments reco rd ed
on th e TWX ta p e a t M ervin Ash and Company in d ic a te d t h a t mani­
p u la tio n s were b ein g c a r r ie d on.
There was evidence t h a t Mr. W right
had used m atched o rd e rs to c r e a te an im p ressio n o f a c t i v i t y
in th e s to c k , and t h a t he had b u i l t up i t s p r ic e in o rd e r t o
d isp o se o f h is sto c k a c q u ire d under th e o p tio n from Mr. P o r te r ,
The o p e ra tio n d id n o t in v o lv e th e f u l l e x te n t o f th e 160,000
sh a re s which were o r i g i n a l l y arran g ed f o r , s in c e n e i t h e r
Mr. P o r te r n o r th e company i t s e l f was a b le to d e liv e r them .
In handing down i t s d e c is io n , th e Commission p o in te d o u t
t h a t Mr. Y/right was th e most c u lp a b le o f th e th re e s in c e he c a r r ie d
o u t most o f th e p ro c e d u re .
He was th e r e f o r e e x p e lle d from a l l
s e c u r i t i e s eschanges in which he h eld membership.
Mr. S te rn and
Mr. King were suspended from a l l exchanges f o r a p e rio d o f tw elve
m onths. ^
In th e W right c ase th e Commission i n t e r p r e t s s e v e ra l
im p o rta n t elem ents o f th e law whioh a r e o f such c h a r a c te r as
t o be a p p lic a b le to m ost o th e r m a n ip u la tiv e c a s e s .
I t was h eld
t h a t , w h ile th e d e fe n d a n ts s e n t l e t t e r s , te le g ra m s, e t c . in
i n t e r s t a t e commerce, t h i s would n o t have been a n e c e s sa ry
433 S .E .C ., 190 f f .
elem en t in th e Comma."s i or 1s c o n te n tio n t h a t th e in str u m e n ta l­
i t i e s c f i n t e r s t a t e commerce were u se d .
I n s te a d , th e Com­
m issio n p o in te d ou t t h a t th e f a c t o f membership on a n a t io n a l
s e c u r i t i e s e r c ta n ;e, or th e use o f f a c i l i t i e s o f such an ex­
change, was s iif . i o i e n t t o c o n s t it u t e use o f th e in s tr u m e n ta l­
i t i e s c f i n t e r s t a t e commerce.
F u rther o r e , i t was not n e c e s -
sar;.' th.at each, d efen d a n t u se in s t r u m e n t a lit ie s o f i n t e r s t a 1e
commerce to be charged v/ith such u s e .
th e f a c t th a t the;,,r
w ere a c t in g in c o n c e r t v;as s u f "cicer.t t o make th e u se o f th e s e
f a c i l i t i e s ch argeab le to a l l o f th e n .
Matched o r d e rs vrere d e fin e d in t h i s ca se a s c o n s is t in g o f
o r d e r s , emanating from a m an ipulator, w hich c r o s s in th e mar­
k e t.
ord ers e n te r e d
vrhich had s u f f i c i e n t s 'r . i l a r i t y o f tim e ,
s i z e , and p r ic e to cause t h e i r e x e c u tio n vrere th o u g h t o f as
matched ord ers even though the;; vrere n ot i d e n t i c a l in s ir .e .
Thi
r u lin g was made in resp o n se to a content"on o f th e d efend ant
t h a t , b ecause ord ers p la c e d cm. o p p o site s id e s o f th e market
vrere n o t o f s u b s t a n t i a l l y th e same s i z e , they w ere n o t matched
ord ers,
the Commission p o in te d out t h a t , s-’nee on th e Los
A n geles Stock Exchange o rd ers vrere ex ec u ted on a u r .it b a s is
o f a hundred sh a r e s u n le s s " a ll or none" vram, s t i p u l a t e d , th e
s i z e o f th e o rd ers p la c e d had no im p ortance, h-ut th e f a c t th a t
th ey cro ssed d id .
-nich o rd ers vrere con stru ed as' hairing teen
p la ced f o r th e purpose o f c r e a tin g a ris le a d in g appearance in
Kinner s to c k .
C o n s is te n t w ith th e p r o v is io n s o f th e A c^ ,th e Commission
-2 5 3 d id n o t v iew th e e x is t e n c e o f th e op tion in K inner sto c k as
ail e s s e n t i a l e le w e 't 01 the c a s e .
The c ircu m sta n ces sur­
rounding th e o p tio n , how ever, were co n sid e re d such a s to
w arrant th e p o in t o f view th a t th e purpose o f th e 'whole op­
e r a tio n '.van th e r a is i n g o f th e market p r i c e .
Under th e s e
c irc u m sta n c es " rea ch in g 11 fo r s to c k , t h a t i s , p ayin g more than
th e mirdumum n e c e s s a r y t o procure i t , was co n str u e d as a part
o f 1he tech n iq u e u sed in narking up the s to c k .
T his in fe r e n c e
was s u b s ta n tia te d by th e f a c t th a t h r . W right d en ied th a t he
had s to c k f o r s a l e when he a c t u a ll y had, th u s f o r c in g a c u s­
tomer to make a pu rchase :!n th e market r a th e r than from hLm.
T his o f cou rse had th e e f f e c t o f str e n g th e n in g th e m arket.
As f o r th e market o p era tio n a s a w h o le, th e Comm ission
in f e r r e d m an ip u lation from th e f a c t th a t th e r esp o n d e n t, who
had had a s u b s t a n t ia l i n t e r e s t in th e s to c k , c o n c u r r e n tly
e f f e c t e d a r i s e in i t s p r ic e and d is p o se d o f h is i n t e r e s t .
I t should be noted th a t in i t s f i n a l d e c is io n th e Com­
m issio n e x p e lle d h r . '.frigh t from id s exchanges a lt o g e t h e r ,
w h ile th o se who op erated w ith him were m erely suspended.
Such an a t t it u d e ap p ears to in d ic a t e a p o lic y on th e p a r t o f
th e Commission t o
e a l s t r in g e n t ly w ith r in g le a d e r s in such
o p e r a tio n s , and t o grade the pu ishm ent o f e th e r s in such a
ma- n e r th a t mere p a r t ic ip a t io n in such: o p e r a tio n s may n o t r e s I t in s e r io u s or permanent in ju r y to th e o ffe n d e r . ^
The c a se w hich f o ll o w s , th a t o f
44
'&
C. to. C ., 21fi•.
,
r . M ichael J . J'eehan,
c o n ta in s mar.y elem en ts w hich are found in tl'ie p reced in g one;
in a d d itio n i t d e a ls w ith th e problem o f i n d i r e c t m a n ip u la tio n ,
th.at i s ,
-'nduci.ng o th e r s to buy in ord er t o r a i s e th e p r i c e .
Furtherm ore, th e defend ant i s one who rad conducted s e c u r it y
f l o t a t i o n s f o r th e company in which 1! e .stock was m an ip u lated ,
and had te e n a f a c to r .in th e management o f t h a t company.
In order t o follow ' th e p o in t o f view o f th e Commission
th rou ghout th e c a s e , i t i s n e c e s s a r y to d e s c r ib e ' r i e f l y th e
gener 1 background from .h ie d i t grew.
The P e ll anca A i r c r a f t Company was formed in 1927
y h r.
B e lla ca and a few fr ie n d s f o r t- e purpose o f m anufacturing
a ir p la n e s .
S h o r tly a fterw a rd s c e r t a in f r ie n d s anu r e l a t i v e s
o f th e du F on ts in v e s te d about £390,009 in i t ;
i t s p la n ts
were r e lo c a t e d , and i t was r e in c o r p o r a te d in D elev/are a s th e
B e lla s c a A ir c r a f t C orp o ra tio n .
The c o r p o r a tio n -was s u c c e s s f u l
from an e n g in e e r in g p o in t o f view and d ev elo p ed an a ir p la n e
which a c q u ir e d c o n sid e r a b le r e p u ta tio n fo r i t s l i f t i n g power
and low c o s t o f o p e r a tio n .
Though th e new co rp o ra te c h a r ie r p ro v id ed fo r th e is s u in g
o f c o n s id e r a b le s to c k , no is s u e o f im portance "was made w h ile
th e du Pont 'n t e r e s t s r e ta in e d th e ir ■o ld ii g s ,
In 192C, how­
e v e r , th e du Pont group d isp o se d o f i t s h o ld in g s , le a v in g t i e
c o rp o ra tio n :■ri need o f new c a p i t a l ,
h r . M ichael J. lieehan formed
a s y n d ic a te w hich d is t r ib u t e d 104.,000 sh a r e s o f common sto ck
on t i e cur'- a t 323*50 per sh a r e , n e t t in g B e lla n c a A ir c r a f t
3 1 ,6 2 5 ,0 0 0 o f new c a p it a l and a p r o f i t o f £200,000 to h r.
ie e h a n 1s s y n d ic a t e .
.-2 5 5 -
During th e p erio d in v/hich th e du Pont groui' m a in ta in ed
i t s h o ld in g , there i s no ev id en ce t h a t th ey vrere in t e r e s t e d in
c o n tr o l o f the company.
I n s te a d , th e y appeared t o occupy the
p o s it io n o f in v e s t o r s , I n t e r e s t e d in p r o f i t s through
th e
developm ent o f t! c company, who e x e r c is e d good b u s in e s s judg­
ment in g e t t in g ou t a t an opportune tim e .
From th e tim e o f
th e f l o t a t i o n o f th e f i r s t sto ck by th e Meehan s y n d ic a te , a
s tr u g g le f o r c o n tr o l o f th e co rp o ra tio n ^ a f f a i r s d e v e lo p e d .
Furtherm ore, th e s y n d ic a te was g iv e n w arran ts on 2 5 ,0 0 0 sh a res
o f common s to c k ,
V .liile lir . H ellan ca ‘was t h e o r e t i c a l l y i n con­
t r o l o f th e company, he was g r e a t ly in flu e n c e d b
who was a member o f the Meehan s y n d ic a te .
a h r . Aiams
Mr. Adams a 'tem p ted
t o fo r o e Mr.. :ie lla n c a to conform to h r . Meehan* r: w ish e s a J a l l
tim es in m a tters o f p o li c y b y a rg u in g th a t th e corporat*on
rr.ight, be in need o f f u r f e r fin a n c in g , which Mr. Meehan ’was
in^i p o s it io n to g iv e or w ith h o ld .
An open break betw een the
two occu rred , how ever, when Mr. Adams attem p ted to have Mr.
Meeha; p la c e d on th e board o f d ir e c t o r s o f uhe c o r p o r a tio n .
From a f i n a n c i a l p o in t o f view th e ^ e lla n c a C orporation
had n o t been s u c c e s s f u l.
From 1929 to 1934 i t s e a rn in g s w ere
a s fo llo w s :
1929 n e t l o s s -------------------------f1 0 9 ,0 0 0
1930
" "
3 2 4 ,0 0 0
1931
" "
3 9 7 ,0 0 0
1932
« r . -------------------------- 1 0 0 ,0 0 0
1933 n e t p r o f i t -------------------- 5 3 ,0 0 0
1934 n et lo s s
-----— ---------- — 1 3 9 ,0 0 0
T o ta l n e t lo s s
$ ip i4 ,o o o
I t sh ou ld be noted t h a t , 3 ln ce th e B e lla n c a A ir c r a f t Corpor­
a t io n had d evelop ed a s u c c e s s f u l p la n e , but appeared la c k in g
in b u s in e s s mangement, a p o s s i b i l i t y e x is t e d o f r e o r g a n iz in g
th e m an agerial and f i n a n c i a l end o f th e o r g a n iz a tio n in such
-255-
a way th a t th e v a lu e o f th e b u s in e s s a s a goin g concern m ight
be v a s t l y in c r e a s e d .
Such a s i t u a t i o n a lso in v i t e d m anipula­
t io n o f th e sto c k o f th e c o r p o r a tio n , s in c e such p o s s i b i l i t i e s
m igh t r e f l e c t th em selv es in th e market v a lu e o f s to c k .
In
ord er to p r o f i t by t h i s s it u a t io n , how ever, i t was n e c e s s a r y
to keep c o n tr o l o f th e c o r p o r a tio n 's su p p ly o f c a p i t a l i f
p o s s ib le .
A cco rd in g ly we fin d th a t when i n 1935 P e lla n c a
A ir c r a f t a p p lie d to th e R e c o n str u c tio n Finance C orporation
f o r a lo a n , (which was r e f u s e d ) , Mr. Adams r e g is t e r e d h i s
str o n g d isa p p r o v a l o f th e move by r e s ig n in g from th e board.
In 1933 an in v e stm e n t banking h o u se , Hammans and Com­
pany had bee me in t e r e s t e d in P e lla n c a .
Thev had a c q u ir e d
o p tio n s on ne lla n c a sto c k from Mr. B e lla n c a and from Mr.
M eehan's w if e .
In 1935 Mr.. I n g o ld , p r e s id e n t o f th e banking
firm became acq u a in ted w ith a Mr. Temple J o y c e, who was fa m il­
i a r w ith Army and Navy n eed s in a v ia t io n and was in t e r e s t e d
i n o b ta in in g a p o s it 'o n w ith an a v ia t io n company.
Mr. In g o ld
o f f e r e d t o f l o a t 3400,009 w orth o f B e lla n c a sto c k on th e con­
d it io n th a t th e management o f th e company was t o go to th e
"new money"; th e o f f e r was a c c e p te d , w ith Mr. Joyce r e p r e ­
s e n tin g th e new mangement.
P r io r t o th e cu lm in a tio n o f th e agreem ent w ith TIammans
and Company, Mr. Meehan had e n te r e d i n t o agreem ents ’w ith Mr.
B e lla n c a and a Mr. D evoe, a " fin d e r o f d e a ls " , f o r s u b s t a n t ia l
q u a n t it ie s o f B ella n c a s to c k .
S h o r tly a fter w a rd s B ella n c a
A ir c r a f t e x p e rie n c e d c o n s id e r a b le a c t i v i t y , w hich some i n ­
v e s t i g a t o r s a t t r ib u t e d t o c o n sp ir a cy on th e p a r t o f Mr. Meehan
-257--
and Mr. Devoe, b u t t h i s co u ld n o t be d e f i n i t e l y e s ta b lis h e d by
th e Commission.
On June 3 , 1 9 3 5 , I!r. Meehan was in c o n tr o l o f 3 0 ,5 5 0 sh a res
o f B e lla n c a s to c k , w ith a l i a b i l i t y f o r 5 0 ,0 0 0 s h a r e s m ore,
w hich he l a t e r s e t t l e d by compromise f o r 1 6 ,0 0 0 s h a r e s .
June 19th he had d isp o se d o f a l l b u t 1400 s h a r e s .
By
Curing t h i s
p e r io d th e p r ic e o f th e s to c k had r is e n from 4 to 5 l / 8 .
Of
th e t o t a l pu rch ases made d u rin g t h i s p e r io d Mr. Meehan was r e ­
s p o n s ib le fo r o n ly 1 5 ,4 0 0 o u t o f a t o t a l o f 4 0 ,9 0 0 s h a r e s .
Some o f th e so purchases were made by person s o v er whose
a c c o u n ts Mr. Meehan had c o n t r o l.
d issem ifia tio n .
O thers vrere made through th e
o f in fo rm a tio n by Mr. Meehan to v a r io u s p eo p le
to th e e f f e c t th a t b e t t e r days w ere a t hand f o r P e lla n c a Air­
c r a ft.
These p e o p le were in d u ced t o buy n o t o n ly i n New York
bu t in o th e r p la c e s , e . g . W ashington, D. C.
They w ere a l l a
p a r t o f a p a tte r n o f which Mr. Meehan was th e c e n t e r , how ever.
Furtherm ore, th e r e were c e r t a in a c t i v i t i e s o f s p e c i a l i s t s
iri B e lla n c a A ir c r a ft which were n o t d i r e c t l y o r i n d i r e c t l y
a t t r ib u t a b le t o Mr. Jieehan, but w hich would l o g i c a l l y f o llo w
a s a r e s u lt o f h is o p e r a tio n s .
C ertain s p e c i a l i s t s abandoned
t h e ir p o s it io n s o f c r e a tin g an o r d e r ly market and assumed
p o s it io n s in B e lla n c a o f a s p e c u la t iv e c h a r a c te r .
There w ere,
how ever, c e r t a in "unexecuted o r d e r s p la c e d under th e m arket
by th e s e s p e c i a l i s t s vh.ich co u ld be assumed to have o r ig in ­
a te d w ith Mr. Meehan, e s p e c i a l l y s in c e th e s p e c i a l i s t s w ere
w e ll acq u a in ted w ith what he was doing and s in c e one o f them was
on in tim a te terms wit,,-, him and was in d eb te d to him p o r s o n n a lly .
-288Under th e agreement w ith Hammans and Company m entioned
above, Mr. Meehan s t i l l had an i n t e r e s t in m a in ta in in g th e
p r ic e o f B e lla n c a Jii r c r a f t s to c k even though he had d is p o s e d
o f p r a c t i c a l l y a l l o f h is h o ld in g s .
In order to o f f e r the
new sto c k on th e market s u c c e s s f u l l y i t was n e c e s s a r y thdth e p r ic e be m ain tain ed around f i v e or b e t t e r .
Mr. Meehan
con tin u ed t o encourage h i s f r ie n d s to buy and to in d u ce
brokerage h ou ses to recommend th e sto c k t o t h e i r c u sto m e rs.
Any w eakness in th e m ark et was su p p o rte d e i t h e r d i r e c t l y th ro u g h
s c a le o r d e rs by M. J . Meehan and Company, o r by h i s w if e , o r
by o th e r a c c o u n ts .
T his a c t i v i t y co n tin u ed u n t i l O ctober 2 5 th ,
when Hammans and Company began to s e l l B e lla n c a .
T his was
brought about by th e f a c t t h a t th ey had d e c id e d t o g iv e up th e
id e a o f a s e c u r i t y f l o t a t i o n f o r th e c o r p o r a tio n .
Prom ptly
upon t h e i r s e l l i n g , th e s to c k dropped to th e neighborhood o f
45
th r e e .
I t was concluded by th e Commission t h a t no u n s tim u la te d
m arket co u ld have caused th e u n u su al amount o f p u rc h a sin g which
took p la c e between June 8 th and June lpt'h..
From th e p o in t o f
view o f th e Cominission th e r e was lik e w is e no d o u b t t h a t Mr.
Meehan and h is a s s o c ia t e s had t r i e d to m a in ta in th e p r ic e o f
t h i s sto ck a r t i f i c i a l l y a t th e l e v e l w hich i t had a t t a in e d
on June 1 8 th .
C ounsel f o r Mr. Meehan a ttem p ted t o argue th a t
t h i s o p e r a tio n was n o t in v i o l a t i o n o f s e c t io n 9 (a ) ( 2 ) , b u t was
p e r m is s ib le under s e c t io n 9 (a ) (6 ) which p erm its p eg g in g or
s t a b i l i z i n g th e market in c o n n e c tio n w it;, a new is s u e o f
s e c u r itie s .
15
In th e o p in io n o f th e Commission t h i s
2 1 . E. C ., pp. 5 9 ff.
-269-
was not th e c a s e , s in c e i t i s n o t in accordan ce -with s e c tio n
9 (a ) (8 ) to m ain tain a p r ic e which h a s been a r t i f i c i a l l y
r a is e d .
As a r e s u l t , th e Commission in vok ed s e c t io n 19 j[a)
o f th e A ct to escpel
Mr. Meehan from a l l exch an ges o f vrhich
lie was a member or, th e grounds o f what was con sid ered , a
s e r io u s v i o l a t i o n o f s e c t io n 9 (a ) (1 ) and 9 (a ) (2 ) o f the
46
A ct.
Again in t h i s c a se th e Commission makes th e p o in t th a t
mere u se o f the f a c i l i t i e s o f a n a t io n a l s e c u r i t i e s exchange
c o n s t it u t e s u se o f th e in s t r u m e n t a lit i e s o f i n t e r s t a t e com­
m erce.
I t likdvri.se r e i t e r a t e s i t s sta tem en t t h a t concur­
r e n t ly p u rch asin g and s e l l i n g a sto c k w ith th e r e s u l t th a t a
q u a n tity h e ld by th e o p e r a to r i s s o ld a t an enhanced p r ic e
c o n s t it u t e s m an ip u lation w ith in th e meaning o f th e l a w . ^
In c o n n e c tio n w ith th e u se o f matched o r d e r s , th e Comm 'ssio n drew r a th e r f i n e d i s t i n c t i o n s betw een t h a t which con­
s t i t u t e d a matched ord er and th a t w hich d id n o t .
I t 'was h eld
th a t where a respon dent e n te r e d an ord er w hich c r o s s e d an or­
der o f a p a r tn er o f h i s fir m , even though, e n te r e d from th e
fir m 's o f f i c e , th er e was no assum ption o f m a tch in g .
F u rth er­
more, when th e r e s p o n d e n t's s e c r e ta r y purchased s to c k w itr
h ; s knowledge and in d oin g so c r o sse d ord ers w hich he had a l ­
read y p la ced in th e m arket, i t was h e ld th a t m atching had n o t
taken p la c e , in th e ab sen ce o f e v id e n c e th a t th e respon dent
had urged her t o purchase th e s to c k .
L ik e w ise , when a l l th a t
i s shown i s th e " b u llin g" o f a sto c k t o an oth er ai d an e x -
46
2 T. F. C ., 6 3 0 .
47
Ib id .,
5@g . e f .
c h . 'VII a b o v e ,
pp.
199 f .
"
h ib itio n of i n t e r e s t by th e l a t t e r , th e f a c t t h a t an o rd er
l a t e r comes from him and m eets an u n ex ecu ted o rd ' r to s e l l
■which h as been p la c e d by th e re sp o n d e n t does n o t c o n s ti t u t e
48
m atch in g .
An in c id e n t n o t m entioned in th e summary ivhich has been
made o f t h i s case sheds c o n s id e ra b le l i g h t on th e Com i s s i o n 's
i n t e r p r e t a t i o n o f th e lav/ w ith r e l a t i o n to m atch in g .
The r e ­
s p o n d e n t's f l o o r r e p r e s e n t a t i v e , Mr. Wiginore, had an o rd e r to
s e l l a block o f th e r e s p o n d e n t's s to c k ,
Mr. Migmore had de­
term in ed to buy i t f o r th e j o i n t a cco u n t o f h im s e lf and I'.r .
D ore.
In o rd e r to do t h i s he handed th e re s p o n d e n t' s o rd e r
o v er !o a n o th e r b r o k e r, who im m ediately s o ld th e sto ck t o Hr.
D ore, w ith th e knovrledge o f Mr. T fignore.
A side from v io la tio n
o f th e r u le s o f th e exchange in th e wa; th e m a tte r was handled
th e r e ap p eared to be l i t t l e i r r e g u l a r i t y in t h i s tr a n s a c tio n .
However, in view o f th e f a t t h a t th e o r d e r was l-'p g e , and t h a t
“ r . V/igmore was u n d er th e c o n tr o l o f Mr. Meehan, t h i s t r a n s ­
a c tio n was c o n sid e re d a m atched o r d e r .
I t was p o in te d o u t
t h a t ex cep t f o r th e s iz e o f th e o r d e r and i t s e f f e c t on th e
m arket th e re was n o th in g t o w a rra n t t h i s c o n c lu s io n .
O ther
m atching which took p la c e was o f a c h a r a c te r which l e f t no
doubt t h a t i t had been accom plished by th e re sp o n d e n t and de49
se rv e s no comment.
In co n n ec tio n w ith in d u c in g o th e r s to buy i t , i t appeared
nc-cessary to b rin g o u t in th e ev id en ce t h a t a c t u a l in d u cin g
had ta k en p la c e o r t h a t rum ors had been c i r u c l a t e d .
The
-2 6 1 mere f a c t th a t mapy o rd ers w hich r a is e d th e p r ic e o f B ella n c a
sto ck r e s u lt e d from in fo rm a tio n r e c e iv e d from s o u r c e s c lo s e to
th e respon dent v/as n o t c o n sid e r e d s u f f i c i e n t f o r t' e i n 50
fe r e n c e o f i l l e g a l i t y .
Broker s o lv e n c y .
B eginning i n th e l a t e r p a r t o f th e y ea r 1 9 3 7 , th e Comm issio n d evoted i t s e l f to th e problem o f fo rm u la tin g e f f e c t i v e
r u le s fo r customer p r o t e c t io n a g a in s t brokerage f a i l u r e .
Y/hile
th e stu d y war- s t i l l in p r o g r e s s , the firm o f R ichard ’Vhitney
and Comp;
fa ile d .
T his f a i l u r e d is c lo s e d m isa p p ro p ria tio n
o f customers* funds and s e c u r i t i e s , th ereb y d em o n stra tin g th e
urgency o f more adequ ate custom er p r o t e c t io n .
Y/hile th e im portance o f t h i s f a i l u r e may have been ex­
aggerated both in th e minds o f th e Commission and o f th e
p u b lic , because o f th e v a r io u s p o s i t io n s o f im portance and
t r u s t which R ichard 7/h itn ey h e ld , n e v e rth e l e s s i t g iv e s a
very s i g n i f i c a n t p ic t u r e o f many f a c t o r s which a r e o p e r a tiv e
among th e members o f th e brokerage community.
Furtherm ore,
i t d i s c l o s e s th e rem arkable d egree o f freedom from e f f e c t i v e
su p e r v isio n which may accru e t o in d iv id u a ls who have once
gained th e c o n fid e n c e o f th e f i n a n c i a l community.
*or th e s e
r ea so n s th e f a ' l u r e o f R ichard Y/hitney and Company d e se r v e s
more than p a s s in g m en tion .
There have been few , i f any, p e o p le in Yfall S t r e e t during
r e c e n t y e a r s who have en jo y ed th e prom inence o f Mr. 7/h itn ey
from th e tim e he became a member o f th e New York Stock Exchange
(in 1912) u n t i l h i s fir m f a i l e d (Mar. 8 , 1 9 3 8 ).
50
2 «?. E . C ., 5 8 8 .
In 1930 he
-26 2 became P r e sid e n t o f th e Exchange, which o f f i c e he h e ld u n t i l
1935.
Both b e fo r e and a f t e r h is p r e sid en cy he occu p ied po­
s i t i o n s o f g r e a t im p ortance on th e Exchange and in a l l i e d en­
te r p r is e s .
Furtherm ore, th e f a c t th a t h is b r o th er was a
p a rtn er in J . P. Morgan and Company enhanced h i s p r e s t ig e
s in c e i t was g e n e r a lly assumed t h a t h is b r o th e r , George,
51
would back him f i n a n c i a l l y i f nece s s a r y .
Hr. T fliitn eyfs fir m conducted a g e n e r a l brokerage b u sin e s s
which in v o lv e d both s to c k s and bonds.
I t s custom ers were
la r g e l y o th e r b rokers or d e a le r s , and i n s t i t u t i o n s or corp or­
a t io n s .
L i t t l e b u s in e s s was done w ith th e p u b lic and
supposedly no margin a c co u n ts w ere c a r r e d .
The firm was
e s s e n t i a l l y a one man a f f a i r , s in c e th ere w ere no m eetin g s o f
th e p a r tn er s on m a tte r s o f p o l i c y , and Hr. 'V hitney made many
im portant d e c is io n s /d th o u t th e knowledge o f any o f th e o th e r
partn erd o f th e fir m .
The firm handled a s u b s t a n t ia l p a r t o f
th e bond b u s in e s s o f J . P . Morgan and Company and
from a
s t r i c t l y brokerage p o in t o f view alw ays showed some margin
52
o f p r o fit.
The c o lla p s e o f ^ ich a rd W hitney and Company was due to
o u ts id e v e n tu r e s w hich had l i t t l e
brokerage b u s 'n e s s .
or no c o n n e c tio n w ith th e
These o u t s id e v e n tu r e s w ere c o n s is t e n t ly
u n s u c c e s s fu l and th e e a r n in g s o f th e brokerage b u s in e s s were
n o t s u f f i c i e n t to make up th e d e f i c i t .
As a r e s u l t Mr. V/hitney
borrowed money from r e l a t i v e s and f r ie n d s o v er a p e r io d o f
y e a r s and a ls o f a l s i f i e d r e c o r d s and r a isa p p r o p r ita te d custom ers'
51
S .E .G ., In th e m a tter o f R ichard W hitney e t a l . , V o l. I , R eport
on I n v e s t ig a t io n , pp. 5 - 6 .
52
Whitney R eport, pp. 6 - 7 .
s e c u r itie s .
H is i r r e g u l a r i t i e s in c o n n e c tio n w ith cu stom ers1
s e c u r i t i e s have been tr a c e d back a s f a r a s 1 9 2 6 .
As tim e
p a ssed and h is s it u a t io n became more d e s p e r a te , he r e s o r te d
to i l l e g a l p r a c t ic e s more habitually*-, u n t i l by 1936 th ey had
become a " gen eral p r a c t ic e " .
In a d d itio n t o th e demands
a r is i n g from l o s s e s in b u s in e s s v e n tu r e s , J,!r. W h itn ey's l i v ­
in g c o s t s were e x tr em e ly h ig h t , amounting to f i f t y or s i x t y
thousand d o lla r s in th e y e a r 1 937, w h ile th e t o t a l p r o f i t s
from h is brokerage b u s in e s s du rin g th a t y e a r were o n ly
>97,147>4-0.
Furtherm ore, du rin g t h is p e r io d s e c u r i t i e s
owned by the firm and i t s p a r tn e r s d e p r e c ia te d in v a lu e ,
as d id th e s e c u r i t i e s b e lo n g in g t o c u sto m e r s, which he had
im p rop erly h yp oth ecated a s c o l l a t e r a l f o r bank lo a n s .
F i n a l l y , U r. W hitney h im se lf l o s t c o n s id e r a b le money through
tr a d in g in s e c u r i t i e s .
In s o r t , i t ay- eared that, he had
been both unsound and d is h o n e s t a s a b u s in e s s man over an
extended p e r io d o f tim e , and y e t i t was n e t u n t i l 1,'arch 7 ,
1938, when th e S e c u r it ie s and Exchange Commission was no­
t i f i e d o f h is m isb eh avior by th e a u t h o r i t i e s o f th e New
Torlc Stock Exchange, t h a t th e f a c t s o f th e m a tter came to
53
lig h t.
There are two e lem en ts in v o lv e d in th e W hitney f a i l u r e
which throw a good d e a l o f l i g h t on th e problem o f broker
s o lv e n c y :
(1 ) la c k o f e f f i c i e n c y on th e p a r t o f th e then
e x is t in g mechanism f o r d e t e c t io n o f i r r e g u l a r i t y by exchange
a u t h o r i t i e s , and (2 ) what has been d e sc r ib e d by th e Com­
m issio n a s a "code o f s ile n c e "
53
V/hitney Report, pp. 9-13*
-rhich o p e r a te s among members
-fN'4o f th e f i n a n c i a l community and ren d ers i t d i f f i c u l t , i f n o t
im p o s s ib le , fo r exchange or o th er a u t h o r it ie s t o g a th er p e r ­
t in e n t in fo r m a tio n in m a tter s o f t h i s c h a r a c te r .
At th e tim e o f the W hitney f a i l u r e th e Committee on Bus­
in e s s Conduct o f th e New York Stock Exchange was r e s p o n s ib le
f o r th e f i n a n c i a l c o n d itio n o f Exchange members.
T h is com­
m it te e had no power o f d i s c i p l i n e , b u t a c te d a s a d is c ip lin a r y
and a d v iso r y agen cy fo r th e Governing Com m ittee.
I t r e fe r r e d
such m a tters to th e l a t t e r a s i t deemed s i g n i f i c a n t , and the
G overning Cormnittee took d is c i p l i n a r y a c t io n , i f i t appeared
w arran ted .
In c a s e s where in s o lv e n c y or f a i l u r e t o m eet
engagem ents was in v o lv e d , how ever, th e P r e s id e n t o f th e Ex­
change was empowered to announce th e su sp e n sio n o f a member
vr. th o u t a c t io n by th e G overning Com m ittee.
54
S u r v e illa n c e o f member firm s by th e Committee on B usi­
n e ss Conduct was la r g e l y lim it e d to fir m s w hich d id a margin
b u s in e s s .
Margin fir m s were r e q u ir e d tw ic e a y e a r t o f i l e w ith
t h i s com m ittee r e tu r n s which d is c lo s e d t h e ir f in a n c i a l con­
d it io n ; non-margin fir m s w ere n o t s u b je c te d t o a r o u tin e au­
d i t by th e exch an ge.
I t sh ou ld a ls o be p o in te d out th a t under
ti e r u lin g then in e x is t e n c e each firm d eterm in ed fo r i t s e l f
w hether or n o t i t was exempted from f i l ng r e t u r n s .
As a r e ­
s u l t , R ichard W hitney and Company had not been req u ired t o f i l e a
f in a n c ia l q u e s tio n n a ir e w ith th e Exchar g e .
W h ile, in December
1937, a r u le was p a ssed by th e Exchange r e q u ir in g non-margin
f : rms to rrake sem i£annual r e p o r t s , th ese fir m s d id not
have to
make an a u d it o f t h e i r f i n a n c i a l c o n d itio n in t h i s
54
W hitney R eport, pp. 19-21.
-2*H -
c o n n e c tlo n .
However, a r o u tin e y e a r ly a u d it was to be r e q u ir e d .
The f i r s t group o f q u e s tio n n a ir e s was s e n t to non-m argin fir m s
on January 2 0 , 1 9 3 8 .
Q u e stio n n a ir e s w ere n o t sch ed u led t o be
s e n t t o th e V /hitney fir m u n t i l May 2 0 , 1 9 3 8 , so t h a t th e s e pro­
v i s i o n s came in t o b ein g to o l a t e to have b ea rin g or. th e V/hitney
fa :lu r e .
I n s t e a d , th e in fo r m a tio n w hich l e d t o th e i n v e s t i ­
g a tio n o f R ichard 7/h itn ey and Company came to th e Committee
on b u sin e s s Conduct from, a s p e c i a l i s t in Greyhound s to c k ,
H r. S h eth a r, who had n o t ic e d " d is t r e s s s e l l i n g " w hich he be­
lie v e d came from R ichard W hitney and ' Company.
L a ter he .
n o t ic e d w eaioiess in other s to c k s , a d upon in q u ir y he was to ld
th a t th e w eakness was due li k e w is e t o s e l l i n g by R ichard
W hitney and Company.
He r ep o rted th e m a tter t o Mr. H. G.
W e llin g to n o f th e Governing C om m ittee.
I t w as, o f c o u r se ,
im p o ss:b le to t e l l w hether t h i s s e l l i n g ’was f o r c l i e n t s or
f o r th e company i t s e l f .
L a ter i t d e v e lo p e d th a t R ichard 7 /h itn ey
and Company, a c co r d in g to th e r ec o r d s o f th e fir m , had n o t
been r e s p o n s ib le f o r th e s e l l i n g im puted t o i t , e i t h e r f o r
i t s ovm accou n t o r fo r t h a t o f cu sto m ers.
However, a rumor,
to th e e f f e c t t h a t R ichard 7 /h itn ey and Company was in d i f ­
f i c u l t y , found i t s way t o th e Committee on b u s in e s s Conduct.
S in c e i t was o n ly a rur.or, c o n s id e r a b le c a u tio n was observed
on th e p a r t o f t h i s com m ittee, w ith th e r e s u l t th a t th e r e was
c o n s id e r a b le d e la y in b r in g in g th e m a tter t o l i g h t .
The above
m entioned e v e n ts occu rred in January and I t was n o t u n t i l
March 8 th t h a t th e firm was suspended from th e Hew' York Stock
55
E xchange.
55
V/hitney. R e p o rt. pp. 19-55 passim .
-2C 6-
From t li e 'p o in t o f vievf o f th e Commission, th e m achinery
o f th e Exchange had shown i t s e l f e x tr em e ly i n e f f i c i e n t , both
in p r e v en tio n o f frau d by member fir m s and in d e t e c t io n o f
frau d a f t e r i t had been com m itted.
The second elem en t in th e c a s e , w hich h a s been d e sc r ib e d
a s a "code o f s ile n c e " by th e Commission, slied s c o n sid e r a b le
l i g h t on th e situ a t" o n w ith which both th e exch anges and th e
Commission are c o n fro n ted when a ttem p tin g t o g a th e r in fo rm a tio n
regard in g m a tter s w hich th e f i n a n c i a l community has come t o
f e e l concern no one but th e m se lv e s.
T his s o - c a l l e d "code o f s ile n c e " appears to c o n s is t o f two
e le m e n ts .
The f i r s t i s th e assum ption t h a t a lo a n between
fr ie n d s i s a p e r so n a l m a tter and i s th e r e fo r e c o n f id e n t ia l .
From th e b orrow er's p o in t o f view th e c o n f id e n t ia l c h a r a cter
o f such lo a n s i s an im portant f a c t o r in th e m aintenance o f
h is c r e d it sta n d in g ; a s a r e s u l t , th e lo a n s made t o Richard
"Whitney were l i t t l e ta lk e d o f t o th o se n o t in v o lv e d in th e
tr a n s a c t io n s , nor were th e y ta lk e d o v er by th e le n d e r s them­
s e lv e s .
T his made i t im p o s s ib le f o r any one le n d e r to have
more than a vague id e a th a t o th e r s y/ere a ls o le n d in g him
money.
The same code a p p lie d t o lo a n s made to th e firm , which
lo a n s lik e w is e Y/ere c o n sid e r e d "personal" in c h a r a c te r ,
^or
t h i s reason Mr. V/hitney was a b le t o borrow v a s t l y rtiore money
than would have been th e c a se i f th e f a c t s o f th e m a tter had
been g e n e r a lly known.
The second a s p e c t o f the "code o f s ile n c e " had to do w ith
the a t t it u d e o f t h o s e c o g n iz a n t o f th e f a c t s o f th e c a se v/ith
regard t o r e p o r tin g th e s e f a c t s t o th e exchange a u t h o r i t ie s ,
-2 6 7 -
or o th e r s , f o r a p p r o p r ia te
a c t io n .
I t was brough t o u t th a t
th ree and a h a lf months p r io r t o th e d is c lo s u r e o f Mr. W it n e y ' s
ir r e g u la r conduct h i s b r o th e r , G eorge, and Thomas Yf. Lanont
o f th e firm o f J . P . Morgan and Company knew th a t he had been
engaged in c r im in a l a c t s .
With t h i s knowledge Hr , Lamont
made a lo a n to George 7/h itn ey fo r th e purpose o f h e lp in g h is
broth er o u t .
Furtherm ore, much o f th e money w hich Mr. W hitney
had borrowed wa3 borrowed from exchange o f f i c i a l s .
exchange members, p a r tn e r s o f
From 16
xchange members, and exchange
fir m s he borrowed, on an unsecured b a s i s , 7 .6 ,1 7 2 ,8 0 0 on L2
o c c a s io n s .
Of t h e s e 16 membdrs, sev en were e i t h e r o f f i c i a l s
or p a r tn e r s o f o f f i c i a l s , or belonged to fir m s in which a
p a rtn er was an o f f i c i a l .
He a ls o borrowed 7 3 0 5 ,0 0 0 w orth o f
s e c u r i t i e s from 6 p a r tn e r s o f members f ir m s , one o f whom’
was an exchange o f f i c i a l .
He a l s o borrowed $ 1 ,3 0 6 ,5 0 0 from
9 exchange firm s on s e c u r it y o f th e common s to c k o f th e
D i s t i l l e d Liquor C o r p o r a tio n .
He was a ls o r e f u s e d lo a n s ty
many o th er p eop le o f im portance both on and o f f th e exch an ge.
There appeared to be l i t t l e f e e l i n g on th e p a r t o f th o s e
in v o lv e d t h a t th ey were o b lig a te d t o g iv e any in fo rm a tio n t o
th e exchange con cern in g th e p o s s i b i l i t y o f 'J.r . V /hitney1s in ­
s o lv e n c y .
Mr. E. H. H. Simmons, H a i r S. W illia m s , L. Martin
Richmond, Kenneth B. S c h le y , and Harry B urning, who were p a r t­
n ers o f members f ir m s , and Mr. Roland R. Redmond,
y/ R o
was
co u n se l f o r th e exch an ge, f e l t in no way o b lig e d t o do s o .
Only John B. s h e th a r , th e s p e c i a l i s t p r e v io u s ly m entioned,
and Bernard E. Sm ith, a member o f th e Exchange who d i s l i k e d
fir. V /hitney, f e l t
under o b lig a t io n t o rep o rt th e m a tter to
-Z0'8t l e exchange a u t h o r i t i e s .
Hr. Oeorge 7 /h itn ey , Hr. Thomas
Lamon t , and Hr. J . P . Horgan t e s t i f i e d t h a t th e ;1- d id n o t f e e l
t h a t , e i t h e r a s members o f a member firm , o r on any o th e r
ground s, th ey were in any 'way o b lig e d t o g iv e in fo rm a tio n o f
56
any k in d to th e Exchange a u t h o r i t i e s .
In r e f e r r in g to th e s e m a tte r s th e Commission s t a t e d , "The
in e s c a p a b ly o u tsta n d in g f a c t r e v e a le d in t h i s r e p o r t i s th e
dangerous outmoded p h ilo so p h y w h ich , u n t i l th e r e c e n t a d ven t
o f a nevr mangement, dom inated th e a f f a i r s o f th e Exchange.
T his p h ilo so p h y was c h a r a c te r iz e d by th e u n w ritte n code o f
s i le n c e r e s p e c tin g th e f i n a n c i a l c o n d itio n or m iscondu ct o f a
member such as R ichard 7 /h itn e y .
I t was r e f l e c t e d in a stubborn
r e s is t a n c e to change and to p r o g r e s s .
I t was ev id e n c ed by a
te n a c io u s c lin g in g t o th e p a s t when even sound b u s in e s s judg­
ment in d ic a te d a c o n tr a r y c o u r s e .
I t was apparent in th e
f a i l u r e to render more than l i p s e r v ic e t o th e co n cep t o f a
n a ti'-n a l s e c u r i t i e s exchange a s a p u b lic i n s t i t u t i o n .
It
m a n ife sted i t s e l f in th e a d m in is tr a tio n o f th e Hew York Stock
Exchange as though i t were a p r iv a t e c lu b v/here th e m iscondu ct
o f members and o f f i c e r s was regard ed a s a p u r e ly p r iv a t e a f f a i r ,
and o f no p u b lic con cern .
" in t h i s c o n n e c tio n , th e f a c t s w hich were brought o u t r e l a t i v e
to th e typ e o f a d m in is tr a tiv e m achinery and th e system under
vrhich th e Exchange op erated a r e o f s in g u la r s i g n i f i c a n c e .
A
natJ on o f in v e s t o r s fo r c e d to r e ly on such an a n tiq u a te d system
o f enforcem ent arid d e te c tio n f o r p r o te c tio n and f a i r d e a lin g
c o u ld n o t lo n g r e t a in i t s c o n fid e n c e .
A t t h i s p o in t we need
56
Wh itn e y R eport, pp. 6 9 ff. and pp. 157-130.
-2 ^ 9 -
n o t r e c i t e in. f u l l th e in a d e q u a c ie s o f t h a t m achinery.
The
te s tim o n y i s r e p l e t e w ith exam ples o f in a d e q u a te m ethods o f ob­
t a i n i n g in fo rm a tio n as to th e f i n a n c i a l c o n d itio n o f i t s mem­
b e rs.
T h is ab sen ce o f a p e r io d ic f i n a n c i a l check-up w as, o f
c o u rs e , accom panied by a la c k o f an a d eq u ate system f o r d e 57
t e c t i n g any such m is a p p ro p ria tio n s as th o s e o f ftic h a rd W hitney."
On J-larch 1 7 , 193S, th e New York S tock Exchan ;e v o te d to
r e v i s e i t s c o n s t i t u t i o n In accordance w ith th e recom m endations
o f th e Conway Committee, in an a tte m p t to tra n sfo rm i t s e l f i n ­
t o an i n s t i t u t i o n which i s e s s e n t i a l l y p u b lic i n c h a r a c t e r .
S in ce th e r e o r g a n iz a tio n o f th e Exchange i s d is c u s s e d in th e
fo llo w in g c h a p te r , i t need only be to u ch ed upon h e r e .
As a
r e s u l t o f th e f in d in g s in th e 'T hitney c a s e , th e new management
o f th e Exchange and th e Commission u n d erto o k a j o i n t a p p r a is a l
o f th e w hole problem o f custom er p r o te c tio n .
Round t a b l e con­
f e r e n c e s w ere h e ld w ith Yfilliam McC. M artin J r . , p r e s id e n t o f
th e Exchange, and w ith c e r ta i n o th e r of i t s r e p r e s e n t a t i v e s .
W hile th e Commission has re-exam ined i t s own r e g u la to r y r o l e ,
i t h as p r im a r i l y em phasized and encouraged s e l f - r e g u -1.a tio n on
th e p a r t of th e exchanges, and h a s , a s f a r as p o s s ib le , avoided
d i r e c t i n t e r v e n ti o n .
T h e re fo re , s e c tio n 3 o f th e A ct i s a t
p r e s e n t e n fo rc e d by th e exchanges -them3e lv e s and w i l l be f u r t h e r
58
d is c u s s e d in th e fo llo w in g c h a p te r.
57
7 /h itn ey R e p o rt, pp. 1 7 7 -1 7 8 .
58
5th Ann. R e p 't. , pp. 3 5-36.
chapter ix
THE REFORM OF THE STOCK EXCHANGES
Study o f exchange o r g a n iz a tio n by th e Commission.
The o r g a n iz a tio n o f th e New York Stock Exchange and th e
o th e r s e c u r i t i e s exchanges th ro u g h o u t th e c o u n try was s e r io u s ly
q u e s tio n e d b e fo re th e S enate Committee on Banking and c u rre n c y .
As a r e s u l t , s e c tio n 19 (c) o f th e S e c u r itie s Exchange Act o f
193A p ro v id e d f o r a stu d y to d eterm in e th e f a c t s o f th e m a tte r
and to s u g g e st p o s s ib le rem edies f o r shortcom ings which m ight ue
fo u n d .
T his s tu d y was u n d ertak en alm o st im m ediately by th e
Commission, and a r e p o r t o f i t s f in d in g s was su b m itte d to C ongress
1
on Jan u a ry 25, 1935.
The law was n o t i n t e r p r e t e d by th e Commission as c a l l ­
in g f o r a s tu d y o f te c h n i c a l d e t a i l s in v o lv e d in th e o p e r a tio n
o f exch an g es, s in c e r e v is io n s i n th e s e m ight be b ro u g h t about
th ro u g h th e o p e r a tio n o f o th e r s e c tio n s of th e A ct,
I n s te a d
th e Commission c o n c e n tra te d i t s e n e rg ie s on a stu d y o f th e
b ro a d e r a s p e c ts o f th e problem , and concerned i t s e l f l a r g e l y w ith
m a tte rs hav in g to do w ith th e a d m in is tr a tiv e s e t- u p o f th e ex­
changes and i t s e f f e c t upon exchange o p e r a tio n b o th i n t e r n a l l y
and w ith r e l a t i o n to th e p u b lic .
Since exchanges a r e i n many
r e s p e c ts s i m i l a r , and s in c e th e .New York Stock Exchange t r a n s ­
cends a l l o th e r exchanges i n volume o f s e c u r i t y tr a n s a c t i o n s ,
t h i s o r g a n iz a tio n was s in g le d o u t f o r th e m ost s p e c i f i c tre a tm e n t.
1
House o f R e p r e s e n ta tiv e s , 7 4 th Cong. 1 s t S e s s , Doc,
R ep o rt on th e Government o f S e c u r itie s Exchanges.
No. 85.
-2 7 1 I n t h i s stu d y th e Commission concerned i t s e l f w ith t h r e e
im p o rta n t a s p e c ts o f exchange o r g a n iz a tio n : ( l ) th e c l a s s i f i c a t i o n
o f members o f ex ch an g es, (2) methods o f e l e c t i n g o f f i c e r s and
co m m ittees, and ($) m achinery o f d i s c i p l i n e .
1 . C l a s s i f i c a t i o n o f members
Membership o f th e g o v ern in g com m ittees was c o n s id e re d o f
p rim ary im p o rtan ce i n t h i s c o n n e c tio n .
These com m ittees, which
were v a r i o u s l y d e s ig n a te d on th e v a rio u s exchanges, had c o n tr o l
o v er th e governm ent o f th e exchanges, th e b u s in e s s co n d u ct o f
t h e i r members, and th e prom otion o f a l l o f i t s o b je c ts and p u r­
p o ses.
As a r e s u l t o f th e b ro ad scope o f t h e i r j u r i s d i c t i o n , th e
g o v ern in g com m ittees o f exchanges were i n a p o s itio n t o b r in g to
b e a r on th e rem ain in g p e rs o n n e l any p r e s s u re w hich m ig h t be n ec e s­
s a ry to i n s u r e c o n tr o l o v e r t h e i r o p e r a tio n s .
These g o v ern in g com m ittees were s e le c te d from th e member­
s h ip o f exchanges and u s u a lly re p re s e n te d no o u ts id e i n t e r e s t in
2
any im p o rta n t way. The Commission f e l t t h a t , from th e p o in t o f
view o f s u c c e s s f u l a d m in is tr a tio n o f th e A ct, i t was v e ry im­
p o r ta n t t h a t th e exchanges be o rg a n iz e d i n such a way a s to i n ­
s u re c o o p e ra tio n betw een th e exchange a u t h o r i t i e s and th e Commis­
s io n .
Such c o o p e ra tio n c o u ld be r e l i e d upon o n ly i f th e govern­
in g com m ittees were composed o f p erso n s whose i n t e r e s t s were n o t
l i k e l y to be opposed to th o s e charged w ith enforcem ent o f th e
A ct.
F o r t h i s re a so n th e Commission c o n sid e re d v ery c a r e f u l l y th e
2
A few exchanges i n v i t e d c e r t a i n o u ts id e r s to s i t w ith th e g o v ern in g
com m ittee, b u t th e s e were n e v e r i n a p o s itio n o f power.
-2.72-
a d v i s a b i l i t y o f p a r t i c ip a ti o n in th e government o f th e exchanges
by p e rso n s o th e r th a n members.
At t h i s tim e, however, i t made
no recommendation on t h i s p o in t ex cep t in th e case of the p r e s i ­
d e n t o f th e exchange, which i s d isc u s s e d under th e second s e c tio n
o f th e r e p o r t ; i t seemed a d v isa b le to observe th e working o u t o f
th e p r o v is io n s o f th e n e t under th e e x is tin g system o f government
3
b e fo re recommending such a change in th e m a tte r o f membership.
The second p o in t b ro u g h t o u t under c l a s s i f i c a t i o n of members
was th e f a c t t h a t th e membership o f th e governing committee was n o t
r e p r e s e n ta tiv e o f th e brokerage b u s in e s s .
"O ffice p a r tn e r s " , who
from th e p o in t o f view of th e p u b lic perform ed the more v i t a l
f u n c tio n s o f th e bro k erage a u s in e s s , had no vo ice i n the conduct o f
exchange a f f a i r s ex c e p t to th e e x te n t to which " f lo o r p a rtn e rs "
co u ld be c o n tr o lle d by them; and as " f lo o r p a r tn e r s " were u s u a lly
n o t p o sse sse d o f s u f f i c i e n t p r e s t i g e to make l i k e l y t h e i r e le c tio n
to th e g overning com m ittees o r to o th e r o f f ic e s on th e exchanges,
th e i n t e r e s t s o f th e brokerage firm s were n o t a e eq u u tely re p re ­
sen ted on th e exchanges.
At th e time o f th e stu ay oy th e Commission,
commission houses were found to own 52 p e rc e n t o f th e t o t a l s e a ts on
th e New York Stock Exchange, w liile o n ly o n e - th ir d o f the governing
■was composed o f members from commission houses; tw o -th ird s o f the
com m ittee was made up o f s p e c i a l i s t s , f lo o r t r a d e r s , anu odd l o t
d e a le r s .
From th e p o in t o f view o f th e Commission i t appeared n o t
o n ly t h a t th e r e p r e s e n ta tio n on th e governing comjiiittees among
3
Report on Government, pp. 3-4-.
members from com m ission h o u ses sh ou ld be in c r e a s e d , but a ls o t h a t
o f f i c e p a rtn ers sh ou ld be in c lu d e d i n th e membership and on govern­
in g com m ittees.
The l a t t e r recommendation appeared to be p a r tic u ­
l a r l y n e c essa ry s in c e o f f i c e p a r tn er s are b rok ers w ith in th e meanin g o f th e S e c u r it ie s Exchange A ct.
2.
E le c tio n o f o f f i c e r s and co m m ittees.
R e p r e se n ta tio n on govern in g com m ittees appeared to th e Commis­
s io n to oe u n fa ir n o t o n ly because o f th e b a s is o f membership on
th e exchanges and th e s e l e c t i o n from t h i s membership, bu t a ls o
because o f the methods u sed in e l e c t i n g g o v ern in g com m ittees.
On
th e i.evv York Stock Exchange e l e c t i o n took p la c e through a nom inating
com m ittee whose membership was proposed by th e nom inating com m ittee
o f th e p reced in g y e a r .
A lthough members o f th e exchange might
propose o th er c a n d id a te s oy p e t i t i o n , th e u se o f an ind ep en dent
s l a t e was found to be i n e f f e c t i v e , s in c e such a c t io n was c o n siu e re d
in the c h a r a cter o f a r e v o l t , anu th e r e were many ways in which
p r e ssu r e might be brought to bear to p r e v en t i t s happening.
As a
r e s u l t o f t h is system th e " in group'! tend ed to be p e r p e tu a te d .
S e v e n ty - fiv e p e r ce n t o f th e govern ors o f th e Jew fo rk Stock Exchange
had been r e - e le c t e d a t l e a s t o n ce, and f i f t y p e r c e n t o f them had
been r e - e le c t e d a t l e a s t tv ,ic e .
I t -was fu r th e r f e l t th a t th e f a c t
th a t membership on th e govern in g com m ittee was o f fo u r year dura­
t io n , w ith o n e -fo u r th o f th e membership b e in g e le c t e d each y e a r ,
tended to make fo r p e r p e tu a tio n o f c o n tr o l and t o make changes o f
p o li c y d i f f i c u l t t o e f f e c t w ith in s h o r t p e r io d s .
4
R eport on Government. pp. 5*^*
-
274-
The methods try means o f w hich th e p r e s id e n ts o f exchanges
were e le c t e d lik e w is e tended to encourage and p e r p e tu a te c o n tr o l
by an "in group".
The p r e s id e n t , who had to be a member in good
sta n d in g , vras nominated by nom inating com m ittees, as in th e c a se
o f o th e r o f f i c e r s .
S in ce o p p o s itio n to th e c h o ic e o f th e s e com­
m it te e s seldom o ccu rred , nom ination was tantam ount to e l e c t i o n in
most c a s e s .
I t was f e l t by th e Commission th a t th e r e was no e s s e n t i a l
reason fo r r e s t r i c t i n g th e c h o ic e o f p r e s id e n ts o f exch anges to
t h e ir membership,
A hile i t was n o t f e l t th a t any im p ortan t ad­
vantage would a r is e from havin g a non-member a s p r e s id e n t , n e v e r ­
t h e l e s s , very capable men m ight be a v a ila b le fo r th e s e p o s it i o n s
y/ho d id not happen to be members o f ex ch a n g es.
I t fo llo w e d th a t
i f non-members were a v a ila o le f o r th e p r e sid e n c y o f e x ch a n g es,
exchange p r e s id e n ts should r e c e iv e a s a la r y in s te a d o f s e r v in g
w ith o u t rem uneration, as had been the custom ,
i t was argued th a t
in any ca se the o f f i c e o f p r e s id e n t o f a s to c k exchange was one
which made la r g e demands upon th e tim e o f tn e incumbent and th a t
th ere was no reason why he sh o u ld not be p a id f o r i t .
The work fo r which the g o v ern in g com m ittees were r e s p o n s io le
was ap p ortion ed among s e v e r a l sta n u in g com m ittees.
On the i.ew
York Stock Exchange th e r e were fo u r te e n o f th ese corm aittees, the
most im portant o f v/hich were th e law and b u s in e s s conduct com­
m it t e e s .
The former had j u r i s d i c t i o n ov er a l l m a tters o f law
a f f e c t i n g th e exchange, in c lu d in g th e making o f changes in th e by­
law s and th e c o n s t it u t io n .
The b u s in e s s conduct com m ittee
handled a l l m a tters r e la t i n g to th e b u s in e s s conduct o f members,
and ob served p r a c t ic e s on th e exchange to s e e t h a t no improper
methods were in o p e r a tio n .
T ogether w ith th e p r e s id e n t, t h i s
com m ittee was th e most im portant govern ing f a c t o r o f th e exch ange.
The membership o f th e se and th e o th er com m ittees was r e s t r i c t e d
to
th e members o f th e govern in g com m ittee; th e r e was, f u r t h e r ­
more, no r e s t r i c t i o n a g a in s t in t e r lo c k in g o f th e s e com m ittees.
As a r e s u l t , th e ten d en cy toward narrow ness in th e f i e l d o f
s e l e c t i o n , c o n c e n tr a tio n o f power, and p e r p e tu a tio n o f an "in
group", was a g a in m a n ifested in th e s e t-u p o f th e sta n d in g
5
com m ittees.
3.
D is c ip lin e o f members.
P r io r to th e p assag e o f th e Act the o f f e n s e s w hich were con­
sid e r e d s u f f i c i e n t l y s e r io u s f o r d i s c i p l i n a r y a c tio n were (1 )
fr a u d u le n t a c t s , "(2 ) f i c t i t i o u s t r a n s a c t io n s , (3 ) d e m o r a liz a tio n
o f th e m arket, (4 ) m is-sta te m e n ts to co m m ittees, ( 5 ) frau d or d i s ­
h o n esty on th e p a r t o f members p r io r to e l e c t i o n ,
(6 ) d e a lin g s on
o th e r exch anges w ith in p r e sc r ib e d t e r r i t o r i a l l i n e s , which perm it
d e a lin g s in s e c u r i t i e s l i s t e d on th e exch an ge, ( 7 ) v i o l a t i o n o f
th e c o n s t it u t io n o r r u le s o f th e exchange, or v i o l a t i o n o f j u s t
and e q u it a b le p r in c ip le s o f tr a d e , (8) a c t s d e tr im e n ta l to th e
w e lfa r e o f th e exch ange, (9 ) r e s t r a in in g o f f i c e r s ana com m ittees
from p erform in g t h e ir d u t ie s by in j u n c t iv e jJ ro cess, ( lu ) r e f u s a l
to t e s t i f y or produce documents b efo re th e govern in g com m ittee
5
R eport on Government, pp. 9 -1 3 .
-2.76or a t th e r e q u e s t o f th a t com m ittee b efo re another com m ittee or
b e fo r e th e a u t h o r it ie s o f another exchange.
These o f f e n s e s , p lu s
th e p r o v is io n s o f th e A ct, form a b a s is f o r h ig h ly c o e r c iv e power
over th e membership by th e exchange a u t h o r it ie s .
At th e tim e o f th e Com m ission(s i n v e s t i g a t i o n , d i s c i p l i n e
o f members was c h i e f l y accom plished through the a r b it r a t io n com­
m itte e and th e b u s in e s s conduct com m ittee, alth ough in g e n e r a l
th e c o n s t it u t io n s o f exchanges provid ed th a t major o f f e n s e s be
c o n sid e re d by th e g overn in g com m ittee.
The a r b it r a t io n com m ittee o f the t.ew fork Stock Exchange
e x e r c is e d a s u p e r v iso r y fu n c tio n in c a se s where punishm ent o f mem­
b ers was n o t in v o lv e d .
T his com m ittee heard co m p la in ts betw een
members and between members and non-members,
o o j e c t io n s :
i t was open to two
f i r s t , th e c o s t s to c la im a n ts were found to be to o
h ig h - in 1933 e le v e n d is p u te s ranged in c o s t s from ■j.100 to *600
p lu s 1 8 8 .5 0 in ste n o g r a p h ic f e e s ; se c o n d ly , s in c e th e com m ittee
c o n s is t e d e n t i r e l y o f exchange members, i t would i n e v it a b ly share
th e p o in t o f view o f th e exchange,
w hile t h i s was not im p ortan t
in d is p u te s betw een members, i t was a d ecid ed d isa d v a n ta g e to non­
members v/ho w ished to push cla im s a g a in s t members.
T his s i t u a t i o n
v;as aggravated by th e f a c t th a t a p p ea ls to th e g overn in g com m ittee
from d e c is io n s o f th e a r b it r a t io n com m ittee were s u b je c t to r e ­
s tr ic tio n s .
The b u s in e s s conduct com m ittee, which a cted upon com p lain t
o f both members and non-members, conducted in v e s t ig a t i o n s and
p a ssed s e n te n c e s , which were p r a c t i c a l l y n ever r e v e r se d by the
govern in g com m ittee,
in th e o p e r a tio n o f th e complex system o f
r u le s on th e exch an ge, many minor v io la t i o n s were bound to o c c u r ,
h h ile th e s e minor i n f r a c t io n s were u s u a lly o v erlo o k ed , th ey m ight
be pu nished; as a r e s u l t , th e b u s in e s s conduct com m ittee was i n a
p o s it io n to w ie ld a g r e a t d e a l o f c o e r c iv e power.
I t was com­
p la in e d th a t t h i s power had been used in th e p a s t in an a r b itr a r y
f a s h io n , p a r t ic u l a r ly to p rev en t a p p ea ls from the v e r d ic t o f th e
b u s in e s s condu ct com m ittee to th e govern ing com m ittee, ana th e r e
was d e f i n i t e fe a r t h a t i t m ight be so used a t any tim e .
In s h o r t,
th e power o f th e b u s in e s s condu ct com m ittee ov er th e exchange mem­
b e r sh ip was found to be o f a c n a r a cter which cou ld hardly be th ought
o f as j u d i c i a l .
I f th e p o s it io n o f exchange members was co n sid ered weak w ith
r e l a t i o n to th e b u s in e s s conduct com m ittee, t h a t o f the custom ers
who w ished to make a com p lain t must be th ought o f a s d e c id e d ly
w eaker.
Under th e tnen c u r r e n t p r a c t ic e , th e custom er su b m itted
h is c la im , u s u a lly in w r it in g , to th e exchange a u t h o r it ie s .
A copy
o f th e com p lain t was serv ed on th e accu sed member, wrho 'was r e q u ir e d
to f i l e an answer to the exchange; but a copy o f t h i s answer was
n ot serv ed on th e com p lain in g custom er, nor 'was the custom er p e r ­
m itte d to make a p e r so n a l appearance b e fo r e the committee e x c e p t
in im p ortant c a s e s .
The d e c is io n was made as a r e s u l t o f th e i n ­
v e s t i g a t i o n o f th e com m ittee and o f th e ev id en ce subm itted oy tn e
a c cu se d ,
in o n ly a few c a s e s was th e custom er p r e se n t to r e f u t e
s ta te m e n ts maue by the member.
A irtherm ore, i f the custom er was
p e r m itte d a h e a r in g , he was n o t p e r m itted to be r ep resen ted by
-2 7 3 -
p r o f e s s io n a l c o u n s e l e x c e p t through th e p e r m issio n o f th e com m ittee,
rthen th e d isa d v a n ta g e s o f th e custom er, due to la c k o f f a m i l i a r i t y
w ith th e m achinery o f b o th th e exchange and th e com m ittee are con­
s id e r e d , la c k o f p r o f e s s io n a l c o u n se l can o n ly be th ou gh t o f a s
c o n s t it u t in g a s e r io u s v i o l a t i o n o f f a i r n e s s .
r e l a t i o n to custom ers was view ed by th e
The procedure w ith
Commission as c o n s t i t u t in g
"a v i o l a t i o n o f many o f th e a c c e p te d canons o f j u d i c i a l p roced u re" .
The b u s in e s s conduct com m ittee, which as we have see n had
alw ays been v ery p o w e r fu l, assumed an added im portance w ith th e
p a ssa g e o f th e S e c u r it i e s Exchange A ct.
b in ce i t was v e ry c lo s e to
th e a f f a i r s o f th e E xchange, i t s c o o p e ra tio n w ith th e Commission was
e s s e n t i a l to an e f f i c i e n t a d m in is tr a tio n o f th e A ct.
The Act pro­
v id ed th a t v i o l a t i o n o f i t s p r o v is io n s c o n s t it u t e d conduct in c o n ­
s i s t e n t w ith j u s t and e q u it a b le p r in c ip le s o f tr a d e , which means
th a t from th e p o in t o f v ie w o f the Exchange th ey are major o f f e n s e s .
The Commission was c o n se q u e n tly v ery much concerned n o t o n ly w ith
im proving th e s i t u a t i o n o f th e com plainant b e fo r e t h i s com m ittee
but a l s o w ith in s u r in g fo r i t a p e r so n n e l from w hich th e Commission
6
co u ld e x p e c t co n tin u o u s c o o p e r a tio n .
The Commission summarized i t s recommendations ca sed upon
th e se f in d in g s a s fo llo w s :
(1 ) A b e t t e r n u m erical r e p r e s e n ta tio n o f th e com m ission
broker who p o s s e s s e s d i r e c t c o n ta c ts w ith tne p u b lic should
be had on th e govern ing com m ittee,
(2) O ff ic e p a r tn e r s o f r e g is t e r e d firm s sh o u ld be e l i g i ­
b le f o r membership on th e govern in g com m ittee.
(3) Nom ination to th e govern in g com m ittee should be oy
p e t i t i o n and n o t by th e d e v ic e o f a nom inating com m ittee.
6
R eport on Government, pp. 13-17*
-2 7 9 -
(4) O n e -th ir d o f th e membership o f th e govern ing
com m ittee should, be e le c t e d a n n u a lly .
(5) N om ination o f th e p r e s id e n t sh o u ld be by p e t i t i o n
and he sh ou ld be e le c t e d by th e f u l l membership.
(6 ) Non-members o f th e exchange sh o u ld be a llo w ed to be
c a n d id a te s f o r th e o f f i c e o f p r e s id e n t ano th e o th er execu ­
tiv e o ffic e s .
(7) Membership on th e sta n d in g com m ittees should n o t be
r e s t r i c t e d to members o f th e government com m ittee.
(8)
The ex p en ses o f a r b it r a t io n sh ou ld be red uced .
(9) The a r b i t r a l tr ib u n a l i n c a s e s to which a non-member
i s a p a rty sh ou ld n ot be a mere com m ittee o f th e exchange, bu t
sh ou ld e it h e r be composed o f non-members, o r , i f members, se r v e
upon i t , r e p r e s e n ta tio n betw een members and non—members should
be e q u a liz e d .
(I j Adequate and e f f e c t i v e a p p ea ls should l i e from the
b u sin e s s condu ct com m ittee to th e govern in g com m ittee.
(11)
Customers p r e fe r r in g co m p la in ts a g a in s t members
sh ou ld be fu r n ish e d w ith th e answer made by the member to th e
cu sto m er’s c o m p la in t, and sh ou ld be e n t i t l e d to appear b efo re
th e com m ittee. Both p a r t ie s in th ese c a s e s should have the
r ig h t of ap p eal t o the govern in g c o m m ittee.7
In su b m ittin g i t s r e p o r t to C ongress th e Commission d id n ot
f e e l th a t i t was w is e to s u g g e s t l e g i s l a t i o n to b r in g about th ese
ch an ges.
I n s te a d i t f e l t th a t v o lu n ta r y a c tio n on th e p a r t o f th e
exchanges would be more d e s ir a b le .
I t f e l t th a t th e s e recommenda­
t io n s should be su b m itted to
th e ex ch a n g es, anu th a t they should be
r e v is e d as th e e x p e r ie n c e o f
the Commission w ith exchange m atters
grew.
I t has a lr e a d y been m entioned t h a t through i t s power to make
fu r th e r r e g u la tio n s the Commission i s in a p o s i t io n to fo r c e a c tio n
on th e p a rt o f th e exch anges i n b r in g in g a b ou t a e s ir e d refo rm s.
7
Report on Government, p. 17.
-2BCT—
The above recommendations w ere, a c c o r d in g ly , in c o r p o r a te d in w hole
or in p a r t i n the c o n s t it u t io n s o f th e New fo rk Stock Exchange,
th e New York Curb Exchange, and the C hicago S to ck Exchange, and
8
were g iv e n due c o n s id e r a tio n by th e o th e r e x ch a n g es.
I t must be
k ep t in mind, how ever, th a t from the p o in t o f view o f th e exchanges
th e s e d e f e c t s were n o t s e r io u s and were th ou gh t o f in c o n sid e r a b le
p a r t as a r e s u l t o f m isun derstan ding by the Commission and the
p u b lic o f the fu n c tio n s w hich th e exchanges a c t u a ll y perform ed,
from th e p o in t o f view o f th e Commission, on the o th er hand, th e
o r g a n iz a tio n o f the exch an ges was d e f i n i t e l y d e f e c t iv e in s e v e r a l
r e sp e c ts.
I t had been th e hope o f th e Commission t h a t th e recommended
changes would do much to a c h ie v e the reform w hich th ey f e l t was
n e c e ssa r y ; th e ex p e rie n c e w ith exchange a f f a i r s d u rin g th e n ext
two or th ree y e a r s showed th e Commission t h a t th e ta s k was h ard ly
begun.
R eport o f th e Conway Committee.
during the l a t t e r p a r t o f 1937 c o n fe r e n c e s were h e ld be­
tween members o f th e Commission and th e New fork Stock Exchange
in th e hope o f working o u t a s a t i s f a c t o r y p la n f o r fu r th e r reform ,
but no agreem ent co u ld be r ea ch ed ,
a s a r e s u l t , Ur. N illia m 0.
L ou glas, Chairman o f the Commission, p u b lic ly r e q u e ste d the hew
fo rk Stock Exchange to b e g in ..ork on a p la n f o r com plete r eo r g a n iz a t io n in order to ren der the exchange more e f f i c i e n t and to g iv e
i t more o f th e c h a r a cter o f a p u b lic i n s t i t u t i o n .
In com pliance w ith t h i s r e q u e st th e New York S tock Exchange
appointed a com m ittee, headed by C arle C. Conway, chairman o f the
8
S .E .C .,
1 st. Annual lue p o r t, 1935* p. 20,
-2 8 1 -
boards o f d ir e c t o r s o f th e C o n tin e n ta l Can Company, t o make th e
req u ired stu d y .
Mr. Trowbridge C allaw ay, o f th e in v estm en t
banking firm o f C allaw ay, F ish and Company, ser v e d a s v i c e ohairman
o f t h i s com m ittee and Mr. W illia m McC. M artin, J r . , o f th e Stock
Exchange firm o f A.C. Edwards and Sons ( l a t e r P r e s id e n t o f th e
New York Stock E xch ange), was chosen as s e c r e t a r y .
o f th e com m ittee w ere:
Other members
Adolph A. B e r le , J r ., a law yer and a
former member o f P r e sid e n t R o o s e v e lt 's " b rain t r u s t " , John A.
Coleman, o f th e S tock Exchange firm o f A d le r , Coleman and Company,
Maurice L. F a r r e ll, s e n io r p a rtn er in th e S tock Exchange firm o f
F .S . Sm ithere and Company, Kenneth C. H ogate, p r e s id e n t o f th e
W all S t r e e t Jo u rn a l, Thomas H. M clnerney, p r e s id e n t o f th e
N a tio n a l Dairy P rodu cts C o rp o ra tio n , and John W. P r e n t is s , a
p a rtn er in th e in v e stm e n t banking house o f Hornblower and Weeks.
T his com m ittee, known a s th e "Conway Committee", su b m itted i t s
rep o rt on January 27, 1 9 3 3 .
9
In ren d erin g i t s r e p o r t th e com m ittee p o in te d o u t t h a t i t s
recommendations w ere made on th e assum ption t h a t p u b lic i n t e r e s t
was paramount.
I t a ls o s ta te d t h a t , w h ile th e p r o p o s a ls made
m ight appear to c o n s t i t u t e a r a d ic a l change in th e a d m in is tr a tiv e
m aohinery o f th e exch ange, in r e a l i t y th e y r e p r e s e n te d j u s t another
Btep in th e e v o lu tio n o f th e New York S tock Exchange a s th e n a t io n 's
primary s e c u r i t i e s m arket.
The f i r s t item to be c o n sid e re d was th e board o f govern ors
(govern in g com m ittee) o f th e exch an ge.
9
I t was su g g e ste d th a t th e
New York Stock Exchange, F in a l Report o f th e Committee fo r th e
Study o f th e O rg a n iza tio n and A d m in istr a tio n o f th e New to rk
Stook E xchange,(C onw ay C om m ittee); s e e a ls o S .E .C ., 4 th Annual
R ep ort, 1933, p . 2 0 .
-281a-
board be reduced from f i f t y members t o t h ir t y - t w o and t h a t th e
membership be s e le c t e d on a d i f f e r e n t b a s is th an fo r m e r ly .
F if­
t e e n members o f th e New York Stook Exchange were to be s e le c t e d
w ith due regard fo r th e v a r io u s i n t e r e s t s r e p r e s e n te d .
S ix members
were t o be s e le c t e d from non-member p a r tn e r s who did e i t h e r a
sto o k or bond b u s in e s s w ith th e p u b lic .
S ix o th e r non-members
were to be chosen who serv ed th e p u b lic from p r in c ip a l o f f i c e s
lo c a te d o u ts id e New York C ity .
Three r e p r e s e n t a t iv e s o f th e
p u b lic were t o be nom inated by th e p r e s id e n t o f th e exchange and
a p p oin ted by
-R 8 ? -
th e board o f govern ors f o r a term o f one y e a r , w ith f u l l c o n sid e r a ­
t io n o f th e n e c e s s it y f o r r e p r e s e n ta tio n o f p u b lic i n t e r e s t in t h e ir
c h o ic e .
The two rem aining governors were to c o n s i s t o f th e p r e s id e n t
o f th e exchange and th e chairman o f th e board; th e p r e s id e n t was to
se r v e on th e board a s lo n g as he remained p r e s id e n t o f th e exch ange,
ana th e chairman was to be a n n u a lly e le c t e d by the members.
The
term o f o f f i c e f o r members o f th e govern in g com m ittee o th er than
th e p r e s id e n t and the chairman was to be th r e e y e a r s w ith th e pro­
v i s i o n th a t a f t e r having served p a r t o r a l l o f two c o n s e c u tiv e term s
10
a member sh ou ld be i n e l i g i b l e f o r a p erio d o f one y e a r .
I t was f e l t th a t th e a f f a i r s o f the dew fo r k Stock Exchange
had reach ed a p o in t where the p r e sid e n t sh ou ld d i v e s t h im s e lf o f
a l l o th e r i n t e r e s t s and d evo te h is f u l l time to th e ta s k o f running
th e exch an ge.
I t was p o in te d o u t th a t a t p r e s e n t th e p r e s id e n t
a c t u a lly d id d ev o te a l l o f h is tim e to the a f f a i r s o f th e exch ange,
and in v iew o f t h i s f a c t i t was f e l t t h a t he should be a d eq u a tely
p a id .
I t was proposed t h a t th e p r e s id e n t should a p p o in t a l l
sta n d in g com m ittees, e x c e p t fo r c e r t a in ones to be m entioned p r e se n t­
l y , s u o j e c t to th e ap p roval o f th e govern ing board,
be should have
a u t h o r ity to a p p o in t a l l o f f i c e r s o f th e exch ange, e x c e p t th e c h a ir ­
man ana th e v ic e-ch a irm a n o f th e board, s u b je c t to th e approval
o f th e ooard o f g o v ern o rs.
I t was a ls o proposed That the c o n s t i ­
t u t io n sh ou ld p erm it the apj_ioir.tir.ent o f such o th e r o f f i c e r s and
such a s s i s t a n t s as th e ooard should deem n e c e s s a r y .
These sh ou ld
a l l r e p o r t to th e p r e s id e n t through such m acldnery a s he m ight see
f i t to e s t a b l i s h .
The p r e sid e n t should be th e p o in t o f c o n ta c t
betw een th e exchange and th e p u b lic and governm ental a g e n c ie s . He
10
Hew York S to ck Exchange,
Report o f th e Committee on O rg a n iza tio n and A d m in is tr a tio n , p . 1 .
-2 0 3 -
sh ou ld be th e c h ie f e x e c u t iv e o f f i c e r o f the exchange and i t s
11
c h ie f o f f ic e r .
The chairman o f th e board sh o u ld be an o u tsta n d in g member
o f th e exch an ge.
He should ser v e w ith o u t s a la r y and should p r e ­
s id e a t a l l m eetin gs o f th e board o f g o v ern o rs.
He should be an
e x - o f f i c i o member o f a l l o th e r sta n d in g com m ittees.
He should
a ls o nom inate c e r t a in im p ortant com m ittees.
i t was a ls o f e l t t h a t th e tr e a s u r e r should be a f u l l tim e
s a la r ie d o f f i c e r a p p oin ted by the p r e s id e n t w ith the approval o f
th e g ov ern in g board.
He a ls o sh ou ld be w ith o u t o th e r i n t e r e s t s
du rin g h is ten u re o f o f f i c e .
C e rta in changes o f a g e n e r a l c h a r a cter were recommended f o r
th e s t a f f .
I t was th o u g h t th a t a l l members o f th e com m ittees should
be r e li e v e d as f a r a s p o s s ib le from the d e t a i l s o f management,
'-t
th e tim e o f t h i s stu d y i t was f e l t th a t the e x i s t i n g p e r so n n e l was
in a d eq u a te f o r t h i s pu rp ose,
h en ce, adequate s t a f f s headed by
com petent e x e c u t iv e s were recommended.
The u ltim a te aim was to
make th e s ta n d in g com m ittees e s s e n t i a l l y p o lic y com m ittees.
It
was p o in te d o u t t h a t th e f a c t th a t the exchange tiad been a b le to
fu n c tio n as e f f i c i e n t l y as i t had in the p a s t meant tn a t an u n fa ir
burden had been p la c e d and was b e in g p la ced upon th o se who serv ed
12
on th e v a r io u s com m ittees.
iVith regard to th e nom inating com m ittee, which the com m ission
had f e l t was one o fth e e f f e c t i v e weapons f o r th e p e r p e tu a tio n o f an
“i n group", th e Conway Committee a d v ised c e r t a in im p ortant ch a n g es,
11
R eport of th e Committee on O rg an izatio n and A d m in istra tio n , p. 2.
12
I b i d . , pp* 2—
3.
-a a 4 -
x t was proposed th a t each y e a r th e n om inatin g com m ittee choose a
s u c c e s s o r com m ittee o f sev e n members, none o f which might be
chosen from th e a lr e a d y e x i s t i n g membership.
The membership o f
th e com m ittee was to be chosen w ith due regard fo r th e v a r io u s
i n t e r e s t s r e p r e se n te d on th e exch an ge.
F in a lly i t was urged th a t
adquate methods m ight oe ev o lv ed f o r p r e se r v in g th e r ig h t o f e x 13
change members to nom inate o p p o s itio n c a n d id a te s.
As f o r th e sta n d in g co m m ittees, a r e d u c tio n in number and
a change in scop e o f many o f them was recommended, which would
r e p r e s e n t c o n s id e r a b le s im p l i f ic a t io n o f th e a d m in is tr a tiv e
m achinery o f th e exchange,
^even sta n d in g com m ittees were proposed
to r e p la c e th e se v e n te e n which were th en f u n c tio n in g .
I t was f e l t
t h a t in most in s ta n c e s f i v e memoers would be s u f f i c i e n t on th e
sta n d in g com m ittees.
I t was a ls o f e l t
th a t th e number o f governors
on sta n d in g com m ittees was to o g r e a t; w h ile i t was th ought d e s ir a b le
to m ain tain th r e e govern ors on th e se com m ittees, i t was urged th a t
a d d it io n a l appointm ents be made from o u ts id e the govern ing com m ittee,
e it h e r from the membership or from p a r tn e r s o f tnemoer fir m s .
One o f th e more im portant changes recommended i n c o n n e c tio n
w ith s ta n d in g com m ittees was th e a b o lis h in g o f th e law com m ittee,
which was co n sid e re d too la r g e f o r c o o r d in a te d a c t io n .
In i t s
p la c e an e x e c u tiv e com m ittee was proposed wliich was to c o n s is t
o f sev en members; t h i s com m ittee would ta x e over c e r t a in fu n c tio n s
o f th en e x i s t i n g com m ittees ana would se r v e in an a u v iso r y c a p a c ity
to the p r e s id e n t and trie board o f g o v ern o rs.
13
R eport o f th e Committee on O rg an izatio n and A d m in istra tio n , p . 3«
.-2 8 3 -
In a d d itio n to th e above m entioned ch an ges, th e Conway
Committee su g g e ste d th a t th e c o n s t it u t io n and r u le s o f th e e x ­
change be r e v is e d and s im p li f i e d , ana recommended t h a t non-member
p a r tn e r s o f member fir m s be brought more d e f i n i t e l y w ith in th e
scop e o f c o n tr o l o f th e exch an ge.
T e Committee a ls o su g g e ste d
th a t v a r io u s s t u d ie s be made by the exchange reg a r d in g what i t
co n sid ered im p ortan t problem s.
The f i r s t was th e s u g g e s tio n
th a t th e c o n s t it u t io n o f th e exchange be a lt e r e d to r e q u ir e th a t
an amendment can be made o n ly a s a r e s u l t o f an a f f ir m a t iv e v o te
o f a m a jo rity o f th e membership v o tin g ; th e d e t a i l s o f t h i s change
were regarded as a m atter f o r c o n s id e r s o le stu d y .
A second prob­
lem , t h a t o f market l i q u i d i t y , had become one o f th e major im portance
s in c e an in c r e a s in g p r o p o r tio n o f n a t io n a l w ea lth had come to be
r e p r e se n te d by s e c u r i t i e s , and a t the same tim e th o se a g e n c ie s o f
a s p e c u la tiv e ch a r a cter w hich c o n tr io u te d to l i q u i d i t y haa been
r e s tr ic te d .
The t h ir d problem proposed f o r study i s
th a t o f
broadening th e scope o f th e exchange by in c r e a s in g membership and
t>y in c r e a s in g the number o f s e c u r i t i e s l i s t e d on i t .
F o u rth ly ,
th e problem o f p u b lic in fo r m a tio n was c o n sid e re d an im p ortan t one;
a t t e n t io n was c a lle d to th e f a c t th a t n o t o n ly th e g e n e r a l p u b lic
but a ls o mary p eo p le w ith in f i n a n c i a l c i r c l e s had in a c c u r a te n o tio n s
o f the fu n c tio n o f th e ex ch a n g e, and i t was f e l t th a t t h is typ e
o f m isun derstan ding cou ld be g r e a t ly m inim ized.
F i n a lly , i t was f e l t t h a t the r e l a t i o n s o f th e exchange
w ith th e government sh ou ld be a m atter o f i n v e s t i g a t i o n and
s tu d y , and t h a t c o o p e r a tio n oetw een th e exchange and the Commis-
-286s io n should r e s u lt in th e r a is i n g o f stan d ard s o f fin a n c e and
b u s in e s s w ith a minimum o f economic d is tu r b a n c e . 14
R e v isio n o f th e New York Stock Exchange ’s C o n s titu tio n and
Reforms in o th e r E xchanges.
I t was su g g e ste d t h a t a s p e c ia l com m ittee o f th r e e members
be a p p o in ted by th e board o f govern ors o f th e Exchange, who w ith
th e a id o f co u n sel sh ou ld d r a ft amendments t o th e c o n s t i t u t i o n t o
g iv e e f f e c t to th e recommendations w hich had been made.
A c co r d in g ly ,
on January 31, 1938, a com m ittee composed o f Mr. E.H.H. Simmons,
Chairman, Mr. C harles B. Harding, and Mr. W illiam MoC. M artin , J r . ,
was ap p oin ted to make n e c e ssa r y amendments.
On February 2 3 , 1938,
t h i s com m ittee subm itted a p p ro p ria te amendments to th e Exchange
b ased on th e s p e c i f i c recommendations o f th e Conway Com m ittee."^
I t a ls o su g g e ste d t h a t a new method o f v o tin g be in a u g u ra ted and
t h a t a new way o f h an d lin g non-member c la im s sh o u ld be i n s t i t u t e d .
I t was unable to comment upon th e o th e r more g e n e r a l s u g g e s tio n s
in th e tim e a v a ila b le , bu t s t r e s s e d t h e i r im p ortan ce.
S in ce th e
c o n s t it u t io n a l r e v is io n req u ired a r e v is io n o f th e r u le s o f th e
govern ing com m ittee and o f a l l o f th e sta n d in g co m m ittees, i t was
recommended th a t a s p e c ia l com m ittee be ap p oin ted fo r t h i s p u rp o se.
On March 17, 1938, th e Exchange adop ted a r e v is e d c o n s t it u t io n based
on th e recommendations o f th e County Committee, to be e f f e c t i v e on
May 16, and on th a t d a te th e new a d m in is tr a tio n o f th e exchange
took over i t s d u tie s ; on June 30, Mr. W illiam McC. M artin, J r . was
e le c t e d p r e s id e n t.
S in ce t h a t tim e th e new s e t-u p o f th e New York
^ R e p o r t o f th e Committee on O r g a n iz a tio n and A d m in is tr a tio n , p . 5 .
"^New York Stock Exchange, Report o f th e S p e c ia l Committee o f Three
A ppointed on January 3 1 , 1938 t o d r a f t Amendments to th e C o n s ti­
t u t io n o f th e Exchange^
-287-
Reforms s im ila r t o th o se w hich have tak en p la c e i n th e New
York S tock Exchange have a ls o o ccu rred and are c o n tin u in g to
occu r i n th e o r g a n iz a tio n o f o th e r exch an ges, such a s th e C hicago
S tock Exchange, th e D e tr o it S to ck Exchange, th e New York Curb
16
Exchange, and o t h e r s .
P r o v is io n s a g a in s t brokerage f a i l u r e
The round t a b le c o n fe r e n c e s betw een New York S to ck Exchange
• r e p r e s e n t a t iv e s and th e Commission which d ev elo p ed d u rin g the
p e r io d o f r e o r g a n iz a tio n have been co n tin u ed a s a r e g u la r p r a c t ic e
and have fu r n is h e d an o p p o rtu n ity fo r d is c u s s io n o f im p o rta n t prob­
le m s.
One o f th e c h i e f s u b j e c ts c o n sid ered a t th e s e m eetin g s has
been th e m a tter o f "a t r u s t i n s t i t u t i o n t o oerform th e banking and
17
c u s t o d ia l fu n c tio n s o f b ro k ers."
The f a i l u r e o f R ichard W hitney and Company in d ic a te d to th e
Commission the need f o r im m ediate r e g u la tio n in th e i n t e r e s t
o f p r e v e n tin g su ch happenings in th e fu tu r e .
As a r e s u l t o f th e
d is c lo s u r e s i n th e W hitney c a se a t h ir t e e n p o in t program d e sig n e d
t o a ffo r d a d d it io n a l p r o te c tio n to the p u b lic i n t h e i r b rokerage
d e a lin g s w ith member firm s o f th e Exchange was worked o u t through
a s e r i e s o f c o n fe r e n c e s , and v/as adopted by th e New York Stock
18
Exchange on O ctober 2 6 ,1 9 3 8 . T h is program c a lle d f o r th e forma­
t io n o f s e p a r a te a f f i l i a t e d c o r p o r a tio n s fo r th e purpose o f
c a r r y in g on u n d e r w r itin g , s e c u r it y , and commodity p o s it io n s fo r
th e accou n t o f th e fir m .
By t h i s means f a i l u r e o f brokerage
16
S .E .C ., 4 th Annual R ep o rt, pp. 2 0 -2 1 , and 5 th Annual R ep o rt, p p .3 6 -3 7 .
17
4 th Annual R e p o r t, p . 21.
18
5 th Annual R e p o r t, p . 38; fo r t e x t o f program s e e S .E .C ., Ip, th e
M atter o f R ichard W hitney e t a l . . Appendix A, p p .173 f f .
firm s due to commitments made in a c t i v i t i e s o th er uhan brokerage
i s sought to be
a void ed ,
,.f t e r t h i s se g r e g a tio n had been
accom plished i t
was provided th a t no member
firm doing o u s in e s s
w ith th e p u b lic , u n le s s o p e r a tin g under th e s u p e r v isio n o f the
S ta te or F ed eral banking a u t h o r it ie s , should perm it i t s aggregate
in d eb te d n e ss to
a l l o th er p erson s to exceed
c a p it a l o f the firm .
1500 p ercen t o f the n et
Furtherm ore, lo a n s o f cash or s e c u r i t i e s be­
tween o f f i c e r s , govern ors, or o th e r members o f the Exchange could
n ot be made w ith ou t p r io r w r itte n approval o f th e committee on
member fir m s , u n le s s f u l l y secured by r e a d ily marketable c o l l a t e r a l .
E xception was made o f lo a n s betw een governors and committee members
and the fir m s o f which th ey were p a r tn e r s , or p a rtn ers o f such fir m s .
llo governor or com m ittee member was p erm itted under the program to
tak e p a r t in any in v e s t ig a t io n o f any m atter r e la t in g to a member
or a member firm w ith th e knowledge th a t such firm i s in d eb ted to
him or th a t he or any o f h is fir m i s in d eb ted to such firm , ex cep t
f o r th ose d eb ts which a r is e from the ord in a ry coarse o f b u sin e ss
on th e exchange, or in th e o v e r -th e -c o u n te r m arkets, or from the
le n d in g or borrowing o f s e c u r i t i e s .
The committee on member firm s
was req u ired to c a l l f o r r e p o r ts o f th e f i n a n c ia l c o n d itio n s o f
members more fr e q u e n tly and in more d e t a i l than fo rm erly ,
answer
to a s o - c a lle d "long form" was req u ired a t l e a s t once a y e a r , w h ile
a s p e c ia l "short-form " was req u ired a t in t e r v a ls o f approxim ately
each q u a rter,
Tt was furtherm ore req u ired th a t a l l member firm s
doing any b u sin e ss w ith o th er than members or member firm s have an
-28.91-
a u d it by an in d ep en d en t a cco u n ta n t a t l e a s t tw ic e a y e a r .
I t was
a ls o planned t h a t th e freq u en cy o f s u p e r v is o r y a u d it s , ex a m in a tio n s,
and in s p e c tio n s o f member fir m s ' o f f i c e s by th e exchange should be
in c r e a s e d .
These w ere to ta k e p la c e a t ir r e g u la r in t e r v a l s w ith o u t
p r io r w arning, and were t o in c lu d e a sp o t check o f s a fe k eep in g
s e c u r i t i e s and s e c u r i t i e s r e p r e s e n tin g e x c e s s m argin.
to th e s e req u irem en ts r e p o r ts to
In a d d itio n
ho exchange were r e q u ir e d on lo a n s
above $ 2 ,5 0 0 , e i t h e r made o r gra n ted im m ed ia te ly .
E x c e p tio n s were
made o f lo a n s o f such c h a r a c te r t h a t th e y w ere n o t a f a c t o r in th e
s o lv e n c y o f th e fir m .
I t was a l s o p ro v id ed t h a t no member firm w hich c a r r ie d margin
accou n ts f o r o th e r s than members o f n a t io n a l s e c u r i t i e s exchanges
or r e g is t e r e d b rok ers or d e a le r s , and no g e n e r a l p a r tn er o f such a
fir m , m ight tr a d e on margin w ith t h e i r own firm or w ith any o th er
member fir m ,
i h i s p r o v is io n d id n o t p rev en t th e o b ta in in g o f bank
lo a n s fo r th e purpose o f c a rr y in g s e c u r i t i e s or embrace such ac­
t i v i t i e s a s u n d e r w r itin g .
Exem ptions -were planned f o r c e r ta in
ty p e s o f tr a n s a c t io n s by members on th e f l o o r .
I t was a ls o pro­
v id ed th a t no member fir m sh ou ld ca rry an a cco u n t f o r a member o f
an oth er firm w.i th o u t th e w r itte n c o n sen t o f an oth er p a r tn er o f such
fir m .
D u p lic a te r e p o r ts o f such a c co u n ts w ere r e q u ir e d to be sen t
t o th e p a rtn er w hose c o n se n t had been g iv e n t o th e opening o f th e
a c c o u n t.
Members who d id b u sin e s s a s in d iv id u a ls vrere fo rb id d en
t o c a r r y a cco u n ts f o r cu sto m ers.
I t was a ls o a d v is e d t h a t more
r i g i d s e le c t io n o f membership on th e Exchange be e x e r c is e d and th a t
the b u sin e s s p r a c t ic e s o f member fir m s be more c a r e f u l ly s u p e r v ise d .
F i n a lly each fir m d oin g undervrriting was r eq u ir ed t o subm it a w eekly
statem en t o f i t s p o s it io n to th e Exchange w hich showed i t s n e t
p o s it io n w ith r e l a t i o n t o th e s e c u r i t i e s u n d e r w r itte n .
-29.0V
The c o n fe r en ce s between th e Commission and th e Exchange
•which r e s u lt e d in th e program which has j u s t been summarized have
been co n tin u ed in ordei^that r u le s m ight be worked o u t
th e proposed program in t o o p e r a tio n .
to b r in g
L uring th e sp r in g o f 1 9 3 9 ,
th e Exchange h e ld open h e a r in g s upon th e p r o p o sa l o f the fo rm a tio n
o f lim it e d l i a b i l i t y companies to ta k e over tr a d in g d e a le r and
o th er a c t i v i t i e s from brokerage fir m s .
On June 2 8 , 1 9 3 9 > th e board
o f govern ors o f th e NewYork S tock Exchange p a sse d r u le 616, which
w ith c e r t a in e x c e p tio n s p rev en ts margin tr a d in g by th o se who ser v e
th e p u b lic as f i d u c i a r i e s .
C onferen ces c o n tin u e d betw een th e
Exchange and th e Commission u n t i l th e o th e r ite m s o f th e program
19
were f i n a l l y e f f e c t u a t e d .
Study o f th e p ro p o sa l fo r
"brokerage bank".
The rVhitney ca se a ls o brought forw ard a p r o p o sa l from
Mr. J iilia m 0 . ^ o u g la s, th en chairman o f th e Commission, f o r th e
e sta b lis h m e n t o f a brokerage bank.
T h is bank was to be a type
o f c e n t r a l i n s t i t u t i o n d e sig n e d to tak e over th e banking and
c r e d it fu n c tio n s w hich b rokers had h e r e to fo r e e x e r c is e d .
A fte r
th e f a i l u r e o f th e E lf a s t , F r isk and Compary in March, 1939> th e
s i t u a t i o n appeared more u r g e n t, and on June 3> 1539* "*r. Jerome M.
Frank, who had su cceeded Mr. io u g la s as chairman o f th e Commission,
ag a in p u b lic ly urged th a t such an i n s t i t u t i o n be e s t a b lis h e d and
20
th a t th e Exchange lo o k in t o the m a tter.
As a r e s u l t th e Ex­
changed employed th e fir m o f lia sk in s and S e l l s , A cco u n ta n ts, to
condu ct an i n v e s t i g a t i o n .
The p la n in c lu d e d a d e p o s ito r y f o r
s e c u r i t i e s p led g ed to le n d in g banks a s w e ll a s - t h o s e ' i n th e hands
o f b r o k e r s.
T his stud y was based upon a s assumed volume o f two
19
5th \n n u a l Rep’t . . pp. 39—40.
20
~
I b i d . , pp. AO- 4 2 .
-2 9 1 -
m illio n sh a re s p e r d ay, w ith s u f f i c i e n t r e s e rv e c a p a c ity to acco­
modate o c c a s io n a l s e r i e s of days o f th re e m illio n s h a re s .
As a
r e s u l t o f t h i s stu d y i t was concluded t h a t w hile such a bank m ight
be e s ta b lis h e d on a b a s is of two m illio n s h a re s , th e p r e s e n t volume
o f exchange tr a d in g was not such a s to make i t p r a c t ic a b le .
T his was
e s p e c i a l l y so s in c e p r a c t i c a l l y a l l th e c o s ts connected v d th such a
bank would be fix e d and on h a l f o f th e e s tim a te d volume th e c o s t p e r
tr a n s a c t i o n would be d o ubled.
I t was f u r t h e r f e l t t h a t such a bank
must be o rg a n iz ed on a t l e a s t a two m illio n sh are b a s is b ecause a
s m a lle r one would n o t be s u f f i c i e n t l y la r g e to accommodate th e
21
f lu c tu a ti o n s in volume o f tra d in g which o r d in a r ily o c c u r.
As a r e s u l t o f t h i s r e p o r t th e Exchange f e l t t h a t a c e n tr a l
t r u s t i n s t i t u t i o n was im p o ss ib le .
The Commission on th e o th e r hand
has n o t ceased to a tte m p t to b rin g about some o th e r p la n , and has
d r a f te d a s e t of r u le s which have been d is c u s s e d w ith the Exchange
w ith a view to in c r e a s in g custom er s a f e ty .
At the p r e s e n t w ritin g
th e problem has n o t been s a t i s f a c t o r i l y so lv e d ,
i'he Commission
i s s t i l l p r e s s in g f o r In c re a s e d s a f e ty w hile b ro k e rs are com plaining
about in c re a s e d c o s ts under th e Act.
21
H askins anc S e l l s , A ccountants, R eport on a Ce n t r a l d e p o s ito ry .
June 2 6 , 1939* pp. 1 -6 .
SUKJTARY ATJ CQKCLDSIOIJS
The g e c u r i t i e s m arkets o f th e U n ited S t a t e s have
grown from unim portant b e g in n in g s t o a p la c e o f prim ary
Im portance i.n th e n a t io n a l economy.
During t h e ir growth
th ey have e v o lv e d a s e t o f p r a c t ic e s w hich have f a i l e d
to keep pace w ith th e grow ing im portance o f t h e i r p o s i t i o n .
These p r a c t ic e s have g iv e n r i s e t o a s e r ie s o f a b u se s,
v/hich had lo n g been p r e se n t in some m easure, b u t 'which
became i n t e n s i f i e d du rin g the p e r io d s p reced in g and fo llo w in g
th e y e a r 1 9 2 9 .
The crash o f t h a t y e a r and th e bear market
v/’n icii fo llo w e d had th e e f f e c t o f a r o u sin g p u b lic resentm ent
a g a in s t th e ex ch a n g e s.
The ch a rg es made a g a in s t them
in th e S en ate and House com m ittees were both g e n e r a l and
s p e c i f i c in c h a r a c te r , bu t i t was p o s s ib le f o r i n v e s t ig a t o r s
o f exchange p r a c t ic e s t o e s t a b l i s h th e e x is t e n c e o f a
s u b s t a n t ia l number o f s p e c i f i c a b u ses and to r e l a t e th e s e
to th e b road er d e f e c t s in th e mechanism o f th e exchange in
such a manner as t o in d ic a t e th e n e c e s s i t y f o r immediate
r e g u la to r y a c t io n .
The exch anges on th e o th e r hand were n o t
a b le , in th e fa c e o f th e e v id e n c e vdiich had been subm itted
a g a in s t them , to e s t a b l i s h a c o n v in c in g c a se to th e c o n tr a r y .
The S e c u r i t i e s Exchange A ct o f 1 9 3 4 , n o t o n ly p rovided
remedy f o r s p e c i f i c a b u se s, bu t p ro v id ed f o r a s tr u c tu r e
f o r s u p e r v isio n o f exch anges and o v e r -th e -c o u n te r m arkets.
I t lik e w is e p ro v id e d f o r g rad u a l changes in th e o rg a n iz a tio n
-2 9 3 -
o f a l l s e c u r i t i e s exchanges o f n a t io n a l im p o rtan ce and
f o r t h i s p u rp o se p ro v id e d f o r program s o f an e v o lu tio n a ry
c h a ra c te r.
S in c e th e Act h as been in o p e r a tio n th e S e c u r i t i e s
and Exchange Commission has been a b le t o a r r i v e a t d e f i n i t e
p o l i c i e s i n th e en fo rcem ent o f th o s e s e c tio n s o f th e A ct
which a r e s p e c if ic i n t h e i r pu rp o se and which do n o t
in v o lv e s i t u a t ons where th e r e i s lik e li h o o d o f e lim in a tin g
o p e r a tio n s which a re n e c e s s a ry f o r th e p ro p e r f u n c tio n in g
o f th e m a rk e ts.
In c a s e s where th e r e have been c o n f l i c t s
between th e aim s o f th e lav; and th e n e c e s s i t i e s o f th e
m ark et, th e Commission has d r a f t e d t e n t a t i v e r u l e s and h as
a tte m p te d to b rin g a b o u t d e s ir e d changes th ro u g h g ra d u a l
m o d ific a tio n s o f p r a c t i c e s in th e l i g h t o f lo n g o b s e rv a tio n
and e x p e rie n c e .
To t h i s end many lo n g s tu d ie s have been
made and broad program s have been ad o p te d ,
^ in c e th e
Commission has been a b le to b rin g p r e s s u re to b e a r upon
exchanges th ro u g h t h r e a t o f f u r t h e r r e g u la tio n , i t h as been
a b le to induce them t o a tte m p t s e lf - r e f o r m and s e lf - p o l ic in g
in a r e a s where th e y m ight o th e rw ise be u n w illin g to
c o o p e ra te .
S im ila r p r e s s u r e h a s been e x e r te d upon o v e r - th e -
c o u n te r m ark ets w ith b e n e f ic ia l r e s u l t s o f l i k e c h a r a c t e r .
Any c o n c lu s io n s u liie li muy tie drtuaj co n cern in g th e
S e c u r it ie s Exchange £ c t o f 1934 sh ou ld be drawn w ith s e v e r a l
-294V
l i m i t in g f a c t o r s in m ind.
Any system o f a c o m p lic a te d
c h a r a c te r can o t be c o n c lu s iv e ly ju d g ed in th e l i g h t
o f o n ly s ix y e a r s o f o p e r a tio n .
F u rth erm o re, m ark et
c o n d itio n s which have o b ta in e d o v er t h i s p e r io d have
n o t been such a s to b rin g ab o u t th o se p r e s s u r e s v;hich
would p u t th e A ct to a r e a l t e s t .
F i n a l l y , i n some o f
i t s most im p o rta n t a s p e c ts i t i s s t i l l i n a s t a t e of
e v o lu ti o n ary developm ent.
C e rta in aim s o f th e A ct have been a c h ie v e d , however,
t o an e x te n t vfoich w a rra n ts d e f i n i t e comment.
The exchange
and, in some m easure, the o v e r - th e - c o u n te r m ark ets have been
p la c e d under s u r v e illa n c e and s u p e rv is io n to a d eg ree which
te n d s to be i n k eep in g w ith th e ends o f th e A c t.
The
r e o r g a n iz a tio n s o f m ajor exchanges have been such as to
p ro v id e f o r p u b lic r e p r e s e n ta tio n s and a c o n s id e ra b le m easure
o f p u b lic c o n tr o l w it! re g a rd to th e fo rm a tio n o f p o l i c i e s .
k o re s p e c i f i c a l l y , th e p u b lic h as been f u r n is h e d w ith
in fo rm a tio n co n cern in g the s e c u r i t i e s which i t buys and
s e l l s , which sh o u ld s tre n g th e n i t s p o s itio n c o n s id e ra b ly .
The i n t e l l i g e n c e w ith 'which t h i s in fo rm a tio n v r ill be u s e d ,
however, depends upon th e d eg ree to which th e p u b lic may
be a b le to a s s im ila te i t .
I t s u ltim a te e f f e c tiv e n e s s can n o t
be commented upon, b u t i t i s a n e c e s s a r y s te p i n th e
developm ent o f a r e s p o n s ib le in v e s tin g p u b lic .
-2 9 f-
F u rth e rm o re , th e r e has been a v e ry r e a l in c r e a s e in
p u b lic p r o te c tio n a g a in s t f ra u d and u n f a i r tr e a tm e n t, and
i n o p p o r tu n ity f o r r e d r e s s , in th e ev en t t h a t i r r e g u l a r i t i e s
a r e com m itted.
The ad v an tag es which a c c ru e from t h i s
s i t u a t i o n b e n e f i t b o th th e p u b lic and th e h o n e s t i s s u e r o f
s e c u r i t i e s , s in c e th e p u b lic co n fid en ce i n th e m ark ets
i s th e r e b y in c r e a s e d .
M a n ip u la tiv e p r a c t i c e s have been s u b je c te d to e f f e c t i v e
s c r u tin y and th e r e i s rea so n to b e lie v e t h a t p u b lic v i c ti m iz a ti o n
th ro u g h t h i s means has been reduced to a p o in t where i t i s
a p p ro a c h in g a minimum.
Hie c o n tr o l o f m argins and c r e d i t do n o t p e rm it th e
same d e g re e o f d e f i n it e n e s s o f s ta te m e n t c o n cern in g t h e i r
e f f i c a c y a s th o s e which have j u s t been m en tio n ed .
Vfhile th e
aim s a r e d e f i n i t e and th e mechanisms f o r c o n tr o l a p p ear t o be
e f f e c t i v e , th e p o lic y o f th e F e d e ra l R eserve Board in tim e s
o f s t r e s s i s an im p o rta n t f a c t o r in th e s i t u a t i o n .
The
e f f e c t which c o n tr o l o f c r e d i t may u lt i m a t e l y have on
th e b e h a v io r o f s e c u r i t y m ark ets under s tr o n g b u l l m arket
c o n d itio n s c a n n o t be e s tim a te d .
I t may o n ly be s a id t h a t
such c o n tr o l may be r e l i e d upon t o o p e ra te in th e d i r e c t io n
o f s t a b i l i t y in th e m ark ets.
The q u e s tio n o f b ro k er so lv en cy i s o f g r e a t im portance
b o th from th e p o in t o f view o f th e p u b lic and t h a t o f th e
-2 9 6 -
b r o k e rs .
W hile th e re c o rd o f b ro k erag e houses had been compara­
t i v e l y good i n t h i s r e s p e c t , th e f a i l u r e o f R ich ard W hitney and
Company and o f E l f a s t F r is k -and Company has made th e Commission
f u l l y c o g n iz a n t o f t h e p o s s i b i l i t i e s o f p u b lic l o s s from b r o k e r1
age f a i l u r e .
The program o f th e Commission f o r m in im izin g b ro k e r­
age f a i l u r e , i n s o f a r a s i t concerns i t s e l f w ith more s t r i c t su p er­
v i s io n o f member f ir m s th ro u g h the Committee on Member F irm s, does
n o t r e p r e s e n t a s e r io u s change i n b ro k e ra g e m ethods.
The e s ta b ­
lis h m e n t o f b ro k e ra g e b a n k s, however, w hich would c a re f o r th e
b an k in g f u n c tio n s now han d led by b r o k e r s , would mean c o n s id e ra b le
r e o r g a n iz a tio n o f t h e b ro k e ra g e b u s in e s s .
At t h i s w r itin g i t i s
n o t p o s s ib le to comment on th e f u tu r e o f t h i s program e x c e p t t h a t
th e c o s ts o f a c e n t r a l bank can n o t a t p r e s e n t be borne by b ro k e rs .
I t may be s a id , how ever, t h a t a c tio n a lr e a d y tak en a g a i n s t b ro k e r­
age f a i l u r e b y th e Commission should b r in g ab o u t r e s u l t s ben e­
f i c i a l to th e p u b lic .
L ik ew ise th e problem o f th e c o n f l i c t betw een th e b ro k e r and
d e a le r f u n c tio n rem ain s u n so lv ed .
No e f f e c t i v e method has y e t
been d e v ise d t o cope w ith i t and t h e Commission has been r e l u c t a n t
to demand com plete s e g r e g a tio n , b o th b ecau se o f i t s e f f e c t s on
b ro k e rs and upon th e m a rk e ts.
However, th e r u le s w hich have been
e n fo rc e d have done c o n s id e ra b le to lesB en th e e v i l e f f e c t s r e s u l ­
t i n g from th e co m b in atio n o f th e s e f u n c tio n s .
S p eaking g e n e r a lly o f th e A ct, I t can be s a id t h a t th u s
1
W hile th e f a i l u r e o f R ic h a rd W hitney and Company d id n o t in v o lv e
th e p u b lic i n any s i g n i f i c a n t s e n s e , i t n e v e r th e le s s d em o n strated
th e p o s s i b i l i t y o f p u b lic l o s s th ro u g h f a i l u r e s o f t h i s ty p e .
-2 9 7 f a r i t has done much t o refo rm th e s e c u r i t i e s m ark ets.
W hile i t s
p ro g re s s may be impeded i n th e f u tu r e becau se o f o b s ta c le s which
a t p r e s e n t a p p e a r v e ry r e a l , t h i s i s i n la r g e m easure o f f s e t by
th e f a c t t h a t th e m ost u rg e n t p a r t s o f th e program w hich i t p ro v id e d
f o r a r e a lre a d y i n e f f e c t i v e o p e r a tio n .
On th e o th e r hand, i t
sh o u ld be p o in te d o u t t h a t th e r e d u c tio n o f s p e c u la tio n
and o th e r
"u n n e c e ssa ry t r a d i n g " , w hich has been one o f th e aim s o f th e
S e c u r i t i e s Exchange A ct of' 1934, may have a d e c id e d ly ad v erse
e f f e c t on th e s e c u r i t y m a rk e ts.
I f , among i n v e s t o r s , th e s e l l e r s
and bi^yers alw ays m atched th e r e would be no need f o r o th e r groups
i n th e m a rk e ts.
S in c e t h i s i s n o t th e c a s e , th e r e m ust be in ­
t e r e s t s who a r e w i l l i n g t o buy s e c u r i t i e s from i n v e s to r s who need
fu n d s and r e s e l l them to o th e r s who w ish to i n v e s t .
I n th e ab­
sence o f su ch i n t e r e s t s th e m ark ets may r e a d i l y become so " th in "
t h a t th e y a re robbed o f m ost o f t h e i r e s s e n t i a l f u n c tio n s .
No
remedy f o r such a c o n d itio n has been su g g e ste d and th e r e i s l i t t l e
o r no re a s o n t o b e lie v e t h a t one i s fo rth c o m in g .
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V. Umv.’
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