the facilities of the banks in getting credit on unregistered securities, which include the shares of stock and bonds of thousands of small corporations (unless, of course, all such securities were registered), or it would make it necessary for persons living outside the great metropolitan centers to establish direct connections with those centers in order to invest their funds. The difficulties caused by this subdivision on all parts of the country outside of New York cannot be overestimated.

The effect of this section is also extremely deflationary. To the extent that it increases the margin requirements or makes any of the pledged securities illegal collateral it requires calling of the loans. This will be caused even in cases where the borrower is in good financial condition, because it prevents the putting up of any securities other than registered securities and a person with large holdings of State and municipal obligations, bank stock, insurance stock, or stock of small corporations which are not registered cannot use them as collateral even though they would be entirely satisfactory to the lender. A person only having unregistered securities available, no matter how valuable they may be, could not protect his equity by using them as collateral and would be compelled to a forced liquidation, thereby sacrificing his entire equity.

Conversely, a broker cannot accept unregistered securities to augment a customer's collateral and in a rapid price decline might thereby be obliged to suffer a loss by a forced sale and without the possibility that now exists of protecting his loan by receipt of any collateral. This might even cause the broker's insolvency.

The effect of making unregistered securities ineligible as collateral would greatly reduce the market value of such securities. To outlaw by one stroke the legality of State and municipal obligations and bank shares, insurance shares, equipment-trust certificates, and other presently unlisted securities as collateral for exchange firms and also as above pointed out for many banks, can only tend to make such securities less desirable and attractive for investment purposes and will impair the credit value of all such unregistered securities. To that extent securities worth billions of dollars will be frozen as a basis for credit in the country at a time when credit is most needed.

In considering the effect of these provisions the assumption cannot be made that the securities presently listed on exchanges will be registered under the act and thus made eligible for collateral. The restrictions placed by these bills upon corporations which register their securities and the officers, directors, and principal stockholders of such corporations may result in many listed securities not being registered.

This discrimination against unlisted securities will operate unfairly against hundreds of thousands of small corporations which are locally owned throughout the United States. It should be particularly noted that, insofar as this section is concerned, brokers may arrange for, and actually extend, loans to customers secured by real property, chattels, and commodities-the only restriction being that if the loan is secured by securities the securities must be registered. This distinction seems wholly arbitrary.

The same subdivision (a) also prevents a member of an exchange from arranging for any credit for a customer except on registered securities. This restriction is not confined only to the usual trans

actions between the broker and customer but would prohibit a member from assisting a person who happens to be a customer in obtaining any loan whatsoever from any third party unless the securities given as collateral are registered securities.

The effect of these requirements for collateral will undoubtedly render ineligible much of the collateral now pledged throughout the country. This will necessitate calling of loans as above pointed out and to the extent that the collateral, although adequate under normal conditions, cannot be liquidated under these forced conditions, losses will result to banks throughout the country. Collateral maintained for loans throughout the country has not been maintained on a level which will permit a forced liquidation by Nation-wide governmental action, without causing such a drop in the market value of the securities to be liquidated that the realizable value of such securities will probably be reduced below the amount of the loans.

Mr. LEA. Mr. Hope, have you heard anyone state any reasons why Government securities should be prohibited for collateral purposes?

Mr. HOPE. No, sir. My reading of the bill is that the bill excludes them, because they are not registered.

Mr. LEA. What reason, if any, is assigned for that proposed law. Mr. HOPE. I know of none. We use them in our own business and regard them as the best collateral, that is, United States Government securities.

The margin requirements established by subdivision (b), page 12 of the bill, are clearly unsound and excessive.

The fact that such liquidation need not be completed for 7 months does not change the fundamental effect of the margin requirements. Liquidation on such widespread scale to be completed by the specified time, would have to be started long before its completion was required.

A further error in these mandatory margin provisions lies in the fact that they do not discriminate between high-grade investment securities and highly speculative issues which fluctuate greatly and are of less certain value as security. In the last analysis the determination of what constitutes a sound margin involves questions of opinion as to the evaluation of actual and potential values and therefore requires the exercise of experienced and trained judgment in the appraisal of conditions which change from day to day. No fixed legislative formula can be used as a substitute for such a judgment and appraisal.

The power granted to the Commission by this section to adjust loan values gives the Commission power to expand and contract credit. It can, by increasing margin requirements, immediately cause the liquidation of loans throughout the country. All margin accounts could be automatically forced to liquidate. Furthermore, arbitrary distinctions could be made between different classes of securities. This, of course, may not have been contemplated, but to give to any governmental agency such complete arbitrary control over the credit structure of the country is such a drastic step that it should be considered with the utmost care, and adopted only if it is absolutely certain that there is little chance that the power can be mistakenly used.

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Subdivision (d), on page 13 of the bill, gives the commission right to establish rules as to the notice and method of closing accounts. This means that the commission, in an endeavor to protect the borrowing public might require such length of notice and procedure for foreclosing loans as would make the security of little value. In other words, marketable securities have been taken as collateral in many cases because the lender is able to realize on his collateral promptly, and thus avoid loss. If some third party can dictate the terms on which the lender can exercise such right, the certainty of the realizable value of such collateral is diminished, and the attractiveness and safety in accepting such collateral for loans will be impaired. The further fact that these rules can be established after the loan has been made greatly increases the uncertainty, and introduces another deflationary element, because it removes a large element of the assured security value from a large part of the collateral now relied upon for a tremendous volume of credit. This is of tremendous concern to the brokers as it involves even their possible solvency.

Section 7, on page 13 of the bill, is entitled "Restrictions on Members' Borrowing.

Subdivision (a) of this section would have a most far-reaching effect which was probably not intended. It prohibits a member from borrowing on any registered security from any person other than a member of the Federal Reserve System.

This would prevent loans from special or general partners, and many other forms of special or emergency borrowings from others where even registered collateral is to be given as security. In emergencies, frequently hurried loans are imperative and can only be obtained from individuals thoroughly familiar with all the circumstances of the existing, and in many cases local and peculiar, conditions of the credit situation, and without having the time to clear a banking transaction. This may have serious effect by eliminating important sources of help at times when they are most needed, and may thus precipitate additional deflationary forces when they are most dangerous. The bill prevents a firm requiring such emeregency loans from securing them with sound collateral, registered or unregistered, which it might have available from any source as can be done at present. To so unqualifiedly confine borrowing to the Federal Reserve System may therefore deprive members from emergency relief with serious consequent dangers to everyone.

This provision also prevents many normal and customary personal loans and the utilization of private credit. Any such step results in the collectivization of all financial relationships between individuals into a Government-controlled banking system and restricts some of the private uses of capital and therefore should be most carefully considered.

These borrowing restrictions may also cause the closing of many branch brokerage offices and thereby the forcing of local business into the large metropolitan centers.

Subdivision (b), page 14, of the bill limits the aggregate indebtedness of members to a percentage, based on the "net current assets" employed in their business. Considering the fact that "net current assets" are not defined, it is a grave question as to whether that method is the sound basis for determining the credit responsibility

and risk of any such member. The Commission could from time to time by classifying assets as current or otherwise thus cause the liquidation and insolvency of firms whose practices it did not like.

Section 8, page 15, of the bill, is entitled "Prohibition against manipulation of security prices."

Subdivision 4 makes it unlawful for any broker to give information that the price of a security is likely to rise or fall partly because of the market activity of certain individuals if he believes that the person may purchase securities on the basis of such information. Widespread circulation of such information might have some harmful effects, but it is not seen what purpose is gained by prohibiting a broker from giving such information personally to his customers. To forbid a broker to so advise his customer might be depriving the customer of information useful to him in the protection of his interests.

Subdivision 5, page 16, of the bill makes it unlawful to give information which in the light of circumstances is misleading, if the broker giving such information has reason to believe that the person to whom it is given will rely upon it in the purchase of securities. The broker is granted the defense that he acted in good faith, but to put the burden on him to justify every statement and to give every customer the right to put his broker to the proof of every statement made, can only result in the refusal of cautious brokers to give any information whatsoever. Certainly this cannot be in the public interest.

The liabilities imposed are severe and would undoubtedly be used by unscrupulous purchasers, when they made an unfortunate purchase, as a means of forcing some settlement or contribution from the broker. They would have nothing to lose and everything to gain. They could engage in speculative purchases and could keep the benefits if the purchases turned out successful. If they were unsuccessful they could try to recover from their broker because of something they claimed that they had heard him say, and if they could not recover, possibly force a settlement because of the drastic penalty provisions.

There is moreover nothing in this section which limits the type of information to which this subdivision refers to being matter specially within the knowledge of the broker. The liability might be based on misinformation which was being generally circulated and to which the customer had just as good source of information as the broker himself. Nor is there any requirement that the mistaken information has any relation to the purchase of the security or its market value.

This liability of the broker would probably drive much of the business from responsible houses to unreliable brokers willing to gamble on such liability and to give any advice to their customers on the chance that they could evade liability.

The restrictions of this section against the giving of advice and the heavy liability provisions herein before discussed also will render practically obsolete the business of investment counsel and may tend to eliminating the possibility of people desiring to invest getting any practical advice from those more experienced. The result may thus be to put a greater difficulty in the way of the small investor in his efforts to make a real investment which will not exist in regard

to the wealthy investor who may have statisticians and assistants in his service to make his personal surveys.

Subdivision 9 (i), page 18, of the bill, will result in the absolute elimination of any transactions with warrants, and subdivision 9 (iii) will likewise make impossible any transactions in convertible bonds.

Mr. MERRITT. Mr. Chairman, may I ask a question?

The CHAIRMAN. Mr. Merritt.

Mr. MERRITT. On page 17 of your brief you refer to subsection 9. Is that what you are reading about now?

Mr. HOPE. Yes, sir.

Mr. MERRITT. About transactions in convertible bonds.

Mr. HOPE. We are coming to that.

Mr. MERRITT. Well, I am going to ask you if my understanding is correct that that subsection would prevent, for instance, the Pennsylvania Railroad from issuing several millions of convertible bonds which they now propose to issue, to enable the road to give employment to many in improving the road and equipment.

Mr. HOPE. That is the way I understand it.

The CHAIRMAN. I do not understand that question.

Mr. MERRITT. The brief states on page 17, on subdivision 8, that that section would make it impossible to have any transactions in convertible bonds.

Now, the Pennsylvania railroad, for the sake of improving its road, is about to issue $40,000,000 of convertible bonds.

Mr. HOPE. The New York Central is the one we have been talking about; refunding.

Mr. MERRITT. The New York Central?

Mr. HOPE. Yes.

Mr. MERRITT. They are offer bonds, which are convertible into stock for the purpose of improving the road and improving the rolling stock. Now, under this subdivision, according to Mr. Hope, it would not be possible to issue those bonds and therefore it could not be used for that purpose.

The CHAIRMAN. Well, what is that based upon?

Mr. HOPE. Page 17, by limiting

The CHAIRMAN. No, I am not talking about your brief.

Mr. HOPE. The bill, page 18 of the bill, section (i).

The CHAIRMAN. What section did you say that was?
Mr. HOPE. It is the first paragraph under (9).

The CHAIRMAN. You say that what?

Mr. HOPE. This issue that the Congressman mentioned refers to convertible issues, entitling the holder of the bonds a right to change them into stock. He does not have to do it; he may. I should say that this would prevent any transactions in such issues.

The CHAIRMAN. Well, I am just asking why you say that.

Mr. MERRITT. That, of course, is

The CHAIRMAN. What?

Mr. MERRITT. That is convertible bond, so called, and contains a call for stock.

Mr. HOPE. It gives the right to call for the stock at certain prices, and within a certain number of years. That is a call, and there are many millions of them.

Mr. WADSWORTH. It is also an option or privilege.