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NATIONAL SECURITIES EXCHANGES REGULATION

THURSDAY, MARCH 22, 1934

HOUSE OF REPRESENTATIVES,
COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE,

Washington, D.C. The committee met, pursuant to adjournment, at 10 a.m., in the committee room, New House Office Building, Hon. Sam Rayburn (chairman) presiding:

The CHAIRMAN. The committee will come to order.

We decided late yesterday that we will use this morning in hearing the representatives of the exchanges.

Mr. Whitney, you may proceed.

STATEMENT OF RICHARD WHITNEY, PRESIDENT, NEW YORK

STOCK EXCHANGE, NEW YORK, N.Y.

Mr. WHITNEY. Mr. Chairman and gentlemen of the committee: The notice has been a little short and many of us have been up all night trying to get something to properly present to you, but I want to ask your forgiveness, if in our haste, there have been, well, omissions, or perhaps errors in what I am going to tell you, although we have tried to check very carefully.

The New York Stock Exchange is opposed to H.R. 8720 for the same reasons it was opposed to the Fletcher-Rayburn bill. The bill now pending before you contains modifications of some of the provisions of the original bill. However, our basic objections to the old bill apply with equal force to the new one. There is not time to discuss all of its provisions and I shall, therefore, confine my remarks to the most vital sections. I shall deal only with sections 6 and 7, which refer to margin requirements and the restrictions on members' borrowings; section 10, which deals with segregation of the functions of broker and dealer; sections 11 and 12, which deal with the requirements for the registration of securities and the reports which will be required of corporations whose securities are registered on an exchange; and section 18, which deals with the powers of the Commission over exchanges. There are many other sections of the bill which, in my opinion, should be amended.

Before discussing any provisions of the bill I want to make my position absolutely clear. I think this bill is unworkable and will have destructive effects not only upon stock exchanges but also upon the value of securities and the business of the country. I do not believe that sound legislation can be based on the framework of this bill. However, I understand that the committee desires constructive suggestions for the improvement of the bill. I shall, therefore, suggest specific amendments to the sections of the bill which contain the most harmful and unworkable provisions. In making these suggestions, I do not wish to be understood as qualifying in any way my fundamental objections to the bill.

The amendments which I shall propose do not emanate solely from the New York Stock Exchange. They have been discussed with representatives of the New York Curb Exchange, the Boston Stock Exchange and the Chicago Stock Exchange and also with the president of the Association of Stock Exchanges which represents 18 stock exchanges located in all parts of this country. The gentlemen representing these exchanges are here today and will, I am sure, confirm my statement that these suggestions have their entire approval.

It is my understanding that Mr. Lothrop Withington, of Boston, is to appear as a witness after me this morning, one of those to whom I have just referred.

Sec. 6. Margin requirements: Section 6 of the bill purports to vest control of margin requirements in the Federal Reserve Board. However, it restricts the power given to the Federal Reserve Board by prescribing rigid minimum margin requirements, which are based upon percentages of current market value or of the lowest price which a security has reached within 3 years preceding the date of the loan, provided, however, that until July 1, 1936, the lowest price at which a security has sold since July 1, 1933, may be taken in lieu of the lowest price in the 3-year period preceding the loan. Different minimum margin requirements are established for the initiation of a loan and its maintenance. Furthermore, there is a provision to the effect that loans existing on the date of the enactment of the bill will not be subject to the minimum margin provisions until January 31, 1939. This last provision was admittedly intended to prevent a forced liquidation of existing loans, which would necessarily follow if the margin requirements of the bill became immediately operative. Let me call to your attention that declining markets resulting from the enactment of this bill would bring in their train the very liquidation you seek to forestall by this provision.

I have already said that I consider the margin requirements of the original Fletcher-Rayburn bill excessive. While the margin requirements of the pending bill are more liberal due to prevailing market prices, they would in the event of a rise in security values reach the same excessive level as was fixed in the Fletcher-Rayburn bill. In brief, the margin requirements of this bill and the Fletcher-Rayburn bill are both defective in that they base credit solely upon a percentage of market value or upon the lowest market price reached within arbitrary periods of time. Earnings, likewise, cannot be used as the sole criterion of value for securities. The loan value of a security must be determined by a consideration not only of earnings and market value but of the size and activity of the particular issue, its distribution among investors, the extent to which it is held in loans or margin accounts, the volatility of the security, and the general condition of the market and of the industry in which the security represents an interest. These are the factors which reasonable men must consider in determining the amount of credit which can be advanced upon security collateral and they cannot be reduced to a formula.

The control of credit necessarily involves the use of judgment and excessive speculation in securities can only be prevented if the persons controlling credit are thoroughly familiar with credit conditions and

have full power to raise or lower margin requirements as circumstances may require. In our opinion, therefore, the Federal Reserve Board, which is already vested with power to control the credit resources of the country, and which now has the responsibility for such credit control, should be given full power to fix such margin requirements as it may deem necessary in view of economic conditions.

To accomplish this result, I suggest that section 6 of the bill be amended to read as follows:

Sec. 6. It shall be unlawful for any member of a national securities exchange or for any broker or dealer transacting a business in securities through any such member, directly or indirectly, to extend or maintain credit to or for any person in contravention of such rules as may be adopted from time to time by the Federal Reserve Board for the purpose of preventing the excessive use of crediu for speculation.

Another section which directly refers to credit conditions is subsection (a) of section 7, which deals with brokers borrowing from nonbanking institutions. We believe that the Federal Reserve Board should likewise be given full power over this subject and we, therefore, suggest that section 7 be amended so as to read:

Sec. 7. It shall be unlawful for any member of a national securities exchange or for any broker or dealer who transacts a business in securities through the medium of any such member, directly or indirectly, to secure the repayment of any money borrowed by the pledge or hypothecation of any securities in contravention of such rules and regulations as may be adopted from time to time by the Federal Reserve Board for the purpose of preventing the excessive use of credit for speculation.

We suggest that the substance of the other subsections of section 7 be transferred to section 18 of the bill, which I will discuss later on.

SEC. 10. Functions of broker and dealer: Section 10 of the bill deals with the segregation and limitation of the functions of broker, specialist, and dealer. It has been changed so as to permit members to combine, under certain safeguards, the functions of dealer and broker, provided they do not act as dealers on the floor of the exchange.

The section still prohibits the function of broker and dealer being combined by a member when on the floor of the exchange. This limitation will effectively put out of business all bond brokers because they customarily act as dealers and also all specialists. It will make it impossible for the odd-lot business to be carried on except on the New York Stock Exchange, which, alone of all the exchanges in the country, has some members who engage exclusively in the odd-lot business.

I cannot believe it is wise to make such a revolutionary change in the accustomed method of doing business until it is shown that any possible abuses cannot be eliminated in some less drastic manner. I suggest, therefore, that this section be amended so as to allow the Commission to adopt such rules and regulations as it may deem necessary in regard to members of an exchange combining the function of dealer and broker when actually engaged in business on the floor of the exchange. This suggestion will give the Commission full power to change and correct its rules as conditions may require. Such a power is essential to experimental regulation in so technical a field and is not possible under fixed rules of law.

The Chairman. You know, Mr. Whitney, there are a great many brokers, in New York, members of the exchange, who do not believe that we should relax this provision as much as we have. They think that there should be an entire segregation; when a man is a broker, he should be nothing else.

Mr. WHITNEY. In the suggested

The CHAIRMAN. Of course, they are a little tenderfooted about coming down here and saying so in public, but they say so to me.

Mr. WHITNEY. That may be because they have a special interest. The CHAIRMAN. It may be.

Mr. WHITNEY. I mean, they may have a special interest and their particular duties are not to look at the whole point of view, such as the stock exchange authorities must look at.

May I add in this suggested amendment, sir, it is left with the full power to the Commission to make such rules and recommendations as they may deem proper in this regard and in all regards as to segregation.

The fundamentals, Mr. Chairman, being that instead of having a fixed rule of law which can only be changed by an act of Congress, and cannot be changed if Congress is not in session-instead of having a fixed rule of law, we advocate the power being put in a commission to make these rules and regulations, which, if they are wrong, they can immediately change. If they are right, then these rules and regulations will stay in effect.

But we are fearful of the danger that may result of placing such rules and regulations with which we, as the authorities of the exchange, do not agree, into a law which cannot be changed, and in the meantime-except by Congress and in the meantime disaster, chaos, and panic may result, and the only person who is hurt is the public.

I suggest, therefore, that section 10 be amended to read as follows:

Sec. 10. (a) It shall be unlawful for a member of a national securities exchange while on the trading premises of such exchange to act as a dealer and broker in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

(b) Subject to such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors, to insure compliance with the provisions of this subsection, the rules of a national securities exchange may provide for the registration of members with the privilege of acting as dealers, and any member so registered shall have the privilege of acting as a dealer and as a broker within the limitations of this subsection. It shall be unlawful for a member with the privilege of acting as a dealer who also acts as a broker to effect any transaction in a security by use of any facility of national securities exchange or otherwise, (1) if in connection with any such transaction he directly or indirectly extends or maintains or arranges for the extension or maintenance of credit for a customer on any security (other than an exempted security) which was a part of a new issue offered to the public by him as a dealer or distributor within 6 months prior to such transaction or (2) unless, if the transaction is with a customer, he discloses to such customer in writing any interest he may have in connection with the security which is the subject matter of the transaction and offers the customer a reasonable time not exceeding 10 days to refuse the transaction after the disclosure if the disclosure is not made at the time of the taking of the order and confirmed in writing substantially simultaneously therewith.

Sections 11, 12, and 13, dealing with the registration requirements for listed securities, and so forth: Sections 11, 12, and 13 deal with the registration requirements for listed securities and the reports to be made by listed corporations. These provisions are among the most vital in the bill. I have already expressed our opposition to them. In view of the technical nature of these provisions and particularly of those dealing with accounting, I have secured from Mr. J. M. B. Hoxsey, executive assistant to the committee on stock list of the New York Stock Exchange, a memorandum discussing these provisions and suggesting the changes which in the light of his experience he believes necessary. Mr. Hoxsey has been engaged in active business for many years and has had a very wide experience in analyzing corporate accounts and corporate affairs. Since he came to the exchange about 10 years ago it has been his sole duty to analyze corporate statements and consider corporate accounting from the point of view of developing for the benefit of stockholders and investors the most informative type of corporate reports. As Mr. Hoxsey's memorandum is quite lengthy, I shall not read it but I have had copies of it prepared which I will be very glad to submit to you.

In line with my attempt to make concrete suggestions, I am having these sections of the bill redrafted in order to carry out the recommendations made by Mr. Hoxsey and I shall submit copies of these proposed amendments as soon as they are prepared. I hope that will be today.

Sec. 18. Powers of Commission over exchanges. I have already suggested that certain provisions of section 7 should be transferred to section 18 which deals with the disciplinary powers of the Commission over exchanges. In order to carry out this suggestion and also to make clear that the Commission shall have power to require exchanges to adopt rules and regulations to prevent excessive speculation or unfair practices in security transactions, I suggest that subdivision (5) of section 18 be amended so as to read:

Sec. 18. The Commission is authorized-
Leaving in subdivisions (1), (2), (3), and (4), subdivision (5).

(5) If after appropriate request in writing to a national securities exchange that such exchange should effect on its own behalf specified changes in its rules and practices, and after appropriate notice and opportunity for hearing, the Commission determines that such exchange has not made the changes so requested, to require such exchange to adopt and enforce such rules and regulations as are necessary for the protection of investors or for the insuring of fair dealing in securities traded in upon such exchange. Without limiting the general power contained in this subsection, the Commission shall have power to require any national securities exchange to adopt rules and regulations with respect to

(a) Market letters, advertising or other publicity by its members and the solicitation of business by its members or their employees;

(b) Pool's syndicates and joint accounts formed for the purpose of stabilizing or otherwise influencing the market price of any security registered on a national securities exchange and also with respect to options, puts, calls, straddles or other similar privileges;

(c) The amount and nature of the capital employed in his business by a member of such national securities exchange carrying margin accounts and the ra' io which must be maintained of such capital to the liabilities of such member;

(d) The short sale of any security upon such national securities exchange;

(e) The acceptance and execution of stop-loss orders by members of such national securities exchange;

(f) The hypothecation of securities carried for the account of any customer by a member of such national securities exchange or the lending of such securities without the written consent of such customer or the use of such securities for delivery on any contract in which such member is, airectly or indirectly, interested;

(g) The fixing of a fair settlement price in respect of any contracts in any security registered on such national securities exchange which has been cornered or of which any person or persons have acquired such a control that such security cannot be obtained for delivery on existing contracts except at prices or on terms arbitrarily dictated by such person or persons;

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