STOCK EXCHANGE PRACTICES FRIDAY, FEBRUARY 23, 1934 UNITED STATES SENATE, COMMITTEE ON BANKING AND CURRENCY, Washington, D.C. The committee met at 10:30 a.m., pursuant to adjournment on yesterday, in room 301 of the Senate Office Building, Senator Duncan U. Fletcher presiding. Present: Senators Fletcher (chairman), Adams, Townsend, and Couzens. Present also: Ferdinand Pecora, counsel to the committee; Julius Silver and David Saperstein, associate counsel to the committee; and Frank J. Meehan, chief statistician to the committee; Robert Jones, attorney for Cities Service Co.; G. T. Stanford, attorney for Sinclair Consolidated Oil Corporation; and Roland L. Redmond, attorney for New York Stock Exchange. The CHAIRMAN. The committee will please come to order. Who will you have first this morning, Mr. Pecora? Mr. PECORA, Mr. Johnston. The CHAIRMAN. Please come forward, hold up your right hand, and be sworn: You solemnly swear that you will tell the truth, the whole truth, and nothing but the truth, regarding the matters now under investigation by the committee. So help you God. Mr. JOHNSTON. I do." The CHAIRMAN. Just take a seat there at the committee table opposite the microphone. TESTIMONY OF ERNEST H. JOHNSTON, WESTFIELD, N.J., VICE PRESIDENT CITIES SERVICE CO., NEW YORK CITY The CHAIRMAN. Mr. Johnston, please give your name, residence, and occupation. Mr. JOHNSTON. Ernest H. Johnston. Mr. PECORA. Do you spell your last name J-o-h-n-s-t-o-n? Mr. PECORA. Go ahead and finish your answer. Mr. JOHNSTON. 157 Lincoln Road, Westfield, N.J. Mr. PECORA, What is your business or occupation? Mr. JOHNSTON. Vice president of the Cities Service Co. Mr. PECORA. How long have you been connected with the Cities Service Co. in that capacity? Mr. JOHNSTON. For about 15 years. Mr. PECORA. Are you also a director of that company? Mr. JOHNSTON. Yes, sir. Mr. PECORA. What is the general nature of the business conducted by that corporation? Mr. JOHNSTON. It is a holding company for public utilities, oil, and natural gas corporations. Mr. PECORA. Where is the office or principal place of business of the company? Mr. JOHNSTON. No. 60 Wall Street. Mr. PECORA. In the city of New York? Mr. JOHNSTON. In the city of New York; yes, sir. Mr. PECORA. Now, Mr. Johnston, in recent years has it been the practice or custom for your company to issue monthly letters addressed to the executive committee? Mr. JOHNSTON. Not since 1929. Mr. PECORA. Well, did it do so in 1929 and prior thereto? Mr. JOHNSTON. Yes, sir. Mr. PECORA. Who was the author of the monthly letters that we have in mind during the year 1928? Mr. JOHNSTON. Charles H. E. Scheer. Mr. PECORA. Is he employed by the company? Mr. JOHNSTON. Yes, sir. Mr. PECORA. In what capacity? Mr. JOHNSTON. He has been with us since 1914. He started in as cadet engineer in Denver, and has been developed by the company along engineering and other lines. He has shown an aptitude in regard to economics, and has been employed in that capacity in recent years. Mr. PECORA. I show you what purports to be an excerpt from one of the monthly letters, so-called, on economic conditions, addressed to the executive committee of Henry L. Doherty & Co., for the month of December 1928. Will you be good enough to look at it and tell me if you recognize it to be an excerpt from such monthly letter? Mr. JOHNSTON (after reading the paper). Yes, sir. Mr. PECORA. Mr. Chairman, I now wish to offer it in evidence. (An excerpt from the monthly letter on economic conditions to the executive committee of Henry L. Doherty & Co. for Dec. 1928, was marked "Committee Exhibit No. 83, Feb. 23, 1934 ", and will be found immediately following where read by Mr. Pecora.) Mr. PECORA. Now, Mr. Chairman, this excerpt just received in evidence as committee exhibit no. 83, reads as follows, under the caption "A Pivotal Element in 1929?": The huge expansion of credit which took place in 1928 was made possible largely by idle funds in the hands of individuals, corporations, and foreign sources which were made available for security speculation through loans to brokers. Had it not been for this unforeseen large supply of credit there would probably have been an actual shortage of credit in 1928 when as it happened nothing more than an increase in interest rates took place. If these sources continue to supply credit in increasing amounts during 1929 all will be well for both the stock markets and business in general. If they merely hold their own or dry up to any degree, it seems highly probable that the driving force for both speculation and business will be found definitely lacking. It therefore seems that for the year 1929 much may depend upon the course of brokers' loans which are classified in banking figures as "for the account of others." This statement without further elaboration may seem to be rather dogmatic and arbitrary; but its importance warrants mention at the first of the New Year, and the next issue of this letter will devote more space to a detailed discussion of the importance and trend of this factor. Now, Mr. Johnston, I notice that this monthly letter on economic conditions, from which this extract is taken, was addressed to the executive committee of Henry L. Doherty & Co. What is the relationship between Henry L. Doherty & Co. and the Cities Service Co.? Mr. JOHNSTON. Henry L. Doherty & Co. are fiscal agents for the Cities Service Co. Mr. PECORA. Well, as such fiscal agents, what are the functions of Henry L. Doherty & Co.? How do they serve, in other words, the Cities Service Co.? Mr. JOHNSTON. At that time the funds of Cities Service Co. and certain of its subsidiaries were deposited with Henry L. Doherty & Co. Mr. PECORA. And what else? Mr. JOHNSTON. Henry L. Doherty & Co. also maintained operating departments and financial advisors. Mr. PECORA. IS Henry L. Doherty & Co. a corporation or is it a copartnership. Mr. JOHNSTON. It is now an individual. But Mr. Doherty has no part in it. Mr. PECORA. In 1929 was it a copartnership, firm, association, or corporation, or what was its legal form? Mr. JOHNSTON. It was an individual doing business under the firm name of Henry L. Doherty & Co., since 1922. Mr. PECORA. And the the individual who did business under the firm name of Henry L. Doherty & Co. was what person! Mr. JOHNSTON. Henry L. Doherty. Mr. PECORA. Now, was he also an officer or director of the Cities Service Co.? Mr. JOHNSTON. Yes, sir. Mr. PECORA. What office did he hold in it? Mr. JOHNSTON. President. Mr. PECORA. Do you know how long he has been president of the Cities Service Co.! Mr. JOHNSTON. Since its organization. Mr. PECORA. Which took place in what year? Mr. JOHNSTON. In 1910. Mr. PECORA. Now, the Cities Service Co. was organized as a holding company, I believe you said? Mr. JOHNSTON. Yes, sir. Mr. PECORA. And has functioned as such ever since its creation? Mr. PECORA. Do you know the utilities companies whose shares are principally held by the Cities Service Co.? Mr. JOHNSTON. Yes, sir. Mr. PECORA. Can you name them? Mr. JOHNSTON. The Electric Utilities are a group under the Cities Service Co. called the Cities Service Power & Light Co. The Cities Service Power & Light Co. have subsidiaries, and the principal ones are: Public Service Co. of Colorado, Ohio Public Service Co., Toledo Edison Co., Empire District Electric Co., St. Joseph Railway, Light, 175541-34-PT 14-10 Heat & Power Co., East Tennessee Light & Power Co., DanburyBethel Gas & Electric Co., and a number of other smaller companies. The CHAIRMAN. Are they all subsidiaries, do you say, or affiliates, or what do you call them? Mr. JOHNSTON. Subsidiaries of the Cities Service Power & Light Co. Senator TOWNSEND. Is the Eastern Shore Gas & Electric Co. a subsidiary of Henry L. Doherty & Co.! Mr. JOHNSTON. The Eastern Shore? Senator TowNSEND. Yes. Mr. JOHNSTON. No, sir. Mr. PECORA. Now, Mr. Johnston, I show you a printed document entitled "Monthly Letter on Economic Conditions to the Executive Committee, Henry L. Doherty & Co., January 1929." Will you look at it and tell me if you recognize it as being a copy of a monthly letter prepared by Mr. Scheer for the executive committee of the Cities Service Co.? Mr. JOHNSTON. Yes, sir. Mr. PECORA. Mr. Chairman, I offer it in evidence. The CHAIRMAN. Let it be admitted. (A printed document entitled "Confidential. Monthly Letter on Economic Conditions to the Executive Committee, Henry L. Doherty & Co., January 1929 ", was marked "Committee Exhibit No. 84, Feb. 23, 1934 ", and the entire document will be retained with the files of the committee, such portions thereof being read by Mr. Pecora immediately below as he wished to draw to the attention of the witness.) Mr. PECORA. Mr. Chairman, this monthly letter is captioned or entitled, on the first page beneath the cover, "The Present Troublesome Part of Brokers' Loans. Its Effect on Security Markets and Business." And the first paragraph of it is as follows: A new source of credit: Every few years some particular element in the business system takes on new and possibly dominating importance by virtue of its unusual expansions or contraction. In 1920 the climax of unprecedented speculation in commodity markets and expansion of productive activity were dominating factors affecting the subsequent depression. During 1928 the appreciable loss of gold and expansion of speculative credit were the dominating factors. This unusual expansion of credit for us in security markets was made possible largely through loans made to brokers by corporations and individuals. The chart reproduced below shows the rapid growth in brokers' loans over the past 3 years, and in particular the sudden rise in loans for the account of others (corporations, individuals, and foreign) during 1928. In the last issue of this letter, under the heading "A Pivotal Element in 1929", it was stated that if this new source of credit merely holds its own or dries up to any degree, it seems highly probable that the driving force for both speculation and business will be found definitely lacking, and that therefore in the coming year much may depend upon the course of that portion of brokers' loans which is classified in banking reports as "for the account of others." Origin of outside credit: Before discussing definite reasons for this view, it might be well to summarize briefly the origin and development of this new source of credit. As can be seen from the chart on page 5 of the August 1928 issue of this letter, bank credit and its base, gold, expanded rapidly from 1922 to early in 1928. Easy credit conditions during this period, aided by the Federal Reserve policy, and the increasing gold stock, were availed of by real estate enterprises, installment finance corporations, and by what is by far the most important-buyers of securities. Money was most plentiful and corporations took advantage of this and of the great demand for securities to float large amounts of new securities, which were used to build up cash reserves after bank loans were paid off, working capital increased, and some plant expansion taken care of. These cash reserves found employment in the call |