Certain amendments have been suggested to section 2 (11) of the 1933 act which are important. New subsections 2 (11) (a) and 2 (11) (b) are proposed to define the term "underwriter" more clearly than is done in the present law and to provide for certain exceptions to those who shall be included within this definition. The new subsection (a) and the first three paragraphs of the new subsection (b) are highly technical in character and are designed to clarify rather than to greatly change the law. The Securities and Exchange Commission and the securities industry are in agreement on these changes. In view of their technical character, however, one of my associates will later in these hearings discuss them in order that the record may be clear.

The new paragraphs four and five under section 2 (11) (b), however, are of great importance, and should be carefully analyzed. I should like at this time to discuss the first of these, namely, paragraph 4, appearing on page 8 of the committee print.

PERSONS NOT SELLING TO THE PUBLIC

Subsection (b) excepts from the definition of the term "underwriter" various classes of persons. The Securities Commission is urging the adoption of subsection 4, which would, in effect, permit the Commission to exempt from inclusion as underwriters, with all their attendant duties and liabilities, persons who do not buy with a view to a public offering, or sell for an issuer in connection with a public offering, if it finds that "having due regard for the public interest and the protection of investors their exclusion as underwriters is not inconsistent with the purposes of this title."

In order to clarify what the result of the adoption of this subsection would mean, I would like to discuss briefly the function and duties of underwriters as they are known in this country.

In general, corporations desiring to raise funds through either bond or stock issues, approach security houses whom they regard as experts in their line, with a view to securing advice as to the type of issue best adapted to the market, and probable prices which can be secured, and general assistance in the setting up of their financing. It has been the custom in this country, assuming that a satisfactory arrangement has been made, for the group of houses thus approached by the company to agree to form what is known as an underwriting group. When registration with the Securities and Exchange Commission is complete this group will, in effect, insure to the company the sale of their issue. In practical operation the group purchases from the corporation the issue in question and offers it to the public, usually through a much larger group of dealers who may not participate in the original purchase from the issuers, but who are allowed a reasonable commission for placing the securities with their clients. By handling the financing in this way the corporation is relieved, as soon as the contract is signed, of any further risk of market change and is assured of receiving its funds at an agreed upon time and place.

Underwriters in this country do not ordinarily purchase issues from corporations with a view to permanent investment themselves, but on the contrary they buy them at such a price as in their opinion will enable them to market the securities with the public within a relatively

short period. The underwriter, in effect, acts first as a financial adviser, and second as an insurer to the corporation, and for that service he is entitled to a reasonable compensation which, however, he receives only if all goes well with the sale of the issue to the public.

Underwriters, as you know, are subject to substantially the same liabilities in respect of the registration statement as officers and directors of the company. These are the severe liabilities provided for in section 11 of the Securities Act of 1933. Moreover, a resale made by an underwriter must involve the delivery of a prospectus. On the prospectus the underwriter is also subject to the broad liability of section 12. If, during the period of distribution, anything happens to change the status of the company, the prospectus must be corrected. If the underwriter has guessed the market wrongly and it takes him a year or more to sell the issue, he must, under the present law, have the company prepare a revised prospectus in which he shares responsibility, bringing the facts and figures down to date. You will recall that an amendment section 7 (c) has been suggested which will somewhat ease the position of an underwriter in this respect. Under the proposed amendment of section 7, moreover, it will be required in such instances that the registration statement as well as the prospectus shall be amended to bring them up to date, and of course the underwriter remains under section 11 liability with respect to the amended registration statement. These requirements for keeping up to date the registration statement and prospectus continue until the last of the issue is sold.

For example, in the case of the Pure Oil Co. preferred stock, the underwriters obviously miscalculated the market. That issue was offered in 1937, and it is not yet all sold by the underwriters. The company has therefore been compelled to revise its prospectus each year and the underwriter has continued to be required to use the prospectus on any sales which he makes, in spite of the fact that a substantial part of the issue has been sold and is regularly traded in in the markets.

The reason for all this is that Congress apparently felt that so long as an original purchaser of securities from a company was in process of distributing those securities to the public, he should be required to supply the public with the same kind of information and assume the same kind of liabilities whether the sale is made within 1 day of the offering, or 1 or 2 years. The theory of it is easily understandable, although at times it seems to work undue hardship. If subsection 4, which is recommended by the Securities and Exchange Commission, were adopted, it would give the Securities and Exchange Commission the authority to exempt from these requirements and these liabilities certain classes of underwriters.

The only limitation under which the Commission would operate would be found in the requirement that the persons so exempted should not have purchased "with a view to a public offering" and should not sell on behalf of the issuer in connection with a public offering. Obviously this proposal is a broad one. It would permit anyone who changed his mind after making his original purchase to resell without section 11 liabilities.

The industry believes that anyone who engages in the underwriting of securities in accordance with the procedures contemplated

by the Securities Act when it became law, should be subject to liabilities of underwriters imposed by section 11 and other provisions of the act. At least careful scrutiny should be given to any proposal to exempt underwriters from the liabilities of underwriters, and it should be quite clear that the public interest demands such exclusion before any such change is made.

To ascertain the reasons which have led the Commission to make this proposal and to see what classes of persons they apparently would exempt from the duties and liabilities of underwriters if it were adopted, we have to look to what the Commission has said about it in its report. From that report, the Commission bases this proposal on the inference that the investment bankers of the country do not have sufficient capital to handle the amount of underwriting necessary for the economy of the country, and for the purpose of enabling institutional investors, principally insurance companies and banks, to supply this supposed deficiency. Thus the Commission's report refers to the possibility of permitting institutional investors "to make agreements to buy for investment either specified or unsold portions of issues which are being offered to the public by under

writers."

To the securities industry this looks like a proposal to put the banks back into the underwriting business and to introduce insurance companies into it for the first time since 1906, either openly or in some form which would enable the banks and insurance companies to escape the effect of laws which prohibit their engaging in underwriting. Of course the institutions can now buy new issues at the public offering price, or at a special price if that fact is disclosed to the public. What the Securities and Exchange Commission must desire, therefore, is to find a clearly legal way in which they may negotiate along with underwriting groups for the purchase of securities or under which they may enter into agreements with underwriting groups to take off of their hands any unsold balances of publicly offered issues after a certain period. Presumably, if this latter arrangement were entered into, the banks would not only buy at some special price not available to the general public or other institutions but would also receive a standby fee represented by some percentage of the offering price for furnishing this insurance.

This latter proposal comes so close to being a purely underwriting function that it is difficult for me as a layman to perceive the difference. And, of course, you realize that underwriting by banks was forbidden by Congress in the Banking Act of 1933 and is generally forbidden by insurance companies by State laws.

What are the reasons for this proposal? I have already said that the only reason assigned, so far as we can find in the comments of the Securities and Exchange Commission, is that it would add substantially to the amount of underwriting capital available and make financing easier. We do not believe this is a fair statement of the situation.

In the first place, we know of no business which has failed to raise funds through lack of sufficient underwriting capital in the securities business. They have failed for various other reasons, but certainly no security suitable for bank or insurance investment has failed to sell because of lack of underwriting capital. We should be interested to

hear of any examples which could be brought forward; we have not been able to find any.

The Investment Bankers Association last winter sent questionnaires to its members asking for information, among other things, as to the amount of capital actually employed in the business. I regret to say that not all of our members replied on this point and some of the answers were not complete and satisfactory, but some 329 firms did reply and give the actual figures of capital employed in the businesses. It is interesting to find that these 329 firms showed an aggregate capital employed in their businesses of $327,000,000, in round figures. According to reports of the Securities and Exchange Commission there are between 6,000 and 7,000 firms registered with the Commission and our report therefore, covered about 5 percent of the firms in the business.

There is no question that the replies we received included the largest houses in the business and so it would be by no means fair to multiply the above sum by 20. However, it is certain that the remaining thousands of houses, which are not represented in our replies, had in the aggregate a substantial sum; whether it was $50,000,000 or $150,000,000 or $300,000,000, I have no way of knowing. Possibly the Securities Commission could supply those figures from its own records, but it would be my guess that there is certainly at least $400,000,000 of capital in liquid form available for the underwriting of American industry.

In the recent American Telephone & Telegraph issue there is a clear indication of what is available. Morgan, Stanley & Co. easily formed one syndicate of 28 large houses to underwrite $95,000,000. Halsey, Stuart & Co. had applications from various firms for $150,000,000 more from 178 houses, according to the information which they have supplied me. This represents only 206 firms and yet they were prepared to put up $245,000,000.

In spite of the size of American industry it is rare that an issue of securities exceeds $100,000,000. As a matter of fact, it is rare if an issue exceeds $50,000,000, and the average security issue is far smaller than that. It would certainly be a safe and conservative statement to make that the average security issue does not exceed 10 percent of the amount of available underwriting capital. I think that is a great exaggeration, too. If this is a true analysis of the underwriting situation in this country today, there is no such need for the proposal which we are considering as the Commission infers.

In the second place, if there were any shortage of underwriting capital this proposal would not remedy the situation in the only field which would be seriously affected. The proposal could be of help only to the first-rate securities of first-rate companies which have no trouble in raising funds anyhow. Insurance companies and banks have a great reservoir of funds but these are not available except for certain limited types of high-grade bonds. The funds of these institutions have always found their way into high-grade bonds publicly offered. Certainly these funds are not available for common-stock underwritings, for both bank and insurance laws-State and Federal-generally forbid such investments in addition to forbidding underwriting. They are not available for second-grade securities for insurance and banking laws and bank examiners will not permit them to be used in that way. Bank funds generally are not available for long-term securities for that is not regarded as sound bank policy. The proposal could thus

be of no help at all on stock issues, nor on bond issues of anything except companies of first rank.

I am sure, also, that neither the Commission nor anyone else would want to be in the position of urging banks and insurance companies to buy inferior securities for the sake merely of getting them at a special price or of getting some kind of a stand-by fee for insuring their sale. It thus seems to the industry that the supposed need for this proposal, viz, a supposed shortage of underwriting capital, does not exist, and that if it did exist the proposal would not meet the need.

As I have said, the industry fears that this proposal would amount to at least an opening wedge to participation by banks and insurance companies in underwriting. The Commission refers to this fear as "fantastic" in their report. They refer to the fact that the Banking Act of 1933 forbids banks to enter the underwriting field and to the fact that the laws of New York and other States prohibit underwriting by insurance companies. That is all true and it may well be that even if the Commission were given power to decide that underwriting by banks and insurance companies did not amount to underwriting for the purposes of the Securities Act, banks and insurance companies would still not be legally authorized to engage in underwriting. But if that is so, the whole reasoning on which the Commission bases the proposal backs down. If the banks and insurance companies cannot engage in underwriting in any event, there is no point to giving the Commission power to relieve them of certain of the duties and responsibilities of underwriters and there is no occasion for putting into the statute a broad power of the character sought. It seems to me that the Commission is trying to take two inconsistent positions on this point; on the one hand it says that it wants to permit banks and insurance companies to engage in certain underwriting transactions without the liability of underwriters and on the other hand assures us that they cannot act as underwriters under any circumstances.

The Banking Act of 1933 prohibited banks from acting as underwriters or distributors of corporate securities. Congress passed this act, because it felt that abuses had arisen in connection with such activities to such an extent that it was contrary to the interests of both the banks and the public that they be continued. However, if it is now desirable for banks and insurance companies again to be underwriters then they should assume the liabilities of underwriting if their State laws permit, and the Federal law on banking should be changed to so permit them. If the State and Federal banking laws do not permit it, then they should stay out of underwriting, plain or camouflaged.

One other aspect of this proposal seems to us important. I have already pointed out that under the Securities Act underwriters are subject to severe civil liabilities and assume large responsibilities on securities which they underwrite. If institutions such as banks and insurance companies were permitted to buy securities on the basis recommended in subsection (4), it would have to be done on their assurance that they are not purchasing "with a view to a public offering." I have no doubt that any institution could sign such a statement on any bonds purchased in this manner with an entirel v clear conscience and with utter truthfulness, and thus get around prohibition in the New York laws and Federal Banking Act, and