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I am a member, was sent this bill and asked to make their criticism on it and criticisms were made independently.
I have seen some of those letters, and I think that Mr. Woods and Mr. Prescott have.
Mr. Hall, of the Investment Bankers Association, was the one who asked me to get a committee to represent the Investment Bankers Association. Mr. Hall is the president. The reason for that is that Mr. Hall and I have had a number of conversations over the telephone and it was because of the large number of letters that were coming from the membership of this organization who had read the bill objecting to it in its present form.
I just wanted to make that correction of the situation.
The CHAIRMAN. Very well. The committee will stand adjourned until 10 o'clock Monday morning.
(Thereupon, at 12:01 p. m., the committee adjourned to meet Monday, June 21, 1937, at 10 a. m.)
TO AMEND THE SECURITIES ACT OF 1933
MONDAY, JUNE 21, 1937
HOUSE OF REPRESENTATIVES,
Washington, D. C. The committee met, pursuant to adjournment, at 10 a. m., in the committee room, New House Office Building, Hon. Clarence F. Lea (chairman) presiding.
The CHAIRMAN. The committee will please come to order. Mr. Prescott, you may proceed.
STATEMENT OF JOHN A. PRESCOTT, PRESIDENT OF PRESCOTT,
WRIGHT, SNIDER CO., OF KANSAS CITY, MO., REPRESENTING THE INVESTMENT BANKERS ASSOCIATION OF AMERICA.
Mr. PRESCOTT. Mr. Chairman and gentlemen of the committee. The CHAIRMAN. Give your name, please.
Mr. PRESCOTT. My name is John A. Prescott. I am president of Prescott, Wright, Snider Co., Kansas City, Mo., which is an investment banking corporation incorporated under the laws of the State of Missouri.
For the information of the committee, I might say that I have been engaged in some form of the securities business since 1888. It has not always been called investment banking, because that term was not invented then.
But during that entire period I have had quite an intimate contact with investors and have formed some conclusions, I think, some ideas about their psychology and their interests.
I was asked the other day by Mr. Hall, the president of the Invesment Bankers Association of America, to come down here and present my views with reference to the pending bill, known as the Lea bill.
Mr. Hall did not impose upon me any restriction in this discussion. While in a sense I appear as a representative of the Investment Bankers' Association, I reserve the right to express my individual views based upon my individual experience; and hope that the committee will consider them as being presented in that way.
ATTITUDES AND POINTS OF VIEW; PRACTICALITIES I am not a lawyer and it does not seem worth while for one who is not a lawyer to attempt an analysis, a detailed analysis, of the bill from the standpoint of draftsmanship or technicalities.
Unless, therefore, the questions from the members of the committee, if they should ask any, should lead to that, it is not my intention to take the matter up in that way at all, but rather to try to present to you some practical considerations that will occur in the minds of the investors and that will tend to show how they will be affected by the operation of this bill.
At first I want to say that I am personally in entire accord and sympathy with the objectives or main purposes of the Commission and the proposals of this bill, of its declared purposes, but the question in my mind is, will it produce the results.desired, will it improve the situation with reference to investors' interests, or will it make the situation worse?
In my opinion, as I have read the bill and studied it, it seems to me that it will not improve the situation; not that I am opposed to any form of legislation at all on the subject, but rather am desirous that whatever legislation is passed shall be so designed that it will accomplish the beneficial result which is desired by the proposers of the bill which is, as I understand it, the protection of the individual investor.
The institutional investor, that is, the large investor who was mentioned here last Friday occasionally, is usually pretty well equipped to look after himself—big insurance companies have trained financial officers who know about as much about investment securities as the investment banker does himself—sometimes more. They are perfectly qualified to take care of their interests and pass judgment on what they buy and to exercise remedies that are available to them in the event that disaster comes; but the individual investor is in a somewhat different position. He is not trained in all of the features of finance. He is more or less helpless when trouble occurs. And, the design of this bill, as I understand it, is to protect him. That is a laudable purpose and one with which I am in entire accord and sympathy; but I should very much regret to see legislation passed which would have the opposite results and make his condition worse than it has been in the past.
In order to enable you to judge of the basis and value of such suggestions as I may make here today, I want to begin by drawing certain distinctions which I think are important.
There is a very decided difference between the way this business is carried on in the big centers where the big supply of capital is and in the smaller centers, where most of the individual investors usually live.
To the big centers, corporations which need large sums of money go to secure it, because the supply of capital there is large and centered there. New York, for instance, is a clearing house for large financial operations both in commercial banking and investment banking. Because of that very situation, however, and the largeness of the supply of capital and the largeness of the demands, methods of handling that business have grown up differing considerably from the practice in smaller centers.
If an industry desires to raise a large amount of capital, it goes to some prominent investment banker or bankers in whose ability to raise large sums it has confidence; and that large banker may be interested
primarily more in the source of that business than he is in the ultimate individual investor with whom he usually has very little if any contact.
Mr. Mapes. May I ask a question?
Mr. PRESCOTT. What I meant by that allusion was the source of opportunities to get securities issued, moving from the people desiring the money and not the people supplying it. That was the thought I had in mind.
Now, the ordinary mode of operation in a case of that kind is for the big banker in the central city to consider the merits of the proposition from his standpoint, and having decided to carry on the financial operation, to sponsor it. He goes through the process of having it underwritten. That means, as you all know, an agreement to buy the securities or see that they are bought, if the public does not take them when they are offered to the public. That is a distinct and valuable function in these large operations, and often is in the small ones, as I will point out later; but those underwriters ordinarily do not distribute the securities direct to the investing public. They invite houses out in the smaller centers to participate sometimes in the underwriting, but usually in the distribution for which they pay them a commission.
The small distributing house in the local center has close personal contact with the ultimate investors and that is why that distributing house is valuable to the underwriting bouse. It can sell the securities direct to the investors, which the underwriters often cannot.
I point out this factor of remote or indirect contact between the large originating houses, which, of course, are largely in the public eye because of the magnitude of their operations, because I think it is very important and very essential to consider in trying to find the solution to the problem at which this bill is aimed.
I want to call attention to another thing, another striking difference in the financing in the central market, or central markets, from that in the local markets, and that is that the commercial banking element sometimes plays a part in the large centers.
I am not alluding to inerlocking relationships in this particular case. Up to very recently, prior to the time the recent banking act was passed, it was possible and customary for a large banking house in a big center not only to do financing, that is to raise capital for their clients, but also to have commercial banking relationships with them. That did many times afford an opportunity for profits and possibility for conflicts of interest, such as does not occur in the smaller centers in the mere distribution of securities.
That difficulty has I think, now practically disappeared because of the passage of the banking act by which banking organizations carrying on a commercial banking business are not permitted to underwrite corporate securities; but it was a very important factor up to very recently.
I mention that because in the investigations that have been made by the Commission, so far as I have seen them in their reports, and had an opportunity to examine them, very largely deal with situations where that element was involved.
The financing was done long ago before that banking situation was changed. Such conflicts probably could not occur to the same extent,
at least, in the future. There is little opportunity for such conflicts, certainly less opportunity than there was formerly.
There are, of course, in these large centers certain smaller houses that may participate modestly in underwritings with the larger houses—they often do—where the underwriting is very large, but they are mainly interested in distributing to their local customers.
That interest enters into the situation in the larger centers, but it is almost exclusive in the smaller centers relating to large issues.
Now, I want to return to the distinctions and call your attention to the difference between the situation that I have attempted to describe in the larger centers and the situation in the smaller centers where most of the actual, ultimate investors live or through which they are generally served. There, operations fall into a number of different classifications. I will refer first to the participation by local houses in the large offerings which originate in the big centers. Many local, widely scattered houses formerly used to be invited to participate quite extensively in the underwriting of large issues. That is not so common now, though it does frequently occur. It is more frequently the practice since the depression for the large originating houses in the big centers to invite the local houses to merely participate in the distribution of securities for a commission without undertaking an underwriting liability. In either case the local investment banker is largely dependent for his information and his facts upon the central house of origination. If he decides to participate in either way he must depend more upon his confidence in the large house of origination and their thoroughness and dependability in investigations than upon his own ability to make original investigation, because as a rule he has no contact and no influence with the issuer. Certainly he has no opportunity to dominate the issuer or to influence him to any extent. He is too small a factor. He is a mere tadpole in the puddle.
That brings me down to another classification which I think is particularly interesting from the standpoint of the investor himself and that is local financing.
You know, of course, big industries do not spring up immediately. They are the result of gradual growth and combinations or acquisitions; or perhåps in some cases just natural growth. Most of them have a small beginning and they very often begin in smaller financial centers or their neighborhoods, and they naturally go to their neighbors and friends for capital when they need it.
This gives rise to a class of operations in which the local investment banker takes a leading part. This often involves underwriting. That is, he practically buys the issue and then resells it to his customers. Sometimes he takes associates and partners, if the underwriting, he feels, is too large for him to assume alone, though he often does assume it alone; but the distribution of such liabilities is usually local or else confined to similar centers, of similar size and financial importance.
So, because it is not large enough it usually does not get into the big banking centers at all and thus become subject to the play of such conflicting interests as may exist there. The originating house in the local community where the security is issued knows the industry it is financing intimately. Its investing clientele usually eventually also knows it quite intimately, even though the first time financing