PROPOSED AMENDMENTS TO SECURITIES ACT OF 1933

AND THE SECURITIES EXCHANGE ACT OF 1934

CONTINUATION OF THURSDAY, JANUARY 22, 1942

STATEMENT OF ELISHA M. FRIEDMAN, NEW YORK, N. Y.

The CHAIRMAN. Mr. Friedman.

Mr. FRIEDMAN. Mr. Chairman and gentlemen, my name is Elisha M. Friedman, consulting economist, representing the general public interest. I wrote this paper as a unit, but I would like to ask your permission to go over those parts that concern the subject assigned for today, section 16, and with your permission to insert the rest of the paper in the record.

The CHAIRMAN. You may do that. The witnesses have the privilege of revising their remarks.

Mr. FRIEDMAN. Thank you.

I. THE SECURITIES EXCHANGE ACT OF 1934

The purpose of the act is not new. The need and the desire to regulate the stock exchange grew out of a generation of thinking. The Hughes committee in New York State attempted in 1909 to correct some evils of speculation. The Pujo investigation in 1912 revealed many grave defects in the financial machinery.

Beyond doubt, the Securities Exchange Commission Act of 1934 was skillfully and ably drawn. It is a fine specimen of legal technique. But no law of man's making is infallible or immutable. Experience of 8 years is now available. Some findings are clear. Some amendment is inevitable.

The paper deals with four topics: How did the law work out? What are the evil effects? What are the causes? What is the cure?

II. HOW DID THE LAW WORK OUT?

1. The aim of the law was defeated.—The aims of the 1934 act are stated in the preamble:

National emergencies which produce widespread unemployment, and the dislocation of trade, transportation, and industry * * * are precipitated, intensified, and prolonged by * * * sudden and unreasonable fluctuations of securities prices * * * and to meet such emergencies, the Federal Government is put to such great expense as to burden the national credit.

Since 1934, when the Securities Exchange Act was passed, these evils have not been avoided. They have become intensified. The rise in securities prices from 1935 to 1937 was one of the longest on record. The decline in securities prices from August 1937 to November 1937, was the steepest and most violent in history. Fluctua

tions of securities prices are even more "sudden and unreasonable." Likewise, the decline in business from August 1937 to April 1938 and the rise in business from April 1938 to December 1938 were the most violent on record. "Dislocation of industry" is "precipitated" and "intensified" by Securities and Echange Commission type of markets. It created or helped to create this through "sudden and unreasonable fluctuations in prices." And in every year since the act was passed, the Federal Government has increased the national debt and "burdened the national credit."

The psychologist has an apt epigram, "Our wishes often retard their fulfillment." The method defeated the purpose.

2. The market has lost its chief characteristic marketability.The stock market is thinner than ever before. In the whole year 1939, only 262,000,000 shares were reported sold on the New York Stock Exchange. This total is less than it was 38 years previouslyalthough the number of shares now listed is 23 times as great, because insider buying and selling is restricted. The 1939 sales were also less than in 1919 and in 1924, even though listings now are seven times and three times as great, respectively. In relation to the number of shares listed on the New York Stock Exchange, the sales in 1939 were by far the smallest on record. Further declines occurred in 1940 and 1941. The decline in sales showed a sharply accelerated rate since the 1934 act was passed. The exchanges in the other 11 States show similar results.

As a result, markets are thin. Bid and asked quotations are wide apart. Listed shares have lost their marketability, and important element in valuing securities. According to James F. Hughes, of New York, an authority on the subject, to raise share prices 1 percent the market required in January 1938 only 1,000,000 shares and in September 1938 only 1,300,000 shares. In the 1920's the moves were not so violent. To make prices fluctuate 1 percent required in 1925, in 1926, and even in 1929, from 5,000,000 to 6,000,000 shares. Again, the movements are as brief as they are violent. In 1938 and 1939 the market rose 22 percent in 12 days, and 16 percent in 9 days, respectively, whereas in 1926 and 1929 to move the market 19 percent required 61 days and 35 days, respectively, 5 times and 3 times as long.

The record is even more sensational on the decline. In points per million shares traded, the decline of March 11 to April 8, 1939, was six times as rapid as the decline of September 3 to November 13, 1929. The decline from September to November 1929 was the first tremendous crack in the market, which was one-sixth as rapid per million shares as it was in 1939.

Again, in 1937 buying by insiders was restricted, and in 1929 there was tremendous buying by insiders, who attempted to stabilize prices. The decline from August 12, 1937, to October 19, 1937, when buying by insiders was restricted, was five times as rapid as in the 1929 panic, when buying by insiders was not restricted. As I pointed out in the New York Times on April 16, 1939, reprinted in the Congressional Record of April 27, 1939, the overregulated stock market in New York swung more violently in 1939 than either of the less regulated markets in London or Paris during the war threats of early 1939.

Since the 1934 act was passed market moves have been fitful and fleeting and unsettling to values. Before the passage of the 1934 act the market moved with steadiness in one direction for many weeks. A slow and generally rising market creates confidence and makes possible the issuance of new securities either by subscription rights or by public offerings. But when a market moves madly for 10 or 12 days, and then turns dead, confidence is destroyed. It becomes difficult, if not impossible, to issue new securities for expansion in this brief period, since registration alone requires 20 days. Even if you are able to time the beginning of the upswing in the market and register immediately you will still be "in registration" when the move is all over.

III. WHAT ARE THE EVIL EFFECTS?

1. Small holders were the losers in the 1937 decline.-It is true that small holders were not forced out by margin calls. The large S. E: C. markets gave them the illusion of security. But the violence of the decline, nevertheless, caused many to sell either through sheer fright or even through the exhaustion of once ample margins. According to the S. E. C. figures, odd-lot purchases near the 1937 top-and the odd-lot purchasers are all little fellows-from January to March 1937, the last 2 months of the boom, amounted to approximately 3,000,000 shares, or about $100,000,000.

The Securities and Exchange Commission's own figures also show that the odd-lot holders were furious sellers at or near the bottom of October and November 1937. The speed of the decline and the losses to the odd-lotters occurred under a law which restricted insider buying and selling, and under which floor traders and specialists, the former shock absorbers of the decline, were rendered powerless through innumerable regulations and through "daylight" margins, higher than required of the public.

The administration spokesmen say that the Government cannot guarantee market stability. True, but should the Government legislate instability by eliminating insiders' buying and selling? The very violence of the swings vitiates market judgment, and in turn makes the market under the Securities and Exchange Commission more a matter of a gamble than of reasoned judgment.

The law sought to save the little fellow from being sucked into the market by pool manipulation of prices, and then being shaken out by thin margins. Those two features of the law are certainly very desirable and should be strengthened. In this respect the law succeeded. But the little fellow now faces new terrors of "shooting the chutes" and of mad ups and downs. This newly created danger can be avoided by slight changes in the law without impairing the principle of the act, which is certainly beyond praise.

2. Liquidity is lacking.--Because the stock exchange has ceased to be a broad liquid market, securities are sold elsewhere. The stock exchange is discriminated against. Large blocks of stock, which might have been bought by insiders through the exchange machinery, have been peddled around, particularly by firms not members of any exchange. In one fortnight, in March 1940, over 350,000 shares were sold off the exchanges, including active issues which used to enjoy a good market--Socony-Vacuum, Commonwealth Edison, and General American Transportation. However, even if such shares are

sold off the exchange, the price of each sale is determined by a price on the exchange. In other words, the stock exchange still fixes values, but receives no revenue to pay for the cost of doing so. It serves merely for window shopping by "comparison shoppers."

Further, trading is also driven from the overregulated stock exchange to the less-regulated over-the-counter market. In England a law of 1697 prohibits stock jobbing and brokerage by outside brokers and many reforms on the London Stock Exchange are directed against trading or selling off the exchange. In France, it is a criminal offense to sell off the exchange any securities listed on the exchange. Unlike the buyer on the stock exchange, the buyer overthe-counter does not enjoy the benefit of price publicity which the tape affords and has no control of the broker's fee or profit.

As a result of discrimination against listed stocks the insiders or large owners of unlisted securities no longer are eager for a listed market and for a public following from which new money for expansion may be more easily raised. The Securities Exchange Act of 1934 has thus arrested the trend from private to publicly owned corporations and from unlisted to listed securities. Promptly after the 1934 act was passed, 35 companies withdrew from the Cincinnati. Exchange to avoid discrimination against the listed companies through regulations concerning expensive reports, sponsoring shares and trading by insiders. Not one new stock, unduplicated, had been listed in Boston since April 1938 and in Chicago, since October 1938 up to the date of this paper. (May 1940.) Thus, the democratic and desirable tendency of diffusing ownership widely among the public has been checked.

3. Marketability is an important factor in price.-Of two companies showing the same share earnings, the shares having the poorer marketability usually sell at a lower price. Similarly, of two bonds enjoying the same degree of security of earnings, the inactive bond usually sells at a lower price. The reduced liquidity under the Securities Exchange Act of 1934 has probably lowered the price level and caused a loss of several billion dollars to the 10,000,000 American shareholders. (See chart on p. 5.)

The chart shows the relation of marketability and price. It shows from 1929 up through 1933, that the two curves, earnings and share prices, moved very close to each other. From 1934 on, the curve of share prices pulled away from the earnings curve and went down and the gap kept on getting wider and wider. What else can be the reason other than that in 1934 the Securities Exchange Act was passed, and subsequently increasing restriction put into effect. The chart proves the point that all of us know-good marketability is an element in price. The chart is very clear. It shows not merely individual companies, but all of the securities in the index, 400 industrial stocks.

Every one-point decline represents a loss to the public of about $1,500,000,000. That has a significance to the Government in the inheritance taxes. It collects less when any of that billion and a half happens to be reflected in the inheritance taxes of the year.

And yet a liquid market can be honest. And an illiquid market can be dishonest, as we know that from some of the exposures of