This principle was likewise applied specifically to stock exchange regulation abroad in the British Report of the Committee on the Amendment of the Company Law of 1929.

Some of these (opportunities for abuse) we consider to be part of the price that the community has to pay for the adoption of a system so beneficial to its trade and industry. It seems to us most undesirable in order to defeat an occasional wrongdoer, to impose restrictions which would seriously hamper the activities of honest men and would inevitably react upon the prosperity of the country.

Or to use the explosive epigram of an Attorney General of New Jersey, "It is impossible to legislate common sense into fools or honesty into thieves." There is not in England, France, Holland, or Switzerland any law like our Stock Exchange Act of 1934. There the stock exchanges govern themselves. The governments prefer not to shoulder the responsibility. Moderate and reasonable regulation is desirable. Restriction and minute prescription is highly undesirable. 7. Can the United States become the world's financial center?— That the United States would become the financial center of the world was predicted years ago by Brooks Adams, the grandson of President John Quincy Adams in his introduction to Henry Adams' Degradation of the Democratic Dogma and also by Henry Adams himself who as president of the American Historical Association in 1894 made a prediction that within the next 50 years, the United States would become the financial center of the world. He narrated the movement of the financial centers of history: Babylon, Rome, Constantinople, Venice, Antwerp:

Finally, about 1810 London became the undisputed capital of the world. Each migration represented a change in equilibrium and caused a social convulsion. By 1900 there were symptoms of instability which suggested that the economic center of civilization was already tending to shift toward America * I suggested its date as probably about 1930 but no one took me seriously.

*

In view of the fact that the American stock exchanges have been so greatly restricted in the United States as compared with England, it is a question whether such an historic forecast could be realized under the present Securities Exchange Act.

And, may I say parenthetically, all of the post-war plans call for reconstruction by the United States. It involves a new series of commitments by the United States abroad, and the question is whether world reconstruction will be based on the principle of economic soundness and be taken over by private enterprise or whether it will be done on the principle of lend-lease and passed on to the taxpayer. But, if you are going to count on the private investor taking the burden, you will have to have a freer market and an unshackeled financial machinery.

Mr. YOUNGDALL. Would you care to express a personal opinion as to which method you think best?

Mr. FRIEDMAN. I think there is no question as to which one is. I was in the War Finance Corporation. I remember it had, in 1921, a big portfolio of securities, and the board was eager to get rid of them. It liquidated something like $500,000,000 of loans at a profit, and it did so chiefly by passing the securities out to private investors. And, that is a problem that faces the Reconstruction Finance Corporation now. If you will liquidate that tremendous

portfolio and pass it back to private channels, you will reduce the public debt by retiring Government bonds. You will restore private enterprise, and you will put the risks on the buyers of securities, rather than on the taxpayers.

If anybody could show a system other than private enterprise that works better, I should change my opinion.

We have covered the Securities Exchange Act of 1934, how the law has worked out; what the evil effects are, and now we are coming to the causes.

IV. WHAT ARE THE CAUSES?

It would be absurd to blame the Securities Exchange Act of 1934 for the lag in recovery before the war boom. But, some clauses of this law did contribute to this lag. They prevented the capital markets from functioning smoothly.

1. Informed trading is reduced or eliminated.-The violence of a decline is due to the fact that an insider attempting to stabilize the price of a security is subject to lawsuit. The assumption is that all insiders are dishonest. In consequence, the market is left to the uninformed. The result in the last few years has been evident. Fluctuations have been sensational in their violence and speed.

The law required that officers, directors, and large stockholders must wait 6 months before selling shares purchased, or before repurchasing shares sold. If not, they may for 2 years thereafter be sued for the profits resulting. The liabilities and risks deter insiders from buying and selling. The intent of the law is sound. It aims to prevent officers and directors from buying or selling on inside information and against the interest of the stockholders on the sound principle that no one should benefit personally in acting as trustee. This is good ethics and good morals.

However, the law as it now stands also checks well-intentioned and honest trading by insiders, who hesitate to support a market if they must hold their shares for 6 months, or be subject to a lawsuit. In fact, normally, any property, whether it be shares or real estate or farms or any property whatsoever that is tied up for any period as a result of a deal or a contract has a resale value much lower than the market price owing to the reluctance of any buyer to surrender the right which inheres in owning property-the right to sell at will. But the 6-month clause does not check the dishonest insider. He can sell on inside bad news and never repurchase or he can buy on inside good news and hold for the long pull. The transactions are published only 2 months later, when the value of publication is nil to the little fellow or general public in revealing transactions of dishonest insider traders. Or the dishonest insider can buy in the name of his wife, child, or friend, or director of another corporation who could reciprocate by giving inside information. The law makes it very easy to kep the letter and very easy to violate its spirit.

This feature is futile and even misleading. The aim is good. The result is bad. The method is as ineffective as a scarecrow in frightening a pack of wolves. However, the honest director is prevented from stabilizing the market in his stock. He and his family and friends may own much of the stock and violent swings might be disturbing to them. He may have a sense of trusteeship. Normally

74947-42-pt. 5- -2

he would, and in the past did, buy on acute weakness or sell on great strength, thus making fluctuations less violent. Besides even if the penalties were removed, the honest insiders still would be taking normal speculative risks. They lose money as often as the public. They trade just as badly, as the monthly S. E. C. reports of purchases and sales show. The smash of 1929 hurt equally and indiscriminately insiders and the public. No one was immune to losses.

If you want to see an interesting document, get the report of the Joint Congressional Committee on Taxation, entitled "Million Dollar Incomes." It analyzes a group of returns from 1917 through 1936— 20 years-of men who made a million dollars or more in 1924 and over 50 percent of whose income was derived from capital gains. Do you know how it ended up? Twenty years' gains amounted to $63,000,000; losses to $97,000,000; net losses to $34,000,000. Those were directors and insiders, who enjoyed the best investment advice, had abundant statistics and good connections.

Now, the mere fact that you restrict an insider does not mean that you are guaranteeing the public a profit. On the other hand, the mere fact that a man has the right to buy and sell without restriction of this clause 16 (b) does not mean that he automatically makes money. There were no restrictions from 1917 through 1934, and most of these losses came before 1934.

The honest insider is now suspect and, therefore, he does nothing. But the market does. It swings violently and causes losses to outsiders. It should be possible to find an effective method to preserve the good intent and to avoid the bad results.

The violent swings are intensified by the S. E. C. policies of delaying for 2 months publication of figures of inside trading. What happened? The rise of the market in 1937 came to a climax on August 14th. Now, here are some very significant figures. Insiders sold on balance at that time, according to the S. E. C. figures. But the trades were not published until October 2, or 7 weeks later when the market had already declined greatly. General Motors from August 14 to October 2, declined from 60 to 49, or 11 points. The Dow Jones averages declined from 190 on August 14 to 154 on October 2, or 36 points.

Now, what happened when the news came out? The record was published on October 2 of the selling on August 14. The small public got frightened and dumped its stocks overboard in an indiscriminate manner. One broker told me of a man who came to his office with a satchel full of securities and said, "Take it away. Do anything you want to with them." What happened to the share prices? General Motors which declined from August 14 to October 2, from 60 to 49, or 11 points, dropped in the next 12 days to 31, or 18 points. In other words, in 12 days it dropped 18 points as against 11 points in the preceding 7 weeks. The small fellow said that if insiders were selling, conditions in General Motors must be terrible. of delayed publication is to make a bad matter worse. It is much better not to publish at all than to publish so late.

So, the result

And, the same history holds for the Dow Jones average. In the 7 weeks it declined from 190 to 154, or 36 points, but in the next 12 days it declined 38 points to 116. Prompt publication of insiders' sales would have obviated the enthusiastic buying at the top and the

dejected selling at the bottom by the little fellow, to mother whom the S. E. C. was created. Obviously, the S. E. C. ought to see that those results are published immediately either by the broker or the stock exchange.

The 6 months' period is futile as a measure of honesty. No time scale can serve. In fact, time is meaningless and irrelevant. A transaction completed in 5 months, 29 days may be thoroughly honest. A transaction completed in 6 months, 1 day may be grossly dishonest. A dishonest sale or purchase can be made in a few minutes and may not be undone for years or ever. The real evil is the abuse of confidential information which the 6 months clause does not prevent.

2. Liquidity has been destroyed by restrictions on trading.-By ruling out informed buying and by uncertainties in rules, which have rot yet been defined, after 8 years, the field has been left to the uninformed stockholders. The result is a "boob's" market, in which there is courageous buying at the top and panicky selling at the bottom. Undoubtedly, there were many insiders with a sense of trusteeship who would have sold stock as shares rose sharply in late 1936 and early 1937 and who would have bought stock in the violent break after October 1937. Such buying and selling would have been a blessing to the "lambs" and to the odd-lotters, who added an extra bulge at the top of the market and an extra dip at the bottom. There is litle doubt that the extent and the speed of the rise and the subsequent fall would have been moderated. The regulations were intended to eliminate manipulation, but they went far toward eliminating the market.

Mr. CROSSER. Mr. Friedman, can you tell us about how much more time you desire?

Mr. FRIEDMAN. About 10 minutes; I have about four pages.

Mr. CROSSER. I understand that you were to have about 15 minutes altogether.

Mr. FRIEDMAN. I shall rush through pretty quickly, then. What is the cure? I will skip some pages, but I think that the general drift is quite clear.

V. WHAT IS THE CURE?

1. Revision of the act is desired and desirable.-Neither the country nor the 15 stock exchanges wish to return to 1929 conditions. Some revision can be effected by a change in the attitude of the Commission, and by issuing rules under its discretionary powers, even if the law is not amended.

The Commission is said to have been granted more discretionary powers than any other Government bureau ever created. A time limit should be set to these discretionary powers. They should lapse if it is impossible or too difficult to write the rules or if the Commission does not see clearly or decide confidently. Eight years of uncertainty should be ended by Congress.

The legislation was hasty. It was a piece of "must" legislation. The President recommended it in February 1934 and the law was signed in June 1934. Only 4 months was allotted to reform the Stock Exchange, an institution that took 150 years to evolve, and whose ramifications affect both capital, labor, and the farmer.

How different was the procedure in Great Britain. The British Committee on the Companies Act was appointed in 1925 and the act

was passed in 1929. The British Committee on Fraudulent Share Sales was appointed in December 1936, and the act was passed in July 1939.

Or let us examine the legislation of other important reforms at home. The investment trust inquiry was begun in January 1936. Recommendations were made in January 1937 that some legislation be enacted. The actual bill was introduced in March 1940. The study covers a period of 4 years, or 12 times as long as the S. E. C. Act of 1934. This is a case of the sound principle, both in finance and in politics, of "Investigate before you act."

Again, the Federal Reserve Act grew out of the panic of 1907, as the S. E. C. Act grew out of the collapse of 1932. The National Monetary Commission was appointed in May 1908. Hearings were held at home and abroad for 2 years. The Aldrich bill was drafted in December 1910, and it was developed with the cooperation of the commercial bankers. The bill presented a plan for the complete reorganization of the banking system. In 1910 the Republicans lost the House, and banking legislation was delayed. Carter Glass, then chairman of the incoming Banking and Currency Committee of the House worked on the legislation between April 1912 and June 1913, when the bill was introduced. It became a law on December 23, 1913, and was amended twice in 1914 and once in every year from 1915 to 1919, or seven times in 6 years. The 1934 S. E. C. Act has not yet been amended once except in regard to minor matters like unlisted trading and over-the-counter markets.

Modification of the law was urged many times during the last few years. Among other changes the following seems desirable:

Repeal section 16 (b) on buying and selling by insiders. The law states, "This subsection shall not be construed to cover any transactions which the Commission by rules and regulations may exempt as not comprehended within the purpose of this subsection;" namely, "unfair use of information" to make a profit.

No rules have been written in over 7 years. Is not this fact itself a significant commentary on the difficulty of writing rules on section 16 (b). The uncertainty is vicious in its effects. Since practical rules could not be worked out in 7 years, should not section 16 (b) be repealed? Instead the publicity features of 16 (a) should be tightened. Publication should be not after a 2-month delay as at present, but immediately at the time of the transaction or at most after 3 days. Section 16 (b) would then in any event become futile and redundant. The small stockholder would thus have genuine protection. Under existing provisions of delay in publicity on insiders' transactions the little man is deceived on the rise and frightened on the decline in the market.

2. Encourage stabilizing operations.-Stalization is essential. Even the Government recognizes this. It has a stabilization fund for Government bonds. If the Government bond market were subject to similar restrictions on stabilizing trades it would probably fluctuate very violently and be as disturbing to public confidence as the fluctuations of the stock market disturb the confidence of private businessmen. Furthermore, the Government also has a stabilization fund to regulate the fluctuations of the foreign currencies. There seems to be one law for the stock market and a different law for the Government bond market and for the foreign exchange market.