AS TO SEGREGATION AND THE SMALL DEALER As to the proposal which is made with respect to section 11 (e) itself (p. 219 above), the viewpoint of the representatives of the industry is that the Commission has already made its study of the feasibility and advisability of the com-. plete segregation of the functions of dealer and broker as directed by the Congress in 1934 and that the intent and purposes of that subsection have now been met. Nor does it seem probable that an additional study if undertaken at this time would bring forth any additional information, data, or facts not already in the possession of the Commission and available to the Congress. In part III of the report which the Commission submitted to the Congress on June 20, 1936, relating to the subject of segregation generally, it is mentioned that a factor deserving of consideration is that compulsory segregation in all probability would drive numerous broker-dealers out of business. The report says that the combination of revenues derivable from both types of activity seems essential for the survival of some of these firms, and this tends to become more true the smaller the locality in which the firm operates (S. E. C. Report of June 20, 1936, p. 105). In view of this and other similar considerations, the representatives of the industry urge that the Congress take action now to free these dealers from the constantly disturbing threat of intervention on the part of the Federal Government which might make it impossible for them to continue in business. The repeal of the present section 11 (e) and the adoption in its stead of the alternative presented on page 219 above is accordingly recommended. The CHAIRMAN. Under section 11, and 11 (b), there is a provision for regulation by the Commission of members and odd-lot dealers. There is also, I believe, a similar provision in reference to specialists, the first reading— so far as may be reasonably necessary to carry on such odd-lot transactions, and so far as practicable to those reasonbaly necessary to permit him to maintain a fair and orderly market. Speaking broadly, what has the Commission done under that regulatory power? Mr. STOTT. Well, at the Commission's suggestion, working with the other exchanges, we have adopted certain restrictive rules and regulations, limiting the specialists' activity, saying that they should not disturb the market quotations unless it is necessary in their acquiring an inventory or at times in disposing of an inventory. Many times it is necesasry for the specialist in order to acquire an inventory to disturb the quotations; but in disturbing the quotations, he must always endeavor to offer the stock back to the market at a reasonable price spread from the price at which he bought it. If I can give an example, probably that would set it up a little better. The CHAIRMAN. Have there been any proceedings before the Commission based on a charge that the regulation under those provisions has not been satisfactory? Mr. STOTT. I know of no proceedings. The CHAIRMAN. I believe that is all. STATEMENT OF R. McLEAN STEWART, CHAIRMAN, SECURITIES ACTS COMMITTEE, INVESTMENT BANKERS ASSOCIATION OF AMERICA, NEW YORK, N. Y. Mr. STEWART. I will appear, if I may, Mr. Chairman. Mr. STEWART. Mr. Chairman, we have merely a very brief statement to make in respect of section 11 (e) as proposed in the committee print at page 85. The problem of the small dealers throughout the country who are not members of an exchange and whose business is not transacted on the floor of an exchange is affected, or could be affected very considerably by section 11 (e) as it now appears in the act. That section, as you know, directed the Commission to make a study of the feasibility and advisability of the complete segregation of the function of broker and dealer and to report thereon to the Congress in 1936. As has already been pointed out a, report was submitted to the Congress; but section 11 (e) remains and in consequence of this, since 1934 when the section was enacted, the business of brokers and dealers throughout the country, in the over-thecounter market has been subject to the threat that any any time the Commission might come to Congress and recommend that the business of broker and dealer be segregated. The Commission itself, I think, pointed out in its report of June 20, 1936, as we say in our printed report at page 223That a factor deserving of consideration is that compulsory segregation in all probability would drive numerous broker-dealers out of business. We think that is true. The small dealer transacting business in the smaller communities throughout the country does not have a great deal of capital. The problem of survival has for him been extremely difficult under the conditions which have prevailed in the last few years, and if the Congress should, on the recommendation of the Commission, direct the segregation of those functions, there is not much doubt that a great many, if not the majority, of these smaller dealers would find it wholly impossible to carry on in the business. Now, we recognize, of course, that altogether aside from the provisions of section 11 (e) as they appear in the statute at present, the Commission might, at any time it choose, come here and propose that legislation be enacted bringing about segregation. However, we feel that if this committee should in its good judgment adopt the proposed new section 11 (e), which we are recommending, that that would be a determination of the problem and would bring about a fair measure of certainty enabling people to plan ahead. It is certainly extremely difficult in these days for anyone to see very far ahead; to know what he should do; to know whether it is the sound thing for him to risk what little capital he has in continuing in this business; and it does seem to us that if the Congress can give this little added measure of certainty to the people in the business, it would help a great deal in permitting them to continue the services which they have been performing for investors-especially in the smaller communities throughout the country. It may be a serious enough problem for the larger dealers to continue in existence if they were compelled to segregate these functions; but for the smaller dealer we are convinced that it would mean that he might have to give up business completely. Now, I think one point should be made absolutely clear. The committee will, I am sure, understand that when a man is acting as a dealer he does not at the same time act as a broker, in the same transaction. We are certainly not recommending any change in this prac tice. It is, of course, true that today, at one time in relation to one customer, a person may act as dealer, and that in carrying out a transaction with another customer at some other time, perhaps during the same day, but in a completely unrelated transaction, he may act as an agent. We cannot see that this fact itself could possibly do any harm to anyone; but, on the other hand, if his ability to function in this manner were destroyed, we do feel that the investment community throughout the country would be very seriously injured. We therefore join in the recommendation that the present section 11 (e) of the 1934 act be repealed and that the proposal set out in the committee print for a new section 11 (e) be adopted. I would particularly emphasize that adoption of this proposal would not take away from the Commission any of its power to prevent improper practices by dealer-brokers. Thank you very much, Mr. Chairman. Mr. WADSWORTH. May I ask a question, Mr. Chairman? Mr. WADSWORTH. The witness referred to a report that has been made by the Commission on this subject. Mr. STEWART. Yes, Mr. Wadsworth; a report was made, an interim report, on June 20, 1936. That is the report we refer to in our printed report, at page 219, I think it is. Mr. WADSWORTH. June 20, 1936? Mr. STEWART. That is right, sir. The Commission submitted to the Congress on June 20, 1936, a report. You see, they were so directed by section 11 (e) as adopted in 1934. Mr. WADSWORTH. Yes. Mr. STEWART. But the report in 1936 was not a final report. Mr. WADSWORTH. But, as I have the language before me, the act of 1934 required the Commission to make its recommendations to Congress on or before January 3, 1936. Mr. STEWART. I think that is true, Mr. Wadsworth. However, the report was not submitted until some time later on. I believe it is the theory of the Commission that the directive contained in section 11 (e) is still a valid directive and that under it they may submit a further report whenever they, in their judgment, think it proper to do so. I recall that the view of the matter was stated to me when we discussed the subject in our conference with the Commission. Mr. WADSWORTH. Of course, if that is a proper interpretation of the language, there is no use in Congress ever putting in a certain date. Mr. STEWART. I would not be competent to express a view as to that, Mr. Wadsworth; but I do think that if the Congress accepts the sug gestion which we have here in our proposal for a new section 11 (e), that "the powers of the Commission under this title shall not include authority to require or effect the segregation of the functions of dealer and broker," that there would be a sufficiently clear determination of the matter to remove doubt as to the view of the Congress. Thank you very much, Mr. Chairman. The CHAIRMAN. Mr. Stewart, I take it that this existing law simply authorizes a report on the question up to January 1936. Does not the general power of the Commission permit it in effect to make such report regardless of this provision? Mr. STEWART. I am sure that is true, Mr. Chairman. I am sure they could make a report at any time, but I would think that if the proposal which is set out in the print now were adopted by you the Congress would have expressed its view that it is not desirable to bring about such a segregation. Then, unless strong and compelling reasons could be presented by the Commission, and I doubt that they ever could be, I think it extremely improbable that they would bring a report to the Congress proposing segregation. The CHAIRMAN. I would take it that if we assume, as you do, that the broker-dealer relations were compelled to be separate, that would probably put some people out of business, some dealers. Mr. STEWART. We are, on the basis of our studies, and indeed, upon the basis of the studies which the Commission itself made, fully convinced that it would have that result, Mr. Chairman. The CHAIRMAN. Is not the real question whether that relation is inimical to the public interest? Of course I assume that such relation should be permitted to continue, unless a good reason is shown why it should be prohibited; and we have a choice between regulation and prohibition on the question, I take it. Mr. STEWART. Our feeling, Mr. Chairman, is that no man should ever in the same transaction be allowed to act both as broker and dealer, and indeed, speaking of my own firm, we have a very specific unequivocal direction to our people that we will never, in any transaction, act as agent on two sides of a transaction, even though it is a completely legal and common practice to do so. The CHAIRMAN. Is there any penalty for a man who deals in that double capacity at the present time? Mr. STEWART. I am probably not competent to make an answer to that. I am not sufficiently familiar with the law of agency; but I would assume that if a man were in fact acting as an agent, he should be exerting all of his best efforts to serve the man for whom he is the agent. That being so, he could not very well act for some other person in that same transaction. The CHAIRMAN. What I really intended to inquire about is whether or not existing law or regulations of the exchange or Commission penalized a man who acts in that dual capacity without disclosing his position as such. Mr. STEWART. Disclosure is always required, and I am quite sure if disclosure were not made, a man would be subject to penalties. The present law requires that before the completion of each transaction the dealer or broker concerned must advise his customer in writing of the capacity in which he has acted. Any fraudulent or other misrepresentation with respect thereto would, of course, be subject to severe penalties. The CHAIRMAN. Very well, thank you. STATEMENT OF A. S. BROWN, JR., PRESIDENT, BROWN'S LETTERS, INC., NEW YORK, N. Y. The CHAIRMAN. Mr. Brown. Mr. BROWN. Mr. Chairman and gentlemen of the committee. Mr. BROWN. I will try not to take more than 3 minutes, Mr. Chair man. My name is A. S. Brown, Jr., president, Brown's Letters, Inc., New York. I publish letters of building reports. You may wonder why I am interested in this hearing. My business is publishing daily reports of building operations; and back in the early days of the depression hundreds of millions of dollars' worth of building operations were held up on account of fear and uncer、 tainty inspired by the actions of professional operators on the floor of the New York Stock Exchange who, through short selling, were knocking down prices day after day. Security values on the New York Stock Exchange were depressed from a peak in 1929 of about $90,000,000,000 to a low in 1932 of about $15,000,000,000. In addition to that, bonds on the New York Stock Exchange decreased about $10,000,000,000. On the New York Curb Exchange values were depressed about $15,000,000,000. Values in over-the-counter securities and securities on other exchanges throughout the country, not listed on the New York Stock Exchange, were proportionately marked down. The reduction in securities alone amounted to well over $100,000,000,000, and real-estate values were also greatly reduced. At that time I wrote many articles.on the evils of short selling during a depression and sent copies of the articles to all the Senators and Congressmen in Washington. President Hoover granted me a half-hour interview, and I tried my best to get him to recommend to Congress that some action be taken to curb the speculators' activities. Through short selling they would put an artificial supply of stock on the market and depress the prices of stock way below their intrinsic worth. President Hoover did nothing about it, excepting to call President Whitney of the New York Stock Exchange to Washington for conferences on the subject. At various times I was asked and testified before committees investigating the New York Stock Exchange. In an hour's talk with Mr. Whitney he tried to convince me that short selling was a stabilizer to the market in that it acted as a cushion when the shorts covered. In telling of the cushion effect to a Senate committee I described it as follows: A man walks out on to a golf course with a small pillow cushion in his hand. He borrows a niblick from a golfer and strikes him on the head with it. When he falls he hurriedly places the cushion under him so that the fall will not hurt him. Although I had been a Republican all my life up to that time I voted for President Roosevelt the last three times, and if he had done nothing else but to recommend legislation resulting in the New York Stock Exchange being placed in a "strait jacket" I would still consider he was worthy of support. Now, they evidently want the Securities and Exchange Commission to let up on them, when in some respects the hold should be tightened. Referring to the broker-dealer functions of specialists, floor traders, and others, it does not seem possible for a member on the floor to execute orders for clients and still have the privilege of trading for his own account without being tempted to give himself preference. He is behind the curtain and knows just what is going on; selfpreservation is the first law of nature. Brokers should not be allowed to loan securities that are in the accounts of customers. When a brokerage account is opened the customer is requested to sign an agreement authorizing the broker to |