yet be entirely free in a short time to turn around and sell the securities to the public without liability to themselves and without the protection afforded by the 1933 act to purchasers; and, if the period were a year or so, without the protection to the public afforded by the requirement that they bring their information down to date. But let me give you an example. Within the past summer the Equitable Life of New York bought a $35,000,000 issue of utility bonds at public bidding and I have no doubt they bought without any idea of a public offering. Within 4 months, however, tempted possibly by a 2-percent profit, they resold $10,000,000 of them to some 20 other smaller insurance companies, purchasers secured for them we are informed by a broker working for a commission. These smaller companies had, of course, been shut out of the original purchase by the ability of this huge institution to buy the entire issue away from investment bankers who normally spread such issues more widely.

The purchasers who bought this issue from the Equitable did not have the benefit of the liability of the seller on the statement, a liability to which underwriters are subject. For the purposes of the Securities Act the Equitable was not an underwriter and, while I do not know, I have no doubt that the Equitable made no representations of any kind to the people who purchased from it.

I do not want to discuss the legal question whether this operation was an underwriting transaction; I assume that it was not legally, or the Equitable would not have engaged in it. I do want to point out that its effect is about the same as would have been the case if it had been an underwriter. There was a very short period of time between the purchase and the resale-a "decent interval" to justify the statement, which I have no doubt was a true one, that the Equitable purchased them without a view to distribution.

This sort of purchase for investment followed by resale might occur in many instances. The institutions might want to sell for any one of many reasons; it might be simply because they changed their mind at the end of 30 days or 60 days, or 6 months; it might be that they were tempted by a profit, it might be because they felt a change in interest rates was impending and they would like to slide out of their holdings and let the public hold the bag on any decline; or it might be, as many people suspected during the 1920's, that as a result of private and confidential information the bank might decide that the company's financial position was none too good and that they would be just as well off without them. If they decided that, at the end of a year they would then be free to sell their bonds to the public at the current market without making any statements whatsoever, and certainly without telling the public of their suspicions or their knowledge. No other underwriter could proceed on such a basis. He would be required to give the prospective purchaser a complete prospectus. If he had learned anything about the company which was unfavorable, he would be required to tell the coustomer what it was before he sold it. The customer would be buying with his eyes

open.

I mention these possibilities to show that the requirement which the Commission has included in its proposal; namely, that no exemption from underwriters' duties could be given to any institution which purchased with a view to a public offering, does not in fact

prevent subsequent public offerings of securities purchased for investment. Such purchases and resales, I realize, have taken place and may take place in the future although the Commission's proposal is not enacted. There is now enough doubt, however, under both Federal and State laws as to the position of a company making such transactions as to act as a strong deterrent except in cases where the surrounding circumstances are clearly within the law. I see no reason, however, why the Congress should encourage this type of transaction by authorizing the Commission to exempt institutions in such instances from liabilities of underwriters in cases in which it would otherwise be found they were underwriters within the meaning of the act.

In any event, if the theory of the 1933 act is correct; that the public is entitled to complete information when an underwriter sells his commitment to the public, and if the Banking Act is right; that the abuses of the 1920's were so great as to require the exclusion of banks from the underwriting and distributing field, then it hardly seems to us that the time has arrived to open the door by so much as a single crack, to the detriment of the investing public.

It seems to the securities industry that this proposal should be supported only if one feels that the decision of Congress in the Banking Act was wrong; that State insurance laws are wrong; and that these institutions should be allowed back in the securities business. If that is true, the place to change the law is the Banking Act and various State insurance laws, and not the Securities Act.

That completes my statement on paragraph 2 (11) (b) (4), Mr. Chairman.

The CHAIRMAN. Perhaps you will take some time to complete your statement?

Mr. STARKWEATHER. On the next one; yes.

The CHAIRMAN. Perhaps it would be better to adjourn at this time. It is almost time to adjourn.

The committee will stand adjourned until 10 o'clock tomorrow morning.

Tomorrow morning our hearings will be somewhat interfered with, on account of the measure on the floor of the House, but we will start at 10 o'clock and do the best we can.

(Thereupon, at 3:28 p. m., the committee adjourned to meet at 10 a. m. the following morning, Wednesday, November 26, 1941.)

PROPOSED AMENDMENTS TO SECURITIES ACT OF 1933 AND THE SECURITIES EXCHANGE ACT OF 1934

WEDNESDAY, NOVEMBER 26, 1941

HOUSE OF REPRESENTATIVES,

COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE,

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 come to order. Mr. Starkweather, you may proceed.

STATEMENT OF JOHN K. STARKWEATHER, NEW YORK, N. Y.— Resumed

PERSONS PURCHASING UNDER COMPETITIVE BIDDING

Mr. STARKWEATHER. Mr. Chairman and gentlemen of the committee, you will recall that yesterday I completed my statement on the first of the two controversial sections under 2 (11) (b); namely, paragraph (4).

The next paragraph is numbered (5), and I propose to devote my time this morning to that.

In connection with section 2 (11) of the 1933 act, the industry recommends a new subsection (b) (5). This appears on page 9 of the committee print and page 25 of our report. It proposes to exempt from inclusion as "underwriters" any persons who buy securities sold by issuers in competitive bidding by means of sealed bids when such competitive bidding is required by any law, regulation, or practice of the United States, of any State or subdivision thereof.

This proposal would eliminate the section 11 liabilities of underwriters in competitive bidding cases, and for this reason deserves careful analysis. The Securities and Exchange Commission does not concur in this proposal. The reason for this proposal cannot be fully understood without an understanding of the competitive bidding situation as it now exists, and with your permission I should like to outline this for you. It is in the field of securities subject to the Public Utility Holding Company Act that competitive bidding is of the greatest significance.

Competitive bidding for securities was the subject of prolonged controversy between the industry and the Securities Commission from early in 1940 until last spring when the Commission actually put into effect its rule U-50 requiring competitive bidding on new

issues of utility securities which are subject to regulation under the Public Utility Holding Company Act. It has since been the subject of speeches by a member of the Commission and others, of extensive argument within the industry and on the part of the press throughout the country, and is still one of the most controversial subjects in the financial field.

The Public Utility Holding Company Act, you will recall, gives the Commission certain powers to regulate the issuance of securities by public utility holding companies and their subsidiaries. Briefly, the law provides that a document called a declaration be filed with the Commission. The declaration contains every elaborate information. The Commission is directed not to allow such a declaration to become effective unless it finds either that the security is a common stock or a bond-there are certain exceptions to that rule but they are not important here; or that it is to be issued or sold solely for certain specified purposes. These are the affirmative requirements-the Commission must make those findings or the declaration cannot become effective. There are also what may be called negative requirements-the Commission is not to permit a declaration to become effective if it finds among other things that the security is not reasonably adapted to the capital structure or earning power of the company, or-and these are important here-if it finds that the fees and commissions are not reasonable, or that the transaction is detrimental to the public interest or the interest of investors or consumers. In other words, the law does not require that the Commission shall decide that underwriting commissions are reasonable or that the interests of investors and consumers are protected-it provides in effect for a veto by the Commission if it finds commissions unreasonable or the interests of investors and consumers not protected.

For the first 5 years after the passage of the Public Utility Holding Company Act in 1935, the Commission exercised wide authority over the financial operations of utility companies coming within their supervision, but during the regimes of Messrs. Kennedy, Landis, and Douglas left the prices and terms of sale of individual issues pretty much in the hands of management. The Securities and Exchange Commission apparently then had no difficulty in administering the statutory provisions I have briefly outlined, or in determining that the statutory standards concerning security issues had been met. While at times many utility operators and many financial firms felt the Securities and Exchange Commission position on various points was extreme or perhaps even unwise, nevertheless during that time little question was raised as to their authority.

Early in 1940, however, the Public Utility Division of the Commission under the chairmanship of Jerome Frank, started an inquiry, apparently looking toward the establishment of compulsory competitive bidding for new issue securities in the utility field. They asked for comments from the securities industry, as a result of which many comments were received, the great bulk of which were adverse. At that time the Investment Bankers Association, among others, prepared a lengthy brief attacking the proposal vigorously. After considering the arguments presented to them the Commission directed their staff to investigate further, and late in 1940 the Public Utility Division. issued a long report on the problem, ending with a recommendation

that the Commission order competitive bidding in the case of all utilities under their supervision.

Hearings were called for on this proposal and during the early part of 1941-the late winter of 1941, I believe, to be exact-several days were devoted by the Commission to these public hearings. A great many underwriters and dealers from all over the country testified at these hearings. With the exception of two firms, to the best of my knowledge, the security business, large and small, was unanimous and vocal in opposition to it. The head of the Edison Electric Institute, representing a very large proportion of the utility business, appeared in opposition. Several institutional buyers appeared in opposition, including Mr. Ecker, vice president of the Metropolitan Life Insurance Co. who has appeared before you in these hearings, and representatives of the mutual savings banks. It was obvious, however, from the start of the hearings that not only had the Public Utility Division of the Securities and Exchange Commission already made up its mind on the subject, but it also seemed from the manner of the questioning by the Commission that the Commission also was not open-minded and that the hearings were largely a formality through which, for one reason or another, they felt it necessary to go. Following these hearings, and in spite of this widspread opposition, the Commission placed in effect in May 1941, its rule U-50, requiring competitive bidding on all public-utility issues subject to the 1935 act, with certain unimportant exceptions. This rule is now in force.

In order that we may be perfectly clear as to what compulsory competitive bidding refers to, let me say that under the rule U-50 a corporation subject to the Public Utility Act, after filing its declaration and its registration documents with the Commission and receiving their permission to proceed with the proposed financing, is required to advertise for public bids for its securities. Usually 10 days to 2 weeks is allowed during which underwriters and other prospective bidders are supplied by the company with the documents which have been filed and with the proposed prospectus. There is no opportunity on the part of the underwriters to change any of the provisions of the issue. They are usually told what lawyers will supply the legal opinion and their fees; they are handed a prospectus which has been prepared by the company and approved by the Securities Commission and told to take it as is or leave it. There is no opportunity for negotiation as to the terms of the indenture. There is insufficient time for the careful expert investigations which underwriters have customarily made on utility issues. There is only a brief time even for consideration of legal opinions and not adequate time for the underwriters' own attorneys, if that is desired, to check the technical parts of the opinions.

I might add even if there were plenty of time, the uncertainty as to who is going to buy the issues makes the spending of sufficient money to cover a complete examination impossible for prospective buyers.

At least one or two of the Commissioners indicated during the hearings last spring that the services of investment bankers in assisting in the setting up of new issues were no longer necessary; that the Commission was prepared to take over the work of overseeing the writing of indentures and the general set-up of the business.