the issue and sale were detrimental to the public interest or to the interest of investors or consumers Congress obviously contemplated that the Commission should discharge the functions imposed on it by those provisions. Congress expected that the Commission would examine the spread and the terms and the conditions of the issue and sale and decide in each case whether the facts were such as to require it to make the findings that the underwriting spread was unreasonable or that other terms and conditions were not in the public interest. The Commission's adoption of the competitive-bidding rule seems to me to amount to an abandonment of the function conferred upon it by Congress. It amounts to saying that they are unable to decide the questions which Congress delegated to them and contemplated they should decide and therefore they are going to look to public auction as a solution of their problem. We in the securities industry have always been perfectly ready to agree that the Commission should take action whenever it finds evils, but we have never seen any authority in the law for taking drastic action designed to upset all financing machinery and all accustomed methods of finance in the utility field until evils are apparent. We have read the report of the Commission with the greatest of care, and while numerous instances are cited of evils existing prior to the formation of the SEC, we have not found examples of such evils since their establishment. Even the Commission has admitted in almost so many words that they have established this rule not because it was clear in their minds that evils existed but because evils might develop. I ran across a statement a day or so ago which was written by Mr. Thomas N. McCarter, chairman of the board of directors of the Public Service Corporation of New Jersey, who is in some difficulty over a technical complication under the Public Utility Holding Company Act, and what he says in this paragraph reminds me a good deal of our position. The young gentlemen who have spent so many months investigating the records and files of our company have not discovered one reprehensible act. Mistakes in judgment in the decision of business problems may have been made, for we, like everybody else, are not infallible. What they seem to feel is that we have the power to do something wrong some day, although for 38 years we have not done it. These evils would apparently consist of corporations not receiving proper prices from underwriters for their securities. If, in the case of any given issue, the public utility would not receive a proper price under the proposal submitted to the Commission, the Commission need only find either that the underwriting discounts are unreasonable or that the public interest or the interest of investors or consumers would be adversely affected, and the issue cannot go through. You will note in this connection that Congress did not ask the Commission to find prices were proper; it was only charged with the duty of preventing an issue if it found that prices were improper. The Louisville Gas & Electric Co. case has been mentioned here in these hearings once or twice. In connection with this matter of pricing, it is interesting to read their conclusions which are inserted in the offical prospectus of the company. They say: The company is entitled to its exemption under section 6 (b), and our problem is whether the price bears such a relation to the whole program before us as to require the imposition of terms and conditions. We are not obligated to find affirmatively that the price is fair; we do find, however, that the price is not outside a reasonable range. I want to comment too along in connection with that, that I also read last night for the first time the statement inserted by Mr. Purcell in the record on this case, and it is interesting to me to consider the basis on which they find that the price is within a reasonable range. Mr. PATRICK. What is that? Mr. STARKWEATHER. This is the Louisville Gas & Electric case and this is an official finding of the Securities and Exchange Commission in the matter. This was referred to in the hearings several days ago and that is why I happen to bring it up. In support of their position as to the reasonableness of the price, the Commission states: Book equity of the present common stock as at July 31, 1941, was stated to be approximately $16.78 per share. which may be increased to $17.45 per share if all of this new stock is sold. I may say that most of the increase in the value of that stock will accrue to the benefit of the holding company, the Standard Gas & Electric, which holds some eight-hundred-odd thousand shares of the present common, I believe. The commission refers to certain questions which are in process of discussion between the Kentucky Utility Commission, the Federal Power Commission, and the Louisville company and it goes on to say: However, if subtraction is made for the plant acquisition adjustment account and deferred charges, the book equity of the present shares of common stock would be $7.32 per share, which would increase to $9.56 per share after the issuance of the additional shares. As to earnings they say the present earnings on the stock prior to this issue amounted to $1.92 per share and after the issuance of these shares will amount to $1.64 per share, as against present dividend of $1.50 a share. They have a margin, therefore, of approximately 10 percent over their dividend, which would be considered, generally speaking, pretty thin. They go on to say, I presume, in support of their position: If the Kentucky Utilities Commission or the Federal Power Commission ultimately require a revision of the company's proposed treatment of its acquisition adjustment, and order an increased amortization, this would have an adverse effect on the future reported earnings on the common stock. It would appear from the Louisville Gas case that the Commission is first largely concerned with the price to be received by the holding company. It would appear that its only concern as to the fairness of the price to investors comes when an underwriting group is involved, but when the company itself offers stock, the matter of price seems to be of comparatively slight significance, because the Commission exempted the Louisville Gas stock from the operation. of its rule U-50 and permitted the company to make the offering. In any event it seems clear to us that no such move as the competitive bidding rule ought to have been taken in the absence of a showing that public utilities were receiving improper prices. We do not believe that at least since the 1935 act was enacted that has been the case. No evidence of improper pricing has been submitted by the Commission and we do not believe that it exists. In addition I might add that the Commission has full power to stop any issue if it believes that the price is unreasonable. The utility business has been built up for many years by the activities of management plus the ability of the investment bankers to handle its financing. It has grown in a little more than a generation from a small insignificant industry to one of our largest. Its rates for the greater part have been controlled by the States. Its financing has also been controlled to a considerable extent by many States. Underwriters and dealers have spent years of study and effort in working out utility problems and as a result of years and years of experience there has grown up in this country an efficient mechanism for handling these securities. The Commission has stated that it believes it to be impossible for it to say whether or not the price of a security is proper or not and that its principal reason for establishing competitive bidding is to insure that the price shall be arrived at by such competitive conditions as will insure that there will be no collusion. The industry, on the other hand, has stated and believes that in view of the huge amount of public utility securities already on the market it would involve only slight effort on the Commission's part to establish reasonable minimum prices at which utilities should be allowed to sell their securities and that this could be done without upsetting the whole fabric of the investment business as this rule is doing. Underwriting groups have, in our opinion, performed a thoroughly useful and desirable function. They have had opportunities over long periods of years to study intimately all the aspects of utility properties. They have been able to sit down with company officials, lawyers, experts, and so forth, at leisure and discuss out the problems and devise the best means for financing. Dealers all over the country, large and small, have participated in these functions, have familiarized themselves with the companies and have built up over the years widespread interest in these companies. This rule cuts the ground out from under the feet of these groups and lays the financing on the table for anyone to take or leave, as the company and the Securities and Exchange Commission set it up, depending on his price views. Needless to say, it is impossible for a new group formed to bid on utility securities to investigate, recommend, and consult with company officials as they have in the past. In the first place, the company does not know who is going to buy it and therefore is under no obligation to consult at length with any one group. It certainly does not want to consult with three or more groups at different times-in at least two recent issues 10 different groups submitted bids. It is hardly conceivable that it will sit down with 3 sets of engineers at one time, with 3 sets of auditors, 3 sets of lawyers, and 3 sets of underwriters and thrash out in detail all of the points involved. It undoubtedly will be justified in doing just what any store or any seller of merchandise does; that is, lay the article on the table and let the buyer take it or leave it. The buyer is privileged to make such an examination as he can without overburdening the issuer, but the examination is bound to be sketchy and the investor really must depend entirely upon the Securities Commission for its security and safety. The company is naturally interested in making the best deal it can for itself. It wants to get the highest price and the lowest interest rate. It wants to have the utmost freedom as to reserves, sinking funds, and so forth, that it can get. In other words, it is all to the interest of the company to issue as loose a security as it can and yet get a good price. The underwriter is no longer in a position to correct this tendency. He has no influence whatsoever. From now on if this rule is to hold it must be up to the Government to see that private untility investments are made safe. That is a heavy responsibility for Government to assume in connection with private business. We in the industry do not believe that Congress ever intended the Commission to assume such a responsibility. Every underwriter is required to put on his prospectus some variation of this statement: These securities have not been approved or disapproved by the Securities and Exchange Commission. The investor, therefore, is in this peculiar position. The underwriter offers him a security, but it is obvious that the underwriter has not been able to properly protect his interest. Who else is he to look to if not to the Securities and Exchange Commission? But the Securities and Exchange Commission specifically says in every prospectus it assumes no responsibility whatsoever. Who is going to assume this responsibility? So far as we can see from this rule the company will make the best deal it can for itself, curbed so far as possible by the Securities and Exchange Commission, and the underwriter must assume all of the responsibility with the public although he has had nothing to do with setting it up-and that responsibility is by no means negligible if you will read over section 11 of the law. This rule, gentlemen, has suddenly made underwriting a very hazardous business. No underwriter can object to assuming the section 11 liabilities under the act of 1933 if he can make the examinations contemplated by Congress and assure himself that his risk is reasonable. But the Congress in 1933 assumed that he would have this opportunity, for that was the way business had always been done. The Securities and Exchange Commission has now, in 1941, changed the old ways of doing business. It has taken from the underwriter his opportunity for complete examination; it has even taken away his right to use his own lawyers for those are now named by the company; it has taken away his right to curb or guide corporate management in any way; but it has left the law which says that unless he does make a complete examination he is liable to severe penalties. I say again, this rule has made underwriting one of our most hazardous businesses. We believe this situation is too serious to be allowed to continue. Either Congress should so amend the 1935 law as to make it clear that competitive bidding may not be required, so that underwriters again can properly and justifiably assume their responsibilities to the public, or the liabilities of underwriters for such issues under the 1933 act should be eliminated in common fairness, and the Securities and Exchange Commission and the corporation left with their own responsibility to handle as they see best. The securities industry has, therefore, proposed this new section, section 2 (11) (b) (5), which would exempt persons who buy registered securities as a result of competitive bidding requirements from inclusion within the meaning of the term "underwriters." This would, in effect, exempt such buying groups from the liabilities to which they are now subject under section 11 of the act, which imposes certain liabilities on issuing corporators, underwriters, and all other persons who sign the registration statement. This amendment would recognize the practical effect of the Securities and Exchange Commission rule U-50 and would alter the liabilities to conform to it. The officers and directors of the issuer, as well as the issuer itself, would continue to bear their full liabilities for information given under the Securities Act, so that the public would continue to have substantial protection. But the dealer who buys in competitive bidding will be placed in the position he actually is in—that is, of one who cannot assume liabilities for something beyond his control. We believe that this whole question should be carefully considered. If Congress believes that the Commission is exercising a proper authority and assuming a proper function in imposing their competitive bidding rule U-50, then we believe in all fairness the underwriting business should be relieved of its present responsibilities under section 11. It should, of course, be noted that if Congress decides to accept the proposal of the industry for a change in section 3 (a) (9) it would exempt registered public-utility issues from registration requirements, and the change here suggested would only be effective in cases where competitive bidding is required by State laws. It is doubly important, therefore, that this committee give consideration to the whole problem here involved not only in this proposal but also in what we believe to be the unwarranted expansion of Securities and Exchange authority under the 1935 act. The CHAIRMAN. Mr. Starkweather, under the rules of the Commission, what time is allowed for bidding? Mr. STARKWEATHER. Well, in practice-I am not sure whether there is a definite requirement in the rules or not-in practice it runs from 10 days to 2 weeks, Mr. Chairman. The advertising usually appears and calls for bids on a certain day, and it is usually about 10 days to 2 weeks distant. The CHAIRMAN. That is subsequent to the registration? The CHAIRMAN. What would you say as to the extent which competitive bidding was used before the rule of the Commission was adopted? Mr. STARKWEATHER. Very little. It has been used to some extent, principally in one or two of the New England States. It has been used in Massachusetts; it has been used in New Hampshire to a limited extent. The number of corporations in that area is very limited. The number of issues involved have been very limited and the experience there is, I think, not typical of the general situation throughout the country. The only large important issues which have been handled have been issues of the Boston Edison Co. The Boston Edison Co. has been financed by Boston interests for generations. They have repeatedly examined it and it has been a comparatively simple matter to handle the requirements of the Massachusetts commission under that law. The CHAIRMAN. As a practical matter, what would be the motives that would induce a company to sell its securities for less than they are worth? |