tion statement be brought up to date before the public offering is eventually made. 4. Special Provisions for Underwriters, Brokers, and Dealers.

The proposals for amendment of the Securities Exchange Act of 1934 have provoked most of the disagreement between the representatives of the securities industry and the Securities and Exchange Commission. The specific proposals discussed in this and the two following sections of this report are chiefly those involving the Commission's powers, which it seeks to have materially enlarged.

Certain changes in Section 8 of the Exchange Act 3 have been proposed by the Commission. The first would extend the operation of the section to include registered brokers and dealers who are not exchange members and do not do business through exchange members, a change to which the industry representatives have agreed. The second suggested amendment, however, has elicited understandable objections from the industry, for it would empower the Commission, apparently in its discretion, to value securities held by a broker or dealer at such proportion of face or market value as it desires for the purpose of determining whether the debt-capital ratio of the broker or dealer exceeds permissible limits. This proposal seems far to outrun the Commission's needs, particularly in view of the breadth of the other grants in the same section. The Wadsworth Bill, indeed, far from increasing the Commission's powers here, would take the entire subject from the care of the Commission and entrust it to the Federal Reserve Board, on the grounds that the Commission has in practice misused the power for the extra-legal coercion of exchanges; but the issue raised by the bill in this instance is one of proper administration of the act, which the committee considers beyond the scope of this report.

44

Section 11 of the Exchange Act directs the Commission to "make a study of the feasibility and advisability of the complete segregation of the functions of dealer and broker, and report the results of this study and its recommendations to the Congress on or before January 3, 1936," and it also authorizes the Commission by rule to prevent floor members of national exchanges from trading for their own account. Such a study was made and a report filed by the Commission with the Congress in the summer of 1936, but it did not purport to be conclusive, reserving for further investigation the focal question of conflicts of interest. Since that time brokers and dealers who combine both functions, and they represent a large majority of the brokers and dealers who have registered,—have been subject to the continuing threat of a Commission ruling which would seriously affect their business. The industry representatives now seek repeal of the unexercised power to segregate and of the provision directing the investigation, and the Commission is unwilling to agree to either change.

45

There seems little substantive reason why the power should be saved or the direction to investigate retained if the Commission, after seven years, has yet to determine whether segregation is necessary. There is obvious justification for granting the request of the industry's representatives and relieving thousands of broker-dealers, whose business in general has declined precipitately under the acts, from further uncertainties. The controversy is significant, however, as a further illustration of the unwillingness of administrative agencies to relinquish voluntarily any power once acquired. It is in the nature of an administrative agency's work and position that once a power has been given it by Congressional action, both political and administrative advantages tend to compel its retention.

On one other proposal the industry's position is less persuasive. The Commission recommends the addition of a new subsection to Section 8 of the Exchange Act to empower it to require effective segregation of money or securities belonging to customers held by exchange members, brokers, or dealers." The industry representatives, while making no objection to requiring such segre

42 Securities Act proposal 30, Industry Report, p. 97.

43 Exchange Act proposaals 8, 9, Industry Report, pp. 199, 201. A third proposed change is referred to infra; see note 46.

Section 202.

45 Exchange Act proposals 11, 12, 15, Industry Report 211, 213, 219. In Exchange Act proposal 32, Industry Report, p. 279, the industry also recommends repeal of Section 19 (c) of this Act, authorizing an investigation and report on various rules of national securities exchanges, the investigation and report having been made (see House Document No. 85, 74th Congress, 1st session). The Commission will concur in this proposal only if its recommendations relative to exchange rules are adopted.

gation, argue that section 60 (e) of the Bankruptcy Act as amended should be changed, and that unless and until it is changed the new subsection proposed would operate to impose more expensive and troublesome regulation than in fact is needed. This committee believes, however, that the Commission's views are in accordance with the public interest, and that without awaiting changes in the Bankruptcy Act the desirability of safeguarding customers' property justifies this extension of the Commission's administrative authority.

5. Regulation of Exchanges

Three proposals for the amendment of the Exchange Act," all put forward by the Securities and Exchange Commission and all opposed by the industry, would place the national securities exchanges as a practical matter completely within the Commission's control.

48

The first proposal is to authorize the Commission to suspend or withdraw the registration of an exchange for failure to enforce its own rules against members and issuers of securities registered thereon. The second would authorize the Commission to suspend or expel from an exchange any member or officer who the Commission should find has wilfully violated any rule of the exchange or has effected any transaction for some other person who he had reason to believe was violating an exchange rule. The third would add to the list of subjects which the Commission could deal with by way of altering or supplementing the rules of an exchange, in accordance with the present Section 19 (b) of the Exchange Act, the following: "(13) the methods of election of officers and committees to insure a fair representation of the membership, and the classification of members for the purpose of such election; (14) the suspension, expulsion, and disciplining of members."

It is apparent that with these amendments the national securities exchanges would necessarily become subservient to the Commission. Assurance is .given,

in the S. E. C. report, that these new powers, if granted, would be exercised to the full only in exceptional cases, but it is clear that with the transfer of these powers from private to governmental hands the present limited independence of the exchanges would be at an end.

In the opinion of the committee the adoption of these proposals would be most unfortunate. The quickest way to atrophy a private institution is to remove from it the right of self-government. There is little reason to believe that a transfer of complete control of stock exchanges into the hands of a governmental agency would increase their power or ability to serve the public. It has been salutary for the exchanges to be subject to a measure of surveillance of the Commission. It has been equally salutary in the opinion of the committee, for the Commission itself to have a vigorous and responsible opposition. If these proposals should be adopted by the Congress, that opposition would no longer exist.

The committee favors instead the industry's single alternative proposal," that the Commission's power under Section 19 (b) of the act to alter and supplement exchange rules on twelve enumerated subjects and "similar matters" be curtailed by the deletion of the quoted words. At the same time the Congress might consider the advisability of adding, as a thirteenth subject, the matter of multiple trading. This is the sole question on which the Commission has sought to invoke its residual powers under this section, and it is of sufficient importance to merit Congressional consideration. Whether or not the Commission's rule-making au

40 Exchange Act proposal 10, Industry Report, p. 207.

47 Exchange Act proposals 27, 28, 30, Industry Report, pp. 267, 269, 275. 48 The suggested amendment reads: * * has wilfully violated any rule of a national securities exchange, the violation of which subjects a member to suspension or expulsion." As the Industry Report points out, however, at page 271, "the Constitutions of the exchanges provide that members may be suspended or expelled for the violation of any rule." The report continues to quote from a Commission report entitled "The Government of Securities Exchanges" (74th Congress, 1st Session, House Document No. 85, p. 16), as follows:

"Because regulations of trading are so complex, countless minor violations occur, with the result that a policy of only punishing major infractions is followed. The occurrence of minor infractions gives to the business-conduct committee [of the New York Stock Exchange, in this instance] a large discretion, which enables it to wield tremendous coercive power."

The report comments that the Committee on Business Conduct referred to could only prefer charges to be tried by the Governing Committee, and that by comparison the absolute power of expulsion which the Commission would have under this proposal would be coercive to a degree.

49 Exchange Act proposal 29, Industry Report, p. 273.

thority should be extended in this one particular case can best be ascertained on the basis of data not now available to this committee but which doubtless could be prepared and presented to Congress.

6. Penalties and Prohibitions

Numerous changes in the liability provisions of the two acts are suggested both in the Wadsworth Bill and in the S. E. C.-Industry Proposals. It has been necessary, because of the limited time available, to forego extended consideration of all the new liability sections proposed, but on three of the suggested changes the committee desires to comment.

It is proposed by the Commission, with the concurrence of the industry, to extend the Commission's right to obtain an injunction, given by Section 20 (b) of the Securities Act and Section 21 (e) of the Exchange Act, to situations where a past violation can be shown although proof of present violation is lacking. This change was recommended in 1939 by this committee 50 and it favors the amendment.

51

The Wadsworth Bill makes a direct approach to the vexing problem of stabilization, which the S. E. C.-Industry Proposals avoid. The Bill would amend Sections 9 (a) (2) and 9 (a) (6) of the Exchange Act to permit stabilizing transactions when "reasonably necessary," limited in volume and price range, reported daily to the Commission, and disclosed in the prospectus if effected in connection with a distribution of securities.

The Commission, in its report, criticizes this proposal vigorously on a variety of grounds, all of which indicate the essential difficulty of defining any line between justifiable stabilizing operations and wrongful manipulation. The conferees, it appears, discussed this question at some length but finally abandoned attempts at statutory amendment in favor of a policy of increased publication of administrative interpretations, which the Commission has agreed to give from time to time as specific problems are presented to it for rulings. Such is the procedure which this committee recommended two years ago, and the opinion transactions when "reasonably necessary," limited in volume and price range, is still held that it affords the preferable approach to a problem which is believed to be impossible of wholly satisfactory solution.

52

53

The third proposal affecting liability, and one of major importance, is the provision contained in both the Wadsworth Bill and the S. E .C.-Industry Proposals for repeal of Section 16 (b) of the Exchange Act, a suggestion to which the Commission is bitterly opposed.

Section 16 (b) contains the provision intended to discourage "insiders" from trading in the securities of their corporation; it makes the officers, directors, and holders of ten or more percent of the stock of any issuer liable to the issuing company for any profit realized on purchases and sales of the issuer's securities within a six months' period. It is a deterrent, not a remedy, and its effectiveness is a matter of dispute.

Both the Wadsworth Bill and the industry conferees would retain the prohibition on short sales by such officers, directors, and stockholders (Section 16 (c)) and the publicity provisions (Section 16 (a)). The two New York Exchanges would extend the publicity provisions, which now apply only to securities registered on national exchanges, to stocks of issuers "engaged in interstate commerce or in the production of goods for interstate commerce or in the rendering of services in aid of interstate commerce" which have assets of $3,000,000 book value and

50 64 A. B. A. REP. 345 (1939). 51 Section 203.

* The language is: "*

transactions effected for the purpose of establishing or maintaining a fair and orderly market or for the purpose of stabilizing the market in connection with or to facilitate a primary or secondary distribution of securities provided that such transactions are (a) reasonably necessary for such purpose, (b) not excessive in volume, (c) effected within a reasonable price range, and (d) reported daily to the Commission; and provided that, when effected in connection with or to facilitate a primary or secondary distribution of securities, the general character, extent, and effect of such transactions are disclosed by means of a prospectus or otherwise to purchasers of the securities being distributed."

The section would also insert in Section 9 (a) (2) of the Exchange Act, in place of the wording "inducing," the following: "creating a false or misleading appearance with respect to the market for such security to induce * ** *""

52 64 A. B. A. REP. 344 (1939). Unless the Commission does issue such interpretations, sufficient in number and in simplicity to serve as a day-by-day guide to the security traders who must act under them, any stabilizing transaction, however desirable, runs risk of being construed as a violation.

53 Wadsworth Bill, section 206; Exchange Act proposal 25, Industry Report, p. 257.

54

300 shareholders, and they would also require reports of changes of ownership within ten days of each change rather than monthly as at present. The accelerating of the reports is presumably intended as a partial offset to the proposed repeal of Section 16 (b); it appears to have no other merit. The extension of reporting to unregistered securities is calculated to minimize the relative disadvantages of registering with an exchange, a subject discussed generally in the first section of this report.

The main argument for repeal of Section 16 (b) is that it drives out of the market the best-informed traders and those most interested in protecting any particular security from sudden and unreasonable fluctuations in price. By providing for confiscation of profits but leaving the full risk of loss on the "inside" trader, the section undoubtedly removes market support for many securities, and it is possible that the thin and nervous markets of recent years are, at least in part, attributable to the working of this provision. In addition, as the Industry Report points out (p. 261), the Section does not meet the problem squarely, for it neither compensates the losing party to a trade nor confines its punitive effect to actual instances where information confidentially obtained is used for private profit.

These arguments are cogent, yet nevertheless the justice of the purpose of the provision is so clear, and the probability of its being effective is so reasonable, that the committee is hesitant to advocate its repeal in the absence of convincing proof of its adverse effect upon the capital market. It is contended, in favor of repeal, that the publicity section is itself a sufficient deterrent, but this seems doubtful at least when a substantial trading profit is at stake; where it should act as a sufficient deterrent, moreover, it might check fair trading by insiders almost as much as unfair trading, and thus it would diminish the benefits antici pated from the repeal of Section 16 (b). A persistent cause of lack of public confidence in the exchanges has been the popular impression that they can be traded on profitably only by persons specially informed. Section 16 (b) aids materially in the removal of reasons for that suspicion, and it also is in full accord with the principle that no person in a fiduciary relation should use information or opportunities coming to him because of his position for his own private profit. Until strong contrary proof shall be forthcoming, it is the committee's opinion that the public interest requires that Section 16 of the Exchange Act should not be changed.

7. Composition of the S. E. C.

55

Section 4 of the Exchange Act established the Securities and Exchange Commission as a body of five men, no more than three of whom shall be members of the same political party, with $10,000 annual salaries and staggered five-year terms of office. The industry now proposes an increase of the Commission to nine members with ten-year terms, each to receive a salary of $15,000 per annum during office or retirement. The Commission, withholding any comment on salary or tenure as inappropriate, opposes the suggested expansion of its membership. The work of the Commission is extraordinary in range, complexity, and importance. Its powers include the shaping of policies, judicial responsibilities, duties of investigation and prosecution, as well as heavy administrative responsi bilities. The inevitable result of placing such an enormous load of work on a body of five men has been that the Commission's staff has had to perform duties and make decisions which the Commissioners themselves, were they able to do so, should have had in personal charge.

There has also been a relatively rapid change in the Commission's membership since its organization. Being a pioneering agency, much in the limelight, members who have achieved distinction there have from time to time been called to other important positions of public service. The Commission has had, in seven years, five chairmen 56 and ten other Commissioners.57

In an agency with such great latitude of discretion in many areas, continuity of policy is of highest importance. The committee feels that an increase in the membership of the Commission, as well as the recommended increase in tenure and salary, would be helpful in ensuring such continuity and permitting a better distribution of responsibilities between the Commissioners and the Commission's staff.

54 There are also exceptions for banks, building or loan associations, certain charities, etc. See proposed Subsection 16 (c), Industry Report, p. 259.

55 Securities Act proposal 3, Industry Report, p. 13.

50 Joseph P. Kennedy, James M. Landis, William O. Douglas, Jerome N. Frank, Edward C. Eicher.

57 Ferdinand Pecora, J. D. Ross, George C. Mathews, Robert E. Healy, John W. Hanes, Edward C. Eicher, Leon Henderson, Sumner T. Pike, Ganson Purcell, Edmund Burke, Jr.

8. Miscellaneous

The Wadsworth Bill contains provisions which would regulate the procedure of the Commission in many important respects: The issuance of rules and regulations, the holding of hearings, review, and appeal. This committee does not comment upon these because they fall within the field of the Special Committee on Administrative Law. This committee desires, however, to state its approval of the principle which the Wadsworth bill follows of limiting or prohibiting public announcements of prosecutions for violations before hearings and findings shall have substantiated the charges brought. In the securities field especially the damage which may be done to private reputations by detrimental publicity is immediate and irreparable.

At the 1939 Annual Meeting of the Association the House of Delegates, in accordance with the recommendation of this special committee, adopted a resolution recommending the creation of a joint Congressional committee to inquire into the need for consolidating and amending existing federal securities legislation. The proposals discussed in this report which are assured detailed consideration by the Congress, deal with the general subject in so comprehensive a manner that no need appears for further inquiry at this time by a joint committee. This recommendation is, therefore, not renewed.

58

There remains for comment one change in each basic act, possibly small in substance but large in significance, which both the Wadsworth Bill and the S. E. C.-Industry proposals would make. This is the inclusion of language which will express a Congressional intent that the acts shall not handicap lawful private enterprise so far as that may be avoided. The proposals would insert, in the statement of purpose with which each act commences, the words "with the least possible interference with honest business." 59 The Wadsworth Bill, by various provisions, would add a more positive direction to the Commission to "encourage and foster orderly, active, stable and liquid markets for securities upon securities exchanges and in the over-the-counter markets.” “

The tenor of these suggestions is that of the resolutions which the special committee recommends for adoption. They emphasize the unanimity which exists on the reasons for amending the acts and the course which such revision should take. With so general an agreement upon the principles it should be possible to evolve, without too prolonged a controversy, changes in the acts which will give the principles effect.

In conclusion the special committee desires to emphasize one consideration of the national interest.

Federal regulation of securities and exchanges has been achieved at the expense of a continuing struggle which has involved and nourished many antagonisms. It is impossible to remove these entirely for they are too deep-seated but it would be unfortunate in the extreme if at this time they were to flare out publicly. The representatives of the Federal Government and of the various private interests concerned will do the nation a very serious disservice if they permit the amendment of these acts to become an occasion for recrimination, however sincerely they may be moved in the expression of their views. The conferences at which the proposals were discussed and formulated are a successful example of cooperative effort and reflect credit upon all the participants. Now that the result of these conferences is before Congress and before the public, one cannot hope too strongly that the same fairness will be observed in their discussion.

The strain to which faith in democratic government is naturally subjected during this world convulsion increases the already heavy responsibilities of the Securities and Exchange Commission. The past few years have witnessed a transfer of vast power to the Commission's hands. With that power has passed the responsibility for its impartial and temperate exercise. The necessity for maintaining the confidence of the people-all the people-in the Federal Government, and in its most prominent and powerful agencies, at this time is overwhelming. It must overbear considerations which in less dangerous times might justify a militant or intransigeant policy of reform, with their accompani

58 64 A. B. A. REP. 104 (1939).

59 Securities Act proposal 1, Industry Report, p. 7. Exchange Act proposal 1, Industry Report, p. 183. The phrase is borrowed from President Roosevelt's message to Congress in March 1933. The Commission approves these changes.

60 Section 201 of the Bill would insert the quoted words in Section 2 of the Exchange Act. Similar words and the phrase "the free flow of capital into private enterprise" are suggested by the bill for Sections 8 (a) and 17 (a) of the Securities Act. These recommendations are not approved by the Commission.