The Stock Market and the Public

I

‘IF we are to have progress,’ said the president of the New York Stock Exchange, ‘we must depend upon the speculator to finance the risks involved. Speculation is in fact the price of progress. We may condemn the occasional excesses of speculation, we may censure its wastefulness, but we cannot ignore the fact that the willingness to take large risks for large possible profits has changed this country from a wilderness to the wealthiest nation in the world.’

This official apology for speculation has not gone unchallenged. Senator Carter Glass considers most speculation in securities as in the nature of pure gambling. And the extreme leftists think of the security exchanges as ‘hope chests’ of public poverty, and of speculation as an approved method of spoliation.

‘You brought this country to the greatest panic in human history!’ — at a Senate committee hearing last year former Senator Brookhart hurled the categorical assertion at an important officer of the New York Stock Exchange. ‘There never was such an economic failure in the history of mankind as your outfit has brought upon us at this time, and it is due to this same speculation that you are defending here more than any other one thing.’

This critical attitude, as well as the facts that give rise to it, is not at all new. ‘The general cry against stock jobbing has been such,’ wrote a commentator on the stock market in London over two hundred years ago, ‘and people have been so long and so justly complaining of it as a public nuisance, and, which is still worse, have complained so long without a remedy, that the jobbers, hardened in crime, are at last come to exceed all bounds, and now, if ever, sleeping justice will awake, and take some notice of them, and if it should not now, yet the diligent creatures are so steady to themselves, that they will, some time or other, make it absolutely necessary to the government to demolish them.’ This pamphlet, ‘proving that scandalous trade, as it is now carried on, to be knavish in its private practice and treason in its public,’ was written in 1719, a year before the bursting of the South Sea Bubble, the greatest example of speculation in English financial history. The author of the pamphlet was Daniel Defoe.

To-day, popular interest in security markets is again running high, and political criticism threatens to reach a climax in legislative action. In view of the inevitability of corrective act ion, it may be useful to consider critically the functions of security markets, and particularly those activities which are not in the public interest. Incidentally we may, at the end of this discussion, determine where the truth lies between the extreme points of view expressed by Mr. Richard Whitney and Senator Glass.

II

Stock exchanges are pure market places, associations of traders who band together to buy and sell securities under stipulated rules and regulations. These markets have three important functions. The first is to provide an open market where people can dispose of or acquire stocks and bonds. This is a legal right inherent in the sovereignty that goes with private ownership of property.

Second, security markets are places where people can buy income. This is called investment. Capital employed in productive enterprise creates an income (most of the time) payable to him who holds title thereto. The reasons for this lie in the scarcity of savings relative to demand, and in the increased productive effectiveness of capital in the form of such things as factories and machines. Security exchanges, where titles to such capital, or claims against it, are sold, provide a convenient place where anyone who possesses funds can buy a participation in the annual earnings of industry.

Third, stock exchanges act as channels for the flow of savings into different industries. In other words, they aid the financing of productive enterprises by the issuance and sale of new shares of stocks and bonds.

This brings us to the question of speculation. In the early days of stock markets, the sales and purchases of securities did not represent original financing, but the exercise of a right of private property — that is, the right to dispose of, or to acquire, assets. To people who were not disinclined to take risks, this gave an opportunity to stake funds on securities with the hope of making gains from the variation of price, distinguished from the earnings of the underlying property. Dealings undertaken with this motive are called speculation.

No one has ever seriously maintained that speculation is its own justification, or that it is the primary function of stock markets. To be sure, its benefits have been publicized, its necessity stoutly defended. And, in view of what has been said about the right of disposal of private property, speculation may even be considered inevitable. But that it is the primary justification for security markets no one has dared maintain. ‘The stock exchange’s prime function is to maintain a market after the distribution [of securities] has taken place,’ said the president of the New York Stock Exchange to a Senate committee, ‘or to affect distribution in the way of speculation, as has often occurred.’

III

How have these functions operated? Through the listing of new shares of securities on the stock exchanges and their slow distribution into the hands of ultimate investors, security markets have acted as a channel through which capital flows into industry. Naturally, the national well-being demands that the annual savings of the people shall flow into the most deserving industries; that the country shall get equal value of productivity for equal amounts of savings placed in different businesses. However, certain practices have been developed in stock exchanges which militate against the realization of such a desirable distribution of funds. Of these, two are particularly objectionable: first, the manipulation of a stock on the exchanges by the issuing corporation, its bankers, syndicates, or individuals interested in the sale of the stock: second, the dissemination of favorable false rumors and news items to attract the investing public. Both of these methods are deplorable because they cause the investor’s savings to flow into certain enterprises under false impressions of their merits. Society naturally loses in potential wealth by such misguidance of capital.

The operations of the Cities Service Securities Company from 1927 to 1929 illustrate how financing may be fostered by ignorance and illusion. The Cities Service Securities Company was incorporated in Delaware in April 1927, to take over from Henry L. Doherty & Co. the functions of Fiscal Agent which the latter performed for Cities Service Company. The Securities Company had no paid organization of its own; the staff of Henry L. Doherty & Co. did the work for it. Its chief function has been variously designated as ‘providing a ready resale market for securities,’ ‘facilitating the marketing of securities,’ ‘supervising the market,’ and ‘sole handling of the market’ for securities. A generic term for this function is ‘sponsoring,’ which was most actively performed during those periods when new original issues of securities of the Cities Service Company and its subsidiaries were being marketed by banking syndicates and distributing groups, or when preparation was being made for the issuance of such new shares. The Securities Company’s efforts might be described as an attempt to make the security in question attractive to the public by keeping up live activity on the Curb Exchange.

From April 1, 1927, to the end of the year the Securities Company, in the performance of its sponsorship, spent $45,851,000 in purchasing 936,104 shares of Cities Service Company common stock. During the same period it sold 938,910 shares for $45,880,759.38. The purchases amounted to 92.4 per cent of the total number of Cities Service common shares traded in on the New York Curb Exchange at this time, and they exceeded the number so traded in during four of the nine months. This could happen because a good many shares were bought or sold ‘over the counter,’ though such transactions outside the Curb Exchange did not exceed one sixth of the total. Again, during the nine months from January through September, in 1928, the Cities Service Securities Company purchased a total of 1,451,890 shares, which fell short of the total number of shares of this stock traded on the Curb Exchange by only 18,810 shares, or by less than 1.3 per cent. During the same period the Company sold a total of 1,869,254 shares, having thus succeeded in disposing of over four hundred thousand shares more than it purchased.

Thereafter the zeal of the Securities Company in ‘sponsoring’ Cities Service stock increased in tune with the speculative boom. In the eleven months from November 1, 1928, to October 5, 1929, the Doherty Management, operating as agents for Cities Service Securities Company, spent $389,248,248.77 in purchasing, mostly on the Curb Exchange, the equivalent of 12,071,692 no-par shares of Cities Service Company common stock (having split the stock four for one in April 1929). These purchases amounted to approximately 73.5 per cent of transactions in Cities Service common stock on the Curb Exchange; the figures, therefore, indicate increased public participation in buying. These twelve million shares of acquired stock and many millions more were concurrently sold during those eleven months. As a result the Cities Service Company was able to dispose of 5,763,850 additional shares of the new no-par stock.

Now the Cities Service Securities Company is a wholly owned subsidiary of Cities Service Company. Therefore its transactions in the latter’s common stock were in effect the same as if Cities Service Company operated in its own shares. This is objectionable enough. In addition, these activities were less in the nature of distributing new stock to investors through the Curb Exchange than in the nature of window dressing, to which the eight hundred odd securities salesmen of Henry L. Doherty & Co. could point as an assurance of the value of the stock. And who determined that value? Not investors, not speculators, but Cities Service Company itself, through its subsidiary. Such valuation of the stock on the exchange is not an expression of investors’ or speculators’ collective judgment as to the present and future promise of the Company; it expresses nothing more than the desire of the interested parties to obtain as much money as possible from the investors. Are they the best judges of the merits of their company in comparison with other avenues of investment?

To ask the question is to answer it. The advantages of free play in the supply of and the demand for savings, as a proper method of evaluation of present capital and future accretions, are atrophied by such machinations.¹

IV

Along with manipulation of markets, overexuberant publicity has been another factor which has distorted the judgment of innocent investors, and hence has caused wastage of savings. Such operations are perhaps best exemplified in the Indian Motorcycle Co. episode. In the latter part of 1929 the company was in financial difficulties. Then a broker and an independent speculator became interested in the stock. Until December 1929, the capital stock consisted of 100,000 shares. On December 19, 1929, the promoters agreed to take 40,000 new shares at $5.00 each. On December 26, these additional shares were listed on the New York Stock Exchange. Later 60,000 additional shares were so taken.

Then the systematic attack upon the gullibility of investors began with full force. The methods employed were twofold: creation of extraordinary activity in the stock on the Board, and paid publicity of fanciful facts whose deviation from the truth was a measure of the promoters’ zeal, though at this time the Company was on the verge of bankruptcy, and the promoter who floated the 100,000 shares knew it.

This, however, did not daunt the faith of the broker and the speculator. They paid approximately $26,000 to conduct a high-powered favorable news campaign in which quite a few daily news and financial journals, no doubt unwittingly, were used as channels through which Indian Motorcycle was effectively extolled. The promoters usually reprinted these news items and circularized their brokerage customers. ‘Orders 65 per cent ahead of business a year ago,’ ‘Indian Motorcycle outlook improved,’ ‘Good proposition for further substantial advance — these headlines indicate the tenor of the news they sponsored. They even used night letters in some instances, where the sales resistance of prospective purchasers of stock gave signs of yielding.

This publicity laid the foundation of their successful operations. But the pièce de résistance of the stunt came from London. From a well-known English motor manufacturer they purchased ‘an air motor which had never been developed, that was simply not even in the blue-print stage,’ though a patent had been taken on it. A story in the Daily Mail of London (February 1, 1930) — ‘British oil motor engine, fire risk banished, can transport safely and cheaply’ — was then photostated, reproduced in this country, and widely circularized.

The effectiveness of these methods can be j udged by the ‘ development ’ of the market. During the week ending January 4, 1930, there were 4700 shares of Indian traded in, at between $4.00 and $6.00 per share. The following week the stock went up to 7 1/2 a share, and 7800 shares changed hands. For the week ending February 22, the figures were 37,400 shares, 10 5/8 high, 8 7/8 low. In the next six days there was a flourish in Indian, with 130,300 shares traded between a high of 14 and a low of 9 1/2. The acme of Indian activity was reached during the six days to March 8, with 155,400 shares changing hands, and the price bobbing up and down between a high of 17 and a low of 9. From then on there was a slow but continuous falling off, both in activity and in price, until the week ending June 28, when 3100 shares were sold at around 5. (Facts taken from the New York Times.)

Thus in six months things settled back to the placid conditions from which they started. During the course of this sponsorship the promoters sold at a profit not only the original subscription of 40,000 shares, but 60,000 more. The results of these operations were: (1) the Indian Motorcycle Company obtained $500,000 of new capital; (2) the promoters made a profit through the boosting of the stock all out of line with current merit or future prospects; and (3) the investors were stuck with the securities, for later the company had to be reorganized.

The exploits of Cities Service Securities Co. and of Indian Motorcycle Co. are only two instances of the many which could be cited. The evidence shows that, on occasion, stock markets have acted defectively, and have been used to ill advantage in guiding the flow of capital. What reasonable economic justification is there for artificial market activity created by the sellers of securities and for all the paraphernalia of paid propaganda? One of the basic principles of contractual capitalism — conscious and deliberate choice — is satirized by such interested sponsorship of securities. The illusion of worth and riches so created becomes only a temporary lure to misguided cupidity. Through such illusion investors are led to voluntary coöperation in the misallocation of capital. And usually it is not long before the lustre wears away.

V

The facts which have been given here do not bolster the argument that stock exchanges are efficient channels of financing the country’s ever-expanding industry. A similar disappointment is experienced in viewing the theoretical principles and practical manifestations of speculation. Some of the claims made for speculation are obviously exaggerated. When it is proclaimed that the country owes its grandeur to speculation, — to the willingness to take risks and to make funds available for the development of industry, — it must be remembered that nothing of the sort happens if the speculation is concerned with an old, longoutstanding stock. In this case the money involved does not directly reach the industry whose stock is being dealt in. Industry obtains capital, not from speculators in old issues, but from buyers of new issues, whether they buy them for investment or for capital appreciation. In fact, dealing in old issues with the sole purpose of making capital gains from the rise or fall of prices may properly be called ‘pure’ speculation. And here the beneficial influence of the stock market is restricted to (a) evaluation of capital securities and the consequent establishment of a rate of return at which industry can procure additional capital in the future, (b) the adjustment of market value to ‘intrinsic value,’ whatever that may be, and (c) stabilization of security prices.

Without considering these derivative benefits in detail, one might raise some pertinent questions, the answers to which would probably show that our indulgence toward speculation in old securities is misplaced. In regard to evaluation of capital securities, why should not the demand of savers for investment securities be sufficient to bring about a proper price for capital stock?

In fact, it would seem desirable to confine the process of evaluation of capital and the determination of the acceptable rate of earnings to the real investors who provide the bulk of savings, and whose activities on the market, therefore, are really indicative of attempts at an adjustment of the supply of savings to the earnings of capital. As for the adjustment of market price to ‘intrinsic value,’ aside from the difficulty that no one knows what this term connotes, most speculators are not interested in it and not averse to deviating from it.

There is little need to disprove the assertion that speculation stabilizes market fluctuations. It is obviously not the speculators’ purpose to effect this, for speculators do their best to upset any balanced condition. Furthermore, the psychological reactions in the market are such that a price movement becomes cumulatively accentuated; margin trading, considered so essential to speculation, tends to assist this tendency, quickening the movement in one direction, and intensifying the inevitable reaction because of the process of ‘squeezing’ margin accounts. The recent regulations laid down to govern margin requirements are a recognition of this fact.

Though there is legitimate doubt as to the necessity and usefulness of speculation in old issues of stocks, the situation perhaps would not be so bad if speculators based their activities only upon prognostications of future trends of the market or of particular securities. It is only when their decisions are correct in better than 50 per cent of their commitments that they stand to make money. However, faced with the challenge of a changeable world, professional speculators have proved more modest about their faculty of judgment than the general public. By bringing about desired changes through the operations of pools and syndicates, or by getting inside information through collaboration with corporate officers before such news is made public, they have thus improved upon their ability to escape the laws of chance.

Such pools employ several different methods. First and foremost, they create excessive activity in a given security by concurrent purchases and sales, some of which have all the aspects and effects of wash sales. In the second place, they often take into the syndicate the specialists in the stock in which they are interested, who possess the so-called ‘specialist’s book’ which indicates the condition of demand and supply of that particular stock at prices above or below the then prevailing market quotations. And, finally, they often resort to organized and paid publicity over the radio or in the news columns of newspapers in order to convince the public that their stock is an unmistakably desirable one for investment. Thus they see to it that the market moves in the desired direction. To the extent that these conditions are true, whatever the merits of the theoretical arguments in defense of speculation, the rationalization remains absolutely unconvincing in face of the facts.

VI

The pool entitled ‘Radio Corporation of America Common Stock Syndicate,’ which operated in March 1929, illustrates clearly the type of speculative transactions which give the operators better than a 50 per cent chance of gain, based not on superior analytical faculty, but on power acquired by the use of methods not available to ordinary investors or outside speculators. On March 7, 1929, a circular, marked ‘Private and Confidential,’ was issued by a brokerage firm and sent to prospective participants who were then quite prominent in American business. The circular carried the signatures of two widely known speculators, who were designated as ‘syndicate managers.’ The stock exchange firm initiating the pool was the specialist in Radio stock. This means that the firm, or the partner actually on the floor of the exchange, possessed the specialist’s book. Therefore a member of the firm knew what the probable reaction would be, in view of the accumulated buy and sell orders above and below the market price, if a movement were started one way or the other. It is a rule of the New York Stock Exchange that the condition of the specialist’s book cannot be divulged, it being considered confidential information.

And here is the interesting fact. The managers of the Syndicate, the two professional speculators, did not do any actual managing. At the time the pool operated (March 12 to 19, 1929), one of them was in Florida and the other in Europe. This left the brokerage firm, who were the specialists in Radio, on the ground. One of the ‘managers’ later admitted that the senior partner in this firm actually ran the pool.

This syndicate bought (and sold) in the space of one week a total of approximately 1,493,400 shares of Radio common, or nearly 12 per cent of the then outstanding number of shares. From a low of 90 the day the pool began operations (Tuesday, March 12, 1929), the Radio stock was pushed up to a high of 109 3/4 on Saturday of that week. On Tuesday, March 19, the closing day of the pool, Radio common was back to a low of 95 and a high of 100 1/2. Four days later, March 23, its range was between 863/4 and 91 7/8. This programme in Radio netted its promoters $5,563,198.48.

The purchases and sales were concurrent. There were certain transactions between two of the participating brokerage houses which came perilously near to being pure wash sales in appearance; some of these sales were undoubtedly so in effect. The wives of the managers and participants appeared as independent traders dealing in Radio at the time of the pool operations, buying from and selling to the Syndicate. On March 12, the brokerage firm which was managing the pool sold 1000 shares of Radio at 92 7/8 from the Syndicate account to another brokerage firm which participated in the Syndicate. These shares were put in the name of the wife of the ‘manager’ who was then in Florida. Other shares were thus placed in her account. Later they were sold back to the Syndicate.

The ‘manager,’ back from Florida, had to explain some of his consort’s speculative manoeuvring. The following testimony before the Senate Committee on Banking and Currency is clouded in wording but clear in implication: —

Q. Now who handled your wife’s account and gave orders as to the buying and selling while you were in Florida?

A. Well, that trade might have been put through by a clerk in the office.

Q. Well, who gave that clerk in the office instructions?

A. I don’t know who gave those instructions.

Q. Well, who would? Who had the authority to?

A. A thousand shares — any clerk in the office there could have done that.

And continuing the same line of inquiry: —

Q. Your wife never gave any orders at all, did she?

A. No.

Q. She does n’t know what it’s all about, does she, except as she has learned it from you over the dinner table?

A. No; I did n’t talk about it.

Q. What?

A. No; I did n’t talk about it.

Q. No; I guess you did n’t. Then she knows less about it. . . . Who would give orders to buy a thousand shares of stock for Mrs. —?

A. They might have a thousand shares in the air and say, ‘Can you put this some place?’ And the clerk says ‘Yes.’

Q. What do you mean by ‘a thousand shares in the air’?

A. A thousand shares that they bought that somebody don’t own, or a thousand shares sold — I don’t know which it was — and they would say, ‘ Have you got some place to put it? ’ The clerk says ‘Yes.’ And put it in my wife’s name.

These transactions were not considered wash sales because a change of ownership was recorded in each instance — though this circumstance appears to have been of small consequence in that later the same shares reverted to the original owners. Wash sales are not allowed by the rules of the New York Stock Exchange, but only a metaphysician could distinguish any difference in effect between wash sales and such activities as that described in this testimony.

Though there was a mild flourish of publicity in financial papers during the period in which the Radio pool was active, the best examples of sponsorship through publicity are found in cases where the pools or syndicates were interested in corporations with a small number of shares outstanding, which for that reason were amenable to manipulation. There were certain professional publicity men to whom the pools could resort. These men employed their own financial news sheets, or they hired speakers to talk over the radio under misleading titles, such as that of president of some research bureau, or they bought the services of regular financial reporters in metropolitan newspapers to boost the stocks in which corporate officers or a group of men organized in a pool might be interested. These publicity men received for their services cash and/or calls on blocks of stock at certain prices which they could sell at higher prices after their zealous efforts in interesting the outside public became successful; and of course they pocketed the difference as profit. The Senate Committee investigations have revealed innumerable instances of such interested sponsorship.

Here is the way one such publicity man testified under oath before the Senate Committee on Banking and Currency: —

Q. So that the committee may understand the extent of your work, how many such operations would you have on hand at one particular time?

A. I had over thirty at one time. . . .

Q. And by whom would you be employed ?

A. Pool operators. . . .

Q. Also by individual traders?

A. Yes.

Q. And also by pool operators who were members of brokerage firms and were operating pools for their own houses at the time; is n’t that correct?

A. Yes, sir.

Such evidence shows that professional speculators use all possible methods to mould chance to their own purposes. Their flirtations with the future naturally leave the uninitiated suitors of fortune quite without hope.

VII

Besides attempting to create, through concerted action and publicity, the very changes that will make their commitments profitable, syndicates and pools obtain, whenever available, the cooperation of corporate officers and directors. Here is the testimony of a trader in a stock which was being manipulated by a syndicate: —

Q. At that time, your syndicate was being furnished with confidential information by [name of the president of a company] as to the earnings of the companies during the time your syndicate was operating, is that true?

A. That is true.

Q. From week to week?

A. That is true.

Q. In advance of the time the public got it?

A. That is true.

The cases are numerous where corporate officers and directors have taken advantage of their position, and of the confidential information that is available to them, in trading on stock exchanges to the detriment of outsiders. It has been revealed that officers of some of the most important corporations sold out their holdings early in 1930, only to buy them back again at lower prices; at the end of the transaction they emerged with as much stock as before, or more, plus a tidy cash profit reaching into millions, which represented t he difference between sale and repurchase prices.

Such sales are usually made under cover. One method of covering up such abandonment of a sinking ship by its captain — for that is what it amounts to — is the so-called ‘sale against the box.’ Here the officer, instead of delivering his own stock, has his broker borrow the stock and sell it. Later, though he has the stock available for delivery, he goes into the market and covers his technically short position at a lower price. Other methods by which oven the brokerage firms arc kept ignorant as to who is selling or buying arc to transfer shares in the name of dummies before delivery for sale, or to trade in the name of personal companies with all sorts of queer titles. These methods are used so that brokers and others ‘would not be influenced by what we were doing.’ Jonathan Swift’s outpouring at the time of t he South Sea Bubble describes this attitude of sauve qui pent: —

In connection with one instance, where it was revealed that the president of a corporation had made between seven and nine million dollars in 1930 by selling his holdings at the beginning of the year and buying them back during the latter part after the company had passed the dividends, Senator Couzens focused attention on a point which ought to be solid food for thought: —

SENATOR COUZENS: May I ask Mr. —— whether he thinks it is ethical for an officer of a large corporation like his, with such a large amount of outstanding stock, to trade back and forward in the stock of his own corporation?

MR. ——: I think personally that it is ethical and helpful.

SENATOR COUZENS: Helpful to what?

Mr. ——: I did not trade back and forth. It is ethical and helpful to buy and sell at different times. I don’t think it is ethical to trade back and forth, but buy and sell.

SENATOR COUZENS: Does not the record show that you bought and sold nearly every month?

MR. ——: No. We sold during the months of February, March, and the first part of the year [1930], and bought back the last part of the year.

CHAIRMAN (SENATOR NORBECK): You sold at 64 and bought back at 15. That is your testimony.

SENATOR COUZENS: Why certainly. Mr. —— seems to think that is all right, and I just want to get before this committee what are the ideals and the standards of some of these large corporation officeholders with respect to these matters. Mr. —— says under oath that he thinks that is a perfectly proper standard to buy and sell the stocks of his own corporation and affect the market, as was done in this case undoubtedly. And he also apparently thinks that that would be perfectly all right for any other officer or director of any other corporation in which he was a silent partner.

VIII

Senator Couzens strikes a note which is beginning to develop into a tragic theme. The lack of responsibility that has been revealed among a few men holding high positions in large public corporations threatens to arouse the popular ire to such an extent that it may upset the cart that has hitherto fetched golden apples. Social mistakes have a habit of striking back like a boomerang. And the intensity of the reactions is commensurate with the excesses of which they are born. One likes to think, however, that the cases of conscious wrongdoing which have interrupted the smooth workings of the machinery for distributing the capital of the country are examples not so much of greed and malice as of ignorance of the social importance of individual acts. One likes to think that it is unduly severe to believe what Hamlet expressed in a moment of dejection: ‘To be honest, as this world goes, is to be one man picked out of ten thousand.’ Usually, however, more harm is done by adhering to and defending wrong theories than by willful disregard of established rules.

It is a quality of vice and virtue, is it not, that their possessors are utterly oblivious of them? It is because of this that some capitalistic institutions have occasionally to be salvaged from the excessive zeal of their own active practitioners.

The foregoing discussion of stockmarket practices has been less concerned with the social implication of motives than with the economic effects of given activities. Instead of presenting a doleful tale of individual defections, the theories and facts relative to stock-exchange practices have been considered. My conclusions will naturally be challenged, for ‘’t is with our judgments as our watches, — none go just alike, yet each believes his own.’

What remedies are there for the imperfect workings of the security exchanges? Whether such objectionable practices in the flotation of original issues of stock as this paper has touched upon will be repeated in the future will depend on how effectively the Securities Act of 1933 is applied. In Section 4 of the Act certain transactions are exempted from its application. Among these are: ‘(1) Transactions by any person other than an issuer, underwriter, or dealer. . . . Transactions by a dealer (including an underwriter no longer acting as an underwriter in respect of the security involved in the transaction), except transactions within a year after the last date upon which the security was bona fide offered to the public by the issuer or by or through an underwriter . . . and except transactions as to securities constituting the whole or a part of an unsold allotment to or subscription by such dealer as a participant in the distribution of such securities by the issuer or by or through an underwriter. (2) Brokers’ transactions, executed upon customers’ orders on any exchange or in the open or counter market, but not the solicitation of such orders.’

Juridic interpretation of the law will determine whether the exceptions to exempted transactions as cited above will be sufficient to safeguard the public against manipulation of security prices and exaggerated publicity, particularly such publicity as is given in the form of news rather than in advertisements. The success of regulation under this Act will depend in great measure on the strictness of the legal definitions of such terms as ‘transactions,’ ‘dealer,’ ‘unsold allotment,’ ‘solicitation.’ This section of the Act, as well as others, makes it abundantly possible for the intent of the law to be evaded, but the legal profession possesses sufficient resourcefulness not to need any prompting in these pages.

Speculation by corporate officers in their own securities is difficult to correct. The right to acquire and to dispose of property cannot be denied to any group of individuals just because they hold corporate positions. It is not the mere exercise of this right, but the motives and circumstances under which it takes place, that often prove detrimental to the unsuspecting public. Publicity of holdings and of transactions by officers and directors in the securities of companies with which they are connected is really the only possible solution of the problem. This, however, is subject to two grave limitations. The first is the abhorrence of publicity with regard to personal matters which is a part of the social tradition in America. But wherever there is a private motive to hide there may be a public necessity to disclose. The second difficulty is more important; namely, the impossibility of defining a personality clearly enough to apply the law without possibility of evasion. If publicity is required of the dealings of officers, what of the speculative proclivities of their consorts, or of some other relations or dummy corporations in whose name the officers or directors may do business?

The activities of pools and syndicates are somewhat easier to deal with. The questionable elements in pool operations consist of their sponsorship by brokerage houses, the participation of corporate officers, the employment of specialists and of publicity men, and the excessive trading back and forth with the intention of affecting the price of the stock in a given direction. The New York Stock Exchange has the authority, if it wishes to exercise it, to prevent brokerage houses and specialists from participating in pool operations. In certain rulings the Exchange promulgated early last August, generally considered so drastic, it only called for information about pools. What it plans to do with the information remains to be seen. But it must be realized that the exchanges cannot prevent outsiders from organizing a pool for the purpose of manipulating security prices.

A heavy tax upon capital gains made on quick turnover may be the best solution. This sort of tax is different from the one Senator Glass advocates. He would put a higher tax per share on sales of stock within a short period after purchase. A tax on capital gains resulting from quick turnover, as advocated here, would be levied only in case of gain, and would eliminate the motive of frenzied speculation without harming the real investor who may suddenly decide, after his purchase, that it would be better for him to sell and shift to some other security. Such investors would be able to reclaim their capital. And the raison d’être of pools which manipulate stocks would disappear.

In this way violent variations in price might be prevented. And the value of securities would come to represent more nearly the result of the impact of investors’ savings on the sources of income — stocks and bonds. Furthermore, it would be unnecessary to attack the difficult problem of margin trading, since most of the urge would be removed by such a tax. The history of the regulation of margin trading does not lend encouragement to those who advocate a repetition of it. In 1697, in the reign of William III, an act was passed ‘to restrain the number and ill practices of brokers and stock-jobbers,’ which, among other things, declared all contracts in joint stock and exchequer tallies to be void which were not to be concluded within three days. This act expired by limitation in ten years and was repealed in 1867. Again, in 1733, under George II, another law, known as Sir John Bernard’s Act, was passed ‘to prevent the infamous practice of stock-jobbing.’ This law declared void and illegal short selling and margin trading. It remained on the statute books 127 years, until it was repealed in 1860. But it was virtually a dead letter from the beginning.

‘Sir John Bernard’s Act was evaded in this way,’ said a witness before the Royal Commission investigating the London Stock Exchange (1877): ‘The Stock Exchange practically said to a candidate for membership, “We will admit you to our institution provided you subscribe to our bargains entered upon here, the law of the land to the contrary notwithstanding.”’ Thus the unwillingness of the London Stock Exchange to abide by the law, and the absence of adequate machinery of enforcement, made the act ineffective. Even though similar handicaps might not be present to-day, there is one difficulty which the law cannot solve: it cannot effectively prevent people from borrowing on collateral of securities and turning around to use the proceeds for further speculative purchases of stocks, the Banking Act of 1933 notwithstanding. So perhaps the wisest course is to eliminate, as proposed here, the motive for excessive speculation, pool operat ions, and margin trading by making it difficult to make capital gains on quick turnover — say, within two or three months.

IX

This brief and imperfect study cannot be concluded without some reference to the speculative proclivities of the human animal. No matter what Congress does, it cannot prevent people from chasing rainbows. The desire to obtain wealth without producing it in some way is not only unsocial: it is as chimerical as perpetual motion. Obviously, everybody cannot emerge successfully from the scramble, yet each speculator, down to the smallest plunger, leads himself on with the hope that he will be luckier than the next fellow.

That stock exchanges are not royal roads to riches is implicit in the nature of speculative profits. Such capital gains, when realized, are chiseled out of the annual increment of savings that flow into the security markets. The source of speculative profits is therefore limited, and available only to the initiated few. Stocks represent future wealth, productive machinery that is used in manufacturing to produce goods. (Holding-company securities do so, if at all, derivatively.) The value of annual production is only a fraction of this industrial capital, and annual savings are a smaller part still. The attempt on the part of every holder of stocks to convert them into cash, or liquid capital, at some high price in order to realize capital gains is tantamount to attempting to convert the value of industrial wealth into presently available goods. It cannot be done. You cannot sell the accumulated labor of the past, embodied in industrial capital, or the promise of future consumable goods, represented by the same capital, for present liquid purchasing power or savings, which at best are equivalent only to a fraction of it.

So in the nature of the case the greater part of any appreciation in price is destined to remain a paper profit, and hence unrealizable. Some people, shrewder or in better command of the situation than others, take the jump on the rest, impinging upon the fund of savings. In view of these conditions, is it not quixotic for the uninitiated to match wits with the weird ways of ‘legitimate’ speculation? The speculatively inclined public might well remember the predicament of an old Galician soldier who, fighting in the War of Granada, received a wound in the head with an arrow. The surgeon said upon examination, ‘You are a dead man; the arrow has pierced your brain.’ The Galician said, ‘Look again, for that is impossible.’ The surgeon replied, ‘It is so; I see it plain.’ ‘It cannot be,’ said the Galician, ‘for if I had any brain I should not have been here.’