THE WAY OF THE STOCK

EXCHANGE

HE testimony of a few members of the New York Stock Exchange before the Pujo Committee at Washington presents again to the public mind the palpable fact that the New York Stock Exchange needs regulation and needs it badly. This evidence also, in some of its details, reveals clearly the small and narrow policies and views under which the Governing Committee of that Exchange carries on its operations.

The New York Stock Exchange is a sort of club that is permitted, by a loose public assent, to be the one great market in this country in which all men may deal in certain stocks and bonds which are listed on that Exchange. It is a great business institution whose transactions run up to a total of $19,600,000,000 in stocks and $800,000,000 in bonds a year. Still it has never been deemed necessary, and probably is not necessary, to regulate its operations and to amend its rules by law. The members of the Stock Exchange are permitted to carry on this great business under rules which they themselves set up. In any such position, there is a clear and distinct understanding between the Nation at large and this group of one thousand men that the business will be so conducted as not to become a public nuisance, a public menace, or a public disgrace. Though the statute law takes no heed of the operations of the Stock Exchange, the people of the Nation are prepared to insist that moral law shall hold upon the floor of the Stock Exchange as well as in every other place in this country.

Therefore, it is shocking to the moral sense of the people as well as to the common sense of men who fully understand what the Stock Exchange is doing, that at man of the standing of Mr. F. K. Sturgis, formerly a president of the Stock Exchange and a member of its committees for more than forty years, should be led to remark in reply to an inquiry before the Pujo Committee:

"I approve of transactions that pay their proper commission and that are properly transacted. You are asking me

a moral question, and I am giving you a Stock Exchange answer."

If that statement means anything at all, it means that the Stock Exchange undertakes to exempt itself not only from the operations of statute laws and from the obligations of an ordinary corporation organized under the law, but also from the operations of the ordinary unwritten moral laws that are supposed to govern business transactions in civilized countries, whether these transactions are carried on on the floor of the Exchange, or elsewhere.

In a broad way, the most severe indictment that has been published against the Stock Exchange is contained in the two sentences quoted above. If there is a difference between the business morals under which the gentlemen of the Exchange operate and the business morals under which other business men operate, that difference must be wiped out, or the people of the United States will wipe out the Stock Exchange itself in the course of time, just as any other long-standing offence to the moral sense of the people is certain, eventually, to be wiped out.

II

If this hearing has been productive of one or two general indictments of Stock Exchange methods and morals, it has also been productive of some more concrete definitions and illustrations of evils which have long been known to exist on the Exchange and in most of our other security markets, and which have also long been known to demand remedies.

The evidence of Mr. Sturgis, and more particularly of Mr. Harry Content, himself a past master of speculative business, and of Mr. Lewisohn, who was apparently fresh from a striking campaign in a newly listed stock, does not leave a good taste in the mouth. In fact, the answers of the Stock Exchange witnesses would give almost any outsider the impression that manipulation of stocks up or down, the employment of crossed orders on the Exchange (orders in which one interest arranges to buy and sell the same security merely to establish a price), and a tremendous amount of personal gambling on the rise and fall of prices, are

commonplace incidents in the ordinary business of the Wall Street market.

Wall Street men know that that impression is exaggerated. It is true that a very large part of the daily transactions represent practically pure gambling, that orders are put in the market by large operators for the specific purpose of changing prices up or down expressly to make profits out of less fortunate traders. That fact came out quite clearly in the evidence of several of these witnesses and does not seem to have been controverted by any It is accepted by all students of finance as an established fact.

one.

To the man who understands the market even a little, the old question about the morals of selling stock which one does not own is not a particularly interesting question. It is in the same category as buying on a margin, in hope of a rise. If a man is going to trade in stocks for profit, he generally has to learn to trade on the short side of the market as well as on the long side of it, or he will ultimately leave in the market whatever he puts into it. If trading can be justified at all, however, under the rules of common sense, trading on the short side must be justified along with trading on the long side. A logical man finds it very difficult to distinguish the moral difference between trading for a profit on the rise and trading for a profit on the decline.

III

On the whole, there is apparently nothing new in the so-called revelations of Stock Exchange methods. There is, however, the fact that apparently hardly a single thing has been done by the Stock Exchange itself to curtail or eliminate those abuses and errors in the administration of this great public market place which were made quite clear in the report of the Hughes Committee some years ago and which are, as a matter of fact, very well understood by all business men who have even superficially examined or studied the business of the Stock Exchange.

One phase, which will probably be much discussed in the country as time goes on, is the answer to the question where the speculative markets of Wall Street get

the money which is necessary to finance the tremendous operations of the market. Single brokers, testifying in Washington, declared that they lent anywhere from $5,000,000 to $25,000,000 a day on the floor of the Stock Exchange, these sums of money being supplied, as a rule, by the large banking institutions of New York and by three or four private banking houses which carry large deposits for their customers. It was also made evident that a substantial part of this lending is with the money of banks away from New York which dispatch their surplus funds to the New York market at a time when interest rates in Wall Street are high or when they themselves have nothing to do with their money at home.

It is an open question whether it is a good thing or a bad thing to have an open market where there is a constant demand for money and where such money can be lent safely, that is, on good collateral which can be turned over quickly in case of necessity. There is a good deal to be said on both sides of this question.

Probably the fact of most public interest is that funds of the people as represented not only by the deposits in the five or six big financial banks of New York but also by the deposits of small country banks which lend in New York are regularly and systematically used to finance the speculation in Wall Street as well as the legitimate commercial and financial demands of Wall Street.

To those of the public who did not know this to be a fact, it will come as somewhat of a shock; and to those who knew it in a general way, the details of such lending will afford, as time goes on, a more definite basis upon which to judge whether this condition of our banking system is beneficial or detrimental to the whole country.

It is probably from this point of view that the testimony taken before the Pujo Committee will prove valuable.

IV

The Committee's investigation has uncovered some of the abuses of Wall Street and has touched very lightly indeed upon the manifest benefits of an open market. No attempt seems to be made by anybody

to bring out the fact, for instance, that more than half a billion dollars of new capital has been raised in the Wall Street market during the last year or so for industrial companies in all corners of the United States, which would have found it extremely difficult, if not impossible, to raise that amount in any other way.

The New York Stock Exchange is, of course, on trial. It has done nothing as yet to justify itself, to explain away the abuse of its privileges through manipulation and open gambling, or to point out to the public that it does perform certain relatively useful and constructive functions. Perhaps in the course of time some man may be found in the New York Stock Exchange who has both brains and character enough to come before the public and tell the truth with a fair chance of being heard and listened to attentively. In the meantime the conviction is gaining

ground not only throughout the country, but even more strongly in the minds of those who study these matters carefully, that the present Board of Governors of the New York Stock Exchange do not even grasp their own economic function with sufficient clearness to explain it to the public or to understand its limitations and its scope.

Therefore, there seems to be firm ground for the belief that the New York Stock Exchange will not regenerate itself, justify its continuance on the present basis, nor be able to attract again within its walls. the general investment and securities business of the country which is being done more and more outside of the walls until its present administrative forces are discarded, and in their place a broader atmosphere is found within its walls to take up the task of regenerating its practices.

T

HE negotiations began last summer. They were carried on, on the one side, by two large operators in oil and oil lands in Mexico and California. These gentlemen had something to sell. At the other end of the transaction was an old and well established banking firm with an excellent reputation, Messrs. William Salomon & Co., of New York. They wanted something to sell. The oil men wanted $10,000,000 in cash; and the bankers wanted to supply this cash for a substantial consideration.

So they got together. They agreed that the bankers should supply about $10,000,000 in cash and should receive in return $10,000,000 of preferred stock of a California oil company, and $10,000,000 of a total of $15,000,000 of common stock. This left the Western gentlemen $5,000,000 of common stock and supplied them with $10,000,000 cash.

Thus we find a single banking house holding $20,000,000 of securities for which it paid about $10,000,000. A banking

house does not buy securities for investment. It buys them to sell again, and the best way to sell them is the easiest way, provided it yields enough profit. Therefore, this house began by taking in two other firms, both members of the Stock Exchange and both houses of good standing: Lewisohn Brothers and Hallgarten & Co. Apparently these two houses were taken in on equal terms just as though they had participated in the original purchase. This was done to give larger power in selling the securities to syndicates and to the public and not through any feeling of philanthropy toward them.

The next step, of course, was to organize syndicates. Apparently there were two of these, one to dispose of some of the stock in Europe and the other to dispose of the remainder of it in the United States. Of course, these syndicates did not get the stock at the original price. Each syndicate subscribed for $5,000,000 of the preferred stock at about 90 and for $2,500,000 of the common stock at 40. Thus we see that when these syndicates had completed

paid

their subscriptions they had $11,000,000 in cash to the three banking firms and had received in return $10,000,000 of preferred stock and $5,000,000 of common stock, thus leaving $5,000,000 of common stock still in the hands of the three banking firms.

Thus the three bankers had made, up to this point, a profit of $1,000,000 cash plus $5,000,000 of common stock on the original investment of $10,000,000 in two months, less, of course, certain expense of carrying on negotiations, etc.

Now these syndicates, naturally, were composed of people most of whom were friends or business associates of the three banking firms. Moreover, when the syndicates were formed it was agreed that the banking firms should go to work and sell the stock for the syndicate members at a profit, if that were possible. Here, then, was the task that faced these gentlemen in the early fall of 1912, namely: to get rid of $10,000,000 preferred stock of the oil company and $5,000,000 of the common stock for the two syndicates and also to get rid of their own $5,000,000 common or such part of it as they wanted to sell at the best prices they could get.

Naturally the only way this could be done reasonably was to get the great outside public interested in this stock, work up enthusiasm over it, and invite the people to come in and take it away. The first step in such a progress was entirely obvious and legitimate. The bankers caused to be prepared certain prospectuses, reports, and descriptions of the properties which described them in glowing terms and painted their prospects in bright colors. No evidence has been produced to show that these pictures were overdrawn and it is not at all improbable that all the promises made or implied in these descriptions will be fulfilled. This brief chronicle of a Stock Exchange episode is in no sense a criticism of this western petroleum company or an intimation that it is anything but a good, substantial corporation. The writer knows nothing about it except what he has read in the prospectuses, etc., and he learned many years ago that he does not "know" anything that he reads in such prospectuses.

This being done, the next step was to take the stock into the Curb market in New York so that the public, if they felt so inclined, might embrace it and take it away. Now a stock in the Curb market may be a very shy and retiring stock, seldom heard of and rarely traded in, or it may be a very active and boisterous stock, making more noise than any other issue in the market. Naturally it was ordained that this oil stock should be of the latter class. rather than of the former. Otherwise, how could the public know that it was in the open market?

To Messrs. Lewisohn Brothers seems to have been allotted the task of making the new stock dance with exhilaration on the Curb. They succeeded very well. Apparently the stock became a prime favorite, not only with speculative houses that like to take a "flyer" in anything that looks active, but also with the public, more or less; with the result that the price advanced remarkably.

In the meantime, of course, selling was going on from all three houses privately, the prices being about the prices quoted on the Curb and showing handsome profits to the bankers. This is the quiet and unostentatious but extremely successful method of gathering profit known technically as "inside distribution." It means that the customers and clients of the banker are invited to buy and do buy on the solicitation of the banking house.

About the first of October a broader field was sought, and the stock was listed on the New York Stock Exchange. Lewisohn Brothers, having been successful on the Curb, continued to handle the stock on the Exchange, coöperating, of course, with the other houses.

Marvelous to relate, transactions in this hitherto almost unknown stock amounted in the month of October to about $35,000,000, or two and one half times the entire common stock issue of the company. Mr. Lewisohn has testified that a good part of this remarkable activity was due to public enthusiasm, but one of his clerks added some details concerning the very large transactions carried on in the stock by the bankers themselves. There are no figures to represent the proportion

of that $35,000,000 which represented public transactions and the proportion that represented "rigging" the market.

At any rate, the price shot upward to more than $70 a share. Then it began to tumble slowly downward. In December the directors declared a dividend; but the price still crumbled. Then the Pujo Committee in Washington put Mr. Lewisohn on the stand and read this story into the public records. The next day the stock touched 50.

Thus, it appears that within three or four months the bankers-aided by the great natural excitement of the people, and abetted by the complacency of the New York Stock Exchange governors, and helped by the banks of New York which accepted this stock as collateral got rid of most if not all of that $5,000,000 of common stock which they themselves held as a profit, and also managed to let go of the stock held by the syndicate. History does not record what the western oil operators did with their $5,000,000 of stock. That was a private matter and nobody's business.

Perhaps, then, the public now owns a large amount of this western oil stock which it bought at an average of $60 a share. If it does not, that is not the fault of the bankers. They have done the best they could.

The outcome of this little affair remains, of course, for solution in the future. There is no legitimate reason to suspect that the stock has no value or is of doubtful value. The one dividend which has been declared seems to have been fairly earned, and if the oil trade continues good this dividend may become permanent or may grow larger as time goes on. Possibly the owners of this stock in the future will be glad enough to own it. There seems to be little here akin to the ordinary "get-rich-quick" game with which all the world is now familiar. On the other hand, of course, everybody knows that an oil stock is primarily a gambling security, and this one is no exception.

This story is told here in some detail because it illustrates most of the methods to which the public is exposed in its dealings in speculative stocks in the open mar

ket. Almost identical methods were used in the original flotations of United States Steel, Amalgamated Copper, and dozens of other similar stocks, some of which have justified their original prices and some of which have not. It may be suspected that a good part of the skill with which Mr. Samuel Untermyer cross-examined Mr. Lewisohn was based upon the fact that Mr. Untermyer himself was originally counsel for the Amalgamated and was trying to analyze a process which he knew by heart. Those who live within range of the markets know that this sort of manipulation and exploitation goes on continuously, in almost all kinds of active stocks, and under almost every kind of circumstances. We have seen dozens of such campaigns that have succeeded and dozens that have failed.

This fact, which sounds somewhat grim and sardonic as one writes it in plain English, is the underlying fact in a widespread agitation for a cleaner Stock Exchange and a more honest marketplace. Since all the world knows to-day the methods of manipulation and exploitation and the diverse and devious ways by which such master craftsmen as Mr. D. G. Reid, Mr. James R. Keene, and the late H. H. Rogers, and others of their kind coaxed the public into buying their fancy flotations in Steel, Copper, or American Can, the public has come to the conclusion that the speculative market is trying to fool all the people all the time and that it is about time to call a halt.

That is the main hope of the investment market. For that reason more than for any other the little people who have saved up a few hundred or a few thousand dollars and do not want to lose it are turning more and more to the safety and security of legitimate investment bonds and stocks that do not need to be crammed down the throats of the public under high pressure and at a fancy profit. By the time enough of the public has learned its lesson we shall have in this country an act similar to the Companies Act of Great Britain, which makes it necessary for a promoter to let the public know what profits he is making in the promotion ventures in which he seeks public interest.