primarily more in the source of that business than he is in the ultimate individual investor with whom he usually has very little if any contact. Mr. MAPES. May I ask a question?

Mr. PRESCOTT. Yes, sir.

Mr. MAPES. What do you mean by source of business?

Mr. PRESCOTT. What I meant by that allusion was the source of opportunities to get securities issued, moving from the people desiring the money and not the people supplying it. That was the thought I had in mind.

Now, the ordinary mode of operation in a case of that kind is for the big banker in the central city to consider the merits of the proposition from his standpoint, and having decided to carry on the financial operation, to sponsor it. He goes through the process of having it underwritten. That means, as you all know, an agreement to buy the securities or see that they are bought, if the public does not take them when they are offered to the public. That is a distinct and valuable function in these large operations, and often is in the small ones, as I will point out later; but those underwriters ordinarily do not distribute the securities direct to the investing public. They invite houses out in the smaller centers to participate sometimes in the underwriting, but usually in the distribution for which they pay them a commission.

The small distributing house in the local center has close personal contact with the ultimate investors and that is why that distributing house is valuable to the underwriting house. It can sell the securities direct to the investors, which the underwriters often cannot.

I point out this factor of remote or indirect contact between the large originating houses, which, of course, are largely in the public eye because of the magnitude of their operations, because I think it is very important and very essential to consider in trying to find the solution to the problem at which this bill is aimed.

I want to call attention to another thing, another striking difference in the financing in the central market, or central markets, from that in the local markets, and that is that the commercial banking element sometimes plays a part in the large centers.

I am not alluding to inerlocking relationships in this particular case. Up to very recently, prior to the time the recent banking act was passed, it was possible and customary for a large banking house in a big center not only to do financing, that is to raise capital for their clients, but also to have commercial banking relationships with them. That did many times afford an opportunity for profits and possibility for conflicts of interest, such as does not occur in the smaller centers in the mere distribution of securities.

That difficulty has I think, now practically disappeared because of the passage of the banking act by which banking organizations carrying on a commercial banking business are not permitted to underwrite corporate securities; but it was a very important factor up to very recently.

I mention that because in the investigations that have been made by the Commission, so far as I have seen them in their reports, and had an opportunity to examine them, very largely deal with situations where that element was involved.

The financing was done long ago before that banking situation was changed. Such conflicts probably could not occur to the same extent,

at least, in the future. There is little opportunity for such conflicts, certainly less opportunity than there was formerly.

There are, of course, in these large centers certain smaller houses that may participate modestly in underwritings with the larger houses they often do where the underwriting is very large, but they are mainly interested in distributing to their local customers.

That interest enters into the situation in the larger centers, but it is almost exclusive in the smaller centers relating to large issues.

Now, I want to return to the distinctions and call your attention to the difference between the situation that I have attempted to describe in the larger centers and the situation in the smaller centers where most of the actual, ultimate investors live or through which they are generally served. There, operations fall into a number of different classifications. I will refer first to the participation by local houses in the large offerings which originate in the big centers. Many local, widely scattered houses formerly used to be invited to participate quite extensively in the underwriting of large issues. That is not so common now, though it does frequently occur. It is more frequently the practice since the depression for the large originating houses in the big centers to invite the local houses to merely participate in the distribution of securities for a commission without undertaking an underwriting liability. In either case the local investment banker is largely dependent for his information and his facts upon the central house of origination. If he decides to participate in either way he must depend more upon his confidence in the large house of origination and their thoroughness and dependability in investigations than upon his own ability to make original investigation, because as a rule he has no contact and no influence with the issuer. tainly he has no opportunity to dominate the issuer or to influence him to any extent. He is too small a factor. He is a mere tadpole in the puddle.

Cer

That brings me down to another classification which I think is particularly interesting from the standpoint of the investor himself and that is local financing.

You know, of course, big industries do not spring up immediately. They are the result of gradual growth and combinations or acquisitions; or perhaps in some cases just natural growth. Most of them have a small beginning and they very often begin in smaller financial centers or their neighborhoods, and they naturally go to their neighbors and friends for capital when they need it.

This gives rise to a class of operations in which the local investment banker takes a leading part. This often involves underwriting. That is, he practically buys the issue and then resells it to his customers. Sometimes he takes associates and partners, if the underwriting, he feels, is too large for him to assume alone, though he often does assume it alone; but the distribution of such liabilities is usually local or else confined to similar centers, of similar size and financial importance.

So, because it is not large enough it usually does not get into the big banking centers at all and thus become subject to the play of such conflicting interests as may exist there. The originating house in the local community where the security is issued knows the industry it is financing intimately. Its investing clientele usually eventually also knows it quite intimately, even though the first time financing

is done there may be a very long educational process necessary in order to make the public familiar with it.

The local investor in my experience is not inclined to jump at conclusions. He is usually pretty careful with his money. He has saved it at personal sacrifice. Sometimes he might have inherited it, but in the great number of cases with small investors, he has accumulated it by saving and naturally he does not want to lose it. And, he wants to know all about the enterprise in which he is invited to put his money; not only reads the circular, but he goes in and talks with his investment banker. He becomes very familiar with it. That results in very close contact between the local investment banker and his customer, the ultimate investor.

There is not in some of these outlying smaller centers any great amount of what we call institutional business. In Kansas City, where I live, there is comparatively little of it. For instance, life insurance companies in the State of Missouri cannot buy a corporate bond unless it has been outstanding 5 years, on the theory that it has not become seasoned. It does not matter how long the enterprise has been in existence or how successful it has been, the law prohibits the insurance companies buying that class of securities. So they are not particularly involved or interested in the original distribution of securities. Banks, of course, are now limited under the present banking laws, so that many of them cannot buy or will not buy because of the element of market liquidity or ability to realize quickly on their investment; but the big point, and the point I wish to emphasize right here more than anything is the intimate relationship and acquaintance and interdependence of the local investment banker and his customer, the ultimate investor.

We know in our business after all of these years of experience that we could not survive and could not continue unless we were fortunate enough to enjoy the confidence of the investing public. We know we know we cannot make many serious mistakes and continue to enjoy that confidence. That is a very real consideration.

I have heard it argued recently that investment bankers place too much emphasis upon their moral obligation to their customer. I do not agree with that argument. All of us meet our customers on the street, in church, in clubs and in social activities, and must feel that obligation very keenly. Certainly it is unpleasant to socially mingle with people who feel sore at us because we have caused them to lose money.

It is a very vital and very important consideration and the good will of his customers is the most important and most vital asset that the local investment banker can have.

The sense of moral obligation may not be quite so keenly felt by the big underwriter in the big center, because he deals almost exclusively with other investment bankers or large institutional investors, both of which usually maintain trained organizations and are pretty well qualified to judge of investment securities. The underwriter probably, and quite naturally, feels that those to whom he sells should assume some of the responsibility because of their ability to exercise informed judgment. Therefore, it may not be quite the same in large and small centers. But aside from all question of the force of the sense of moral obligation; which some consider intangible, but which I do not, there must almost always exist as a powerful moving consideration

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a sense of the importance of a sound business policy calculated to keep the confidence and goodwill of our customers lest we ultimately be forced out of business by the lack of it.

Another peculiarity in local markets is that in original financing operations in local communities, of our local industries, our industries are in the same regional area in which we live. The issues are not large. They do not have wide distribution. In our own company's experience, the smallest issue I think we ever handled was $250,000. That is in recent years. Our largest was only $3,500,000. The average distribution to customers, individual customers, was from $2,000 to $2,500. The individual holding was not large in any case, and was not of a size to have commanding influence. Also the wide distribution in small units indicates the inability of the investor to protect himself without some one to consult with and some one to represent him and to organize the cooperative forces when trouble comes.

Another thing, the investor himself, as I perhaps have indicated before, becomes very familiar with the business enterprise in which he invests, first, because it is near enough to him so that he can know it, and even if he has only $2,000 or $2,500 involved, it may be a very appreciable part of his entire investment fund and he is going to look very carefully and keep posted on that sort of a thing, often much more than a large investor in the large center who has a very much larger sum involved. It is much more vital to him.

CONFLICTS OF INTEREST

A great deal of the discussion I have heard has been about conflict of interests. In some of the cases which have been included in the reports of the Commission, which I have seen, of their investigations, there was apparently conflict of interests, from which certain assumptions were made, probably, to some extent at least justifiable, if not entirely so; but certainly to some extent they were. But, in my experience in our local market and in other similar markets-and I have a fairly wide acquaintance with those similar markets conflicts of that kind scarcely ever occur. In the first place we do not perform the commercial banking functions. We cannot do it under the laws of most of the western or Mississippi Valley States. We are forbidden by law to carry on commercial banking operations unless we incorporate under the banking laws and are supervised by the various State authorities, or Federal authorities.

Another thing that leads to lack of conflict is the fact that most houses are in one of two classifications. Either they are bond houses or they are stock houses. It happens that it does not very often pay to be in both, because the class of investors who buy bonds is very different from the class who go into equities in the hope of increase in values rather than mere income.

So it does not often or frequently occur at least it has not with us-that we have been called upon to represent the holders of more than one class of securities and we naturally interest ourselves in seeing that our investor should come out as well as possible with those securities because we sold them to him and he will hold us responsible, morally, if not legally.

Stock securities are handled by a distinct type of people, who buy them not on the basis of investment, definite income, as a rule-and

I refer now more particularly to the common stock issues-but for the opportunity for increase in value; by the people who are not satisfied with ordinary interest or dividend returns and are willing to take an additional risk in order to realize greater profits.

DOMINATION BY UNDERWRITERS

In our relationship with issuing houses in these communities there is no such thing, to my knowledge, as domination of the issuing house when the business is prosperous and scarcely ever in the event of reorganization..

I know of no case in which our house has had an interest in the equities which enabled us to dominate. Usually we have no equity at all. We are a bond house, or I should modify that to the extent of saying we handle senior securities, sometimes prefered stock; almost never common stocks. We do not wish to divide our allegiance and for the reason of self preservation we do not wish to be placed in a position of having conflicting interests. I know of no case where we have ever been placed in that position in the event of a liquidation or reorganization.

Now, the suggestion I have to make in reference to all that, that I have just said is

Mr. BULWINKLE. Mr. Prescott, just a minute, if you please.

Mr. PRESCOTT. Yes, Mr. Bulwinkle.

Mr. BULWINKLE. Since October, 1929, how many times has your house participated in reorganizations?

Mr. PRESCOTT. Well, I could not give you the exact number; but I should say probably 15 of our own. That is, I mean, where we have to take the leadership.

Mr. BULWINKLE. Were there any where there was over $2,000,000 in reorganization?

Mr. PRESCOTT. Not in the form of a reorganization. The largest one that we had was a readjustment, and that amounted to slightly less than $2,000,000.

Mr. BULWINKLE. All right.

The CHAIRMAN. Mr. Prescott, in those cases that you have, what were the general causes that required reorganization?

Mr. PRESCOTT. In almost every case, Mr. Lea, the troubles were due to the conditions of the times.

The CHAIRMAN. Due to what?

Mr. PRESCOTT. Conditions of the times; the depression, in other words. There was no case in reorganization that was due to mismanagement or diversion of funds, or anything of that kind. It was simply a case of recasting the capital structure on such a basis that the business could be carried on with sufficient operating capital to make it successful.

The CHAIRMAN. Trying to get it out of the red into the black?

Mr. PRESCOTT. Trying to get it out of the red into the black. That was the purpose of it, and to preserve it, and of course, the interest of the people to whom we had sold securities was paramount from our point of view in doint that.

The CHAIRMAN. I presume a great many of those cases never went into bankruptcy.